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Table of Contents

 

 

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q

 

 

 

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

For the quarterly period ended June 30, 2015

or

 

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

For the transition period from                      to                     

COMMISSION FILE NUMBER 001-34955

 

 

ANCHOR BANCORP WISCONSIN INC.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   39-1726871

(State or other jurisdiction of

incorporation or organization)

 

(IRS Employer

Identification No.)

25 West Main Street

Madison, Wisconsin

  53703
(Address of principal executive office)   (Zip Code)

(608) 252-8700

Registrant’s telephone number, including area code

 

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

 

 

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

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

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

 

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

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

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

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

Class: Common stock — $0.01 Par Value

Number of shares outstanding as of July 31, 2015: 9,601,891

 

 

 


Table of Contents

ANCHOR BANCORP WISCONSIN INC.

INDEX - FORM 10-Q

 

              Page #  

Part I - Financial Information

  
  Item 1   

Financial Statements

  
    

Unaudited Consolidated Balance Sheets as of June 30, 2015 and Audited as of December 31, 2014

     2   
    

Unaudited Consolidated Statements of Income and Comprehensive Income for the Three and Six Months Ended June 30, 2015 and 2014

     3   
    

Unaudited Consolidated Statements of Changes in Stockholders’ Equity for the Six Months Ended June  30, 2015 and Audited for the Year Ended December 31, 2014

     5   
    

Unaudited Consolidated Statements of Cash Flows for Six Months Ended June 30, 2015 and 2014

     6   
    

Notes to Unaudited Consolidated Financial Statements

     8   
  Item 2   

Management’s Discussion and Analysis of Financial Condition and Results of Operations

  
    

Critical Accounting Estimates and Judgments

     48   
    

Forward-Looking Statements

     50   
    

Executive Overview

     51   
    

Results of Operations

     55   
    

Financial Condition

     65   
    

Risk Management

     65   
    

Credit Risk Management

     66   
    

Liquidity Risk Management

     74   
    

Market Risk Management

     76   
    

Compliance Risk Management

     78   
    

Strategic and/or Reputation Risk Management

     78   
    

Regulatory Developments

     78   
  Item 3   

Quantitative and Qualitative Disclosures About Market Risk

     81   
  Item 4   

Controls and Procedures

     81   

Part II - Other Information

  
  Item 1   

Legal Proceedings

     81   
  Item 1A   

Risk Factors

     81   
  Item 2   

Unregistered Sales of Equity Securities and Use of Proceeds

     82   
  Item 3   

Defaults Upon Senior Securities

     82   
  Item 4   

Mine Safety Disclosures

     82   
  Item 5   

Other Information

     82   
  Item 6   

Exhibits

     82   

Signatures

     83   

 

1


Table of Contents

ANCHOR BANCORP WISCONSIN INC. AND SUBSIDIARIES

Consolidated Balance Sheets

 

     June 30,     December 31,  
     2015     2014  
     (In thousands, except share data)  
     (Unaudited)     (Audited)  

Assets

    

Cash and due from banks

   $ 30,310      $ 46,400   

Interest-earning deposits

     80,424        100,873   
  

 

 

   

 

 

 

Cash and cash equivalents

     110,734        147,273   

Investment securities available for sale (AFS)

     345,261        294,599   

Investment securities held to maturity (HTM)

     5,491        —     

Loans held for sale

     13,513        6,594   

Loans held for investment

     1,568,571       1,571,476   

Less: allowance for loan losses

     (47,037     (47,037
  

 

 

   

 

 

 

Loans held for investment, net

     1,521,534        1,524,439   

Other real estate owned (OREO), net

     27,255        35,491   

Premises and equipment, net

     27,726        23,569   

Federal Home Loan Bank stock, at cost

     11,940        11,940   

Mortgage servicing rights, net

     19,321        19,404   

Accrued interest receivable

     7,555        7,627   

Deferred tax asset, net

     103,072        —     

Other assets

     12,193        11,443   
  

 

 

   

 

 

 

Total assets

   $ 2,205,595      $ 2,082,379   
  

 

 

   

 

 

 

Liabilities and Stockholders’ Equity

    

Deposits

    

Non-interest bearing

   $ 281,621      $ 291,248   

Interest bearing

     1,539,171        1,522,923   
  

 

 

   

 

 

 

Total deposits

     1,820,792        1,814,171   

Other borrowed funds

     12,737        13,752   

Accrued interest payable

     357        316   

Accrued taxes, insurance and employee related expenses

     7,795        7,259   

Other liabilities

     21,294        19,218   
  

 

 

   

 

 

 

Total liabilities

     1,862,975        1,854,716   
  

 

 

   

 

 

 

Preferred stock: par value $0.01, authorized 100,000 shares, none issued or outstanding

     —          —     

Common stock: par value $0.01, 11,900,000 shares authorized, 9,609,931 and 9,552,094 shares issued, 9,601,891 and 9,547,587 shares outstanding at June 30, 2015 and December 31, 2014, respectively

     96        95   

Additional paid-in capital

     196,415        195,083   

Retained earnings

     148,539        34,981   

Accumulated other comprehensive loss

     (2,229     (2,402

Treasury stock: 8,040 and 4,507 shares at June 30, 2015 and December 31, 2014, respectively, at cost

     (201     (94
  

 

 

   

 

 

 

Total stockholders’ equity

     342,620        227,663   
  

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 2,205,595      $ 2,082,379   
  

 

 

   

 

 

 

See accompanying Notes to Unaudited Consolidated Financial Statements

 

2


Table of Contents

ANCHOR BANCORP WISCONSIN INC. AND SUBSIDIARIES

Consolidated Statements of Income and Comprehensive Income

(Unaudited)

 

     Three Months Ended June 30,     Six Months Ended June 30,  
     2015     2014     2015     2014  
     (In thousands, except per share data)  

Interest income

        

Loans

   $ 16,900      $ 17,321      $ 33,517      $ 35,197   

Investment securities and Federal Home Loan Bank stock

     1,570        1,541        2,960        3,062   

Interest-earning deposits

     71        94        148        159   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total interest income

     18,541        18,956        36,625        38,418   

Interest expense

        

Deposits

     1,058        1,033        2,026        2,121   

Other borrowed funds

     59        61        119        120   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total interest expense

     1,117        1,094        2,145        2,241   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income

     17,424        17,862        34,480        36,177   

Provision for loan losses

     (646     —          (2,000     —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income after provision for loan losses

     18,070        17,862        36,480        36,177   

Non-interest income

        

Service charges on deposits

     2,596        2,523        4,964        4,789   

Investment and insurance commissions

     1,060        1,131        2,147        1,987   

Loan fees

     179        222        910        451   

Loan servicing income, net of amortization

     467        740        1,060        1,514   

Loan processing fee income

     360        189        626        339   

Net impairment losses recognized in earnings

     —          (13     —          (34

Net gain on sale of loans

     1,912        698        3,513        1,290   

Net gain on sale of investment securities

     —          —          63        301   

Net gain on sale of OREO

     743        1,040        2,210        1,201   

Net gain (loss) on disposal of premises and equipment

     1,332        (7     1,332        (76

Net gain on sale of branch

     448        —          448        —     

Other income

     641        1,087        1,205        1,780   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total non-interest income

     9,738        7,610        18,478        13,542   

 

(Continued)

 

3


Table of Contents

ANCHOR BANCORP WISCONSIN INC. AND SUBSIDIARIES

Consolidated Statements of Income and Comprehensive Income

(Unaudited)

 

     Three Months Ended June 30,     Six Months Ended June 30,  
     2015     2014     2015     2014  
     (In thousands, except per share data)  

