FORM 10-Q

U.S. SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

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

For the quarterly period ended March 31, 2011

OR

      TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

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

Commission file number 0-18542

MID-WISCONSIN FINANCIAL SERVICES, INC.

 (Exact name of registrant as specified in its charter)

WISCONSIN

06-1169935

(State or other jurisdiction of incorporation or organization)

          (IRS Employer Identification No.)

132 West State Street

Medford, WI  54451

(Address of principal executive offices) (Zip Code)

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

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

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

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

     Large accelerated filer  £      

                                   Accelerated filer  £        

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

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

Yes  £  No  S

As of May 3, 2011 there were 1,652,983 shares of $0.10 par value common stock outstanding.  

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MID-WISCONSIN FINANCIAL SERVICES, INC.

TABLE OF CONTENTS

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PART I – FINANCIAL INFORMATION

Item 1. Financial Statements:

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ITEM 1.  Financial Statements Continued:

 The accompanying notes to the consolidated financial statements are an integral part of these statements.

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ITEM 1.  Financial Statements Continued:

The accompanying notes to the consolidated financial statements are an integral part of these statements.

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ITEM 1.  Financial Statements Continued:

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ITEM 1.  Financial Statements Continued:

The accompanying notes to the consolidated financial statements are an integral part of these statements.

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Mid-Wisconsin Financial Services, Inc. and Subsidiary

Notes to Unaudited Consolidated Financial Statements

Note 1 – Basis of Presentation

General

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

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

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

Recent Accounting Pronouncements

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

In January 2010, the FASB issued an accounting standard providing additional guidance relating to fair value measurement disclosures.  Specifically, companies will be required to separately disclose significant transfers into and out of Level 1 and Level 2 measurements in the fair value hierarchy and the reasons for those transfers.  Significance should generally be based on earnings and total assets or liabilities, or when changes are recognized in other comprehensive income, based on total equity.  

Companies may take different approaches in determining when to recognize such transfers, including using the actual date of the event or change in circumstances causing the transfer, or using the beginning or ending of a reporting period.  For Level 3 fair value measurements, the new guidance requires presentation of separate information about purchases, sales, issuances and settlements.  Additionally, the FASB also clarified existing fair value measurement disclosure requirements relating to the level of disaggregation, inputs, and valuation techniques.  This accounting standard was effective at the beginning of 2010, except for the detailed Level 3 disclosures which were effective at the beginning of 2011.  The Company adopted the accounting standard at the beginning of 2010 with no material impact on its results of operations, financial position, and liquidity.

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Note 2 – Earnings (Loss) per Common Share

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

Note 3 - Fair Value Measurements

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

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

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

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

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

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

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

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

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

Loans – Loans are not measured at fair value on a recurring basis.  However, loans considered to be impaired are measured at fair value on a nonrecurring basis.  The fair value measurement of an impaired loan is based on the fair value of the underlying collateral.  Fair value measurements of underlying collateral that utilize observable market data such as independent appraisals reflecting recent comparable sales are considered Level 2 measurements.  Other fair value measurements that incorporate estimated assumptions market participants would use to measure fair value are considered Level 3 measurements.

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

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

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

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

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

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

At March 31, 2011 loans with a carrying amount of $13,947 were considered impaired and were written down to their estimated fair value of $11,052.  As a result, the Company recognized a specific valuation allowance against these impaired loans totaling $2,895.  At year end December 31, 2010 loans with a carrying amount of $9,749 were considered impaired and were written down to their estimated fair value of $7,808.  As a result, the Company recognized a specific valuation allowance against these impaired loans totaling $1,941.  

The fair value of OREO is based on observable market data such as independent appraisals or comparable sales.  Any write down in the carrying value of a property at the time of acquisition is charged to the allowance for loan and lease losses.  Any subsequent write downs to reflect current fair market value, as well as gains and losses on disposition, are treated as period costs.  During the period ending March 31, 2011, the Bank acquired OREO of $45 measured at fair value less selling costs.  In addition, an impairment write down of $6 was made against these real estate properties and charged to operations for the three months ended March 31, 2011.

