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EX-32.2 - EXHIBIT 32.2 - BANK MUTUAL CORPv444796_ex32-2.htm
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EX-31.2 - EXHIBIT 31.2 - BANK MUTUAL CORPv444796_ex31-2.htm
EX-31.1 - EXHIBIT 31.1 - BANK MUTUAL CORPv444796_ex31-1.htm

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

xQuarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the quarterly period ended June 30, 2016

 

OR

 

¨Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

Commission File Number: 001-36528

 

BANK MUTUAL CORPORATION

(Exact name of registrant as specified in its charter)

 

Wisconsin   39-2004336
(State or other jurisdiction of   (IRS Employer Identification No.)
incorporation or organization)    

 

4949 West Brown Deer Road
Milwaukee, Wisconsin  53223
(414) 354-1500
(Address, including Zip Code, and telephone number,
including area code, of registrant’s principal executive offices)

 

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, 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 website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) 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 the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer   ¨  Accelerated filer x    
Non-accelerated filer     ¨  Small reporting company ¨    

 

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

 

Yes    ¨                     No   x

 

The number of shares outstanding of the issuer’s common stock, $0.01 par value per share, was 45,590,282 shares, at August 1, 2016.

 

   

 

 

BANK MUTUAL CORPORATION

 

FORM 10-Q QUARTERLY REPORT

 

Table of Contents

 

Item   Page
     
PART I    
     
Item l. Financial Statements  
     
  Unaudited Condensed Consolidated Statements of Financial Condition as of June 30, 2016, and December 31, 2015 3
     
  Unaudited Condensed Consolidated Statements of Income  for the Three and Six Months Ended June 30, 2016 and 2015 4
     
  Unaudited Condensed Consolidated Statements of Total Comprehensive Income for the Three and Six Months Ended June 30, 2016 and 2015 6
     
  Unaudited Condensed Consolidated Statements of Equity for the Six Months Ended June 30, 2016 and 2015 7
     
  Unaudited Condensed Consolidated Statements of Cash Flows  for the Six Months Ended June 30, 2016 and 2015 8
     
  Notes to Unaudited Condensed Consolidated Financial Statements 9
     
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 34
     
Item 3. Quantitative and Qualitative Disclosures about Market Risk 49
     
Item 4. Controls and Procedures 52
     
PART II    
     
Item 1A. Risk Factors 53
     
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 53
     
Item 6. Exhibits 53
     
SIGNATURES 54

 

 2 

 

 

PART I

 

Item 1. Financial Statements

 

Bank Mutual Corporation and Subsidiaries

Unaudited Condensed Consolidated Statements of Financial Condition

 

   June 30   December 31 
   2016   2015 
   (Dollars in thousands) 
Assets          
           
Cash and due from banks  $29,753   $27,971 
Interest-earning deposits   11,454    16,530 
Cash and cash equivalents   41,207    44,501 
Mortgage-related securities available-for-sale, at fair value   413,871    407,874 
Mortgage-related securities held-to-maturity, at amortized cost (fair value of $114,479 in 2016 and $121,641 in 2015)   110,474    120,891 
Loans held-for-sale   5,453    3,350 
Loans receivable (net of allowance for loan losses of $17,962 in 2016 and $17,641 in 2015)   1,858,059    1,740,018 
Mortgage servicing rights, net   6,834    7,205 
Other assets   184,244    178,328 
           
Total assets  $2,620,142   $2,502,167 
           
Liabilities and shareholders’ equity          
           
Liabilities:          
Deposit liabilities  $1,836,737   $1,795,591 
Borrowings   422,554    372,375 
Advance payments by borrowers for taxes and insurance   19,921    3,382 
Other liabilities   54,084    51,425 
Total liabilities   2,333,296    2,222,773 
Shareholders’ equity:          
Preferred stock–$0.01 par value:          
Authorized–20,000,000 shares in 2016 and 2015
Issued and outstanding–none in 2016 and 2015
        
Common stock–$0.01 par value:          
Authorized–200,000,000 shares in 2016 and 2015
Issued–78,783,849 shares in 2016 and 2015
          
Outstanding–45,590,282 shares in 2016 and 45,443,548 in 2015   788    788 
Additional paid-in capital   485,041    486,273 
Retained earnings   168,121    164,482 
Accumulated other comprehensive loss   (6,271)   (9,365)
Treasury stock–33,193,567 shares in 2016 and 33,340,301 in 2015   (360,833)   (362,784)
Total shareholders’ equity   286,846    279,394 
           
Total liabilities and shareholders’ equity  $2,620,142   $2,502,167 

 

Refer to Notes to Unaudited Condensed Consolidated Financial Statements

 

 3 

 

 

Bank Mutual Corporation and Subsidiaries

Unaudited Condensed Consolidated Statements of Income

 

   Three Months Ended
June 30
 
   2016   2015 
   (Dollars in thousands,
except per share data)
 
Interest income:          
Loans  $17,360   $16,337 
Mortgage-related securities   2,722    2,871 
Investment securities   119    57 
Interest-earning deposits   10    6 
 Total interest income   20,211    19,271 
Interest expense:          
Deposit liabilities   1,446    1,152 
Borrowings   1,247    1,157 
Total interest expense   2,693    2,309 
Net interest income   17,518    16,962 
Provision for (recovery of) loan losses   1,164    (752)
Net interest income after recovery of loan losses   16,354    17,714 
Non-interest income:          
Deposit-related fees and charges   2,928    2,949 
Loan-related fees   1,607    490 
Brokerage and insurance commissions   846    822 
Mortgage banking revenue, net   1,142    974 
Income from bank-owned life insurance (“BOLI”)   463    473 
Gain on real estate held for investment       154 
Other non-interest income   23    45 
Total non-interest income   7,009    5,907 
Non-interest expense:          
Compensation, payroll taxes, and other employee benefits   10,236    11,066 
Occupancy, equipment, and data processing costs   3,284    3,315 
Advertising and marketing   970    555 
Federal insurance premiums   383    358 
Losses (gains) and expenses on foreclosed real estate, net   (131)   393 
Other non-interest expense   2,327    2,255 
Total non-interest expense   17,069    17,942 
Income before income taxes   6,294    5,679 
Income tax expense   2,345    2,090 
           
Net income  $3,949   $3,589 
           
Per share data:          
Earnings per share–basic  $0.09   $0.08 
Earnings per share–diluted  $0.09   $0.08 
Cash dividends per share paid  $0.055   $0.050 

 

Refer to Notes to Unaudited Condensed Consolidated Financial Statements

 

 4 

 

 

Bank Mutual Corporation and Subsidiaries

Unaudited Condensed Consolidated Statements of Income

 

   Six Months Ended
June 30
 
   2016   2015 
   (Dollars in thousands,
except per share data)
 
Interest income:          
Loans  $34,296   $32,854 
Mortgage-related securities   5,983    5,713 
Investment securities   221    104 
Interest-earning deposits   18    10 
Total interest income   40,518    38,681 
Interest expense:          
Deposit liabilities   2,851    2,246 
Borrowings   2,500    2,309 
Total interest expense   5,351    4,555 
Net interest income   35,167    34,126 
Provision for (recovery of) loan losses   591    (1,716)
Net interest income after recovery of loan losses   34,576    35,842 
Non-interest income:          
Deposit-related fees and charges   5,693    5,752 
Loan-related fees   2,865    927 
Brokerage and insurance commissions   1,714    1,988 
Mortgage banking revenue, net   1,967    1,841 
Income from bank-owned life insurance (“BOLI”)   927    942 
Loss on real estate held for investment       (166)
Other non-interest income   88    170 
Total non-interest income   13,254    11,454 
Non-interest expense:          
Compensation, payroll taxes, and other employee benefits   20,703    22,230 
Occupancy, equipment, and data processing costs   6,816    7,115 
Advertising and marketing   1,555    868 
Federal insurance premiums   805    728 
Losses (gains) and expenses on foreclosed real estate, net   (89)   539 
Other non-interest expense   4,697    4,520 
Total non-interest expense   34,487    36,000 
Income before income taxes   13,343    11,296 
Income tax expense   4,921    4,154 
           
Net income  $8,422   $7,142 
           
Per share data:          
Earnings per share–basic  $0.18   $0.15 
Earnings per share–diluted  $0.18   $0.15 
Cash dividends per share paid  $0.105   $0.090 

 

Refer to Notes to Unaudited Condensed Consolidated Financial Statements

 

 5 

 

 

Bank Mutual Corporations and Subsidiaries

Unaudited Condensed Consolidated Statements of Total Comprehensive Income

 

   Three Months Ended
June 30
 
   2016   2015 
   (Dollars in thousands) 
         
Net income  $3,949   $3,589 
Other comprehensive income (loss), net of tax:          
Change in net unrealized gain on securities available-for-sale, net of deferred income taxes of $511 in 2016 and $(984) in 2015   763    (1,469)
Change in net unrealized loss on interest rate swaps, net of deferred income taxes of $(27)   (40)    
Amortization of net prior service costs and unrecognized loss included in net periodic benefit cost, net of deferred income taxes of $33 in 2016 and $271 in 2015   50    409 
Total other comprehensive income (loss), net of tax   773    (1,060)
           
Total comprehensive income  $4,722   $2,529 

 

   Six Months Ended
June 30
 
   2016   2015 
   (Dollars in thousands) 
         
Net income  $8,422   $7,142 
Other comprehensive income (loss), net of tax:          
Change in net unrealized gain on securities available-for-sale, net of deferred income taxes of $2,138 in 2016 and $(567) in 2015   3,191    (846)
Change in net unrealized loss on interest rate swaps, net of deferred income taxes of $(133)   (198)    
Amortization of net prior service costs and unrecognized loss included in net periodic benefit cost, net of deferred income taxes of $67 in 2016 and $536 in 2015   101    804 
Total other comprehensive income (loss), net of tax   3,094    (42)
           
Total comprehensive income  $11,516   $7,100 

 

Refer to Notes to Unaudited Condensed Consolidated Financial Statements

 

 6 

 

 

Bank Mutual Corporations and Subsidiaries

Unaudited Condensed Consolidated Statements of Equity

 

               Accumulated       Non-Controlling     
       Additional       Other       Interest in     
   Common   Paid-In   Retained   Comprehensive   Treasury   Real Estate     
   Stock   Capital   Earnings   Income (Loss)   Stock   Partnership   Total 
   (Dollars in thousands, except per share data) 
                             
Balance at January 1, 2016  $788   $486,273   $164,482   $(9,365)  $(362,784)      $279,394 
Net income           8,422                8,422 
Other comprehensive income               3,094            3,094 
Purchase of treasury stock                   (221)       (221)
Issuance of restricted stock       (1,469)           1,469         
Exercise of stock options       (422)           703        281 
Share based payments       659                    659 
Cash dividends ($0.105 per share)           (4,783)               (4,783)
                                    
Balance at June 30, 2016  $788   $485,041   $168,121   $(6,271)  $(360,833)      $286,846 
                                    
Balance at January 1, 2015  $788   $488,467   $159,065   $(11,136)  $(356,467)  $3,774   $284,491 
Net income           7,142                7,142 
Other comprehensive income               (42)           (42)
Decrease in non-controlling interest in real estate partnership                       (3,774)   (3,774)
Purchase of treasury stock                   (5,605)       (5,605)
Issuance of restricted stock       (2,366)           2,366         
Exercise of stock options       (558)           884        326 
Share based payments       697                    697 
Cash dividends ($0.09 per share)           (4,196)               (4,196)
                                    
Balance at June 30, 2015  $788   $486,240   $162,011   $(11,178)  $(358,822)      $279,039 

 

Refer to Notes to Unaudited Condensed Consolidated Financial Statements

 

 7 

 

 

Bank Mutual Corporation and Subsidiaries

Unaudited Condensed Consolidated Statements of Cash Flows

 

   Six Months Ended
June 30
 
   2016   2015 
   (Dollars in thousands) 
Operating activities:          
Net income  $8,422   $7,142 
Adjustments to reconcile net income to net cash from operating activities:          
Provision for (recovery of) loan losses   591    (1,716)
Loss (gain) on foreclosed real estate, net   (299)   328 
Provision for depreciation   1,667    1,576 
Amortization of mortgage servicing rights   987    1,000 
Net premium amortization on securities   1,326    1,020 
Loans originated for sale   (64,548)   (56,595)
Proceeds from loan sales   63,500    56,947 
Gain on loan sales activities, net   (1,671)   (1,499)
Deferred income tax expense   2,047    3,857 
Loss on real estate held for investment       166 
Other, net   (7,324)   (10,239)
Net cash provided by operating activities   4,698    1,987 
Investing activities:          
Principal repayments on mortgage-related securities available-for-sale   54,470    54,438 
Principal repayments on mortgage-related securities held-to-maturity   10,092    1,141 
Purchases of mortgage-related securities available-for-sale   (56,137)   (149,257)
Purchases of FHLB of Chicago stock   (774)   (1,992)
Net (increase) decrease in loans receivable   (119,531)   3,377 
Proceeds from sale of foreclosed properties   1,735    1,713 
Proceeds from sale of real estate held for investment       427 
Net purchases of premises and equipment   (988)   (1,943)
Net cash used by investing activities   (111,133)   (92,096)
Financing activities:          
Net increase in deposit liabilities   41,146    13,312 
Net increase in short-term borrowings   75,000    77,200 
Repayments of long-term borrowings   (24,821)   (640)
Net increase in advance payments by borrowers for taxes and insurance   16,539    16,288 
Cash dividends   (4,783)   (4,196)
Purchases of treasury stock   (221)   (5,605)
Other, net   281    410 
Net cash provided by financing activities   103,141    96,769 
Increase (decrease) in cash and cash equivalents   (3,294)   6,660 
Cash and cash equivalents at beginning of period   44,501    46,177 
Cash and cash equivalents at end of period  $41,207   $52,837 
Supplemental information:          
Cash paid in period for:          
Interest on deposit liabilities and borrowings  $5,282   $4,323 
Income taxes   938    1,282 
Non-cash transactions:          
Loans transferred to foreclosed properties and repossessed assets   899    1,151 

 

Refer to Notes to Unaudited Condensed Consolidated Financial Statements

 

 8 

 

 

Bank Mutual Corporation and Subsidiaries

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

June 30, 2016

 

(Dollars in Thousands, Except Share and Per Share Amounts)

 

1. Basis of Presentation

 

The Unaudited Condensed Consolidated Financial Statements include the accounts of Bank Mutual Corporation (the “Company”), its wholly-owned subsidiary Bank Mutual (the “Bank”), and the Bank’s subsidiaries.

 

The accompanying Unaudited Condensed Consolidated Financial Statements have been prepared in accordance with United States generally accepted accounting principles (“GAAP”) for interim financial information, Rule 10-01 of Regulation S-X, and the instructions to Form 10-Q. The financial statements do not include all of the information and footnotes required by GAAP for complete financial information. However, in the opinion of management, all adjustments (consisting of normal recurring entries) necessary for a fair presentation of operations, cash flows, and financial position have been included in the accompanying financial statements. This report should be read in conjunction with the Company’s 2015 Annual Report on Form 10-K. Operating results for the three and six months ended June 30, 2016, are not necessarily indicative of the results that may be expected for the full year ending December 31, 2016.

 

In 2014 the Financial Accounting Standards Board (“FASB”) issued new accounting guidance related to the recognition of revenue from contracts with customers. In 2015 the FASB deferred the effective date one year from the date in the original guidance. The guidance is effective for fiscal years and interim periods beginning after December 15, 2018, which will be the first quarter of 2019 for the Company. In 2016 the FASB issued two new pronouncements to amend and clarify the original guidance with no change to the effective date. The Company’s adoption of this item is not expected to have a material impact on its results of operations or financial condition.

 

In 2015 the FASB issued new accounting guidance relating to the consolidation of legal entities for financial reporting purposes. For public companies, the guidance is effective for periods beginning after December 15, 2015, which was the first quarter of 2016 for the Company. The Company’s adoption of this new guidance did not have a material impact on its results of operations or financial condition.

 

In 2016 the FASB issued new accounting guidance related to certain aspects of the recognition and measurement of financial assets and liabilities. For public companies the guidance is effective for periods beginning after December 15, 2017, which will be the first quarter of 2018 for the Company. Early application of some aspects of the new guidance is also permitted, although the Company does not intend to adopt the guidance early. The Company’s eventual adoption of this new guidance is not expected to have a material impact on its results of operations or financial condition.

 

In 2016 the FASB issued new accounting guidance related to the accounting for lease assets and liabilities. For public companies the guidance is effective for periods beginning after December 15, 2018, which will be the first quarter of 2019 for the Company. The Company’s adoption of this item is not expected to have a material impact on its results of operations or financial condition.