Non-interest expense

        

Compensation and benefits

   $ 13,371      $ 10,739      $ 25,158      $ 21,901   

Occupancy

     1,970        1,614        3,718        3,852   

Furniture and equipment

     760        791        1,466        1,557   

Federal deposit insurance premiums

     688        700        1,357        1,748   

Data processing

     1,546        1,315        2,997        2,686   

Communications

     405        463        984        1,036   

Marketing

     648        879        1,187        1,532   

OREO expense, net

     737        2,267        973        3,452   

Investor loss reimbursement

     (273     (248     (373     (86

Mortgage servicing rights impairment (recovery)

     (391     84        (421     95   

Provision for unfunded commitments

     170        600        291        780   

Loan processing and servicing expense

     655        709        1,438        1,276   

Retail operations expense

     643        676        1,251        1,239   

Legal services

     402        602        717        955   

Other professional fees

     606        351        1,040        758   

Insurance

     232        206        475        516   

Other expense

     1,094        1,107        1,978        1,875   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total non-interest expense

     23,263        22,855        44,236        45,172   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income before income taxes

     4,545        2,617        10,722        4,547   

Income tax expense (benefit)

     (102,976     10        (102,944     10   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income

   $ 107,521      $ 2,607      $ 113,666      $ 4,537   
  

 

 

   

 

 

   

 

 

   

 

 

 

Reclassification adjustment for realized net gains recognized in Consolidated Statements of Income - Net gain on sale and call of investment securities, before tax

     —          —          (63     (301

Reclassification adjustments recognized in Consolidated Statements of Income - Net impairment losses recognized in earnings:

        

Net change in unrealized credit related other-than-temporary impairment

     —          (36     —          (78

Realized credit losses

     —          49        —          112   

Change in net unrealized gains (losses) on available for sale securities, net of tax

     (2,419     2,179        351        5,039   

Tax effect related to items of other comprehensive income

     (115     —          (115     —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Total other comprehensive income (loss)

     (2,534     2,192        173        4,772   
  

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income

   $ 104,987      $ 4,799      $ 113,839      $ 9,309   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income per common share:

        

Basic

   $ 11.42      $ 0.29      $ 12.10      $ 0.50   

Diluted

     11.37        0.29        12.05        0.50   

Dividends declared per common share

     —          —          —          —     

See accompanying Notes to Unaudited Consolidated Financial Statements

 

4


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ANCHOR BANCORP WISCONSIN INC. AND SUBSIDIARIES

Consolidated Statements of Changes in Stockholders’ Equity

 

                  Additional          

Accu-

mulated

Other

Compre-

hensive

             
     Common Stock      Paid-in     Retained     Income     Treasury        
     Shares     Amount      Capital     Earnings     (Loss)     Stock     Total  
     (In thousands)  

Balance at December 31, 2013 (Audited)

     9,050,000      $ 91       $ 188,370      $ 20,359      $ (6,622   $ —        $ 202,198   

Net income

     —          —           —          14,622        —          —          14,622   

Other comprehensive income, net of tax

     —          —           —          —          4,220        —          4,220   

Stock issuance cost

     —          —           (2,324     —          —          —          (2,324

Issuance of common stock

     305,794        3         7,948        —          —          —          7,951   

Issuance of shares of restricted stock

     196,300        1         (83     —          —          82        —     

Forfeiture of shares of restricted stock

     —          —           176        —          —          (176     —     

Stock-based compensation expense

     —          —           996        —          —          —          996   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at December 31, 2014 (Audited)

     9,552,094      $ 95       $ 195,083      $ 34,981      $ (2,402   $ (94   $ 227,663   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income

     —          —           —          113,666        —          —          113,666   

Other comprehensive income, net of tax

     —          —           —          —          173        —          173   

Tax benefit for restricted stock

     —          —           167          —          —          167   

Retirement of vested shares

     (8,010     —           (172     (108     —          —          (280

Issuance of shares of restricted stock

     65,847        1         (26     —          —          25        —     

Forfeiture of shares of restricted stock

     —          —           132        —          —          (132     —     

Stock-based compensation expense

     —          —           1,231        —          —          —          1,231   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at June 30, 2015 (Unaudited)

     9,609,931      $ 96       $ 196,415      $ 148,539      $ (2,229   $ (201   $ 342,620   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying Notes to Unaudited Consolidated Financial Statements

 

5


Table of Contents

ANCHOR BANCORP WISCONSIN INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

(Unaudited)

 

     Six Months Ended June 30,  
     2015     2014  
     (In thousands)  

Operating Activities

    

Net income

   $ 113,666      $ 4,537   

Adjustments to reconcile net income to net cash provided by operating activities:

    

Amortization and accretion of investment securities premium, net

     827        676   

Net gain on sale of investment securities

     (63     (301

Net impairment losses on investment securities

     —          34   

Origination of loans held for sale

     (143,838     (57,931

Proceeds from sale of loans held for sale

     140,432        57,045   

Net gain on sale of loans

     (3,513     (1,290

Provision for loan losses

     (2,000     —     

Provision for unfunded commitments

     291        780   

Valuation adjustments for OREO

     446        2,279   

Net gain on sale of OREO

     (2,210     (1,201

Depreciation and amortization

     1,572        1,212   

Net loss (gain) on disposal of premises and equipment

     (1,332     76   

Net gain on sale of branch

     (448     —     

Mortgage servicing rights impairment (recovery)

     (421     95   

Stock-based compensation expense

     1,231        —     

Reversal of deferred tax asset valuation allowance

     (103,187     —     

Net decrease in accrued interest receivable

     68        576   

Net decrease (increase) in other assets

     (246     107   

Net increase (decrease) in accrued interest payable

     44        (22

Net increase (decrease) in accrued taxes, insurance and employee related expenses

     536        (1,716

Net increase (decrease) in other liabilities

     (427     1,573   
  

 

 

   

 

 

 

Net cash provided by operating activities

     1,428        6,529   

Investing Activities

    

Proceeds from sale of investment securities

     14,647        388   

Purchase of investment securities-AFS

     (95,191     (37,787

Purchase of investment securities-HTM

     (5,491     —     

Principal collected on investment securities

     31,618        24,344   

Net decrease in loans held for investment

     73        29,702   

Net change in assets due to branch sale

     (8,059     —     

Proceeds from sale of premises and equipment

     1,756        —     

Purchases of premises and equipment

     (6,529     (1,947

Proceeds from sale of OREO

     12,641        13,899   

Capitalized improvements of OREO

     (118     (28
  

 

 

   

 

 

 

Net cash provided by (used in) investing activities

     (54,653     28,571   

 

(Continued)

 

6


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ANCHOR BANCORP WISCONSIN INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

(Unaudited)

 

     Six Months Ended June 30,  
     2015     2014  
     (In thousands)  

Financing Activities

    

Net decrease in deposits

   $ (17,362   $ (41,239

Increase in advance payments by borrowers for taxes and insurance

     35,176        39,186   

Proceeds from borrowed funds

     47,627        53,561   

Repayment of borrowed funds

     (48,642     (52,657

Tax benefit for restricted stock

     167        —     

Retirement of vested shares

     (280     —     
  

 

 

   

 

 

 

Net cash provided by (used in) financing activities

     16,686        (1,149
  

 

 

   

 

 

 

Net increase (decrease) in cash and cash equivalents

     (36,539     33,951   

Cash and cash equivalents at beginning of period

     147,273        143,396   
  

 

 

   

 

 

 

Cash and cash equivalents at end of period

   $ 110,734      $ 177,347   
  

 

 

   

 

 

 

Supplemental disclosures of cash flow information:

    

Cash paid or credited to accounts:

    

Interest on deposits and borrowings

   $ 2,104      $ 2,263   

Income tax payments

     90        22   

Non-cash transactions:

    

Transfer of loans to OREO

     2,523        7,659   

Investment purchased not settled

     (2,212     —     

Tax effect of change in AFS unrealized gain/loss

     (115     —     

See accompanying Notes to Unaudited Consolidated Financial Statements

 

7


Table of Contents

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

Note 1 – Basis of Presentation

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

The accompanying unaudited interim consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X under the Securities Exchange Act of 1934, as amended. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments (including normal recurring accruals) necessary for a fair presentation of the unaudited interim consolidated financial statements have been included.