In 2010, the Bank acquired OREO of $4,965 measured at fair value less selling costs.  In addition, an impairment write down of $159 was made against these as well as some of the other real estate properties acquired in prior years and charged to earnings for the year ended December 31, 2010.

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

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

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

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

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

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

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

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

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

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

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

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

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Limitations – Fair value estimates are made at a specific point in time based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of particular financial instruments. Fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates. Fair value estimates are based on existing on- and off-balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. Significant assets and liabilities that are not considered financial assets or liabilities include premises and equipment, goodwill and intangibles, and other assets and other liabilities. In addition, the income tax ramifications related to the realization of the unrealized gains or losses can have a significant effect on fair value estimates and have not been considered in the estimates.

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

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Note 4- Securities

The amortized cost and fair values of investment securities available-for-sale were as follows:

The amortized cost and fair values of investment debt securities available-for-sale at March 31, 2011, by contractual maturity, are shown below.  Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

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

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

The Company reviews the investment securities portfolio on a quarterly basis to monitor its exposure to other-than-temporary impairment (“OTTI”) that may result due to the current adverse economic conditions.  A determination as to whether a security’s decline in market value is OTTI takes into consideration numerous factors.  Some factors the Company may consider in the OTTI analysis include, the length of time the security has been in an unrealized loss position, changes in security ratings, the financial condition of the issuer, whether there has been defaulted payments, and the value of underlying collateral.  Based on the Company’s evaluation, a third party vendor reviews specific investment securities identified by management for OTTI.  To determine OTTI, a discounted cash flow model is utilized to estimate the fair value of the security.  The use of a discounted cash flow model involves judgment, particularly of interest rates, estimated default rates and prepayment speeds.  

During 2010, the Company determined that OTTI existed in one non-agency mortgage-backed security and two corporate securities since the unrealized losses on these securities appear to be related in part to expected credit losses that will not be recovered by the Company.  Subsequent to December 31, 2010, the Company sold the three OTTI securities, which resulted in net investment losses of $55.  As of March 31, 2011 the Company has determined that there are no remaining OTTI securities in the investment portfolio.

The following is a summary of the credit loss of OTTI recognized in earnings on investment securities during 2010.  

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

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Based on the Company’s evaluation, management believes that any remaining unrealized loss at March 31, 2011 are primarily attributable to changes in interest rates and the current market conditions, and not credit deterioration.  

Note 5 – Loans

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

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The commercial credit exposure based on internally assigned credit grade follows:

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

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The following table presents impaired loans for the periods indicated as follows:

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Note 6 – Other Real Estate Owned (“OREO”)

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

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

OREO was $3,873 at March 31, 2011, compared to $4,230 at December 31, 2010.  Excluding the properties of the guarantor of a loan to a former car dealership (“Impaired Borrower”), the other properties held as OREO in 2011 consist of $2,655 of commercial real estate (the largest being $1,744 related to a hotel/water park project), $42 real estate construction loans, $195 agricultural loans and $246 residential real estate.  OREO as of year-end 2010 consisted of $2,716 of commercial real estate, $82 real estate construction, $150 agricultural loans and $547 residential real estate.  Management generally seeks to ensure properties held are monitored to minimize the Company’s risk of loss. Evaluations of the fair market value of the OREO properties are done quarterly and valuation adjustments, if necessary, are recorded in our consolidated financial statements.

In the three months ended March 31, 2011, OREO continued to turn over rapidly, as we have had success in aggressively marking down the assets to a value that enables us to sell the property quickly.  During 2010 we sold 35 OREO properties resulting in a net gain from the sale of OREO of $187.  In the first quarter 2011, we sold five OREO properties resulting in a net gain from the sale of OREO of $51.

Note 7- Long-term Borrowings

Long-term borrowings were as follows.