 

In 2016 the FASB issued new accounting guidance related to the accounting for employee share-based compensation. For public companies the guidance is effective for periods beginning after December 15, 2016, with early adoption permitted. The Company adopted this guidance in the first quarter of 2016. The Company’s adoption of this item did not have a material impact on its results of operations or financial condition.

 

In 2016 the FASB issued new accounting guidance related to the measurement of credit losses on financial instruments. The new guidance replaces the current methodology of measuring credit losses based on incurred losses at the balance sheet date with a methodology that measures credit losses based on the current estimate of expected credit losses. For the Company this guidance is effective for periods beginning after December 15, 2019, which will be the first quarter of 2020. Management has not yet completed the complex analysis required to determine the impact adoption of this new guidance could have on the Company’s results of operations or financial condition.

 

 9 

 

 

Bank Mutual Corporation and Subsidiaries

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

June 30, 2016

 

(Dollars in Thousands, Except Share and Per Share Amounts)

 

2. Mortgage-Related Securities Available-for-Sale and Held-to-Maturity

 

The amortized cost and fair value of mortgage-related securities available-for-sale and held-to-maturity are as follows:

 

   June 30, 2016 
       Gross   Gross   Estimated 
   Amortized   Unrealized   Unrealized   Fair 
   Cost   Gains   Losses   Value 
Securities available-for-sale:                    
Federal Home Loan Mortgage Corporation  $208,327   $3,543   $(3)  $211,867 
Federal National Mortgage Association   177,429    3,070    (124)   180,375 
Government National Mortgage Association   2,518    28        2,546 
Private-label CMOs   19,061    307    (285)   19,083 
Total available-for-sale  $407,335   $6,948   $(412)  $413,871 
Securities held-to-maturity:                    
Federal National Mortgage Association  $110,474   $4,005       $114,479 
Total held-to-maturity  $110,474   $4,005       $114,479 

 

   December 31, 2015 
       Gross   Gross   Estimated 
   Amortized   Unrealized   Unrealized   Fair 
   Cost   Gains   Losses   Value 
Securities available-for-sale:                    
Federal Home Loan Mortgage Corporation  $215,255   $1,823   $(800)  $216,278 
Federal National Mortgage Association   169,792    853    (874)   169,771 
Government National Mortgage Association   21    3        24 
Private-label CMOs   21,600    446    (245)   21,801 
Total available-for-sale  $406,668   $3,125   $(1,919)  $407,874 
Securities held-to-maturity:                    
Federal National Mortgage Association  $120,891   $750       $121,641 
Total held-to-maturity  $120,891   $750       $121,641 

 

 10 

 

 

Bank Mutual Corporation and Subsidiaries

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

June 30, 2016

 

(Dollars in Thousands, Except Share and Per Share Amounts)

 

2. Mortgage-Related Securities Available-for-Sale and Held-to-Maturity (continued)

 

The following tables summarize mortgage-related securities by amount of time the securities have had a gross unrealized loss as of the dates indicated:

 

   June 30, 2016 
   Less Than 12 Months   Greater Than 12 Months         
   in an Unrealized Loss Position   in an Unrealized Loss Position   Gross   Total 
:  Unrealized
Loss
Amount
   Number of
Securities
   Estimated
Fair
Value
   Unrealized
Loss
Amount
   Number of
Securities
   Estimated
Fair
Value
   Unrealized
Loss
Amount
   Estimated
Fair
Value
 
Securities available-for-sale:                                        
Federal Home Loan Mortgage Corporation              $3    1   $193   $3   $193 
Federal National Mortgage Association  $62    1   $3,005    62    5    16,681    124    19,686 
Private-label CMOs   6    3    2,991    279    11    10,786    285    13,777 
Total available-for-sale  $68    4   $5,996   $344    17   $27,660   $412   $33,656 

 

   December 31, 2015 
   Less Than 12 Months   Greater Than 12 Months         
   in an Unrealized Loss Position   in an Unrealized Loss Position   Gross   Total 
:  Unrealized
Loss
Amount
   Number of
Securities
   Estimated
Fair
Value
   Unrealized
Loss
Amount
   Number of
Securities
   Estimated
Fair
Value
   Unrealized
Loss
Amount
   Estimated
Fair
Value
 
Securities available-for-sale:                                        
Federal Home Loan Mortgage Corporation  $777    17   $107,807   $23    3   $7,937   $800   $115,744 
Federal National Mortgage Association   634    16    79,273    240    4    10,679    874    89,952 
Private-label CMOs   1    1    1,357    244    10    10,574    245    11,931 
Total available-for-sale  $1,412    34   $188,437   $507    17   $29,190   $1,919   $217,627 

 

The Company determined that the unrealized losses on its mortgage-related securities were temporary as of June 30, 2016, and December 31, 2015. The Company does not intend to sell these securities and it is unlikely that it will be required to sell these securities before the recovery of their amortized cost. The Company believes it is probable that it will receive all future contractual cash flows related to these securities. This determination was based on management’s judgment regarding the nature of the loan collateral that supports the securities, a review of the current ratings issued on the securities by various credit rating agencies, recent trends in the fair market values of the securities and, in the case of private-label collateralized mortgage obligations (“CMOs”), a review of the actual delinquency and/or default performance of the loan collateral that supports the securities.

 

As of June 30, 2016, and December 31, 2015, the Company had private-label CMOs, with a fair value of $13,696 and $15,725, respectively, and unrealized gains of $84 and $237, respectively, that were rated less than investment grade. These private-label CMOs were analyzed using modeling techniques that considered the priority of cash flows in the CMO structure and various default and loss rate scenarios that management considered appropriate given the nature of the loan collateral.

 

 11 

 

 

Bank Mutual Corporation and Subsidiaries

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

June 30, 2016

 

(Dollars in Thousands, Except Share and Per Share Amounts)

 

2. Mortgage-Related Securities Available-for-Sale and Held-to-Maturity (continued)

 

The following table contains a summary of other-than-temporary impairment (“OTTI”) related to credit losses that have been recognized in earnings as of the dates indicated for private label CMOs, as well as the end of period values for securities that have experienced such losses:

 

   Three Months Ended
June 30
   Six Months Ended
June 30
 
   2016   2015   2016   2015 
Beginning balance of unrealized OTTI related to credit losses  $557   $692   $592   $789 
Reductions for increase in cash flows expected to be received   (35)   (35)   (70)   (132)
Ending balance of unrealized OTTI related to credit losses  $522   $657   $522   $657 
Adjusted cost at end of period  $3,810   $4,911   $3,810   $4,911 
Estimated fair value at end of period  $4,098   $5,390   $4,098   $5,390 

 

Results of operations included no gross realized gains or losses on the sale of securities during the three and six months ended June 30, 2016 or 2015.

 

Mortgage-related securities available-for-sale with a fair value of approximately $86,952 and $67,923 at June 30, 2016, and December 31, 2015, respectively, were pledged to secure deposits, borrowings, and for other purposes as permitted or required by law.

 

 12 

 

 

Bank Mutual Corporation and Subsidiaries

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

June 30, 2016

 

(Dollars in Thousands, Except Share and Per Share Amounts)

 

3. Loans Receivable

 

The following table summarizes the components of loans receivable as of the dates indicated:

 

   June 30   December 31 
   2016   2015 
Commercial loans:          
Commercial and industrial  $233,597   $235,313 
Commercial real estate   332,514    299,550 
Multi-family real estate   517,703    409,674 
Construction and development loans:          
Commercial real estate   34,001    28,156 
Multi-family real estate   263,701    291,380 
Land and land development   10,583    11,143 
Total construction and development   308,285    330,679 
Total commercial loans   1,392,099    1,275,216 
Retail loans:          
One- to four-family first mortgages:          
Permanent   449,800    461,797 
Construction   40,106    42,357 
Total one- to four-family first mortgages   489,906    504,154 
Home equity loans:          
Fixed term home equity   114,695    122,985 
Home equity lines of credit   72,569    75,261 
Total home equity loans   187,264    198,246 
Other consumer loans:          
Student   7,490    8,129 
Other   11,336    11,678 
Total other consumer loans   18,826    19,807 
Total retail loans   695,996    722,207 
Gross loans receivable   2,088,095    1,997,423 
Undisbursed loan proceeds   (210,269)   (238,124)
Allowance for loan losses   (17,962)   (17,641)
Deferred fees and costs, net   (1,805)   (1,640)
Total loans receivable, net   1,858,059   $1,740,018 

 

The Company’s commercial and retail borrowers are primarily located in the Company’s local lending areas in Wisconsin, Illinois, Michigan, Minnesota, and Iowa, as is the real estate and non-real estate collateral that secures the Company’s loans.

 

At June 30, 2016, and December 31, 2015, certain one- to four-family mortgage loans, multi-family mortgage loans, and home equity loans with aggregate carrying values of approximately $563,000 and $496,000 were pledged to secure advances from the Federal Home Loan Bank (“FHLB”) of Chicago.

 

The unpaid principal balance of loans serviced for others was $1,016,474 and $1,038,588 at June 30, 2016, and December 31, 2015, respectively. These loans are not reflected in the consolidated financial statements.

 

 13 

 

 

Bank Mutual Corporation and Subsidiaries

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

June 30, 2016

 

(Dollars in Thousands, Except Share and Per Share Amounts)

 

3. Loans Receivable (continued)

 

The following tables summarize the activity in the allowance for loan losses by loan portfolio segment for the periods indicated. The tables also summarize the allowance for loan loss and loans receivable by the nature of the impairment evaluation, either individually or collectively, at the dates indicated (the loans receivable amounts in the table are net of undisbursed loan proceeds).

 

   At or for the Six Months Ended June 30, 2016 
   Commercial
and
Industrial
   Commercial
Real
Estate
   Multi-
Family
Real Estate
   Construction
and
Development
   One- to
Four-
Family
   Home Equity
and Other
Consumer
   Total 
Allowance for loan losses:                            
Beginning balance  $3,658   $4,796   $3,337   $2,835   $1,835   $1,180   $17,641 
Provision (recovery)   (337)   (487)   1,564    (369)   133    87    591 
Charge-offs       (99)           (84)   (223)   (406)
Recoveries   4    19    30        33    50    136 
Ending balance  $3,325   $4,229   $4,931   $2,466   $1,917   $1,094   $17,962 
Loss allowance individually evaluated for impairment  $196                       $196 
Loss allowance collectively evaluated for impairment  $3,129   $4,229   $4,931   $2,466   $1,917   $1,094   $17,766 
                                    
Loan receivable balances at the end of the period:                                   
Loans individually evaluated for impairment  $8,632   $6,391   $3,993   $2,021   $3,511   $876   $25,424 
Loans collectively evaluated for impairment   224,965    326,123    513,710    116,299    466,091    205,214    1,852,402 
Total loans receivable  $233,597   $332,514   $517,703   $118,320   $469,602   $206,090   $1,877,826 

 

   At or for the Six Months Ended June 30, 2015 
  Commercial
and
Industrial
   Commercial
Real
Estate
   Multi-
Family
Real Estate
   Construction
and
Development
   One- to
Four-
Family
   Home Equity
and Other
Consumer
   Total 
Allowance for loan losses:                            
Beginning balance  $2,349   $6,880   $6,078   $2,801   $3,004   $1,177   $22,289 
Provision (recovery)   33    (370)   (1,678)   60    (253)   492    (1,716)
Charge-offs   (74)   (69)           (218)   (348)   (709)
Recoveries   6    83            41    46    176 
Ending balance  $2,314   $6,524   $4,400   $2,861   $2,574   $1,367   $20,040 
Loss allowance individually evaluated for impairment      $262   $621               $883 
Loss allowance collectively evaluated for impairment  $2,314   $6,262   $3,779   $2,861   $2,574   $1,367   $19,157 
                                    
Loan receivable balances at the end of the period:                                   
Loans individually evaluated for impairment  $8,032   $9,815   $9,538   $2,136   $4,786   $549   $34,856 
Loans collectively evaluated for impairment   202,658    263,403    339,750    111,473    470,984    226,709    1,614,977 
Total loans receivable  $210,690   $273,218   $349,288   $113,609   $475,770   $227,258   $1,649,833 

 

The Company adjusts certain factors used to determine the allowance for loan losses on loans that are collectively evaluated for impairment. Management considered these adjustments necessary and prudent in light of trends in net charge-offs, real estate values, economic conditions, and unemployment. The Company estimates that these changes, as well as overall changes in the balance of loans to which these factors were applied, resulted in an increase (decrease) in the total allowance for loan losses of $1,149 and $660 during the three and six months ended June 30, 2016, and of $(1,097) and $(2,228) during the three and six months ended June 30, 2015.

 

 14 

 

 

Bank Mutual Corporation and Subsidiaries

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

June 30, 2016

 

(Dollars in Thousands, Except Share and Per Share Amounts)

 

3. Loans Receivable (continued)

 

The following tables present information regarding impaired loans that have a related allowance for loan loss and those that do not as of the dates indicated (the loans receivable amounts in the table are net of undisbursed loan proceeds).

 

   June 30, 2016 
Impaired loans with an allowance recorded:  Loans
Receivable
Balance, Net
   Unpaid
Principal
Balance
   Related
Allowance
for Loss
   Average Loan
Receivable
Balance, Net
   Interest
Income
Recognized
 
Commercial and industrial:                         
Term loans                    
Lines of credit  $1,898   $1,960   $196   $3,042   $52 
Total commercial and industrial   1,898    1,960    196    3,042    52 
Commercial real estate:                         
Office                    
Retail/wholesale/mixed                    
Industrial/warehouse                    
Other                    
Total commercial real estate                    
Multi-family real estate                    
Construction and development:                         
Commercial real estate                    
Multi-family real estate                    
Land and land development                    
Total construction and development                    
One- to four-family                    
Home equity and other consumer:                         
Home equity                    
Student                    
Other                    
Total home equity and other consumer                    
Total with an allowance recorded  $1,898   $1,960   $196   $3,042   $52 
                          
Impaired loans with no allowance recorded:                         
Commercial and industrial:                         
Term loans  $92   $107       $105   $3 
Lines of credit   2,273    2,352        1,440    61 
Total commercial and industrial   2,365    2,459        1,545    64 
Commercial real estate:                         
Office   2,043    2,418        2,084    76 
Retail/wholesale/mixed   1,472    2,254        1,549    58 
Industrial/warehouse   187    265        191    7 
Other   2    153        7    7 
Total commercial real estate   3,704    5,090        3,831    148 
Multi-family real estate   286    292        193    12 
Construction and development:                         
Commercial real estate   548    597        581     
Multi-family real estate                    
Land and land development   157    215        162    8 
Total construction and development   705    812        743    8 
One- to four-family   2,764    3,132        2,549    31 
Home equity and other consumer:                         
Home equity   816    898        729    6 
Student                    
Other   60    166        72    1 
Total home equity and other consumer   876    1,064        801    7 
Total with no allowance recorded  $10,700   $12,849       $9,662   $270 

 

 15 

 

 

Bank Mutual Corporation and Subsidiaries

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

June 30, 2016

 

(Dollars in Thousands, Except Share and Per Share Amounts)

 

3. Loans Receivable (continued)

 

   December 31, 2015 
Impaired loans with an allowance recorded:  Loans
Receivable
Balance, Net
   Unpaid
Principal
Balance
   Related
Allowance
for Loss
   Average Loan
Receivable
Balance, Net
   Interest
Income
Recognized
 
Commercial and industrial:                         
Term loans                    
Lines of credit  $2,783   $2,795   $535   $557   $142 
Total commercial and industrial                     
Commercial real estate:                         
Office                         
Retail/wholesale/mixed               1,538     
Industrial/warehouse                    
Other                    
Total commercial real estate               1,538     
Multi-family real estate               1,112     
Construction and development:                         
Commercial real estate                    
Multi-family real estate                    
Land and land development                    
Total construction and development                     
One- to four-family                    
Home equity and other consumer:                         
Home equity                    
Student                    
Other                    
Total home equity and other consumer                    
Total with an allowance recorded  $2,783   $2,795   $535   $3,207   $142 
                          
Impaired loans with no allowance recorded:                         
Commercial and industrial:                         
Term loans  $116   $133       $129   $3 
Lines of credit   2,016    2,032        422    117 
Total commercial and industrial   2,132    2,165        551    120 
Commercial real estate:                         
Office   2,126    2,426        833    148 
Retail/wholesale/mixed   1,637    2,348        1,672    79 
Industrial/warehouse   194    265        204    18 
Other   11    155        22    14 
Total commercial real estate   3,968    5,194        2,731    259 
Multi-family real estate                     
Construction and development:                         
Commercial real estate   597    597        597     
Multi-family real estate                    
Land and land development   169    220        187    17 
Total construction and development   766    817         784    17 
One- to four-family   2,703    3,168        3,744    70 
Home equity and other consumer:                         
Home equity   703    805        509    21 
Student                    
Other   82    184        87    1 
Total home equity and other consumer   785    989        596    22 
Total with no allowance recorded  $10,354   $12,333       $8,406   $488 