In preparing the unaudited consolidated financial statements in conformity with GAAP, management is required to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the fair value of investment securities, the determination of the allowance for loan losses, the valuation of OREO, the net carrying value of mortgage servicing rights and deferred tax assets. The results of operations and other data for the three and six month periods ended June 30, 2015, are not necessarily indicative of results that may be expected for the year ending December 31, 2015. The Company has evaluated all subsequent events through the date of this filing. The interim unaudited consolidated financial statements presented herein should be read in conjunction with the audited consolidated financial statements and related notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014.

Reclassifications. Certain prior period amounts have been reclassified to conform to the current period presentations. There was no impact on earnings or total stockholders’ equity as a result of the reclassifications.

Note 2 – Significant Transactions

Management regularly and periodically evaluates and assesses all aspects of the Bank’s operations, including, but not limited to, retail branch delivery and placement of its support functions, for opportunities to improve the profitability of the Company. In the case of branch delivery, this could include the closure, sale or other disposal of a branch or addition to the current branch structure. During the first six months of 2015 the following events have occurred.

Sale of Branches

The Bank sold its Viroqua branch on May 15, 2015. The sale consisted of selected loans and deposits. In addition, the sale included the building, furniture and equipment. As part of the sale, a lease on the land was terminated. Total deposits sold were $11.2 million and generated a gain of $448,000 on the sale.

The Bank, on April 9, 2015, entered into a definitive agreement for the sale of its Winneconne branch to another financial institution located in Wisconsin. Under the agreement, the purchasing bank will assume approximately $13.4 million in deposits along with loans and other assets. The transaction is subject to regulatory approval and customary closing conditions and is targeted to close by the end of September 2015.

Purchase of New Building

The Bank, on January 28, 2015, completed the purchase of a new building located on the east side of Madison, Wisconsin at a purchase price of $4.0 million. This facility, which houses the Bank’s support departments, became operational during the second quarter of 2015.

 

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Operational Efficiency Measures

The Bank has taken several actions during the second quarter of 2015 to address and improve overall operational efficiency. Management anticipates that these actions will result in an annual net cost savings related to reduced compensation, occupancy and other operating costs of approximately $5.4 million and will be completed by the third quarter of 2015. These actions included:

 

    Offering a Voluntary Separation Plan (“VSP”) package to eligible employees. The VSP was designed to provide eligible employees with a variety of benefits, including additional compensation, subsidized COBRA health benefits and optional job placement services. The program was offered to a group of 140 of the Bank’s 705 employees with 78 employees accepting the VSP with agreed-upon exit dates through September 30, 2015. Management anticipates that approximately 30 individuals will be hired to meet the future business needs of AnchorBank to replace employees who accepted the VSP.

 

    Consolidating six retail bank branches in the third quarter of 2015. The six locations are in the Wisconsin communities of Appleton, Menasha, Oshkosh, Janesville, Franklin, and Madison. Customers have been notified of the transition and will continue to have convenient and uninterrupted access to their deposit, lending and investment accounts at surrounding Bank locations in each of these markets, as well as access to online banking, ATMs and the Bank’s Customer Call Service Center. A total of 23 full and part-time positions not eligible for the VSP will be eliminated through the six-branch consolidation.

 

    Creating a new Universal Banker staffing model in the Bank’s branch delivery system to address consumer shift towards digital products and services which resulted in lower transaction volumes. The Universal Banker will perform most branch transactions for customers resulting in improved customer service. The Universal Bank staffing model will have a core of employees who can process teller transactions, open new accounts and provide customer service. This core group of employees will be further supported with one or more customer service associates. The first phase of this service was launched during the second quarter and a broader rollout will occur during the remainder of 2015.

As a result of these operational efficiency measures, the Bank expects to incur one-time costs of $3.7 million, composed primarily of employment severance and asset disposition costs. During the quarter ended June 30, 2015, $2.3 million of these one-time costs were recognized as expense with an estimated $1.4 million expected to be recorded in the quarter ending September 30, 2015. A gain was recorded in the quarter ended June 30, 2015 for the sale of the Appleton Fox River Drive branch building of $1.4 million.

Deferred Tax Asset Valuation

During September 2009, the Company established a full deferred tax asset valuation allowance. During the second quarter of 2015, as a result of management’s periodic assessment of the deferred tax asset position, the Company has substantially reversed this deferred tax asset valuation allowance. The Company has determined that it is more likely than not it will be able to realize its deferred tax asset, including its entire federal tax loss carryforwards and a significant portion of its state tax loss carryforwards, with the exception of $5.9 million pertaining to certain multi state loss carryforward, including states we no longer do business in. This action resulted in the recognition of a $103.0 million income tax benefit, net of current quarter tax provision, during the second quarter of 2015. For a more detailed discussion, see Note 16 in the Notes to Unaudited Consolidated Financial Statements.

Note 3 – Recent Accounting Pronouncements

Accounting Standards Update (“ASU”) No. 2015-05 “Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement.” ASU 2015-05 provides guidance to customers about whether a cloud computing arrangement includes a software license. If a cloud computing arrangement includes a software license, the customer should account for the software license element of the arrangement consistent with the acquisition of other software licenses. If the arrangement does not include a software license, the customer should account for a cloud computing arrangement as a service contract. This amendment is effective for fiscal years beginning after December 15, 2015, and interim periods within those fiscal years. Early adoption is permitted. The amendment may be adopted either prospectively to all arrangements entered into or materially modified after the effective date or retrospectively. The Company intends to adopt the accounting standard during the first quarter of 2016, as required, with no material impact.

 

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ASU No. 2015-03 “Interest-Imputation of Interest (Subtopic 835-30).” ASU 2015-03 simplifies the presentation of debt issuance costs, requiring that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability. This amendment is effective for fiscal years beginning after December 15, 2015, and interim periods within those fiscal years. Early adoption is permitted for financial statements that have not been previously issued. Entities should apply the new guidance on a retrospective basis, wherein the balance sheet of each individual period presented should be adjusted to reflect the period-specific effects of applying the new guidance. The Company intends to adopt the accounting standard during the first quarter of 2016, as required, with no material impact.

ASU No. 2015-02 “Consolidation (Topic 810).” ASU 2015-02 is an amendment to the consolidation process and addresses the current accounting for consolidation of certain legal entities. All legal entities are subject to reevaluation under the revised consolidation model. The new standard reduces the number of consolidation models from four to two, simplifying consolidation by placing more emphasis on risk of loss when determining a controlling financial interest, reducing the frequency of the application of related-party guidance when determining a controlling financial interest in a variable interest entity and changing consolidation conclusions in several industries that typically make use of limited partnerships or VIEs. This amendment is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. Early adoption is permitted, including adoption in an interim period. Entities may apply the amendment prospectively or retrospectively to all prior periods presented in the financial statements. Early adoption is permitted provided that the guidance is applied from the beginning of the year of adoption. The Company intends to adopt the accounting standard during the first quarter of 2016, as required, with no material impact.