Federal Home Loan Bank Advances – Long-term advances from the Federal Home Loan Bank (“FHLB”) have maturities through 2015 and had a weighted-average interest rate of 4.24% at both March 31, 2011 and December 31, 2010.

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

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

Note 8 – Subsequent Event

In 2005, Mid-Wisconsin Statutory Trust I (the “Trust”), a Delaware Business Trust subsidiary of the Company, issued $10,000 in trust preferred securities.  The Trust used the proceeds from the offering along with Mid-Wisconsin’s common ownership investment to purchase $10,310 of the Company’s subordinated debentures (the “Debentures”).  The Debentures have a floating interest rate equal to the three-month LIBOR plus 1.43%, adjusted quarterly.  The interest rate at December 31, 2010 was 1.73%.  The Debentures mature on December 15, 2035.

Additionally, pursuant to the U.S. Treasury’s Capital Purchase Program, on February 20, 2009, the Company entered into a Letter Agreement with Treasury, pursuant to which the Company issued (i) 10,000 shares of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series A (“Series A Preferred Stock”), and (ii) a warrant to purchase 500 shares of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series B (“Series B Preferred Stock” and, together with the Series A Preferred Stock, the “TARP Preferred Stock”), which were immediately exercised, for an aggregate purchase price of $10,000. Cumulative dividends on the Series A Preferred Stock accrue and are payable quarterly at a rate of 5% per annum for five years.  The rate will increase to 9% per annum thereafter if the shares are not redeemed by the Company.  The Series B Preferred Stock dividends accrue and are payable quarterly at a rate of 9%.

In consultation with the Federal Reserve Bank of Minneapolis, on May 12, 2011, the Company exercised its rights to suspend dividends on the outstanding TARP Preferred Stock and intends to defer interest on the Debentures related to the Trust and its trust preferred securities, effective for the next interest or dividend payment due on each.  Under the terms of the Debentures, the Company is allowed to defer payments of interest for 20 quarterly periods without default or penalty, but such amounts will continue to accrue.  Also during the deferral period, the Company generally may not pay cash dividends on or repurchase its common stock or preferred stock, including the TARP Preferred Stock.  Dividend payments on the TARP Preferred Stock may be deferred without default, but the dividend is cumulative and therefore will continue to accrue and, if the Company fails to pay dividends for an aggregate of six

quarters, whether or not consecutive, the holder will have the right to appoint representatives to the Company’s board of directors.  The terms of the TARP Preferred Stock also prevent the Company from paying cash dividends on or repurchasing its common stock while dividends are in arrears.  Therefore, the Company will not be able to pay dividends on its common stock until it has fully paid all accrued and unpaid dividends on the Debentures and the TARP Preferred Stock.

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

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

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

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Special Note Regarding Forward-Looking Statements

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

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

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

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

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

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

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

Critical Accounting Policies

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

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

Allowance for Loan and Lease Losses (“ALLL”):   Management’s evaluation process used to determine the adequacy of the allowance for loan and lease losses is subject to the use of estimates, assumptions, and judgments. The evaluation process combines several factors: management’s ongoing review and grading of the loan portfolio, consideration of historical loan loss and delinquency experience, trends in past due and nonperforming loans, risk characteristics of the various classifications of loans, concentrations of loans to specific borrowers or industries, existing economic conditions, the fair value of underlying collateral, and other qualitative and quantitative factors which could affect potential credit losses. Because current economic conditions can change and future events are inherently difficult to predict, the anticipated amount of estimated loan losses, and therefore the adequacy of the allowance for loan and lease losses, could change significantly.  As an integral part of their examination process, various regulatory agencies also review the allowance for loan and lease losses. Such agencies may require that certain loan balances be classified differently or charged-off when their credit evaluations differ from those of management, based on their judgments about information available to them at the time of their examination. The Company believes the allowance for loan and lease losses as recorded in the consolidated financial statements is adequate.