 

 16 

 

 

Bank Mutual Corporation and Subsidiaries

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

June 30, 2016

 

(Dollars in Thousands, Except Share and Per Share Amounts)

 

3. Loans Receivable (continued)

 

The following tables present information relating to the Company’s internal risk ratings of its loans receivable as of the dates indicated (all amounts in the tables are net of undisbursed loan proceeds):

 

   June 30, 2016 
   Pass   Watch   Special
Mention
   Substandard   Total 
Commercial and industrial:                         
Term loans  $65,776   $6,846   $110   $665   $73,397 
Lines of credit   116,310    34,189    1,734    7,967    160,200 
Total commercial and industrial   182,086    41,035    1,844    8,632    233,597 
Commercial real estate:                         
Office   100,397    4,634    14,517    2,043    121,591 
Retail/wholesale/mixed use   109,709    27,050    14,566    3,896    155,221 
Industrial/warehouse   43,341    4,325        450    48,116 
Other   7,584            2    7,586 
Total commercial real estate   261,031    36,009    29,083    6,391    332,514 
Multi-family real estate   505,841        7,869    3,993    517,703 
Construction and development:                         
Commercial real estate   6,541            548    7,089 
Multi-family real estate   100,666                100,666 
Land and land development   8,901    191        1,473    10,565 
Total construction/development   116,108    191        2,021    118,320 
One- to four-family   463,781    441    1,869    3,511    469,602 
Home equity and other consumer:                         
Home equity   186,448            816    187,264 
Student   7,490                7,490 
Other   11,276            60    11,336 
Total home equity and other consumer   205,214            876    206,090 
Total  $1,734,061   $77,676   $40,665   $25,424   $1,877,826 

 

 17 

 

 

Bank Mutual Corporation and Subsidiaries

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

June 30, 2016

 

(Dollars in Thousands, Except Share and Per Share Amounts)

 

3. Loans Receivable (continued)

 

   December 31, 2015 
   Pass   Watch   Special
Mention
   Substandard   Total 
Commercial and industrial:                         
Term loans  $53,785   $5,536   $252   $2,605   $62,178 
Lines of credit   145,118    17,086    1,299    9,632    173,135 
Total commercial and industrial   198,903    22,622    1,551    12,237    235,313 
Commercial real estate:                         
Office   69,223    5,567    15,063    2,126    91,979 
Retail/wholesale/mixed use   103,634    28,091    14,510    6,599    152,834 
Industrial/warehouse   46,545    1,326    588    1,598    50,057 
Other   4,669            11    4,680 
Total commercial real estate   224,071    34,984    30,161    10,334    299,550 
Multi-family real estate   394,097    7,338        8,239    409,674 
Construction and development:                         
Commercial real estate   13,928            597    14,525 
Multi-family real estate   93,635                93,635 
Land and land development   9,411    69        1,517    10,997 
Total construction/development   116,974    69        2,114    119,157 
One- to four-family   471,412    2,059    671    3,410    477,552 
Home equity and other consumer:                         
Home equity   197,543            703    198,246 
Student   8,129                8,129 
Other   11,596            82    11,678 
Total home equity and other consumer   217,268            785    218,053 
Total  $1,622,725   $67,072   $32,383   $37,119   $1,759,299 

 

Loans rated “pass” or “watch” are generally current on contractual loan and principal payments and comply with other contractual loan terms. Pass loans generally have no noticeable credit deficiencies or potential weaknesses. Loans rated watch, however, will typically exhibit early signs of credit deficiencies or potential weaknesses that deserve management’s close attention. Loans rated “special mention” do not currently expose the Company to a sufficient degree of risk to warrant a lower rating, but possess clear trends in credit deficiencies or potential weaknesses that deserve management’s close attention. The allowance for loan losses on loans rated pass, watch, or special mention is typically evaluated collectively for impairment using a homogenous pool approach. This approach utilizes quantitative factors developed by management from its assessment of historical loss experience, qualitative factors, and other considerations.

 

Loans rated “substandard” involve a distinct possibility that the Company could sustain some loss if deficiencies associated with the loan are not corrected. Loans rated “doubtful” indicate that full collection is highly questionable or improbable. The Company did not have any loans that were rated doubtful at June 30, 2016, or December 31, 2015. Loans rated substandard or doubtful that are also considered in management’s judgment to be impaired are generally analyzed individually to determine an appropriate allowance for loan loss. A loan rated “loss” is considered uncollectible, even if a partial recovery could be expected in the future. The Company generally charges off loans that are rated as a loss. As such, the Company did not have any loans that were rated loss at June 30, 2016, or December 31, 2015.

 

 18 

 

 

Bank Mutual Corporation and Subsidiaries

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

June 30, 2016

 

(Dollars in Thousands, Except Share and Per Share Amounts)

 

3. Loans Receivable (continued)

 

The following tables contain information relating to the past due and non-accrual status of the Company’s loans receivable as of the dates indicated (all amounts in the table are net of undisbursed loan proceeds):

 

   June 30, 2016 
   Past Due Status           Total 
   30-59
Days
   60-89
Days
   > 90
Days
   Total
Past Due
   Total
Current
   Total
Loans
   Non-
Accrual
 
Commercial and industrial:                                   
Term loans  $128       $31   $159   $73,238   $73,397   $92 
Lines of credit                   160,200    160,200    4,171 
Total commercial and industrial   128        31    159    233,438    233,597    4,263 
Commercial real estate:                                   
Office   1,725            1,725    119,866    121,591    2,043 
Retail/wholesale/mixed           592    592    154,629    155,221    1,472 
Industrial/warehouse   187            187    47,929    48,116    187 
Other                   7,586    7,586    2 
Total commercial real estate   1,912         592    2,504    330,010    332,514    3,704 
Multi-family real estate   469            469    517,234    517,703    286 
Construction and development:                                   
Commercial real estate           548    548    6,541    7,089    548 
Multi-family real estate                   100,666    100,666     
Land and land development   473            473    10,092    10,565    157 
Total construction   473        548    1,021    117,299    118,320    705 
One- to four-family   6,394   $1,711    2,700    10,805    458,797    469,602    2,764 
Home equity and other consumer:                                   
Home equity   437    100    816    1,353    185,911    187,264    816 
Student   203    121    239    563    6,927    7,490     
Other   69    63    60    192    11,144    11,336    60 
Total home equity and other consumer   709    284    1,115    2,108    203,982    206,090    876 
Total  $10,085   $1,995   $4,986   $17,066   $1,860,760   $1,877,826   $12,598 

 

 19 

 

 

Bank Mutual Corporation and Subsidiaries

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

June 30, 2016

 

(Dollars in Thousands, Except Share and Per Share Amounts)

 

3. Loans Receivable (continued)

 

   December 31, 2015 
   Past Due Status           Total 
   30-59
Days
   60-89
Days
   > 90
Days
   Total
Past Due
   Total
Current
   Total
Loans
   Non-
Accrual
 
Commercial and industrial:                                   
Term loans          $61   $61   $62,117   $62,178   $116 
Lines of credit  $8,901            8,901    164,234    173,135    4,799 
Total commercial and industrial   8,901        61    8,962    226,351    235,313    4,915 
Commercial real estate:                                   
Office                   91,979    91,979    2,126 
Retail/wholesale/mixed   768   $2    684    1,454    151,380    152,834    1,637 
Industrial/warehouse                   50,057    50,057    194 
Other                   4,680    4,680    11 
Total commercial real estate   768    2    684    1,454    298,096    299,550    3,968 
Multi-family real estate   721            721    408,953    409,674     
Construction and development:                                   
Commercial real estate           597    597    13,928    14,525    597 
Multi-family real estate                   93,635    93,635     
Land and land development                   10,997    10,997    169 
Total construction           597    597    118,560    119,157    766 
One- to four-family   6,490    2,959    2,634    12,083    465,469    477,552    2,703 
Home equity and other consumer:                                   
Home equity   1,214    217    703    2,134    196,112    198,246    703 
Student   178    62    484    724    7,405    8,129     
Other   38    49    82    169    11,509    11,678    82 
Total home equity and other consumer   1,430    328    1,269    3,027    215,026    218,053    785 
Total  $18,310   $3,289   $5,245   $26,844   $1,732,455   $1,759,299   $13,137 

 

As of June 30, 2016, and December 31, 2015, $239 and $484 in student loans, respectively, were 90-days past due, but remained on accrual status because such loans were originated under programs guaranteed by the federal government. No other loans 90-days past due were in accrual status as of either date.

 

The Company classifies a loan modification as a troubled debt restructuring (“TDR”) when it has granted a borrower experiencing financial difficulties a concession that it would otherwise not consider. Loan modifications that result in insignificant delays in the receipt of payments (generally six months or less) are not considered TDRs under the Company’s TDR policy. TDRs are relatively insignificant and/or infrequent in the Company and generally consist of loans placed in interest-only status for a short period of time or payment forbearance for greater than six months. As of June 30, 2016, and December 31, 2015, TDRs were $8,264 and $8,704, respectively, and consisted primarily of commercial and industrial and one- to four-family mortgage loans. TDRs in accrual status as of those same dates were $2,900 and $2,558, respectively. Additions to TDRs during the six months ended June 30, 2016 and 2015, were immaterial. In addition, TDRs that experienced a payment default within one year of their restructuring during these six months ended June 30, 2016, and twelve months ended June 30, 2015, were also immaterial. TDRs are evaluated for impairment and appropriate credit losses are recorded in accordance with the Company’s accounting policies and GAAP.

 

 20 

 

 

Bank Mutual Corporation and Subsidiaries

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

June 30, 2016

 

(Dollars in Thousands, Except Share and Per Share Amounts)

 

4. Mortgage Servicing Rights

 

The following table presents the activity in the Company’s mortgage servicing rights (“MSRs”) for the periods indicated:

 

   Six Months Ended June 30 
   2016   2015 
MSRs at beginning of the period, net  $7,205   $7,867 
Additions   616    623 
Amortization   (987)   (1,000)
MSRs at end of the period, net  $6,834   $7,490 

 

The following table shows the estimated future amortization expense for MSRs for the periods indicated:

 

      Amount 
Estimate for six months ending December 31:  2016  $701 
Estimate for years ending December 31:  2017   1,190 
   2018   1,003 
   2019   816 
   2020   661 
   2021   591 
   Thereafter   1,872 
   Total  $6,834 

 

The projections of amortization expense shown above for MSRs are based on existing asset balances and the existing interest rate environment as of June 30, 2016. Future amortization expense may be significantly different depending upon changes in the mortgage servicing portfolio, mortgage interest rates, and market conditions.

 

5. Other Assets

 

The following table summarizes the components of other assets as of the dates indicated:

 

   June 30   December 31 
   2016   2015 
Accrued interest:          
Loans receivable  $5,030   $4,894 
Mortgage-related securities   1,112    1,141 
Total accrued interest   6,142    6,035 
Foreclosed properties and repossessed assets:          
Commercial real estate   1,355    1,685 
Land and land development   746    747 
One-to four-family   667    874 
Total foreclosed properties and repossessed assets   2,768    3,306 
Bank-owned life insurance   62,593    61,656 
Premises and equipment, net   48,458    49,218 
Federal Home Loan Bank stock, at cost   18,365    17,591 
Deferred tax asset, net   13,262    16,485 
Other assets   32,656    24,037 
Total other assets  $184,244   $178,328 

 

 21 

 

 

Bank Mutual Corporation and Subsidiaries

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

June 30, 2016

 

(Dollars in Thousands, Except Share and Per Share Amounts)

 

5. Other Assets (continued)

 

Residential one-to four-family mortgage loans that were in the process of foreclosure were $2,012 and $2,576 at June 30, 2016, and December 31, 2015, respectively.

 

6. Deposit Liabilities

 

The following table summarizes the components of deposit liabilities as of the dates indicated:

 

   June 30   December 31 
   2016   2015 
Checking accounts:          
Non-interest-bearing  $236,252   $213,761 
Interest-bearing   269,860    277,606 
Total checking accounts   506,112    491,367 
Money market accounts   555,549    542,020 
Savings accounts   228,520    217,633 
Certificates of deposit:          
Due within one year   334,844    282,584 
After one but within two years   155,504    182,599 
After two but within three years   48,687    61,806 
After three but within four years   5,772    15,373 
After four but within five years   1,749    2,209 
Total certificates of deposits   546,556    544,571 
Total deposit liabilities  $1,836,737   $1,795,591 

 

7. Borrowings

 

The following table summarizes borrowings as of the dates indicated:

 

   June 30, 2016   December 31, 2015 
       Weighted-       Weighted- 
       Average       Average 
   Balance   Rate   Balance   Rate 
FHLB overnight advances  $205,000    0.30%  $130,000    0.16%
FHLB term advances maturing in:                    
2016   60,000    0.59    75,950    0.63 
2017   53,866    1.19    56,183    1.20 
2018   32,211    2.21    34,607    2.18 
2019   17,834    3.04    19,127    2.98 
2020   25,448    3.67    26,853    3.62 
2021   15,673    3.01    16,971    2.97 
Thereafter   12,522    4.55    12,684    4.55 
Total borrowings  $422,554    1.15%  $372,375    1.27%

 

All of the Company’s term advances from the FHLB of Chicago are subject to prepayment penalties if voluntarily repaid by the Company prior to stated maturity.

 

 22 

 

 

Bank Mutual Corporation and Subsidiaries

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

June 30, 2016

 

(Dollars in Thousands, Except Share and Per Share Amounts)

 

7. Borrowings (continued)

 

As discussed in Note 12, “Financial Instruments with Off-Balance Sheet Risk and Derivative Financial Instruments,” the Company has entered into cash flow hedges using interest rate swaps to manage the interest rate risk exposure associated with certain forecasted borrowings from the FHLB of Chicago. Two advances maturing in July 2016 of $10,000 each have corresponding pay-fixed interest rate swaps that mature in 2018 and 2019, respectively. Although these advances have stated interest rates of 0.45%, they have effective interest rates including the impact of the interest rate swaps of 1.09% and 1.35%, respectively. However, these advances have been included in the table, above, at their contractual rates and maturities. If they had been included in the table at their hedge-adjusted rates and maturities, the advances reported as maturing in 2018 and 2019 would have each been $10,000 higher and the weighted average rates for those maturity years would have been 1.94% and 2.43% as of June 30, 2016, respectively. Furthermore, the weighted average rate reported for total borrowings would have been 1.18% as of the same date.

 

The Company is required to pledge certain unencumbered mortgage loans and mortgage-related securities as collateral against its outstanding advances from the FHLB of Chicago. Advances are also collateralized by the shares of capital stock of the FHLB of Chicago that are owned by the Company. The Company’s borrowings at the FHLB of Chicago are limited to the lesser of: (i) 35% of total assets; (ii) 22.2 times the FHLB of Chicago capital stock owned by the Company; or (iii) the total of 80% of the book value of one- to four-family mortgage loans, 72% of the book value of certain multi-family mortgage loans, 51% of the book value of certain home equity loans, and 98% of the fair value of certain mortgage-related securities.

 

 23 

 

 

Bank Mutual Corporation and Subsidiaries

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

June 30, 2016

 

(Dollars in Thousands, Except Share and Per Share Amounts)

 

8. Regulatory Capital Requirements

 

The Company and Bank are subject to various regulatory capital requirements administered by federal banking agencies and as defined in applicable regulations. Failure to meet minimum capital requirements can initiate certain mandatory actions and possible additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and Bank must meet specific capital guidelines that involve quantitative measures of assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Company and Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Management believes that, as of June 30, 2016, and December 31, 2015, the Company and the Bank met or exceeded all regulatory capital adequacy requirements to which it is subject. The following table presents the Company and the Bank’s actual and required regulatory capital amounts and ratios as of the dates indicated.