ASU No. 2014-09, “Revenue from Contracts with Customers (Topic 606).” In May 2014, the Financial Accounting Standards Board (“FASB”) issued an amendment to clarify the principles for recognizing revenue and to develop a common revenue standard. The standard outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. The core principle of the revenue model is that “an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.” In applying the revenue model to contracts within its scope, an entity should apply the following steps: (1) identify the contract(s) with a customer, (2) identify the performance obligations in the contract, (3) determine the transaction price, (4) allocate the transaction price to the performance obligations in the contract, and (5) recognize revenue when (or as) the entity satisfies a performance obligation. The standard applies to all contracts with customers except those that are within the scope of other topics in the FASB Codification. The standard also requires significantly expanded disclosures about revenue recognition. The FASB on April 1, 2015, agreed to propose a delay of its revenue recognition standard by one year effective for adoption for annual periods beginning after December 15, 2017. Subsequently, on July 9, 2015, the FASB approved a one year extension of the effective date. The standard will be effective for annual periods beginning after December 15, 2018 but early adoption as of December 15, 2017 is permitted. The Company intends to adopt the accounting standard during the first quarter of 2019 and is currently evaluating the impact on its results of operations, financial position and liquidity.

 

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Note 4 - Investment Securities

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

 

     Amortized      Gross Unrealized      Fair  
     Cost      Gains      Losses      Value  
     (In thousands)  

June 30, 2015

  

Available for sale:

           

U.S. government sponsored and federal agency obligations

   $ 3,188       $ 25       $ —         $ 3,213   

Government sponsored agency mortgage-backed securities (1)

     203,657         532         (1,062      203,127   

GNMA mortgage-backed securities (1)

     140,475         315         (1,897      138,893   

Other securities

     55         3         (30      28   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 347,375       $ 875       $ (2,989    $ 345,261   
  

 

 

    

 

 

    

 

 

    

 

 

 

Held to maturity:

           

Corporate bonds

   $ 5,491       $ 33       $ —         $ 5,524   
  

 

 

    

 

 

    

 

 

    

 

 

 

December 31, 2014

  

Available for sale:

           

U.S. government sponsored and federal agency obligations

   $ 3,245       $ 16       $ —         $ 3,261   

Government sponsored agency mortgage-backed securities (1)

     120,627         411         (417      120,621   

GNMA mortgage-backed securities (1)

     173,069         411         (2,793      170,687   

Other securities

     60         2         (32      30   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 297,001       $ 840       $ (3,242    $ 294,599   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1)  Includes mortgage-backed securities and CMOs that are primarily collateralized by residential mortgages.

One independent pricing service is used to value all investment securities.

 

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The table below presents the fair value and gross unrealized losses of securities in a loss position, aggregated by investment category and length of time that individual holdings have been in a continuous unrealized loss position at June 30, 2015, and December 31, 2014.

 

     Unrealized Loss Position               
     Less than 12 months     12 months or More     Total  
            Unrealized            Unrealized            Unrealized  
     Fair Value      Loss     Fair Value      Loss     Fair Value      Loss  
     (In thousands)  

June 30, 2015

               

Government sponsored agency mortgage-backed securities (1)

   $ 103,159       $ (852   $ 14,220       $ (210   $ 117,379       $ (1,062

GNMA mortgage-backed securities

     21,301         (35     83,509         (1,862     104,810         (1,897

Other securities

     —           —          24         (30     24         (30
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 
   $ 124,460       $ (887   $ 97,753       $ (2,102   $ 222,213       $ (2,989
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

December 31, 2014

               

Government sponsored agency mortgage-backed securities (1)

   $ 54,020       $ (228   $ 8,178       $ (189   $ 62,198       $ (417

GNMA mortgage-backed securities

     27,113         (110     98,230         (2,683     125,343         (2,793

Other securities

     2         (1     25         (31     27         (32
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 
   $ 81,135       $ (339   $ 106,433       $ (2,903   $ 187,568       $ (3,242
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

 

(1)  Includes mortgage-backed securities and CMOs.

Management evaluates securities for other-than-temporary impairment (“OTTI”) on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. In estimating other-than-temporary impairment losses on investment securities, management considers many factors which include: (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Company to retain its investment for a period of time sufficient to allow for any anticipated recovery in fair value.

At June 30, 2015, and December 31, 2014, there were no securities classified as other-than-temporarily impaired. Unrealized other-than-temporary impairment due to credit losses of $13,000 and $34,000 was included in earnings for the three and six months ended June 30, 2014. For the three and six months ended June 30, 2014 realized losses of $49,000 and $112,000, respectively, related to credit issues (i.e. – principal reduced without a receipt of cash) were incurred that were previously recognized in earnings as unrealized other-than-temporary impairment. During December 2014, these other-than-temporarily impaired securities were sold at a loss of $37,000.

Unrealized losses on government sponsored agency mortgage-backed securities, GNMA mortgage-backed securities, and other securities as of June 30, 2015, and December 31, 2014 due to changes in interest rates and other non-credit related factors totaled $3.0 million and $3.2 million, respectively. The number of individual securities in the tables above total 42 at June 30, 2015, and 34 at December 31, 2014. The Company has analyzed these securities for evidence of other-than-temporary impairment and concluded that no OTTI exists and that the unrealized losses are properly classified in accumulated other comprehensive income (loss).

 

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The following table is a roll forward of the amount of other-than-temporary impairment related to credit losses that has been recognized in earnings for which a portion of impairment was deemed temporary and recognized in other comprehensive income (loss) for the period presented:

 

     Three Months
Ended June 30,
     Six Months
Ended June 30,
 
     2014  
     (In thousands)  

Beginning balance of unrealized OTTI related to credit losses

   $ 759       $ 801   

Additional unrealized OTTI related to credit losses for which OTTI was previously recognized

     12         33   

Additional debit related OTTI previously recognized for OTTI recovery during the period

     2         3   

Decrease for realized amount of credit losses for which unrealized credit related OTTI was previously recognized

     (51      (115
  

 

 

    

 

 

 

Ending balance of unrealized OTTI related to credit losses

   $ 722       $ 722   
  

 

 

    

 

 

 

There were no investment securities sold during the quarters ended June 30, 2015 and June 30, 2014. The cost of investment securities sold is determined using the specific identification method. Sales of investment securities available for sale are summarized below:

 

     Six Months Ended June 30,  
     2015      2014  
     (In thousands)  

Proceeds from sales

   $ 14,647       $ 388   
  

 

 

    

 

 

 

Gross gains

   $ 65       $ 301   

Gross losses

     (2      —     
  

 

 

    

 

 

 

Net gain on sales

   $ 63       $ 301   
  

 

 

    

 

 

 

At June 30, 2015 and December 31, 2014, investment securities available for sale with a fair value of approximately $88.0 million and $121.5 million, respectively, were pledged to secure deposits, borrowings and for other purposes as permitted or required by law.

The fair values of investment securities by contractual maturity at June 30, 2015, are shown below. Actual maturities may differ from contractual maturities because issuers have the right to call or prepay obligations with or without call or prepayment penalties.