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

Income taxes:  The assessment of income tax assets and liabilities involves the use of estimates, assumptions, interpretations, and judgment concerning certain accounting pronouncements and federal and state tax codes. There can be no assurance that future events, such as court decisions or positions of federal and state taxing authorities, will not differ from management’s current assessment, the impact of

which could be significant to the consolidated results of operations and reported earnings. The Company believes the tax assets and liabilities are adequate and properly recorded in the consolidated financial statements.

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

RESULTS OF OPERATIONS

Performance Summary

The Company reported net loss to common shareholders of $20, or $0.01 per common share, for the three months ended March 31, 2011, compared to a net loss to common shareholders of $148, or $0.09 per common share, for the three ended March 31, 2010.  Financial results continue to be impacted by the provision for loan and lease losses, expenses associated with credit collections, declining net interest margin and FDIC insurance costs.  Despite the continuing provisioning, we continue to believe that the Company’s core earnings (net income excluding loan loss provisions, OREO expenses and FDIC insurance costs) and basic fundamentals remain healthy. Key factors behind these results are discussed below:

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·

Net interest income of $3,884 for the three months ended March 31, 2011, decreased by 5.9% from the same quarter in 2010.  On a fully tax-equivalent basis, the net interest margin at March 31, 2011 decreased to 3.36% from 3.55% for the same period in 2010.  The drop in net interest margin was primarily due to an elevated level of liquidity that was generated from core deposit growth, weak loan demand and the sale of investment securities during the latter half of 2010.  Average loans outstanding decreased by $20,994  and  average balance of federal funds sold and securities purchased under agreements to resell increased $17,973 at March 31, 2011, compared to a year earlier.  The average yield on earning assets was 4.86% at March 31, 2011 compared to 5.52% at March 31, 2010.

·

Loans of $334,836 at March 31, 2011, decreased $4,334 from December 31, 2010. Loan growth was negatively impacted by the current credit environment, economic conditions, loan payoffs, and charge-offs.  Although competition among local and regional banks for creditworthy borrowers and core deposit customers remains high, we remain committed to supporting our markets through lending to creditworthy borrowers as opportunities arise.

·

Total deposits were $394,214 at March 31, 2011, down $6,396 from year-ended December 31, 2010 primarily due to normal customer inflows and outflows and the runoff of brokered certificate of deposits that matured.

·

Net charge-offs were $814 in the first quarter of 2011, and $487 for the first quarter of 2010. The provision for loan and lease losses was $1,050 for the first quarter of 2011, compared with $1,400 for the first quarter of 2010.  The first quarter 2011 provision has been reduced from the first quarter 2010, but still remained heightened due to economic factors that include: the high unemployment rate in our market areas, increased delinquencies in existing commercial real estate and construction credits resulting from weakness in the local economies, depressed collateral values, and internal assessments of currently performing loans with increased risk for future delinquencies.  The Bank’s coverage ratio of the allowance for loan and lease losses to total loans at March 31, 2011 improved to 2.90% compared to 2.79% at December 31, 2010 and 2.48% at March 31, 2010.

·

Noninterest income for the three months ended March 31, 2011 increased $490 or 49.6% from the first quarter of 2010 due to a legal settlement, the details of which are subject to a confidentiality agreement.  Noninterest expense for the three months ended March 31, 2011 was $4,174, an increase of $392 compared to the first quarter of 2011 due primarily to increased marketing costs associated with a new deposit campaign, FDIC costs, foreclosure/OREO expenses, loan servicing costs, and loss on sale of investment securities.

·

As of March 31, 2011, the Company’s tier 1 risk-based capital ratio and total risk-based capital ratios were 10.1 % and 15.7%, respectively.  Both ratios are in excess of regulatory minimum requirements.

The following table presents a summary of our quarterly financial results.  

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Table 1: Summary Results of Operations

($ in thousands, except per share data)

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Net Interest Income

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

Taxable-equivalent net interest income for the three months ended March 31, 2011, was $3,949, down from $4,191 in the related 2010 period. The $242 decrease in taxable equivalent net interest income was a function of a $20,994 decrease in the average balance of loans and a 66 basis points (“bps”) decrease in yields on interest-earning assets.