 

   Actual   Required to be
Adequately
Capitalized
   Required to be Well
Capitalized
 
As of June 30, 2016:  Amount   Ratio   Amount   Ratio   Amount   Ratio 
At the Company:                              
Total risk-weighted capital  $303,819    15.32%  $158,633    8.00%  $198,291    10.00%
Tier 1 risk-weighted capital   285,857    14.42    118,975    6.00    158,633    8.00 
CET1 risk-weighted capital   285,857    14.42    89,231    4.50    128,889    6.50 
Tier 1 leverage capital   285,857    11.29    101,312    4.00    126,640    5.00 
At the Bank:                              
Total risk-weighted capital  $277,153    13.98%  $158,613    8.00%  $198,266    10.00%
Tier 1 risk-weighted capital   259,191    13.07    118,960    6.00    158,613    8.00 
CET1 risk-weighted capital   259,191    13.07    89,220    4.50    128,873    6.50 
Tier 1 leverage capital   259,191    10.14    102,282    4.00    127,853    5.00 

 

As of December 31, 2015:  Amount   Ratio   Amount   Ratio   Amount   Ratio 
At the Company:                              
Total risk-weighted capital  $296,709    15.83%  $149,922    8.00%  $187,402    10.00%
Tier 1 risk-weighted capital   279,068    14.89    112,441    6.00    149,922    8.00 
CET1 risk-weighted capital   279,068    14.89    84,331    4.50    121,811    6.50 
Tier 1 leverage capital   279,068    11.37    98,197    4.00    122,747    5.00 
At the Bank:                              
Total risk-weighted capital  $272,568    14.55%  $149,900    8.00%  $187,375    10.00%
Tier 1 risk-weighted capital   254,927    13.61    112,425    6.00    149,900    8.00 
CET1 risk-weighted capital   254,927    13.61    84,319    4.50    121,794    6.50 
Tier 1 leverage capital   254,927    10.48    97,328    4.00    121,660    5.00 

 

 24 

 

 

Bank Mutual Corporation and Subsidiaries

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

June 30, 2016

 

(Dollars in Thousands, Except Share and Per Share Amounts)

 

9. Earnings Per Share

 

The following table summarizes the computation of basic and diluted earnings per share for the periods indicated:

 

   Three Months Ended   Six Months Ended 
   June 30   June 30 
   2016   2015   2016   2015 
                 
Net income  $3,949   $3,589   $8,422   $7,142 
Weighted average shares outstanding   45,047,410    45,960,012    45,058,399    46,099,294 
Vested restricted stock for period   118,509    65,934    105,025    57,458 
Basic shares outstanding   45,165,919    46,025,946    45,163,424    46,156,752 
Net dilutive effect of:                    
Stock option shares   412,784    364,640    399,451    351,327 
Non-vested restricted stock   54,410    36,288    50,799    33,265 
Diluted shares outstanding   45,633,113    46,426,874    45,613,674    46,541,344 
Basic earnings per share  $0.09   $0.08   $0.18   $0.15 
Diluted earnings per share  $0.09   $0.08   $0.18   $0.15 

 

The Company had stock options for 362,534 and 361,000 shares outstanding as of June 30, 2016 and 2015, respectively, that were not included in the computation of diluted earnings per share because they were anti-dilutive. These options had weighted average exercise prices of $8.17 and $8.07 per share as of those dates, respectively.

 

10. Employee Benefit Plans

 

The Company has a discretionary, defined contribution savings plan (the “Savings Plan”). The Savings Plan is qualified under Sections 401 and 401(k) of the Internal Revenue Code and provides employees meeting certain minimum age and service requirements the ability to make contributions to the Savings Plan on a pretax basis. The Company then matches a percentage of the employee’s contributions. Matching contributions expensed by the Company were $210 and $214 during the three months ended June 30, 2016 and 2015, respectively, and $425 and $408 during the six months ended June 30, 2016 and 2015, respectively.

 

The Company also has a qualified defined benefit pension plan covering employees meeting certain minimum age and service requirements and a supplemental defined benefit pension plan for certain eligible employees. The supplemental pension plan is funded through a "rabbi trust" arrangement. The benefits under these plans are generally based on the employee’s years of service and average annual wages, as defined in the plan. The Company’s funding policy is to contribute annually the amount necessary to satisfy the requirements of the Employee Retirement Income Security Act of 1974. In prior periods the Company closed the qualified defined benefit pension plan to new participants and froze the benefits of all existing participants. These changes resulted in the future benefits under the Company’s supplemental defined benefit pension plan also being effectively frozen.

 

 25 

 

 

Bank Mutual Corporation and Subsidiaries

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

June 30, 2016

 

(Dollars in Thousands, Except Share and Per Share Amounts)

 

10. Employee Benefit Plans (continued)

 

The following table summarizes the qualified plan’s net periodic benefit cost for the periods indicated:

 

   Three Months Ended
June 30
   Six Months Ended
June 30
 
   2016   2015   2016   2015 
Service cost      $242       $484 
Interest cost  $669    660   $1,338    1,320 
Expected return on plan assets   (861)   (735)   (1,722)   (1,470)
Amortization of net loss from earlier periods   57    656    114    1,312 
Net periodic benefit cost  $(135)  $823   $(270)  $1,646 

 

The following table summarizes the supplemental plan’s net periodic costs for the periods indicated.

 

   Three Months Ended
June 30
   Six Months Ended
June 30
 
   2016   2015   2016   2015 
Interest cost  $93   $99   $186   $198 
Amortization of net loss from earlier periods   26    23    52    46 
Net periodic benefit cost  $119   $122   $238   $244 

 

A contribution of $650,000 to the qualified plan is expected to be made in the third quarter of 2016. This contribution was determined based on a number of factors, including the results of an actuarial valuation report as of January 1, 2016. No contribution is necessary for the supplemental plan.

 

11. Stock-Based Benefit Plans

 

In 2004 the Company’s shareholders approved the 2004 Stock Incentive Plan (the “2004 Plan”). Options and restricted stock granted under the 2004 Plan vested over five years and options had expiration terms of ten years. No further awards may be made under the 2004 Plan.

 

In 2014 the Company’s shareholders approved the 2014 Incentive Compensation Plan (the “2014 Plan”), which provides for the award of stock options, stock appreciation rights, restricted stock, restricted stock units, performance shares, and cash awards. Stock-related awards under the 2014 Plan vest over a period of three or more years and, if applicable, have a maximum term of ten years. The number of shares of common stock of the Company that may be issued under the 2014 Plan is limited to 3,000,000 shares. As of June 30, 2016, 2,497,600 shares remain eligible for award under the 2014 Plan.

 

Restricted stock grants are amortized to compensation expense as the Company’s employees and directors become vested in the granted shares. The amount amortized to expense was $204 and $201 for the three months ended June 30, 2016 and 2015, respectively. The amount amortized to expense was $479 and $405 for the six months ended June 30, 2016 and 2015, respectively. Outstanding non-vested restricted stock grants had a fair value of $2,286 and an unamortized cost of $1,986 at June 30, 2016. The cost of these shares is expected to be recognized over a weighted-average period of 1.31 years.

 

During the three months ended June 30, 2016 and 2015, the Company recorded stock option compensation expense of $90 and $102, respectively. During the six months ended June 30, 2016 and 2015, the Company recorded stock option compensation expense of $180 and $207, respectively. As of June 30, 2016, there was $611 in total unrecognized stock option compensation expense related to non-vested options. This cost is expected to be recognized over a weighted-average period of 1.07 years.

 

 26 

 

 

Bank Mutual Corporation and Subsidiaries

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

June 30, 2016

 

(Dollars in Thousands, Except Share and Per Share Amounts)

 

11. Stock-Based Benefit Plans (continued)

 

The following table summarizes the activity in the Company’s stock options during the periods indicated:

 

   Six Months Ended June 30 
   2016   2015 
   Stock
Options
   Weighted
Average
Exercise
Price
   Stock
Options
   Weighted
Average
Exercise
Price
 
Outstanding at beginning of period   1,421,500   $5.4378    1,631,000   $5.2980 
Granted   56,300    7.2900    37,000    6.7000 
Exercised   (57,334)   4.9148    (71,900)   4.5487 
Forfeited   (5,132)   6.1322    (16,600)   5.5808 
Outstanding at end of period   1,415,334   $5.5301    1,579,500   $5.3619 

 

The following table provides additional information regarding the Company’s outstanding options as of June 30, 2016.

 

   Remaining   Non-Vested Options   Vested Options 
   Contractual
Life
   Stock
Options
   Intrinsic
Value
   Stock
Options
   Intrinsic
Value
 
Exercise price:                         
$11.160   1.8            32,000     
$12.025   2.1            50,000     
$7.226   3.8            50,000   $23 
$4.740   4.5            70,000    206 
$5.050   4.5            236,000    621 
$4.300   4.7            25,000    85 
$3.720   5.1    2,500   $10    10,000    40 
$3.390   5.5    65,000    279    243,000    1,042 
$3.800   5.8    2,000    8    8,000    31 
$4.820   6.6    95,200    272    148,600    425 
$5.360   6.8    8,000    19    12,000    28 
$5.700   6.9    8,000    16    12,000    24 
$6.340   7.1    6,000    8    4,000    5 
$7.170   7.6    109,800    56    77,100    39 
$6.010   7.8    4,500    8    3,000    5 
$5.850   7.9    6,666    12    13,334    24 
$6.100   8.1    13,333    21    6,667    11 
$6.700   8.6    19,996    20    10,338    10 
$7.190   9.1    7,000    3         
$7.290   9.6    56,300    22         
Total        404,295   $754    1,011,039   $2,619 
Weighted-average remaining contractual life        7.3 years         5.3 years      
Weighted-average exercise price       $5.8175        $5.4152      

 

There were 57,334 options exercised during the six months ended June 30, 2016, which had an intrinsic value of $155. There were 71,900 options exercised during the six months ended June 30, 2015, which had an intrinsic value of $190. The weighted average grant date fair value of non-vested options at June 30, 2016, was $1.75 per share. During the six months ended June 30, 2016, options for 56,300 shares were granted, options for 243,038 shares became vested, and 5,132 non-vested options shares were forfeited.

 

 27 

 

 

Bank Mutual Corporation and Subsidiaries

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

June 30, 2016

 

(Dollars in Thousands, Except Share and Per Share Amounts)

 

11. Stock-Based Benefit Plans (continued)

 

The Company uses the Black-Scholes option-pricing model to estimate the fair value of granted options. This model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. However, the Company's stock options have characteristics significantly different from traded options and changes in the subjective input assumptions can materially affect the fair value estimate. Option valuation models such as Black-Scholes require the input of highly subjective assumptions including the expected stock price volatility, which is computed using ten years of actual price activity in the Company’s stock. The Company uses historical data of employee behavior as a basis to estimate the expected life of the options, as well as forfeitures due to employee terminations. The Company also uses its actual dividend yield at the time of the grant, as well as actual U.S. Treasury yields in effect at the time of the grant to estimate the risk-free rate. The following weighted-average assumptions were used to value 56,300 options granted during the six month period ended June 30, 2016: risk free rate of 1.80%, dividend yield of 2.74%, expected stock volatility of 31%, and expected term to exercise of 7.5 years. These options had a weighted-average value of $2.28 per option using these assumptions. The following weighted-average assumptions were used to value 37,000 options granted during the six month period ended June 30, 2015: risk free rate of 1.75%, dividend yield of 2.40%, expected stock volatility of 34%, and expected term to exercise of 7.5 years. These options had a weighted-average value of $2.09 per option using these assumptions.

 

12. Financial Instruments with Off-Balance Sheet Risk and Derivative Financial Instruments

 

The Company is party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments consist of commitments to extend credit and involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized in the Consolidated Statements of Financial Condition. The contract amounts reflect the extent of involvement the Company has in particular classes of financial instruments and also represents the Company’s maximum exposure to credit loss.

 

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and generally require payment of a fee. As some commitments expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates the collateral needed and creditworthiness of each customer on a case by case basis. The Company generally extends credit only on a secured basis. Collateral obtained varies, but consists principally of one- to four-family residences.

 

Off-balance sheet financial instruments or obligations whose contract amounts represent credit and/or interest rate are summarized in the following table as of the dates indicated:

 

   June 30   December 31 
   2016   2015 
Unused commercial lines of credit  $158,779   $146,183 
Commercial loans   10,034    6,772 
Standby letters of credit   4,359    4,458 
Real estate loan commitments:          
Fixed rate   62,917    36,921 
Adjustable rate   349,040    308,173 
Unused consumer lines of credit   165,730    164,989 

 

 28 

 

 

Bank Mutual Corporation and Subsidiaries

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

June 30, 2016

 

(Dollars in Thousands, Except Share and Per Share Amounts)

 

12. Financial Instruments with Off-Balance Sheet Risk and Derivative Financial Instruments (continued)

 

The Company sells substantially all of its long-term, fixed-rate, one- to four-family loan originations in the secondary market. The Company uses interest rate lock commitments (“IRLCs”) and forward commitments to sell loans to manage interest rate risk associated with its loan sales activities, both of which are considered to be free-standing derivative financial instruments under GAAP. Changes in the fair value of the derivative instruments are recognized currently through earnings. During the three months ended June 30, 2016 and 2015, net unrealized gains (losses) of $(42) and $170, respectively, were recognized in net gain on loan sales activities on these derivative instruments. During the six months ended June 30, 2016 and 2015, net unrealized gains of $36 and $206, respectively, were recognized in net gain on loan sales activities on these derivative instruments. These amounts were exclusive of net unrealized gains (losses) of $96 and $16 on loans held-for-sale for the three months ended June 30, 2016 and 2015, respectively, and $137 and $(80) for the six month ended June 30, 2016 and 2015, respectively, which were also included in net gain on loan sales activities.

 

The Company enters into interest rate swap arrangements to manage the interest rate risk exposure associated with specific commercial loan relationships at the time such loans are originated. These interest rate swaps, as well as the embedded derivatives associated with certain of its commercial loan relationships, are free-standing derivative instruments under GAAP. As such, changes in the fair value of these derivative instruments are recognized currently through earnings. During the three months ended June 30, 2016 and 2015, net unrealized gains of $85 and $205, respectively, and net losses of $85 and $205, respectively, related to interest rate swaps and embedded derivatives were recorded in loan-related fees. During the six months ended June 30, 2016 and 2015, net unrealized gains of $453 and $55, respectively, and net losses of $453 and $55, respectively, related to interest rate swaps and embedded derivatives were recorded in loan-related fees.

 

The Company also enters into interest rate swap arrangements to manage the interest rate risk exposure associated with certain forecasted borrowings from the FHLB of Chicago. These interest rate swaps have been designated as forecasted transaction cash flow hedges by management (refer to Note 7, “Borrowings”). As such, the effective portion of the change in the fair value of these derivatives is recorded in other comprehensive income and the ineffective portion was recorded in interest expense. During the three and six months ended June 30, 2016, $40 and $198 in unrealized loss net of tax related to interest rate swaps was recorded in other comprehensive income, respectively. There was no net unrealized gain or loss related to interest rate swaps recorded in other comprehensive income during the three and six months ended June 30, 2015. There was no ineffective portion of this hedge for any of these periods.

 

The following table summarizes the Company’s derivative assets and liabilities as of the dates indicated:

 

   June 30, 2016   December 31, 2015 
   Notional
Amount
   Fair Value   Notional
Amount
   Fair Value 
Interest rate lock commitments  $20,027   $573   $7,961   $166 
Forward commitments to sell loans   20,744    (446)   9,543    (72)
Embedded free-standing derivatives on commercial loans
   23,283    1,157    23,559    705 
Receive-fixed free-standing interest rate swaps   195,126    12,183    82,780    2,648 
Pay-fixed free-standing interest rate swaps   218,409    (13,340)   106,339    (3,353)
Pay-fixed cash flow hedge interest rate swaps   20,000    (331)   20,000     
Net unrealized gains (losses)       $(204)       $94 

 

The unrealized gains shown in the above table were included as a component of other assets as of the dates indicated. The unrealized losses were included in other liabilities as of the dates indicated.

 

 29 

 

 

Bank Mutual Corporation and Subsidiaries

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

June 30, 2016

 

(Dollars in Thousands, Except Share and Per Share Amounts)

 

13. Fair Value Measurements

 

Fair value is 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 (exit price). The Company utilizes market data or assumptions that market participants would use in pricing the asset or liability, including assumptions about risk and the risks inherent in the inputs to the valuation technique. These inputs can be readily observable, market corroborated, or generally unobservable. The Company primarily applies the market approach for recurring value measurements and endeavors to utilize the best available information. Accordingly, the Company utilizes valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs. The Company is able to classify fair value measurements based on the observability of those inputs. Accounting guidance establishes a fair value hierarchy that prioritizes the inputs used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1), the next highest priority is given to prices based on models, methodologies, and/or management judgments that rely on direct or indirect observable inputs (Level 2), and the lowest priority to prices derived from models, methodologies, and/or management judgments that rely on significant unobservable inputs (Level 3). There were no transfers of assets or liabilities between categories of the fair value hierarchy during the six months ended June 30, 2016.

 

The methods and assumptions used by the Company in estimating the fair value of its financial instruments, whether or not such fair values are recognized in the consolidated financial statements, are summarized below:

 

Cash and Cash Equivalents The carrying amounts reported in the statements of financial condition for cash and cash equivalents approximate those assets’ fair values. The Company considers the fair value of cash and cash equivalents to be Level 1 in the fair value hierarchy.