 

     Available for Sale      Held to Maturity  
     Amortized Cost      Fair Value      Amortized Cost      Fair Value  
     (In thousands)  

After 1 Year through 5 Years

   $ 3,365       $ 3,398       $ —         $ —     

After 5 Years through 10 Years

     10,830         10,845         2,492         2,522   

Over Ten Years

     333,180         331,018         2,999         3,002   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 347,375       $ 345,261       $ 5,491       $ 5,524   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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Note 5 - Loans Held for Investment, net

Loans held for investment, net consists of the following:

 

     June 30,
2015
     December 31,
2014
 
     (In thousands)  

Residential

   $ 528,017       $ 541,211   

Commercial and industrial

     22,848         16,514   

Commercial real estate:

     

Land and construction

     137,574         106,436   

Multi-family

     293,012         265,735   

Retail/office

     146,844         155,095   

Other commercial real estate

     134,572         156,243   
  

 

 

    

 

 

 

Total commercial real estate

     712,002         683,509   

Consumer:

     

Education

     98,830         108,384   

Other consumer

     220,114         233,487   
  

 

 

    

 

 

 

Total consumer loans

     318,944         341,871   
  

 

 

    

 

 

 

Total gross loans

     1,581,811         1,583,105   

Undisbursed loan proceeds(1)

     (12,086      (10,080

Unamortized loan fees, net

     (1,150      (1,544

Unearned interest

     (4      (5
  

 

 

    

 

 

 

Total loan contra balances

     (13,240      (11,629
  

 

 

    

 

 

 

Loans held for investment

     1,568,571         1,571,476   

Allowance for loan losses

     (47,037      (47,037
  

 

 

    

 

 

 

Loans held for investment, net

   $ 1,521,534       $ 1,524,439   
  

 

 

    

 

 

 

 

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

Residential Loans

At June 30, 2015, $528.0 million, or 33.4%, of the total gross loans consisted of residential loans, substantially all of which were 1-to-4 family dwellings. Residential loans consist of both adjustable and fixed-rate loans. The adjustable-rate loans currently in the portfolio were originated with up to 30-year maturities and terms which provide for annual increases or decreases of the rate on the loans, based on a designated index. These rate changes are generally subject to a limit of 2% per adjustment and an aggregate 6% adjustment over the life of the loan. These loans are documented according to standard industry practices. The Company does not originate negative amortization and option payment adjustable rate mortgages.

At June 30, 2015, approximately $306.5 million, or 58.1%, of the held for investment residential gross loans consisted of loans with adjustable interest rates. At June 30, 2015, approximately $221.5 million, or 41.9%, of the held for investment residential gross loans consisted of loans with fixed rates of interest. Although these loans generally provide for repayments of principal over a fixed period of 10 to 30 years, because of prepayments and due-on-sale clauses, such loans generally remain outstanding for a shorter period of time.

Commercial and Industrial Loans

The Company originates loans for commercial and business purposes, including issuing letters of credit. At June 30, 2015, the commercial and industrial gross loans amounted to $22.8 million, or 1.4%, of the total gross loans.

 

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Commercial Real Estate Loans

At June 30, 2015, $712.0 million of gross loans were secured by commercial real estate, which represented 45.0% of the total gross loans. The origination of such loans is generally limited to the Company’s primary market area, concentrated in Wisconsin’s greater Madison, Fox Valley and Milwaukee regions.

Consumer Loans

The Company offers consumer loans in order to provide a wider range of financial services to its customers. Consumer loans consist of education loans and other consumer loans. At June 30, 2015, $318.9 million, or 20.2%, of the total gross loans consisted of consumer loans.

Approximately $98.8 million, or 6.3%, of the total gross loans at June 30, 2015, consisted of education loans. The origination of student loans was discontinued October 1, 2010 following the March 2010 law ending loan guarantees provided by the U.S. Department of Education. Both the principal amount of an education loan and interest on loans originated prior to March 2010 thereon are generally guaranteed by the U. S. Department of Education up to a minimum of 97% of the balance of the loan. Education loans are serviced by Great Lakes Higher Education.

Other consumer loans primarily consist of home equity loans and lines. The primary home equity loan product has an adjustable rate that is linked to the prime interest rate and is secured by a mortgage, either a primary or a junior lien, on the borrower’s residence. In addition, other consumer loans include vehicle loans and other secured and unsecured loans made for a variety of consumer purposes.

Credit is also extended to Bank customers through credit cards issued by a third party, ELAN Financial Services, pursuant to an agency arrangement.

Allowances for Loan Losses

The allowance for loan losses consists of specific and general components. Specific allowance allocations are established for probable losses resulting from analysis of impaired loans. A loan is considered impaired when it is probable that the Company will be unable to collect all contractual principal and interest due according to the terms of the loan agreement. Impaired loans include all non-accrual loans and troubled debt restructurings. Troubled debt restructurings (“TDR’s”) are loans that have been modified, due to financial difficulties of the borrower, where the terms of the modified loan are more favorable for the borrower than what the Company would normally offer. Impairment is determined when the present value of expected future cash flows discounted at the loan’s effective interest rate or the fair value of the underlying collateral less costs to sell, if the loan is collateral dependent is less than the carrying value of the loan. Cash collections on impaired loans are generally credited to the loan balance and no interest income is recognized on those loans until the principal balance is current and collection of principal and interest becomes probable.

On a quarterly basis the Bank analyzes its general allowance methodology and has determined it was necessary to increase the historical loss period by an additional quarter. For the quarter ended June 30, 2015, the Bank utilized a thirteen quarter look-back period compared to a twelve quarter look-back period for the quarter ended March 31, 2015. The modification is being done to reflect a more stable economic environment and to capture additional loss statistics considered reflective of the current portfolio. The impact to the allowance for loan losses at June 30, 2015, was a $238,000 increase in the required reserve as compared to the previous methodology. Management will continue to analyze the historical loss period utilized on a quarterly basis.

 

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

 

     June 30,      December 31,  
     2015      2014  
     (In thousands)  

General reserve

   $ 35,503       $ 34,027   

Specific reserve:

     

Substandard rated loans, excluding TDR accrual

     3,253         4,569   

Impaired loans

     8,281         8,441   
  

 

 

    

 

 

 

Total allowance for loan losses

   $ 47,037       $ 47,037   
  

 

 

    

 

 

 

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

 

     June 30,      December 31,  
     2015      2014  
     (In thousands)  

Pass

   $ 1,480,660       $ 1,465,224   

Special mention

     11,815         6,243   
  

 

 

    

 

 

 

Total pass and special mention rated loans

     1,492,475         1,471,467   

Substandard rated loans, excluding TDR accrual (1)

     13,220         16,353   

TDRs - accrual (2)

     58,566         60,170   

Non-accrual

     17,550         35,115   
  

 

 

    

 

 

 

Total impaired loans

     76,116         95,285   
  

 

 

    

 

 

 

Total gross loans

   $ 1,581,811       $ 1,583,105   
  

 

 

    

 

 

 

 

(1)  Includes residential and consumer loans identified as substandard that are not necessarily on non-accrual.
(2)  Includes TDR accruing loans of $54.9 million and $55.4 million at June 30, 2015 and December 31, 2014, respectively, that are rated pass.