The tax-equivalent net interest margin for the first three months of 2011 was 3.07%, down from 3.20% in the related 2010 period.  For 2011, the yield on earning assets of 4.86% was 66 bps lower than the comparable period last year.  Loan yields decreased 30 bps, to 5.78%, impacted by levels of nonaccrual loans, lower loan yields given the repricing of adjustable rate loans, soft loan demand, and competitive pricing pressures to retain and/or obtain creditworthy borrowers.  The yield on investment securities and other short-term investments decreased 123 bps to 2.57%, impacted by the Company’s excess liquidity position resulting from soft loan demand during 2011 and the sale of investment securities during the latter half of 2010.

The cost of interest-bearing liabilities of 1.79% for the first three months of 2011 was 53 bps lower than the related 2010 period.  The average cost of interest-bearing deposits was 1.55%, down 47 basis points,

while the cost of wholesale funding (comprised of short-term borrowings and long-term borrowings) decreased 27 bps to 3.30% for the three months ended March 31, 2011.  The $10,310 of subordinated debentures had a fixed rate of 5.98% through December 15, 2010, after which they have a floating rate equal to the three-month LIBOR plus 1.43%, adjusted quarterly.  The interest rate at March 31, 2011 was 1.73%.  

Average earning assets of $476,478 for the first three months of 2011 were $2,363 lower than the comparable period last year.   Average federal funds sold and securities purchased under agreements to resell grew $17,973 to $31,463, reflecting the Company’s increased liquidity position.  Average loans decreased $20,994 to $339,737 as a result of soft loan demand, pay-offs and charge-offs.   Taxable equivalent interest income in 2011 decreased $809 to $5,710due to earning asset volume changes, of which $569 of the decrease is attributable to the decrease in loans.

Average interest-bearing liabilities of $399,525 for the first three months of 2011 were down $7,608 over the related 2010 period. Average interest-bearing deposits decreased $8,738 and, average noninterest-bearing deposits increased $4,967.  For the first three months of 2011, interest expense decreased $567 of which $456 was due to rate changes.

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Table 2:  Year-To-Date Net Interest Income Analysis – Taxable Equivalent Basis

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Table 3:  Volume/Rate Variance - Taxable Equivalent Basis

Provision for Loan Losses

The provision for loan losses for the first three months of 2011 was $1,050, compared to $1,400 for the same period in 2010 and $4,755 for the full year 2010.  Net charge-offs were $814 for the first three months of 2011, compared to $487 for the same period of 2010. At March 31, 2011, the ALLL was $9,707, an increase of $236 over December 31, 2010.  The ratio of the ALLL to total loans was 2.90% and 2.79% at March 31, 2011 and December 31, 2010, respectively. Nonperforming loans at March 31, 2011, were $18,494, compared to $13,808 at December 31, 2010, representing 5.52% and 4.07% of total loans, respectively.

The provision for loan losses is predominantly a function of the Company’s methodology and judgment as to qualitative and quantitative factors used to determine the adequacy of the ALLL.  The adequacy of the ALLL is affected by changes in the size and character of the loan portfolio, changes in levels of impaired and other nonperforming loans, historical losses and delinquencies on each portfolio category,

the risk inherent in specific loans, concentrations of loans to specific borrowers or industries, existing and future economic conditions, the fair value of underlying collateral, and other factors which could affect potential credit losses.  We believe the current level of provisioning and level of our allowance for loan and lease losses followed the direction of our policies and was adequate to cover anticipated and unexpected loan losses inherent in our loan portfolio.  However, we may need to increase our provisions in the future should the quality of the loan portfolio decline or other factors used to determine the allowance worsen.  Please refer to the discussion on “Allowance for Loan and Lease Losses” on page 34 for further information.