 

Mortgage-Related Securities Available-for-Sale and Held-to-Maturity Fair values for these securities are based on price estimates obtained from a third-party independent pricing service. This service utilizes pricing models that vary by asset class and incorporate available trade, bid, ask, and other market information of comparable instruments. For structured securities, such as CMOs, the pricing models include cash flow estimates that consider the impact of loan performance data, including, but not limited to, expectations relating to loan prepayments, default rates, and loss severities. Management has reviewed the pricing methodology used by its pricing service to verify that prices are determined in accordance with the fair value guidance specified in GAAP. The Company considers the fair value of mortgage-related securities to be Level 2 in the fair value hierarchy.

 

Loans Receivable Loans receivable are segregated by type such as one- to four-family, multi-family, and commercial real estate mortgage loans, consumer loans, and commercial business loans. The fair value of each type is calculated by discounting scheduled cash flows through the expected maturity of the loans using estimated market discount rates that reflect the credit and interest rate risk inherent in the loan type. The estimated maturity is based on the Company’s historical experience with prepayments for each loan classification, modified, as required, by an estimate of the effect of current economic and lending conditions. The Company considers the fair value of loans receivable to be Level 3 in the fair value hierarchy.

 

Mortgage Servicing Rights The Company estimates the fair market value of MSRs for those loans that are sold with servicing rights retained. For valuation purposes, the related loans are stratified into pools by product type and, within product type, by interest rates. The fair value of the MSR pools is based upon the present value of estimated future cash flows using current market assumptions for prepayments, servicing cost, and other factors. The Company considers the fair value of MSRs to be Level 3 in the fair value hierarchy.

 

 30 

 

 

Bank Mutual Corporation and Subsidiaries

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

June 30, 2016

 

(Dollars in Thousands, Except Share and Per Share Amounts)

 

13. Fair Value Measurements (continued)

 

The following table summarizes the significant inputs utilized by the Company to estimate the fair value of its MSRs as of June 30, 2016:

 

   Weighted-
Average
   Range
Loan size  $116   $1-$417
Contractual interest rate   3.72%  2.50%-7.10%
Constant prepayment rate (“CPR”)   13.12%  2.56%-24.19%
Remaining maturity in months   218   2-480
Servicing fee   0.25% 
Annual servicing cost per loan (not in thousands)  $60  
Annual ancillary income per loan (not in thousands)  $30  
Discount rate   9.17%  9.13%-10.88%

 

MSR pools with an amortized cost basis greater than fair value are carried at fair value in the Company’s financial statements. There were no pools determined to be impaired at June 30, 2016, or December 31, 2015. Accordingly, the Company had no valuation allowance as of June 30, 2016, or December 31, 2015.

 

Federal Home Loan Bank Stock FHLB of Chicago stock is carried at cost, which is its redeemable (fair) value, since the market for this stock is restricted. The Company considers the fair value of FHLB of Chicago stock to be Level 2 in the fair value hierarchy.

 

Accrued Interest Receivable and Payable The carrying values of accrued interest receivable and payable approximate their fair value. The Company considers the fair value of accrued interest receivable and payable to be Level 2 in the fair value hierarchy.

 

Deposit Liabilities and Advance Payments by Borrowers for Taxes and Insurance Fair value for demand deposits equal book value. The Company considers the fair value of demand deposits to be Level 2 in the fair value hierarchy. Fair values for certificates of deposits are estimated using a discounted cash flow calculation that applies current market borrowing interest rates to a schedule of aggregated expected monthly maturities on deposits. The Company considers the fair value of certificates of deposit to be Level 3 in the fair value hierarchy. The advance payments by borrowers for taxes and insurance are equal to their carrying amounts at the reporting date. The Company considers the fair value of advance payment by borrowers to be Level 2 in the fair value hierarchy.

 

Borrowings The fair value of long-term borrowings is estimated using discounted cash flow calculations with the discount rates equal to interest rates currently being offered for borrowings with similar terms and maturities. The carrying value on short-term borrowings approximates fair value. The Company considers the fair value of borrowings to be Level 2 in the fair value hierarchy.

 

Financial Instruments with Off-Balance Sheet Risk and Derivative Financial Instruments Off-balance sheet financial instruments consist of commitments to extend credit, IRLCs, forward commitments to sell loans, interest rate swaps, and embedded derivatives related to certain commercial loan relationships. Commitments to extend credit that are not IRLCs generally carry variable rates of interest. As such, the fair value of these instruments is not material. The Company considers the fair value of these instruments to be Level 2 in the fair value hierarchy. The carrying value of IRLCs, forward commitments to sell loans, interest rate swaps, and embedded derivatives is equal to their fair value. For IRLCs and forward commitments, the fair value is the difference between the current market prices for securities collateralized by similar loans and the notional amounts of the IRLCs and forward commitments. The fair value of the Company’s interest rate swaps and embedded derivatives is determined using discounted cash flow analysis on the expected cash flows of each derivative and also includes a nonperformance or credit risk component. The Company considers the fair value of IRLCs, forward commitments to sell loans, interest rate swaps, and embedded derivatives to be Level 2 in the fair value hierarchy.

 

 31 

 

 

Bank Mutual Corporation and Subsidiaries

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

June 30, 2016

 

(Dollars in Thousands, Except Share and Per Share Amounts)

 

13. Fair Value Measurements (continued)

 

The carrying values and fair values of the Company’s financial instruments are presented in the following table as of the indicated dates.

 

   June 30
2016
   December 31
2015
 
   Carrying
Value
   Fair
Value
   Carrying
Value
   Fair
Value
 
Cash and cash equivalents  $41,207   $41,207   $44,501   $44,501 
Mortgage related securities available-for-sale   413,871    413,871    407,874    407,874 
Mortgage related securities held-to-maturity   110,474    114,479    120,891    121,641 
Loans held-for-sale   5,453    5,453    3,350    3,350 
Loans receivable, net   1,858,059    1,876,576    1,740,018    1,751,670 
Mortgage servicing rights, net   6,834    7,358    7,205    9,455 
Federal Home Loan Bank stock   18,365    18,365    17,591    17,591 
Accrued interest receivable   6,142    6,142    6,035    6,035 
Deposit liabilities   1,836,737    1,819,919    1,795,591    1,786,934 
Borrowings   422,554    431,592    372,375    378,266 
Advance payments by borrowers   19,921    19,921    3,382    3,382 
Accrued interest payable   1,145    1,145    1,091    1,091 
Unrealized gain (loss) on off-balance-sheet items:                    
Interest rate lock commitments   573    573    166    166 
Forward commitments to sell loans   (446)   (446)   (72)   (72)
Embedded free-standing derivatives on commercial loans   1,157    1,157    705    705 
Receive-fixed free-standing interest rate swaps   12,183    12,183    2,648    2,648 
Pay-fixed free-standing interest rate swaps   (13,340)   (13,340)   (3,353)   (3,353)
Pay-fixed cash flow hedge interest rate swaps   (331)   (331)        

 

The following table segregates by fair value hierarchy (i.e., Level 1, 2, or 3) all of the Company's assets and liabilities that were accounted for at fair value on a recurring basis as of the dates indicated:

 

   At June 30, 2016 
   Level 1   Level 2   Level 3   Total 
Loans held-for-sale      $5,453       $5,453 
Mortgage-related securities available-for-sale       413,871        413,871 

 

   At December 31, 2015 
   Level 1   Level 2   Level 3   Total 
Loans held-for-sale      $3,350       $3,350 
Mortgage-related securities available-for-sale       407,874        407,874 

 

Impaired Loans For non-accrual loans greater than an established threshold and individually evaluated for impairment and all renegotiated loans, impairment is measured based on: (i) the fair value of the loan or the fair value of the collateral less estimated selling costs (collectively the “collateral value method”) or (ii) the present value of the estimated cash flows discounted at the loan’s original effective interest rate (the “discounted cash flow method”). The resulting valuation allowance, if any, is a component of the allowance for loan losses. The discounted cash flow method is a fair value measure. For the collateral value method, the Company generally obtains appraisals on a periodic basis to support the fair value of collateral underlying the loans. Appraisals are performed by independent certified and/or licensed appraisers that have been reviewed by the Company and incorporate information such as recent sales prices for comparable properties, costs of construction, and net

 

 32 

 

 

Bank Mutual Corporation and Subsidiaries

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

June 30, 2016

 

(Dollars in Thousands, Except Share and Per Share Amounts)

 

13. Fair Value Measurements (continued)

 

operating income of the property or business. Selling costs are generally estimated at 10%. Appraised values may be further discounted based on management judgment regarding changes in market conditions and other factors since the time of the appraisal. A significant unobservable input in using net operating income to estimate fair value is the capitalization rate. At June 30, 2016, the range of capitalization rates utilized to determine the fair value of the underlying collateral on certain loans was 5.5% to 12%. The Company considers these fair values to be Level 3 in the fair value hierarchy. For those loans individually evaluated for impairment using the collateral value method, a valuation allowance of $196 was recorded for loans with a recorded investment of $25,424 at June 30, 2016. These amounts were $535 and $37,119 at December 31, 2015, respectively. Provision for (recovery of) loan losses related to these loans was $(339) during the six months ended June 30, 2016, and $535 during the twelve month period ended December 31, 2015. Provision for (recovery of) loan losses related to impaired loans at June 30, 2015, was $(21) for the six months ended June 30, 2015.

 

Foreclosed Properties Foreclosed properties acquired through, or in lieu of, loan foreclosure are recorded at the lower of cost or fair value less estimated costs to sell. In determining fair value, the Company generally obtains appraisals to support the fair value of foreclosed properties, as described in the previous paragraph. In certain instances, the Company may also use the selling list price, less estimated costs to sell, as the fair value of foreclosed properties. In such instances, the list price is generally less than the appraised value. The Company considers these fair values to be Level 3 in the fair value hierarchy. As of June 30, 2016, $2,252 in foreclosed properties was valued at collateral value compared to $2,794 at December 31, 2015. Losses of $19 and $330 related to these foreclosed properties were recorded during the six months ended June 30, 2016, and the twelve months ended December 31, 2015, respectively. Losses on foreclosed properties valued at collateral value at June 30, 2015 were $425 for the six months ended June 30, 2015.

 

 33 

 

 

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

 

Cautionary Statement

 

This report contains or incorporates by reference various forward-looking statements concerning the Company's prospects that are based on the current expectations and beliefs of management. Forward-looking statements may contain, and are intended to be identified by, words such as “anticipate,” “believe,” “estimate,” “expect,” “objective,” “projection,” “intend,” and similar expressions; the use of verbs in the future tense and discussions of periods after the date on which this report is issued are also forward-looking statements. The statements contained herein and such future statements involve or may involve certain assumptions, risks, and uncertainties, many of which are beyond the Company's control, that could cause the Company's actual results and performance to differ materially from what is stated or expected. In addition to the assumptions and other factors referenced specifically in connection with such statements, the following factors could impact the business and financial prospects of the Company: general economic conditions, including volatility in credit, lending, and financial markets; weakness and declines in the real estate market, which could affect both collateral values and loan activity; periods of relatively high unemployment or economic weakness and other factors which could affect borrowers’ ability to repay their loans; negative developments affecting particular borrowers, which could further adversely impact loan repayments and collection; legislative and regulatory initiatives and changes, including action taken, or that may be taken, in response to difficulties in financial markets and/or which could negatively affect the rights of creditors; monetary and fiscal policies of the federal government; the effects of further regulation and consolidation within the financial services industry; regulators’ strict expectations for financial institutions’ capital levels and restrictions imposed on institutions, as to payments of dividends, share repurchases, or otherwise, to maintain or achieve those levels; recent, pending, and/or potential rulemaking or various federal regulatory agencies that could affect the Company or the Bank; increased competition and/or disintermediation within the financial services industry; changes in tax rates, deductions and/or policies; potential further changes in Federal Deposit Insurance Corporation (“FDIC”) premiums and other governmental assessments; changes in deposit flows; changes in the cost of funds; fluctuations in general market rates of interest and/or yields or rates on competing loans, investments, and sources of funds; demand for loan or deposit products; illiquidity of financial markets and other negative developments affecting particular investment and mortgage-related securities, which could adversely impact the fair value of and/or cash flows from such securities; changes in customers’ demand for other financial services; the Company’s potential inability to carry out business plans or strategies; changes in accounting policies or guidelines; natural disasters, acts of terrorism, or developments in the war on terrorism or other global conflicts; the risk of failures in computer or other technology systems or data maintenance, or breaches of security relating to such systems; and the factors discussed in the Company’s filings with the Securities and Exchange Commission, particularly under Part I, Item 1A, “Risk Factors,” of the Company’s 2015 Annual Report on Form 10-K.

 

Results of Operations

 

Overview The Company’s net income was $3.9 million or $0.09 per diluted share in the second quarter of 2016 compared to $3.6 million or $0.08 per diluted share in the same quarter of the previous year. Year-to-date, the Company reported net income of $8.4 million or $0.18 per diluted share in 2016 compared to $7.1 million or $0.15 per diluted share in the same six-month period in 2015. Net income during the three- and six-month periods in 2016 represented a return on assets (“ROA”) of 0.61% and 0.66%, respectively, and a return on equity (“ROE”) of 5.54% and 5.93%, respectively. This figures compared to ROA of 0.60% in both of the 2015 periods, respectively, and an ROE of 5.10% and 5.07% in the 2015 periods, respectively. The improvements in earnings between these periods were principally due to higher net interest income, higher loan-related fees, lower compensation-related expenses, and lower occupancy, equipment, and data processing costs. Also contributing were net gains and expenses on foreclosed real estate in the 2016 periods compared to net losses and expenses in the 2015 periods. These improvements were partially offset by provision for loan losses in the 2016 periods compared to recoveries in the 2015 periods, as well as higher advertising and marketing expenses and higher income tax expense. Also impacting the year-to-date comparison were lower brokerage and insurance commissions in 2016 compared to 2015. The following paragraphs describe these changes in greater detail, along with other matters affecting the Company’s results of operations during the three months ended June 30, 2016 and 2015.

 

 34 

 

 

Net Interest Income The Company’s net interest income increased by $556,000 or 3.3% and by $1.0 million or 3.1% during the three and six months ended June 30, 2016, respectively, compared to the same periods in 2015, respectively. These increases were due in part to an increase in the Company’s average earning assets in the 2016 periods compared to the same periods in the prior year, as well an increase in funding from non-interest bearing checking accounts between the periods. Also contributing to the increase in the 2016 year-to-date period was a call premium of $482,000 that the Company received on a mortgage-related security that was called in the first quarter of the year. These developments were partially offset by a decrease in the Company’s net interest margin in the 2016 periods compared to the same periods in 2015.

 

The Company’s average earning assets increased by $167.0 million or 7.7% during the six months ended June 30, 2016, compared to the same period in 2015. This increase was primarily attributable to a $160.0 million or 9.9% increase in average loans receivable during the 2016 six-month period compared to the same period in the prior year.

 

Also contributing favorably to the Company’s net interest income in the 2016 periods, as well as its net interest margin, was an increase in funding from non-interest-bearing checking accounts. The average balance in these accounts increased by $26.5 million or 13.2% during the six months ended June 30, 2016, compared to the same period in 2015.

 

The Company’s net interest margin was 3.01% during the first six months of 2016. Excluding the impact of the aforementioned call premium, net interest margin during the first six months of 2016 would have been 2.97%, which compares to 3.15% during the same six-month period in 2015. In the 2016 six-month period the average yield on the Company’s earning assets decreased by 14 basis points (excluding the call premium) and its average cost of funds increased by five basis points compared to the prior-year six-month period. The decrease in the average yield on earning assets was largely due to the continued repricing of the Company’s loan portfolio to lower yields in the current interest rate environment, as well as its continued emphasis on the origination of variable-rate loans, which generally have lower initial yields than fixed-rate loans. Also contributing to the decrease in yield on earning assets was the purchase of mortgage-related securities in 2016 at yields that were less than the prevailing rates in the investment portfolio.

 

The increase in the Company’s average cost of funds was primarily due to a six basis point increase in its average cost of deposits during the first six months of 2016 compared to the same period in the prior year. The impact of this increase was offset slightly by a decline in the average cost of borrowings from the FHLB of Chicago. This decline was caused by an increase in overnight borrowings, which were drawn to fund growth in earning assets, as previously noted. Overnight borrowings generally have a lower interest cost than the rates the Company offers on its certificates of deposit.

 

 35 

 

 

The following tables present certain details regarding the Company's average balance sheet and net interest income for the periods indicated. The tables present the average yield on interest-earning assets and the average cost of interest-bearing liabilities. The yields and costs are derived by dividing income or expense by the average balance of interest-earning assets or interest-bearing liabilities, respectively, for the periods shown. The average balances are derived from daily balances over the periods indicated. Interest income includes fees, which are considered adjustments to yields. Net interest spread is the difference between the yield on interest-earning assets and the rate paid on interest-bearing liabilities. Net interest margin is derived by dividing net interest income by average interest-earning assets. The Company’s tax exempt investments are insignificant, so no tax equivalent adjustments have been made.