 

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

 

     Residential     Commercial
and Industrial
    Commercial
Real Estate
    Consumer     Total  
     (In thousands)  

For the Three Months Ended:

          

June 30, 2015

          

Beginning balance

   $ 10,661      $ 1,007      $ 29,452      $ 5,917      $ 47,037   

Provision

     (2,390     (423     2,347        (180     (646

Charge-offs

     (183     (14     (1,032     (193     (1,422

Recoveries

     399        608        909        152        2,068   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

   $ 8,487      $ 1,178      $ 31,676      $ 5,696      $ 47,037   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

June 30, 2014

          

Beginning balance

   $ 9,378      $ 4,938      $ 35,043      $ 4,138      $ 53,497   

Provision

     1,388        911        (3,383     1,084        —     

Charge-offs

     (566     (3,633     (1,141     (291     (5,631

Recoveries

     125        380        651        153        1,309   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

   $ 10,325      $ 2,596      $ 31,170      $ 5,084      $ 49,175   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

For the Six Months Ended:

          

June 30, 2015

          

Beginning balance

   $ 10,684      $ 1,436      $ 28,716      $ 6,201      $ 47,037   

Provision

     (2,973     (1,674     2,718        (71     (2,000

Charge-offs

     (421     (106     (1,311     (627     (2,465

Recoveries

     1,197        1,522        1,553        193        4,465   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

   $ 8,487      $ 1,178      $ 31,676      $ 5,696      $ 47,037   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

June 30, 2014

          

Beginning balance

   $ 13,059      $ 6,402      $ 42,065      $ 3,656      $ 65,182   

Provision

     (1,428     373        (1,551     2,606        —     

Charge-offs

     (1,662     (4,955     (11,902     (1,435     (19,954

Recoveries

     356        776        2,558        257        3,947   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

   $ 10,325      $ 2,596      $ 31,170      $ 5,084      $ 49,175   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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Table of Contents

The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on impairment method as of June 30, 2015 and December 31, 2014:

 

     Residential      Commercial
and Industrial
     Commercial
Real Estate
     Consumer      Total  
     (In thousands)  

June 30, 2015

              

Allowance for loan losses:

              

Associated with impaired loans

   $ 1,384       $ 67       $ 6,292       $ 538       $ 8,281   

Associated with all other loans

     7,103         1,111         25,384         5,158         38,756   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 8,487       $ 1,178       $ 31,676       $ 5,696       $ 47,037   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Loans:

              

Impaired loans individually evaluated

   $ 13,418       $ 176       $ 60,701       $ 1,821       $ 76,116   

All other loans

     514,599         22,672         651,301         317,123         1,505,695   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 528,017       $ 22,848       $ 712,002       $ 318,944       $ 1,581,811   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

December 31, 2014

  

Allowance for loan losses:

              

Associated with impaired loans

   $ 1,400       $ 140       $ 6,475       $ 426       $ 8,441   

Associated with all other loans

     9,284         1,296         22,241         5,775         38,596   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 10,684       $ 1,436       $ 28,716       $ 6,201       $ 47,037   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Loans:

              

Impaired loans individually evaluated

   $ 14,497       $ 113       $ 79,160       $ 1,515       $ 95,285   

All other loans

     526,714         16,401         604,349         340,356         1,487,820   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 541,211       $ 16,514       $ 683,509       $ 341,871       $ 1,583,105   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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The following table presents impaired loans segregated by loans with no specific allowance and loans with an allowance by class of loans. The recorded investment amounts represent the gross loan balance less charge-offs. The unpaid principal balance represents the contractual loan balance less any principal payments applied. The interest income recognized column represents all interest income recorded either on a cash or accrual basis after the loan became impaired.

 

     Recorded
Investment
     Unpaid
Principal
Balance
     Associated
Allowance
     Average
Carrying
Amount
     Year-to-Date
Interest Income
Recognized
 
     (In thousands)  

June 30, 2015

              

With no specific allowance recorded:

              

Residential

   $ 4,716       $ 5,711       $ —         $ 4,814       $ 94   

Commercial and industrial

     16         62         —           —           —     

Land and construction

     605         3,374         —           3,050         2   

Multi-family

     16,249         17,338         —           16,809         469   

Retail/office

     6,144         13,240         —           6,675         125   

Other commercial real estate

     11,435         12,363         —           11,683         213   

Education (1)

     —           —           —           —           —     

Other consumer

     751         1,185         —           1,051         57   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Subtotal

     39,916         53,273         —           44,082         960   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

With an allowance recorded (2):

              

Residential

   $ 8,702       $ 8,988       $ 1,384       $ 7,773       $ 162   

Commercial and industrial

     160         160         67         97         —     

Land and construction

     6,206         12,187         3,326         5,320         1   

Multi-family

     9,638         9,638         1,166         8,562         193   

Retail/office

     9,873         10,456         1,576         8,692         192   

Other commercial real estate

     551         597         224         433         11   

Education (1)

     143         143         143         186         —     

Other consumer

     927         937         395         665         21   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Subtotal

     36,200         43,106         8,281         31,728         580   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

              

Residential

   $ 13,418       $ 14,699       $ 1,384       $ 12,587       $ 256   

Commercial and industrial

     176         222         67         97         —     

Land and construction

     6,811         15,561         3,326         8,370         3   

Multi-family

     25,887         26,976         1,166         25,371         662   

Retail/office

     16,017         23,696         1,576         15,367         317   

Other commercial real estate

     11,986         12,960         224         12,116         224   

Education (1)

     143         143         143         186         —     

Other consumer

     1,678         2,122         395         1,716         78   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
   $ 76,116       $ 96,379       $ 8,281       $ 75,810       $ 1,540   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1)  Excludes the guaranteed portion of education loans 90+ days past due with balance of $4.6 million and average carrying amounts totaling $6.3 million at June 30, 2015.
(2)  Includes ratio-based allowance for loan losses of $292,000 associated with loans totaling $650,000 at June 30, 2015 for which individual reviews have not been completed but an allowance established based on the ratio of allowance for loan losses to gross loans individually reviewed, by class of loan.

 

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Table of Contents
     Recorded
Investment
     Unpaid
Principal
Balance
     Associated
Allowance
     Average
Carrying
Amount
     Year-to-Date
Interest Income
Recognized
 
     (In thousands)  

December 31, 2014

              

With no specific allowance recorded:

              

Residential

   $ 4,992       $ 6,406       $ —         $ 5,455       $ 165   

Commercial and industrial

     —           268         —           843         26   

Land and construction

     9,421         19,334         —           12,192         208   

Multi-family

     17,614         19,863         —           17,979         780   

Retail/office

     7,840         15,581         —           8,040         354   

Other commercial real estate

     13,972         15,318         —           14,617         467   

Education (1)

     205         205         —           101         —     

Other consumer

     469         845         —           1,003         89   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Subtotal

     54,513         77,820         —           60,230         2,089   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

With an allowance recorded (2):

              

Residential

   $ 9,505       $ 9,671       $ 1,400       $ 8,574       $ 403   

Commercial and industrial

     113         236         140         111         1   

Land and construction

     8,362         12,536         3,657         4,440         180   

Multi-family

     11,641         11,641         1,308         10,465         485   

Retail/office

     9,387         9,566         1,391         8,207         356   

Other commercial real estate

     923         936         119         854         17   

Education (1)

     —           —           —           —           —     

Other consumer

     841         841         426         617         48   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Subtotal

     40,772         45,427         8,441         33,268         1,490   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

              

Residential

   $ 14,497       $ 16,077       $ 1,400       $ 14,029       $ 568   

Commercial and industrial

     113         504         140         954         27   

Land and construction

     17,783         31,870         3,657         16,632         388   

Multi-family

     29,255         31,504         1,308         28,444         1,265   

Retail/office

     17,227         25,147         1,391         16,247         710   

Other commercial real estate

     14,895         16,254         119         15,471         484   

Education (1)

     205         205         —           101         —     

Other consumer

     1,310         1,686         426         1,620         137   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
   $ 95,285       $ 123,247       $ 8,441       $ 93,498       $ 3,579   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1)  Excludes the guaranteed portion of education loans 90+ days past due with balance of $6.6 million and average carrying amounts totaling $7.7 million at December 31, 2014.
(2)  Includes ratio-based allowance for loan losses of $0.5 million associated with loans totaling $1.9 million at December 31, 2014 for which individual reviews have not been completed but an allowance established based on the ratio of allowance for loan losses to gross loans individually reviewed, by class of loan.