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Noninterest Income

Table 4:  Noninterest Income

Noninterest income for the first three months of 2011 was $1,477, up $490 from the same period in 2010.  All noninterest income item categories decreased from the 2010 levels with the exception of other operating income.  Other operating income included proceeds of $500 from a legal settlement, the details of which are subject to a confidentiality agreement.

Service fees on deposit accounts were down $34 from the comparable three month period last year due to a decrease in overdraft fees due to changes in customer behavior, and recent regulatory changes.

The Wealth Management Services Group generates trust service fees and investment product commissions. Wealth Management income was $310 for the first three months of 2011, down $16 from the same period in 2010, primarily due to a decrease in the valuation of assets under management, on which fees are based.   

Mortgage banking income represents income received from the sale of residential real estate loans into the secondary market.  Mortgage banking income for the first quarter of 2011 remained relatively stable from the same period in 2010.  At year end 2010 and 2009, the Bank held a significant amount of loans held for sale to the secondary market that were not sold until the first quarter of 2011 and 2010.  Residential loan activity reached an all time refinancing high in 2010 due to a historically low interest rate environment.  Interest rates have since increased, and the Company anticipates the volume of loans sold to the secondary market in 2011 will be considerably lower than 2010, resulting in lower income.   Residential real estate loans originated for sale to the secondary market was $5,615 for the first quarter of 2011, compared to $7,724 for the first quarter of 2010.

Noninterest Expense

Total noninterest expense was $4,174 for the first quarter 2011, an increase of $392 over the first quarter of 2010.  

Table 5:  Noninterest Expense

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Salaries and employee benefits increased $26 or 1.2% in 2011.  The increase is primarily attributable to an increase in performance based incentives and related payroll taxes of $54 in the first quarter of 2011.  These increased expenses were partially offset by a decline in health and life insurance expenses of $19 resulting from the reduced number of employees covered under the plans and $5 decline in salaries between periods.

Occupancy expense increased $23 or 5.0% in the first quarter 2011, primarily due to building maintenance and utility costs.  Foreclosure/OREO expense increased $47 between comparable periods.  In 2010, the Company recognized a recovery of an OREO valuation write-down taken in 2009 which more than offset foreclosure/OREO expenses.  No such recovery was recognized in 2011.  Legal and professional fees of $167 decreased $30, primarily due to lower legal costs associated with loan collection in 2011.  An increase in FDIC expense of $79 was primarily due to increased deposit insurance rates. Other operating expenses increased $185 compared to the first three months of 2010, primarily due to increased marketing costs associated with the introduction of new a deposit program and loan servicing costs.  The Company recognized a $55 loss on the sale of investments in the first quarter of 2011.  The security sales were executed in an effort to increase the credit quality of the Company’s investment portfolio.

Effective February 1, 2011, the Bank’s branch located in Lake Tomahawk, Wisconsin was closed and the branch building was sold in the second quarter 2011.

Income Taxes

For the first three months of 2011, the income tax benefit was $3 compared to a $79 income tax benefit for the comparable period in 2010 as a result of an increase in taxable income.  Management determined that a valuation allowance on deferred tax assets was not necessary. Management further believes that tax benefits associated with current and past years pre-tax losses will be realized through the Company’s ability to generate sufficient income in the future.  

FINANCIAL CONDITION

Investment Securities Portfolio

The investment securities portfolio is intended to provide the Bank with adequate liquidity, flexible asset/liability management and a source of stable income.  The portfolio is structured with minimum credit exposure to the Bank. All securities are classified as available-for-sale and are carried at market value.  Unrealized gains and losses are excluded from earnings, but are reported as other comprehensive income in a separate component of stockholders’ equity, net of income tax.   Premium amortization and discount accretion are recognized as adjustments to interest income using the interest method.  Realized gains or losses on sales are based on the net proceeds and the adjusted carrying value amount of the securities sold using the specific identification method.

At March 31, 2011, the total carrying value of investment securities was $105,902, an increase of $4,592, or 4.5%, since December 31, 2010, primarily attributable to the soft loan demand and excess liquidity position of the Bank.

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Table 6:  Investments