 

   Three Months Ended June 30 
   2016   2015 
       Interest   Average       Interest   Average 
   Average   Earned/   Yield/   Average   Earned/   Yield/ 
   Balance   Paid   Rate   Balance   Paid   Rate 
   (Dollars in thousands) 
Assets:                              
Interest-earning assets:                              
Loans receivable (1)  $1,815,579   $17,360    3.82%  $1,617,213   $16,337    4.04%
Mortgage-related securities   519,808    2,722    2.09    530,732    2,871    2.16 
Investment securities (2)   18,323    119    2.60    15,973    57    1.43 
Interest-earning deposits   18,415    10    0.22    19,192    6    0.13 
Total interest-earning assets   2,372,125    20,211    3.41    2,183,110    19,271    3.53 
Non-interest-earning assets   204,756              216,403           
Total average assets  $2,576,881             $2,399,513           
                               
Liabilities and equity:                              
Interest-bearing liabilities:                              
Regular savings deposits   228,337    7    0.01    222,429    14    0.03 
Money market accounts   530,593    211    0.16    504,880    183    0.14 
Interest-bearing demand accounts   272,107    13    0.02    247,730    7    0.01 
Certificates of deposit   546,553    1,215    0.89    536,860    948    0.71 
Total deposit liabilities   1,577,590    1,446    0.37    1,511,899    1,152    0.30 
Advance payments by borrowers for taxes and insurance   16,997        0.00    18,068        0.00 
Borrowings   382,396    1,247    1.30    298,470    1,157    1.55 
Total interest-bearing liabilities   1,976,983    2,693    0.54    1,828,437    2,309    0.51 
Non-interest-bearing liabilities:                              
Non-interest-bearing deposits   234,390              208,688           
Other non-interest-bearing liabilities   80,449              80,920           
Total non-interest-bearing liabilities   314,839              289,608           
Total liabilities   2,291,822              2,118,045           
Total equity   285,059              281,468           
Total average liabilities and equity  $2,576,881             $2,399,513           
Net interest income and net interest rate spread       $17,518    2.87%       $16,962    3.02%
Net interest margin             2.95%             3.11%
Average interest-earning assets to average interest-bearing liabilities   1.20x             1.19x          

 

(1)For the purposes of these computations, non-accruing loans and loans held-for-sale are included in loans receivable.
(2)The carrying value and earnings on stock in the FHLB of Chicago is included in investment securities.

 

 36 

 

 

   Six Months Ended June 30 
   2016   2015 
       Interest   Average       Interest   Average 
   Average   Earned/   Yield/   Average   Earned/   Yield/ 
   Balance   Paid   Rate   Balance   Paid   Rate 
   (Dollars in thousands) 
Assets:    
Interest-earning assets:                              
Loans receivable (1)  $1,778,316   $34,296    3.86   $1,618,290   $32,854    4.06%
Mortgage-related securities   521,904    5,983    2.29    517,623    5,713    2.21 
Investment securities (2)   18,209    221    2.43    15,420    104    1.35 
Interest-earning deposits   17,075    18    0.21    17,210    10    0.12 
Total interest-earning assets   2,335,504    40,518    3.47    2,168,543    38,681    3.57 
Non-interest-earning assets   204,564              217,729           
Total average assets  $2,540,068             $2,386,272           
                               
Liabilities and equity:                              
Interest-bearing liabilities:                              
Regular savings deposits   223,358    15    0.01    220,454    28    0.03 
Money market accounts   527,494    399    0.15    507,717    368    0.14 
Interest-bearing demand accounts   265,389    25    0.02    243,428    15    0.01 
Certificates of deposit   547,351    2,412    0.88    537,174    1,835    0.68 
Total deposit liabilities   1,563,592    2,851    0.36    1,508,773    2,246    0.30 
Advance payments by borrowers for taxes and insurance   12,717    0.00    0.00    13,660    0.00    0.00 
Borrowings   370,608    2,500    1.35    294,975    2,309    1.57 
Total interest-bearing liabilities   1,946,917    5,351    0.55    1,817,408    4,555    0.50 
Non-interest-bearing liabilities:                              
Non-interest-bearing deposits   227,082              200,576           
Other non-interest-bearing liabilities   82,214              86,774           
Total non-interest-bearing liabilities   309,296              287,350           
Total liabilities   2,256,213              2,104,758           
Total equity   283,855              281,514           
Total average liabilities and equity  $2,540,068             $2,386,272           
Net interest income and net interest rate spread       $35,167    2.92%       $34,126    3.07%
Net interest margin             3.01%             3.15%
Average interest-earning assets to average interest-bearing liabilities   1.20x             1.19x          

 

(3)For the purposes of these computations, non-accruing loans and loans held-for-sale are included in loans receivable.
(4)The carrying value and earnings on stock in the FHLB of Chicago is included in investment securities.

 

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The following tables present the extent to which changes in interest rates and changes in the volume of interest-earning assets and interest-bearing liabilities have affected the Company’s interest income and interest expense during the periods indicated. Information is provided in each category with respect to the change attributable to change in volume (change in volume multiplied by prior rate), the change attributable to change in rate (change in rate multiplied by prior volume), and the net change. The change attributable to the combined impact of volume and rate has been allocated proportionately to the change due to volume and the change due to rate.

 

   Three Months Ended June 30, 2016
Compared to June 30, 2015
 
   Increase (Decrease) 
   Volume   Rate   Net 
  (Dollars in thousands) 
Interest-earning assets:    
Loans receivable  $1,946   $(923)  $1,023 
Mortgage-related securities   (57)   (92)   (149)
Investment securities   9    53    62 
Interest-earning deposits       4    4 
Total interest-earning assets   1,898    (958)   940 
Interest-bearing liabilities:               
Savings accounts   4    (11)   (7)
Money market accounts   9    19    28 
Interest-bearing demand accounts   1    5    6 
Certificates of deposit   17    250    267 
Total deposit liabilities   31    263    294 
Advance payments by borrowers for taxes and insurance            
Borrowings   292    (202)   90 
Total interest-bearing liabilities   323    61    384 
Net change in net interest income  $1,575   $(1,019)  $556 

 

   Six Months Ended June 30, 2016
Compared to June 30, 2015
 
   Increase (Decrease) 
   Volume   Rate   Net 
   (Dollars in thousands) 
Interest-earning assets:               
Loans receivable  $3,113   $(1,671)  $1,442 
Mortgage-related securities   61    209    270 
Investment securities   22    95    117 
Interest-earning deposits       8    8 
Total interest-earning assets   3,196    (1,359)   1,837 
Interest-bearing liabilities:               
Savings accounts   9    (22)   (13)
Money market accounts   14    17    31 
Interest-bearing demand accounts   1    9    10 
Certificates of deposit   36    541    577 
Total deposit liabilities   60    545    605 
Advance payments by borrowers for taxes and insurance            
Borrowings   540    (349)   191 
Total interest-bearing liabilities   600    196    796 
Net change in net interest income  $2,596   $(1,555)  $1,041 

 

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Provision for (recovery of) Loan Losses The Company’s provision for (recovery of) loan losses was $1.2 million in the second quarter of 2016 compared to $(752,000) in the same quarter last year. The provision (recovery) for the six months ended June 30, 2016, was $591,000 compared to $(1.7) million in the same period last year. Management believes that general economic, employment, and real estate conditions continue to be relatively stable in the Company’s local markets. In addition, the Company’s level of non-performing and classified loans, as well as its actual loan charge-offs, have continued to trend lower in recent periods, as noted in “Financial Condition—Asset Quality,” below. However, economic growth in the United States has slowed in recent months and the global economy, in addition to also having slowed, has experienced political-, trade-, and currency-related challenges. Management believes that these developments could be early indications of emerging difficulties in the credit and lending environment for the Company. These conclusions, along with an assessment of the credit risk inherent in the Company’s loan portfolio, have contributed to management’s conclusion that the allowance for loan losses as a percent of total loans has reached a general level that management considers appropriate. As such, the Company’s allowance for loan losses increased from $17.0 million or 0.95% of loans receivable at March 31, 2016, to $18.0 million or 0.97% at June 30, 2016, which is the primary reason for the provision for loan losses in the 2016 periods. Management anticipates that the Company’s provision for loan losses may continue to consist of provisions rather than recoveries for the foreseeable future. This is expected to be particularly true if the Company’s loan portfolio continues to grow as it has in recent periods.

 

Trends in the credit quality of the Company’s loan portfolio are subject to many factors that are outside of the Company’s control, such as economic and market conditions that can fluctuate considerably from period to period. As such, there can be no assurances that there will not be significant fluctuations in the Company’s non-performing loans, classified loans, and/or loan charge-off activity from period to period, which may result in significant variability in the Company’s provision for loan losses.

 

Non-Interest Income Total non-interest income increased by $1.1 million or 18.7% and $1.8 million or 15.7% during the three and six months ended June 30, 2016, respectively, compared to the same periods in 2015, respectively. Significant reasons for the changes in the components of non-interest income are discussed in the following paragraphs.

 

Deposit-related fees and charges declined by $21,000 or 0.7% and by $59,000 or 1.0% during the three and six months ended June 30, 2016, respectively, compared to the same periods in the previous year, respectively. Deposit-related fees and charges consist of overdraft fees, ATM and debit card fees, merchant processing fees, account service charges, and other revenue items related to services performed by the Company for its retail and commercial deposit customers. Management attributes the decline in deposit-related fees and charges to changes in customer spending behavior in recent periods which has resulted in lower revenue from overdraft charges and from check printing commissions. These developments have been partially offset by increased revenue from treasury management and merchant card processing services that the Company offers to commercial depositors.

 

Loan-related fees were $1.6 million and $2.9 million during the three and six months ended June 30, 2016, respectively. These amounts compared to $490,000 and $927,000 during the same periods in 2015, respectively. Loan-related fees consist of periodic income from lending activities that are not deferred as yield adjustments under the applicable accounting rules. The largest source of fees in this revenue category is interest rate swap fees related to commercial loan relationships. The Company mitigates the interest rate risk associated with certain of its loan relationships by executing interest rate swaps, the accounting for which results in the recognition of a certain amount of fee income at the time the swap contracts are executed. The increases in loan-related fees in the 2016 periods were the result of increased loan production, as well as a lower interest rate environment that has increased borrower preference for the types of loan transactions that generate interest rate swap fees. Management believes this source of revenue will vary considerably from period to period depending on the rate environment and on borrower preference for the types of transactions that generate interest rate swaps.

 

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Brokerage and insurance commissions were $846,000 during the second quarter of 2016, which was $24,000 or 2.9% higher than the same quarter in the previous year. Year-to-date this source of revenue was $274,000 or 13.8% lower than the same period in 2015. This revenue item generally consists of commissions earned on sales of tax-deferred annuities, mutual funds, and certain other securities, fees earned for investment advisory services, and commissions earned on sales of personal and business insurance products. However, the prior year periods include certain non-recurring incentive payments. Excluding these payments, brokerage and insurance commissions during the three and six months ended June 30, 2016, were over 30% higher in 2016 periods than they were in the same periods of 2015, respectively. Management attributes this increase to new products, services, systems, and investment advisors that the Company has added in recent periods.

 

Mortgage banking revenue, net, was $1.1 million and $2.0 million during three and six months ended June 30, 2016, respectively. This compared to $974,000 and $1.8 million during the same periods in 2015, respectively. The following table presents the components of mortgage banking revenue, net, for the periods indicated:

 

   Three Months Ended
June 30
   Six Months Ended
June 30
 
   2016   2015   2016   2015 
   (Dollars in thousands) 
Gross loan servicing fees  $637   $666   $1,283   $1,342 
MSR amortization   (554)   (492)   (987)   (1,000)
Change in MSR valuation allowance                
Loan servicing revenue, net   83    174    296    342 
Gain on loan sales activities, net   1,059    800    1,671    1,499 
Mortgage banking revenue, net  $1,142   $974   $1,967   $1,841 

 

Loan servicing revenue, net, decreased during the three- and six-month periods in 2016 compared to the same periods in 2015. These decreases were caused in part by a decline in gross servicing fees due to an overall decline in loans serviced for third-party investors. As of June 30, 2016, the Company serviced $1.02 billion in loans for third-party investors compared to $1.04 billion at December 31, 2015. Also contributing to the decrease in loan servicing revenue, net, in the second quarter of 2016 was an increase in amortization of mortgage servicing rights (“MSRs”). This increase was caused by lower market interest rates for one- to four-family loans in the second quarter, which resulted in increased loan prepayment activity and faster amortization of the related MSRs.

 

The change in valuation allowance that the Company establishes against its MSRs is recorded as a recovery or loss, as the case may be, in the period in which the change occurs. As of June 30, 2016, the Company had no valuation allowance against its MSRs, which had a net book value of $6.8 million as of that date. MSR valuation allowances typically increase in periods of lower market interest rates, which results in a charge to earnings in the period of the increase. During lower market interest rate environments, such as that which has occurred in recent months, loan refinance activity and expectations for future loan prepayments generally increase, which typically reduces the fair value of MSRs and results in an increase in the MSR valuation allowance. However, market interest rates for one- to four-family mortgage loans as of June 30, 2016, were not sufficiently low enough to generate an MSR valuation allowance as of that date. However, there can be no assurances that an increase in the MSR valuation allowance will not be required in the future, particularly if market interest rates for one- to four-family residential loans remain low or decline further.

 

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Gain on loan sales activities, net, was $1.1 million and $1.7 million during the three and six months ended June 30, 2016, respectively, compared to $800,000 and $1.5 million during the same periods in 2015, respectively. The Company typically sells most of the fixed-rate, one- to four-family mortgage loans that it originates. During the first six months of 2016, sales of these loans were $62.6 million, which was $6.6 million or 11.7% higher than the same period of 2015. Management attributes this increase to lower market interest rates for one- to four-family mortgage loans in 2016 compared to 2015. Management expects that lower rates, combined with expectations for an improving housing market in the near term, may result in higher originations and sales of residential loans by the Company during the remainder of 2016 compared to the same period in 2015. As of June 30, 2016, the Company’s pipeline of residential loans intended for sale was the highest it had been since early 2013. However, the origination and sale of residential loans are subject to variations in market interest rates and other factors outside of management’s control. Accordingly, there can be no assurances that such originations and sales will increase or will not vary considerably from period to period.

 

During the second quarter of 2015 the Company recorded a $154,000 gain on the disposition of a real estate property that it held for investment purposes. On a year-to-date basis in 2015, this gain was more than offset by a $320,000 loss that the Company recorded in the first quarter of that year on certain other real estate properties that it held for investment purposes. No real estate properties were sold during the first six months of 2016. The Company continues to actively market certain of the properties that it holds for investment purposes. There can be no assurances that the Company will be able to sell such properties or that gains or losses on sales, if any, will not fluctuate considerably from period to period.

 

Non-Interest Expense Total non-interest expense decreased by $873,000 or 4.9% and $1.5 million or 4.2% during the three and six months ended June 30, 2016, respectively, compared to the same periods in 2015, respectively. Significant reasons for the changes in the components of non-interest expense are discussed in the following paragraphs.

 

Compensation-related expenses decreased by $830,000 or 7.5% and by $1.5 million or 6.9% during the three and six months ended June 30, 2016, respectively, compared to the same periods in 2015, respectively. These decreases were mostly due to lower costs associated with the Company’s defined benefit pension plan, which was due in part to an increase in the discount rate used to determine the present value of the pension obligation, but also to a freeze of the plan’s benefits at the end of 2015. This latter change also resulted in a lengthening of the amortization period for unrealized losses in the pension plan, which further contributed to lower pension costs in 2016. Also contributing to the decreases in compensation-related expenses in the 2016 periods compared to the same periods in the prior year was a decline in the number of employees at the Company. This decline was primarily due to the consolidation of seven retail banking offices in the second quarter of 2015 and an additional four in the first quarter of 2016. These developments were partially offset by normal annual merit increases granted to most employees at the beginning of 2016, as well as higher stock-based compensation and employee commission expense compared to the 2015 periods.

 

Occupancy, equipment, and data processing expenses were $3.3 million and $6.8 million during the three and six months ended June 30, 2016, respectively. These amounts compared to $3.3 million and $7.1 million during the same periods in 2015, respectively. The six-month period in the prior year included $269,000 in one-time costs associated with the Company’s announcement that it was consolidating seven retail branch offices. Other on-going occupancy costs declined by $243,000 during the first half of 2016 compared to the same period in 2015 due to reduced operating costs related to such consolidations, as well as four other branch consolidations that were completed in the first quarter of 2016. However, these cost reductions were substantially offset by increased data processing, software, and equipment costs associated with other initiatives undertaken by the Company over the past eighteen months.