 

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Table of Contents

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

 

            Interest Income Recognized             Interest Income Recognized  
     Average
Carrying
Amount
     Three Months
Ended
    Six Months
Ended
     Average
Carrying
Amount
     Three Months
Ended
    Six Months
Ended
 
        June 30, 2015         June 30, 2014  
     (In Thousands)  

Residential

   $ 12,587       $ 126      $ 256       $ 13,483       $ 107      $ 231   

Commercial and industrial

     96         —          —           2,998         25        27   

Land and construction

     8,240         (18     3         20,785         158        237   

Multi-family

     25,503         274        662         21,725         (40     286   

Retail/office

     15,366         157        317         19,304         90        264   

Other commercial real estate

     12,116         111        224         16,691         (82     160   

Education

     186         —          —           209         —          —     

Other consumer

     1,716         45        78         2,376         22        55   
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 
   $ 75,810       $ 695      $ 1,540       $ 97,571       $ 280      $ 1,260   
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

The following is additional information regarding impaired loans:

 

     June 30,
2015
     December 31,
2014
 
     (In thousands)  

Carrying amount of impaired loans

   $ 67,835       $ 86,844   

Recorded investment

     76,116         95,285   

Troubled debt restructurings - accrual (1)

     58,566         60,170   

Loans and troubled debt restructurings on non-accrual status

     17,550         35,115   

Troubled debt restructurings - non-accrual (2)

     8,591         16,483   

Non-accrual loans - excluding troubled debt restructurings

     8,959         18,632   

Troubled debt restructurings valuation allowance

     7,407         8,593   

Loans past due ninety days or more and still accruing (3)

     4,630         6,613   

 

(1)  Includes TDR accruing loans of $54.9 million and $55.4 million at June 30, 2015 and December 31, 2014, respectively that are rated pass.
(2)  Troubled debt restructurings - non-accrual are included in the loans and troubled debt restructurings on non-accural status line item above.
(3)  Represents the guaranteed portion of education loans that were 90+ days past due which continue to accrue interest due to a guarantee provided by government agencies covering approximately 97% of the outstanding balance.

Although the Company is currently not committed to lend any additional funds on impaired loans in accordance with the original terms of these loans, it is not legally obligated to, and will cautiously disburse additional funds on any loans while in nonaccrual status or if the borrower is in default.

 

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Table of Contents

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

 

     Days Past Due                
     30-59      60-89      90 or More      Current      Total  
     (In thousands)  

June 30, 2015

              

Residential

   $ 469       $ 378       $ 1,916       $ 525,254       $ 528,017   

Commercial and industrial

     423         19         150         22,256         22,848   

Land and construction

     —           —           96         137,478         137,574   

Multi-family

     —           —           —           293,012         293,012   

Retail/office

     694         —           1,159         144,991         146,844   

Other commercial real estate

     358         29         180         134,005         134,572   

Education

     3,501         1,409         4,773         89,147         98,830   

Other consumer

     451         113         630         218,920         220,114   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
   $ 5,896       $ 1,948       $ 8,904       $ 1,565,063       $ 1,581,811   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

December 31, 2014

              

Residential

   $ 1,186       $ 802       $ 2,995       $ 536,228       $ 541,211   

Commercial and industrial

     205         —           196         16,113         16,514   

Land and construction

     267         29         1,111         105,029         106,436   

Multi-family

     —           —           3,518         262,217         265,735   

Retail/office

     —           —           2,172         152,923         155,095   

Other commercial real estate

     —           —           3,011         153,232         156,243   

Education

     3,505         2,140         6,818         95,921         108,384   

Other consumer

     632         126         517         232,212         233,487   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
   $ 5,795       $ 3,097       $ 20,338       $ 1,553,875       $ 1,583,105   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total delinquencies (loans past due 30 days or more) at June 30, 2015 and December 31, 2014, were $16.7 million and $29.2 million, respectively. The Company has experienced a reduction in delinquencies since December 31, 2014, primarily due to improving credit conditions and $2.5 million of loans transferring to OREO. The Company has $4.6 million of education loans past due 90 days or more at June 30, 2015, that are still accruing interest due to the approximate 97% guarantee provided by governmental agencies. Loans less than 90 days delinquent may be placed on non-accrual status when the probability of collection of principal and interest is deemed to be insufficient to warrant further accrual.

Credit Quality Indicators:

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

Pass. Loans classified as pass represent assets that are evaluated and are performing under the stated terms.

Watch. Loans classified as watch possess potential weaknesses that require management attention, but do not yet warrant adverse classification. These loans are treated the same as loans classified as “Pass” for reporting purposes.

Special Mention. Loans classified as special mention exhibit material negative financial trends due to company specific or industry conditions which, if not corrected or mitigated, threaten their capacity to meet current or continuing debt obligations.

Substandard. Loans classified as substandard are inadequately protected by the current net worth, paying capacity of the obligor, or by the collateral pledged. Substandard assets must have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt.

 

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Table of Contents

Non-Accrual. Loans classified as non-accrual have the weaknesses of those classified as Substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable.

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

 

     Pass (1)     Special
Mention
    Substandard     Non-Accrual     Total Gross
Loans
 
     (In thousands)  

June 30, 2015

          

Commercial and industrial

   $ 20,979      $ 523      $ 1,196      $ 150      $ 22,848   

Commercial real estate:

          

Land and construction

     129,188        —          1,981        6,405        137,574   

Multi-family

     290,474        874        905        759        293,012   

Retail/office

     141,327        —          2,493        3,024        146,844   

Other

     118,774        10,053        4,431        1,314        134,572   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
   $ 700,742      $ 11,450      $ 11,006      $ 11,652      $ 734,850   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Percent of total

     95.3     1.6     1.5     1.6     100.0
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

December 31, 2014

          

Commercial and industrial

   $ 14,990      $ —        $ 1,491      $ 33      $ 16,514   

Commercial real estate:

          

Land and construction

     85,425        946        2,870        17,195        106,436   

Multi-family

     261,254        —          915        3,566        265,735   

Retail/office

     143,260        4,753        3,112        3,970        155,095   

Other

     145,995        174        6,452        3,622        156,243   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
   $ 650,924      $ 5,873      $ 14,840      $ 28,386      $ 700,023   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Percent of total

     93.0     0.8     2.1     4.1     100.0
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) Includes TDR accruing loans.

 

23


Table of Contents

Residential and consumer loans are managed on a pool basis due to their homogeneous nature. Loans that are delinquent 90 days or more are placed on non-accrual. The following table presents the residential and consumer gross loans based on accrual status:

 

     June 30, 2015      December 31, 2014  
     Accrual (1)      Non-Accrual      Total Gross
Loans
     Accrual (1)      Non-Accrual      Total Gross
Loans
 
     (In thousands)  

Residential

   $ 523,136       $ 4,881       $ 528,017       $ 535,338       $ 5,873       $ 541,211   

Consumer

                 

Education (2)

     98,687         143         98,830         108,179         205         108,384   

Other consumer

     219,240         874         220,114         232,836         651         233,487   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
   $ 841,063       $ 5,898       $ 846,961       $ 876,353       $ 6,729       $ 883,082   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1)  Accrual residential and consumer loans includes substandard rated loans including TDR-accrual.
(2)  Non-accrual education loans represent the portion of these loans 90+ days past due that are not covered by a guarantee provided by government agencies that is limited to approximately 97% of the outstanding balance.

Troubled Debt Restructurings

Modifications of loan terms in a TDR are generally in the form of an extension of payment terms or lowering of the interest rate, although occasionally the Company has reduced the outstanding principal balance.