 

Advertising and marketing-related expenses were $970,000 and $1.6 million during the three and six months ended June 30, 2016, respectively, compared to $555,000 and $868,000 during the same periods in 2015, respectively. The Company has increased spending on advertising and marketing in 2016 in an effort to increase sales and expand the Company’s overall brand awareness, especially as such relates to the retail deposit business. Management anticipates that for the entire year 2016 the Company’s advertising and marketing-related expenses are likely to be 20% to 25% higher than it was in 2015. However, this increase depends on future management decisions and there can be no assurances.

 

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Federal deposit insurance premiums were $383,000 and $358,000 during the three months ended June 30, 2016 and 2015, respectively. Year-to-date, these premiums were $805,000 and $728,000 in 2016 and 2015, respectively. These increases were due primarily to an increase in the Company’s total assets in the 2016 periods compared to 2015. Earlier in 2016 the FDIC issued a final rule that changes how insured financial institutions less than $10 billion in assets, such as the Company, will be assessed for deposit insurance. Although the new rule became effective on July 1, 2016, deposit insurance assessment rates will not change for insured institutions until the FDIC’s deposit insurance fund reaches a certain level, as specified in the new rule. Industry observers estimates this level could be reached in the third quarter of 2016, although there can be no assurances. Once the new deposit insurance assessment rates become effective, management estimates that the Company’s federal deposit insurance premiums could decline by approximately 25% per quarter. The final rule also established a process for the creation of insurance premium credits for insured institutions with less than $10 billion in assets. These credits would be determined by the FDIC at a future date in accordance with performance measures established for the deposit insurance fund, as specified in the new rule. The credits could be used by insured institutions to offset future premium costs until the credits are exhausted. At this time, management is unable to determine the amount or timing of the credits that it might be awarded, if any.

 

Net losses (gains) and expenses on foreclosed real estate were $(131,000) and $393,000 during the three months ended June 30, 2016 and 2015, respectively. On a year-to-date basis these amounts were $(89,000) and $539,000 in 2016 and 2015, respectively. In general, the Company has experienced net gains on disposition of foreclosed properties in recent months, as well as lower expenses on foreclosed real estate due to reduced holdings of such properties.

 

Other non-interest expenses were $2.3 million in the second quarter of 2016 compared to a similar amount in the same quarter of last year. Year-to-date, other non-interest expenses were $4.7 million in 2016 compared to $4.5 million in 2015. In the 2016 year-to-date period the Company prepaid $9.2 million in fixed-rate FHLB of Chicago advances. These advances had originally been drawn to fund the purchase of mortgage-related securities that were called by the issuer during the period, as previously noted. Management elected to prepay these advances concurrent with the call, which resulted in a prepayment penalty of $207,000.

 

Income Tax Expense Income tax expense was $2.3 million and $2.1 million during the second quarters of 2016 and 2015, respectively, and was $4.9 million and $4.2 million during the year-to-date periods in the same years, respectively. The effective tax rates (“ETRs”) for the quarter periods were 37.3% and 36.8%, respectively, and for the year-to-date periods were $36.9% and 36.8%, respectively. The Company’s ETR will vary from period to period due primarily to the impact of non-taxable revenue items, such as earnings from BOLI and tax-exempt interest income.

 

Financial Condition

 

Overview The Company’s total assets increased by $118.0 million or 4.7% during the six months ended June 30, 2016, due principally to an increase in total loans receivable. This increase was primarily funded by additional borrowings, deposit liabilities, and advance payments by borrowers. The Company’s total shareholders’ equity was $286.8 million at June 30, 2016, compared to $279.4 million at December 31, 2015.

 

Mortgage-Related Securities Available-for-Sale The Company’s portfolio of mortgage-related securities available-for-sale increased by $6.0 million or 1.5% during the six months ended June 30, 2016. This increase was principally due to the purchase of $56.1 million in securities intended by management to maintain the available-for-sale portfolio at a level considered sufficient to sustain liquidity on the Company’s balance sheet. The impact of these purchases was partially offset by normal periodic repayments.

 

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Changes in the fair value of the Company’s mortgage-related securities available-for-sale are recorded through accumulated other comprehensive loss (net of deferred income taxes), which is a component of shareholders’ equity. The fair value adjustment on the Company’s mortgage-related securities available-for-sale was a net unrealized gain of $6.5 million at June 30, 2016, compared to a net unrealized gain of $1.2 million at December 31, 2015. This increase was caused by a decline in market interest rates during the period, which had a favorable impact on the fair value of the Company’s mortgage-related securities.

 

Mortgage-Related Securities Held-to-Maturity The Company maintains a portfolio of mortgage-related securities held-to-maturity that consists of securities issued and guaranteed by the Federal National Mortgage Association (“Fannie Mae”) and backed by multi-family residential loans. The Company has classified these securities has held-to-maturity because it has the ability and intent to hold these securities until they mature. The Company’s portfolio of mortgage-related securities held-to-maturity decreased by $10.4 million or 8.6% during the six months ended June 30, 2016. During this period securities with a carrying value of $9.2 million were called by Fannie Mae. As a result, the Company recorded a call premium in interest income of $482,000, as previously described. The Company did not purchase any held-to-maturity securities during the six months ended June 30, 2016.

 

Loans Held-for-Sale The Company’s policy is to sell substantially all of its fixed-rate, one- to four-family mortgage loan originations in the secondary market. Loans held-for-sale were $5.5 million and $3.4 million at June 30, 2016, and December 31, 2015, respectively. For reasons noted previously in this report, management believes that sales of one- to four-family mortgage loans during the remainder of 2016 may exceed the level of sales recorded during the same period in 2015, although there can be no assurances.

 

Loans Receivable The Company’s loans receivable increased by $118.0 million or 6.8% during the six months ended June 30, 2016. During this period increases in multi-family, commercial real estate, and construction loans (net of the undisbursed portion) were partially offset by declines in the Company’s other loan categories. Management attributes the increases in part to a low interest rate environment that has encouraged loan growth in the Company’s local markets, particularly for loans secured by multi-family and commercial real estate. This rate environment has also improved the competitiveness of the Company’s loan offerings linked to its interest rate swap loan program, as noted earlier in this report. Because of this improvement, the Company has been able to increase new loan production, as well as retain in its loan portfolio a larger portion of construction loans transitioning to permanent financing than it typically has in prior periods. However, management is not certain that the loan growth experienced in recent periods can be sustained in the future. The loan portfolio is subject to economic, market, and competitive factors outside of the Company’s control and there can be no assurances that expected loan growth will continue or that total loans will not decrease in future periods.

 

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The following table sets forth the Company’s commercial and retail loans that were originated for portfolio during the periods indicated:

 

   Six Months Ended
June 30
 
   2016   2015 
   (Dollars in thousands) 
Commercial loans:          
Commercial and industrial  $21,232   $46,415 
Commercial real estate   45,705    28,216 
Multi-family real estate   111,167    35,251 
Construction and development   84,102    136,808 
Total commercial loans   262,203    246,690 
Retail loans:          
One- to four-family first mortgages (1)   42,184    40,602 
Home equity   15,342    15,829 
Other consumer   1,137    752 
Total retail loans   58,663    57,183 
Total loan originations  $320,866   $303,873 

 

(1)Excludes $64.5 million and $56.6 million in loans originated for sale during the six months ended June 30, 2016 and 2015, respectively.

 

Mortgage Servicing Rights The carrying value of the Company’s MSRs was $6.8 million at June 30, 2016, and $7.2 million at December 31, 2015, respectively. The Company maintained no valuation allowance against its MSRs as of either of those dates. As of June 30, 2016, the Company serviced $1.02 billion in loans for third-party investors compared to $1.04 billion at December 31, 2015. Refer to “Results of Operations—Non-Interest Income,” above, for additional discussion related to the Company’s MSRs.

 

Deposit Liabilities The Company’s deposit liabilities increased by $41.1 million or 2.3% during the six months ended June 30, 2016. Transaction deposits, which consist of checking, savings, and money market accounts, increased by $39.2 million or 3.1% during the period and certificates of deposit increased by $1.9 million or 0.4%. Management believes that the low interest rate environment that has persisted for the past few years has encouraged some customers to switch to transaction deposits in an effort to retain flexibility in the event interest rates increase in the future. If interest rates increase in the future, customer preference may shift from transaction deposits back to certificates of deposit, which typically have a higher interest cost to the Company. This development could increase the Company’s cost of funds in the future, which would also have an adverse impact on its net interest margin.

 

Borrowings Borrowings, which consist of advances from the FHLB of Chicago, increased by $50.2 million or 13.5% during the six months ended June 30, 2016. This increase was primarily caused by overnight borrowings from the FHLB of Chicago, which were drawn to fund growth in the Company’s earning assets during the period, as previously described. Management believes that additional funds are available to be borrowed from the FHLB of Chicago or other sources in the future to fund maturing term advances, loan originations, security purchases, and other corporate purposes, if needed or desirable. However, there can be no assurances of the future availability of borrowings or any particular level of future borrowings.

 

Advance Payments by Borrowers for Taxes and Insurance Advance payments by borrowers for taxes and insurance (i.e., escrow deposits) were $19.9 million at June 30, 2016, compared to $3.4 million at December 31, 2015. Escrow deposits typically increase during the course of the calendar year until real estate tax obligations are paid, generally in December of each year or January of the following year.

 

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Shareholders' Equity The Company’s shareholders’ equity was $286.8 million at June 30, 2016, compared to $279.4 million at December 31, 2015. This increase was due to $8.4 million in net income and a $3.1 million decrease in accumulated other comprehensive loss. These developments were only partially offset by $4.8 million in regular cash dividends. The decrease in accumulated other comprehensive loss was mostly due to an increase in the fair value of available-for-sale securities (net of income tax effect), which was caused by a decline in market interest rates during the period. The Company did not repurchase a significant amount of its common stock during the six months ended June 30, 2016. The book value of the Company’s common stock was $6.29 per share at June 30, 2016, compared to $6.15 at December 31, 2015.

 

On August 1, 2016, the Company’s board of directors declared a $0.055 per share dividend payable on August 29, 2016, to shareholders of record on August 12, 2016. For additional discussion relating to the Company’s ability to pay dividends or repurchase its common stock refer to “Liquidity and Capital Resources—Capital Resources,” below.

 

Asset Quality The following table summarizes non-performing loans and assets as of the dates indicated:

 

   At June 30   At December 31 
   2016   2015 
   (Dollars in thousands) 
Non-accrual commercial loans:          
Commercial and industrial  $4,263   $4,915 
Commercial real estate   3,704    3,968 
Multi-family real estate   286     
Construction and development   705    766 
Total commercial loans   8,958    9,649 
Non-accrual retail loans:          
One- to four-family first mortgages   2,764    2,703 
Home equity   816    703 
Other consumer   60    82 
Total non-accrual retail loans   3,640    3,488 
Total non-accrual loans   12,598    13,137 
Accruing loans delinquent 90 days or more (1)   239    484 
Total non-performing loans   12,837    13,621 
Foreclosed real estate and repossessed assets   2,768    3,306 
Total non-performing assets  $15,605   $16,927 
           
Non-performing loans to total loans   0.69%   0.78%
Non-performing assets to total assets   0.60%   0.68%
Interest income that would have been recognized if non-accrual loans had been current (2)  $428   $637 
Interest income on non-accrual loans included in interest income (2)  $322   $630 

 

(1)Consists of student loans that are guaranteed under programs sponsored by the U.S. government.
(2)Amounts shown are for the six months ended June 30, 2016, and the twelve months ended December 31, 2015, respectively.

 

The Company’s non-performing loans were $12.8 million or 0.69% of loans receivable as of June 30, 2016, compared to $13.6 million or 0.78% of loans receivable as of December 31, 2015. Non-performing assets, which includes non-performing loans, were $15.6 million or 0.60% of total assets and $16.9 million or 0.68% of total assets as of these same dates, respectively. Non-performing assets are classified as “substandard” in accordance with the Company’s internal risk rating policy. In addition to these non-performing assets, at June 30, 2016, management was closely monitoring $53.3 million in additional loans that were classified as either “special mention” or “substandard” in accordance with the Company’s internal risk rating policy. This amount compared to $55.9 million at December 31, 2015. As of June 30, 2016, most of these additional classified loans were secured by commercial real estate, multi-family real estate, land, and certain commercial business assets. Management does not believe any of these loans were impaired as of June 30, 2016, although there can be no assurances that the loans will not become impaired in future periods.

 

 45 

 

 

Trends in the credit quality of the Company’s loan portfolio are subject to many factors that are outside of the Company’s control, such as economic and market conditions that can fluctuate considerably from period to period. As such, there can be no assurances that there will not be significant fluctuations in the Company’s non-performing loans, classified loans, and/or loan charge-off activity from period to period, which may result in significant variability in the Company’s provision for loan losses.

 

A summary of the Company’s allowance for loan losses is shown below for the periods indicated:

 

   Six Months Ended June 30 
   2016   2015 
   (Dollars in thousands) 
Balance at beginning of period  $17,641   $22,289 
Provision for (recovery of) loan losses   591    (1,716)
Charge-offs:          
Commercial and industrial       (74)
Commercial real estate   (99)   (69)
Multi-family real estate        
Construction and development        
One- to four-family first mortgages   (84)   (218)
Home equity   (35)   (42)
Other consumer   (188)   (306)
Total charge-offs   (406)   (709)
Recoveries:          
Commercial and industrial   4    6 
Commercial real estate   19    83 
Multi-family real estate   30     
Construction and development        
One- to four-family first mortgages   33    41 
Home equity   9    21 
Other consumer   41    25 
Total recoveries   136    176 
Net charge-offs   (270)   (533)
Balance at end of period  $17,962   $20,040 

 

   June 30   December 31 
   2016   2015 
Allowance for loan losses to total loans   0.97%   1.01%
Allowance for loan losses to non-performing loans   139.92%   129.51%
Net charge-offs to average loans (1)   0.03%   0.06%

 

(1)The rate for the six months ended June 30, 2016, is annualized.

 

The Company’s allowance for loan losses was $18.0 million or 0.97% of loans receivable at June 30, 2016, compared to $17.6 million or 1.01% at December 31, 2015. As a percent of non-performing loans, the Company’s allowance for loan losses was 139.9% at June 30, 2016, compared to 129.5% at December 31, 2015. The reason for the increase in the Company’s allowance for loan losses during the six months ended June 30, 2016, was described earlier in this report. Management believes the allowance for loan losses at June 30, 2016, was adequate to cover probable and estimable losses in the Company’s loan portfolio as of that date. However, future increases to the allowance may be necessary and results of operations could be adversely affected if future conditions differ from the assumptions used by management to determine the allowance for loan losses as of the end of the period.

 

 46 

 

 

Management is responsible for the timely and periodic determination of the amount of the allowance required. 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. To the best of management’s knowledge, all known and inherent losses have been provided for in the allowance for loan losses.

 

Refer to “Operating Results—Provision for Loan Losses,” above, for additional discussion.

 

Liquidity and Capital Resources

 

Liquidity The term "liquidity" refers to the Company’s ability to generate cash flow to fund loan originations, loan purchases, deposit withdrawals, and operating expenses. The Company’s primary sources of funds are deposit liabilities, scheduled payments, prepayments, and maturities of loans and mortgage-related securities, sales of one- to four-family loans in the secondary market, borrowings from the FHLB of Chicago, and cash flow provided by the Company’s operations. From time-to-time the Company may also sell securities classified as available-for-sale. Historically, these sources of funds have been adequate to maintain liquidity, with the Company borrowing correspondingly more in periods in which its operations generate less cash.

 

Scheduled payments and maturities of loans and mortgage-related securities are relatively predictable sources of funds. However, cash flows from customer deposits, calls of investment securities (if any), prepayments of loans and mortgage-related securities, loan originations, and draws by borrowers on unused lines of credit are strongly influenced by interest rates, general and local economic conditions, and/or competition in the marketplace. These factors increase the variability of cash flows from these sources of funds.

 

The Company is committed to maintaining a strong liquidity position; therefore, management monitors the Company’s liquidity position on a daily basis. Based upon historical experience and available sources of liquidity, management anticipates that the Company will have sufficient funds to meet current funding commitments. For additional discussion refer to “Financial Condition,” above, and “Qualitative and Quantitative Disclosures about Market Risk” in Part I, Item 3, below.

 

Capital Resources The Company’s ratio of shareholders’ equity to total assets was 10.95% at June 30, 2016, compared to 11.17% at December 31, 2015. The decrease was primarily due to an increase in the Company’s total assets during the period, as previously described. The Company is required to maintain specified amounts of regulatory capital pursuant to regulations promulgated by the FRB. The Company is “well capitalized” for regulatory capital purposes. As of June 30, 2016, the Company had a total risk-based capital ratio of 15.32% and a Tier 1 leverage capital ratio of 11.29%. The minimum ratios to be considered “well capitalized” under current supervisory regulations are 10% for total risk-based capital and 5% for Tier 1 capital. The minimum ratios to be considered “adequately capitalized” are 8% and 4%, respectively. For additional discussion refer to “Note 8. Regulatory Capital Requirements” in “Item 1. Financial Statements.”

 

The payment of dividends or the repurchase of common stock by the Company is highly dependent on the ability of the Bank to pay dividends or otherwise distribute capital to the Company. Such payments are also subject to any requirements imposed by law or regulations and to the application and interpretation thereof by the OCC and FRB. The Company cannot provide any assurances that dividends will continue to be paid, the amount of any such dividends, or whether the Company will choose to or be able to repurchase its common stock in future periods.

 

 47 

 

 

Contractual Obligations, Commitments, Off-Balance Sheet Arrangements, and Contingencies

 

Contractual Obligations The following table presents, as of June 30, 2016, significant fixed and determinable contractual obligations to third parties by payment date (excluding interest payments due in the future on deposits and borrowed funds):

 

   Payments Due In 
       One to   Three to   Over     
   One Year   Three   Five   Five     
   Or Less   Years   Years   Years   Total 
   (Dollars in thousands) 
Deposits with no stated maturity  $1,290,181               $1,290,181 
Certificates of deposit   334,844   $204,191   $7,521        546,556 
Borrowed funds   288,866    77,793    43,374   $12,522    422,554 
Operating leases   930    1,605    1,542    3,165    7,242 
Purchase obligations   2,640    5,280    660        8,580 
Deferred retirement plans and deferred compensation plans   781    1,604    1,381    4,398    8,164 

 

The Company’s operating lease obligations represent short- and long-term lease and rental payments for facilities, certain software and data processing equipment, and other equipment. Purchase obligations represent obligations under agreements to purchase goods or services that are enforceable and legally binding on the Company and that specify all significant terms, including: fixed or minimum quantities to be purchased; fixed, minimum or variable price provisions; and the approximate timing of the transaction. The purchase obligation amounts presented above primarily relate to certain contractual payments for services provided for information technology.

 

The Company also has obligations under its deferred retirement plan for executives and directors as described in Note 10, “Employee Benefit Plans,” to the Unaudited Condensed Consolidated Financial Statements, above.

 

Commitments to Extend Credit The following table details the amounts and expected maturities of approved commitments as of June 30, 2016:

 

   Payments Due In 
       One to   Three to   Over     
   One Year   Three   Five   Five     
   Or Less   Years   Years   Years   Total 
   (Dollars in thousands) 
Commercial lines of credit  $158,779               $158,779 
Commercial loans   10,034                10,034 
Standby letters of credit   3,848   $236   $275        4,359 
Multi-family and commercial real estate loans   383,402                383,402 
Residential real estate loans   28,555                28,555 
Revolving home equity and credit card lines   165,730                165,730 
Net commitments to sell mortgage loans   20,744                20,744 

 

Commitments to extend credit, including loan commitments, standby letters of credit, unused lines of credit and commercial letters of credit do not necessarily represent future cash requirements, since these commitments often expire without being drawn upon.

 

 48 

 

 

Off-Balance Sheet Arrangements At June 30, 2016, the Company had forward commitments to sell one- to four-family mortgage loans of $20.7 million to Fannie Mae. As described in Note 12, “Financial Instruments with Off-Balance Sheet Risk,” to the Company’s Unaudited Condensed Consolidated Financial Statements, the Company uses forward commitments to sell loans to mitigate interest rate risk on one- to four-family IRLCs and loans held-for-sale.

 

Contingent Liabilities The Company did not have a material exposure to contingent liabilities as of June 30, 2016.

 

Item 3. Quantitative and Qualitative Disclosures about Market Risk

 

Gap Analysis

 

Repricing characteristics of assets and liabilities may be analyzed by examining the extent to which such assets and liabilities are “interest rate sensitive” and by monitoring a financial institution's interest rate sensitivity “gap.” An asset or liability is said to be “interest rate sensitive” within a specific time period if it will mature or reprice within that time period. The interest rate sensitivity gap is defined as the difference between the amount of interest-earning assets maturing or repricing within a specific time period and the amount of interest-bearing liabilities maturing or repricing within that same time period.

 

A gap is considered positive when the amount of interest-earning assets maturing or repricing within a specific time period exceeds the amount of interest-bearing liabilities maturing or repricing within that specific time period. A gap is considered negative when the amount of interest-bearing liabilities maturing or repricing within a specific time period exceeds the amount of interest-earning assets maturing or repricing within the same period. During a period of rising interest rates, a financial institution with a negative gap position would be expected, absent the effects of other factors, to experience a greater increase in the costs of its liabilities relative to the yields of its assets and thus a decrease in the institution's net interest income. An institution with a positive gap position would be expected, absent the effect of other factors, to experience the opposite result. Conversely, during a period of falling interest rates, a negative gap would tend to result in an increase in net interest income while a positive gap would tend to reduce net interest income.

 

The following table presents the amounts of the Company’s interest-earning assets and interest-bearing liabilities outstanding at June 30, 2016, which management anticipates to reprice or mature in each of the future time periods shown. The information presented in the following table is based on the following assumptions:

 

·Loans—based upon contractual maturities, repricing date, if applicable, scheduled repayments of principal, and projected prepayments of principal based upon the Company’s historical experience or anticipated prepayments. Actual cash flows may differ substantially from these assumptions.

 

·Mortgage-related securities—based upon known repricing dates (if applicable) and an independent outside source for determining estimated prepayment speeds. Actual cash flows may differ substantially from these assumptions.

 

·Deposit liabilities—based upon contractual maturities and the Company’s historical decay rates. Actual cash flows may differ substantially from these assumptions.

 

·Borrowings—based upon final maturity.

 

 49 

 

 

   June 30, 2016 
   Within   Three to   More than   More than         
   Three   Twelve   1 Year to   3 Years -   Over 5     
   Months   Months   3 Years   5 Years   Years   Total 
Loans receivable:  (Dollars in thousands) 
Commercial loans:                        
Fixed  $31,201   $57,525   $165,273   $89,378   $18,543   $361,920 
Adjustable   682,037    39,376    103,877    19,125    1,242    845,657 
Retail loans:                              
Fixed   19,698    38,023    72,710    43,668    61,845    235,944 
Adjustable   104,718    122,754    81,988    67,620    50,325    427,405 
Interest-earning deposits   11,449                    11,449 
Mortgage-related securities:                              
Fixed   40,104    99,514    209,341    70,351    83,029    502,339 
Adjustable   15,470                    15,470 
Other interest-earning assets   18,365                    18,365 
Total interest-earning assets   923,042    357,192    633,189    290,142    214,984    2,418,549 
                               
Deposit liabilities:                              
Non-interest-bearing demand accounts                   236,271    236,271 
Interest-bearing demand accounts                   267,224    267,224 
Savings accounts                   228,520    228,520 
Money market accounts   558,165                    558,165 
Certificates of deposit   116,203    224,196    198,638    7,521        546,558 
Advance payments by borrowers                              
for taxes and insurance       19,921                19,921 
Borrowings   245,341    44,884    69,699    51,952    10,678    422,554 
Total non-interest- and interest-
bearing liabilities
   919,709    289,001    268,337    59,473    742,693    2,279,213 
Interest rate sensitivity gap  $3,333   $68,191   $364,852   $230,669   $(527,709)  $139,336 
Cumulative interest rate sensitivity gap  $3,333   $71,524   $436,376   $667,045   $139,336      
Cumulative interest rate sensitivity gap                              
as a percent of total assets   0.13%   2.73%   16.66%   25.46%   5.32%     
Cumulative interest-earning assets as a                              
percentage of non-interest- and interest-bearing liabilities   100.36%   105.92%   129.54%   143.41%   106.11%     

  

Based on the above gap analysis, at June 30, 2016, the Company’s interest-bearing assets maturing or repricing within one year exceeds its interest-earning liabilities maturing or repricing within the same period. Based on this information, over the course of the next year net interest income could be favorably impacted by an increase in market interest rates. Alternatively, net interest income could be unfavorably impacted by a decrease in market interest rates. However, it should be noted that the Company’s future net interest income is affected by more than just future market interest rates. Net interest income is also affected by absolute and relative levels of earning assets and interest-bearing liabilities, the level of non-performing loans and other investments, and by other factors outlined in Part I, Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Cautionary Statement,” as well as Part I, Item 1A, “Risk Factors,” of the Company’s 2015 Annual Report on Form 10-K.

 

In addition to not anticipating all of the factors that could impact future net interest income, gap analysis has certain shortcomings. For example, although certain assets and liabilities may mature or reprice in similar periods, the interest rates on such react by different degrees to changes in market interest rates, especially in instances where changes in rates are limited by contractual caps or floors or instances where rates are influenced by competitive forces. Interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market rates. For example, it is the Company’s past experience that rate changes on most of its deposit liabilities generally lag changes in market interest rates. Certain assets, such as adjustable-rate loans, have features which limit changes in interest rates on a short term basis and over the life of the loan. If interest rates change, prepayment, and early withdrawal levels would likely deviate significantly from those assumed in calculating the table. Finally, the ability of borrowers to make payments on their adjustable-rate loans may decrease if interest rates increase. Because of these shortcomings, management of the Company believes that gap analysis is a better indicator of the relative change in the Company’s interest rate risk exposure from period to period than it is an indicator of the direction or amount of future change in net interest income.

 

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Present Value of Equity

 

In addition to the gap analysis table, management also uses simulation models to monitor interest rate risk. The models report the present value of equity (“PVE”) in different interest rate environments, assuming an instantaneous and permanent interest rate shock to all interest rate sensitive assets and liabilities. The PVE is the difference between the present value of expected cash flows of interest rate sensitive assets and liabilities. The changes in market value of assets and liabilities due to changes in interest rates reflect the interest rate sensitivity of those assets and liabilities as their values are derived from the characteristics of the asset or liability (i.e., fixed rate, adjustable rate, caps, and floors) relative to the current interest rate environment. For example, in a rising interest rate environment, the fair market value of a fixed-rate asset will decline whereas the fair market value of an adjustable-rate asset, depending on its repricing characteristics, may not decline. Increases in the market value of assets will increase the PVE whereas decreases in market value of assets will decrease the PVE. Conversely, increases in the market value of liabilities will decrease the PVE whereas decreases in the market value of liabilities will increase the PVE.

 

The following table presents the estimated present value ratio over a range of interest rate change scenarios at June 30, 2016. The present value ratio is the PVE as a percent of the present value of total assets in each of the different rate environments. For purposes of this table, management has made assumptions such as prepayment rates and decay rates similar to those used for the gap analysis table.

 

       Present Value of Equity 
       as a Percent of the 
Change in  Present Value of Equity   Present Value of Assets 
Interest Rates  Dollar   Dollar   Percent   Present Value   Percent 
(Basis Points)  Amount   Change   Change   Ratio   Change 
   (Dollars in thousands)             
+400  $337,742   $13,320    4.1%   13.62%   11.3%
+300   339,443    15,021    4.6    13.45    9.9 
+200   337,635    13,213    4.1    13.15    7.5 
+100   329,114    4,692    1.4    12.62    3.1 
0   324,422            12.24     
-100   345,905    21,483    6.6    12.81    4.7 

  

Based on the above analysis, the Company’s present value ratio is not expected to be materially impacted by changes in interest rates. However, it should be noted that the Company’s PVE is impacted by more than changes in market interest rates. Future PVE is also affected by management’s decisions relating to reinvestment of future cash flows, decisions relating to funding sources, and by other factors outlined in Part I, Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Cautionary Statement,” above, as well as Part I, Item 1A, “Risk Factors,” of the Company’s 2015 Annual Report on Form 10-K.

 

As is the case with gap analysis, PVE analysis also has certain shortcomings. PVE modeling requires management to make assumptions about future changes in market interest rates that are unlikely to occur, such as immediate, sustained, and parallel (or equal) changes in all market rates across all maturity terms. PVE modeling also requires that management make assumptions which may not reflect the manner in which actual yields and costs respond to changes in market interest rates. For example, it is the Company’s past experience that rate changes on most of its deposit liabilities generally lag changes in market interest rates. In addition, management makes assumptions regarding the changes in prepayment speeds of mortgage loans and securities. Prepayments will accelerate in a falling rate environment and the reverse will occur in a rising rate environment. Management also assumes that decay rates on core deposits will accelerate in a rising rate environment and the reverse in a falling rate environment. The model assumes that the Company will take no action in response to the changes in interest rates, when in practice rate changes on most deposit liabilities lag behind market changes and/or may be limited by competition. In addition, prepayment estimates and other assumptions within the model are subjective in nature, involve uncertainties, and therefore cannot be determined with precision. Accordingly, although the PVE model may provide an estimate of the Company’s interest rate risk at a particular point in time, such measurements are not intended to and do not provide a precise forecast of the effect of changes in interest rates on the Company’s PVE. Because of these shortcomings, management of the Company believes that PVE analysis is a better indicator of the relative change in the Company’s interest rate risk exposure from period to period than it is an indicator of the direction or amount of future change in net interest income.

 

 51 

 

 

Item 4. Controls and Procedures

 

Disclosure Controls and Procedures

 

The Company’s management, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company’s disclosure controls and procedures, as such terms are defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as of the end of the period covered by this report. Based on such evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, the Company’s disclosure controls and procedures are effective in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act.

 

Internal Control Over Financial Reporting

 

There have not been any changes in the Company’s internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the fiscal quarter to which this report relates that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

 52 

 

 

PART II

 

Item 1A. Risk Factors

 

Refer to “Risk Factors” in Part I, Item 1A, of the Company’s 2015 Annual Report on Form 10-K. Refer also to "Management’s Discussion and Analysis of Financial Condition and Results of Operations—Cautionary Statement" in Part I, Item 2, above.

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

 

The following discloses information regarding the shares of the Company’s common stock repurchased by the Company during the second quarter of 2016, all of which were purchased pursuant to stock repurchase plans authorized by its board of directors.

 

Period  Shares
Purchased
   Average
Price
per Share
   Shares Purchased
as Part of
Announced Plans
   Shares Remaining
to be Purchased
Under Announced
Plans
 
April 2016   24,387   $7.35    24,387    970,332 
May 2016               970,332 
June 2016               970,332 
Total/Average   24,387   $7.35    24,387      

 

Item 6. Exhibits

 

Refer to Exhibit Index, which follows the signature page hereof.

 

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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.

 

    BANK MUTUAL CORPORATION
    (Registrant)
     
Date: August 2, 2016   /s/ David A. Baumgarten
    David A. Baumgarten
    President and Chief Executive Officer
       
Date: August 2, 2016   /s/ Michael W. Dosland
    Michael W. Dosland
    Senior Vice President and Chief Financial Officer

 

 54 

 

 

EXHIBIT INDEX

 

BANK MUTUAL CORPORATION

 

Form 10-Q for Quarter Ended June 30, 2016

 

Exhibit No.   Description   Incorporated Herein
by Reference To
  Filed Herewith
             
31.1  

Sarbanes-Oxley Act Section 302 Certification signed by the Chairman and Chief Executive Officer of Bank Mutual Corporation

 

      X
31.2  

Sarbanes-Oxley Act Section 302 Certification signed by the Senior Vice President and Chief Financial Officer of Bank Mutual Corporation

 

      X
32.1  

Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 signed by the Chief Executive Officer of Bank Mutual Corporation

 

      X
32.2   Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 signed by the Chief Financial Officer of Bank Mutual Corporation       X
             
101   The following materials are provided from Bank Mutual Corporation’s Quarterly Report on Form 10-Q for the period ended June 30, 2016, formatted in Extensible Business Reporting Language (“XBRL”): (i) the Unaudited Condensed Consolidated Statements of Financial Condition, (ii) Unaudited Condensed Consolidated Statements of Income, (iii) Unaudited Condensed Statements of Comprehensive Income (iv) Unaudited Condensed Consolidated Statements of Equity, (v) Unaudited Condensed Consolidated Statements of Cash Flow, and (vi) Notes to Unaudited Condensed Consolidated Financial Statements.
             
101.INS   XBRL Instance Document       X
             
101.SCH   XBRL Taxonomy Extension Schema Document       X
             
101.CAL   XBRL Taxonomy Extension Calculation       X

 

   

 

 

Exhibit No.   Description   Incorporated Herein
by Reference To
  Filed Herewith
             
101.LAB   XBRL Extension Labels Linkbase Document       X
             
101.PRE   XBRL Taxonomy Extension Presentation Linkbase Document       X
             
101.DEF   XBRL Taxonomy Extension Definition Linkbase Document       X