Loans modified in a troubled debt restructuring that are currently on non-accrual status will remain on non-accrual status for a period of at least six months, or longer period, sufficient to prove that the borrower demonstrates that they can make the payments under the modified terms. If after this period, the borrower has made payments in accordance with the modified terms, the loan is returned to accrual status but retains its designation as a TDR. Once a TDR loan is returned to accrual, further review of the credit could take place resulting in a further upgrade into the pass risk category but still remaining as a TDR.

The following table presents information related to loans modified in a troubled debt restructuring by class:

 

     Three Months Ended June 30,  
     2015      2014  

Troubled Debt

Restructurings (1)

   Number of
Modifications
     Gross Loans
(at beginning
of period)
     Gross
Loans (2)
(at period end)
     Number of
Modifications
     Gross Loans
(at beginning
of period)
     Gross
Loans (2)
(at period end)
 
     (Dollars in thousands)  

Residential

     3       $ 208       $ 215         5       $ 775       $ 546   

Land and construction

     —           —           —           2         372         357   

Multi-family

     —           —           —           1         315         273   

Other consumer

     5         348         362         10         287         280   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     8       $ 556       $ 577         18       $ 1,749       $ 1,456   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1)  Loans modified in a TDR that were fully paid down, charged-off or foreclosed upon by period end are not reported in this table.
(2)  Gross loans are inclusive of all partial paydowns and charge-offs since the modification date.

 

24


Table of Contents
     Six Months Ended June 30,  
     2015      2014  

Troubled Debt

Restructurings (1)

   Number of
Modifications
     Gross Loans
(at beginning
of period)
     Gross
Loans (2)
(at period end)
     Number of
Modifications
     Gross Loans
(at beginning
of period)
     Gross
Loans (2)
(at period end)
 
     (Dollars in thousands)  

Residential

     4       $ 271       $ 293         10       $ 1,294       $ 1,284   

Commercial and industrial

     1         12         12         1         48         48   

Land and construction

     —           —           —           2         372         357   

Multi-family

     —           —           —           3         1,283         1,198   

Other commercial real estate

     —           —           —           2         251         257   

Other consumer

     9         549         562         11         353         346   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     14       $ 832       $ 867         29       $ 3,601       $ 3,490   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1)  Loans modified in a TDR that were fully paid down, charged-off or foreclosed upon by period end are not reported in this table.
(2)  Gross loans are inclusive of all partial paydowns and charge-offs since the modification date.

The following tables present gross loans modified in a troubled debt restructuring during the three months ended June 30, 2015 and 2014 by class and by type of modification:

 

     Three Months Ended June 30, 2015  

Troubled Debt Restructurings (1)(2)

   Principal
and Interest
to Interest
Only
     Interest Rate
Reduction
To Below
Market Rate
     Below
Market
Rate (3)
     Other (4)      Total  
     (In thousands)  

Residential

   $ —         $ 136       $ 79       $ —         $ 215   

Other consumer

     —           180         —           182         362   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
   $ —         $ 316       $ 79       $ 182       $ 577   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     Three Months Ended June 30, 2014  

Troubled Debt Restructurings (1)(2)

   Principal
and Interest
to Interest
Only
     Interest Rate
Reduction
To Below
Market Rate
     Below
Market
Rate (3)
     Other (4)      Total  
     (In thousands)  

Residential

   $ 176       $ 163       $ —         $ 207       $ 546   

Land and construction

     —           —           —           357         357   

Multi-family

     —           —           —           273         273   

Other consumer

     —           188         —           92         280   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
   $ 176       $ 351       $ —         $ 929       $ 1,456   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1)  Loans modified in a TDR that were fully paid down, charged-off or foreclosed upon by period end are not reported in this table.
(2)  Gross loans is inclusive of all partial paydowns and charge-offs since the modification date.
(3)  Includes loans modified at below market rates for borrowers with similar risk profiles and having comparable loan terms and conditions. Market rates are determined by reference to internal new loan pricing grids that specify credit spreads based on loan risk rating and term to maturity.
(4)  Other modifications primarily include providing for the deferral of interest currently due to the new maturity date of the loan.

 

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Table of Contents
     Six Months Ended June 30, 2015  

Troubled Debt Restructurings (1)(2)

   Principal
and Interest
to Interest
Only
     Interest Rate
Reduction
To Below
Market Rate
     Below
Market
Rate (3)
     Other (4)      Total  
     (In thousands)  

Residential

   $ —         $ 214       $ 79       $ —         $ 293   

Commercial and industrial

     —           12         —           —           12   

Other consumer

     —           340         —           222         562   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
   $ —         $ 566       $ 79       $ 222       $ 867   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     Six Months Ended June 30, 2014  

Troubled Debt Restructurings (1)(2)

   Principal
and Interest
to Interest
Only
     Interest Rate
Reduction
To Below
Market Rate
     Below
Market
Rate (3)
     Other (4)      Total  
     (In thousands)  

Residential

   $ 176       $ 448       $ 120       $ 540       $ 1,284   

Commercial and industrial

     —           —           —           48         48   

Land and construction

     —           —           —           357         357   

Multi-family

     —           —           925         273         1,198   

Other commercial real estate

     —           —           215         42         257   

Other consumer

     —           254         —           92         346   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
   $ 176       $ 702       $ 1,260       $ 1,352       $ 3,490   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1)  Loans modified in a TDR that were fully paid down, charged-off or foreclosed upon by period end are not reported in this table.
(2)  Gross loans is inclusive of all partial paydowns and charge-offs since the modification date.
(3)  Includes loans modified at below market rates for borrowers with similar risk profiles and having comparable loan terms and conditions. Market rates are determined by reference to internal new loan pricing grids that specify credit spreads based on loan risk rating and term to maturity.
(4)  Other modifications primarily include providing for the deferral of interest currently due to the new maturity date of the loan.

One commercial and industrial loan and one consumer loan with a gross balance of $12,200 and $37,000, respectively, modified in a troubled debt restructuring during the twelve months prior to June 30, 2015, subsequently defaulted during the six month period ending June 30, 2015. There were no loans modified in a troubled debt restructuring during the twelve months prior to June 30, 2014, that subsequently defaulted during the six month period ended June 30, 2014.

Pledged Loans

At June 30, 2015 and December 31, 2014, residential, multi-family, education and other consumer loans with unpaid principal of approximately $693.9 million and $726.6 million, respectively were pledged to secure borrowings and for other purposes as permitted or required by law. Certain real-estate related loans are pledged as collateral for FHLB borrowings. See Note 9-Other Borrowed Funds.

 

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Table of Contents

Note 6 – Other Real Estate Owned

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

 

     Three Months Ended June 30,      Six Months Ended June 30,  
     2015      2014      2015      2014  
     (In thousands)  

Balance at beginning of period

   $ 30,632       $ 62,140       $ 35,491       $ 63,460   

Additions

     1,253         3,321         2,523         7,659   

Capitalized improvements

     —           —           118         28   

OREO valuation adjustments, net (1)

     (594      (1,824      (446      (2,279

Sales

     (4,036      (7,467      (10,431      (12,698
  

 

 

    

 

 

    

 

 

    

 

 

 

Balance at end of period

   $ 27,255       $ 56,170       $ 27,255       $ 56,170   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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

As of June 30, 2015, the recorded investment of loans secured by 1-4 family residential real estate for which foreclosure proceedings are in process was $1.7 million.

The balances at end of period above are net of a valuation allowance of $15.8 million and $24.5 million at June 30, 2015 and 2014, respectively, recognized during the holding period for declines in fair value subsequent to foreclosure or acceptance of deed in lieu of foreclosure. A summary of activity in the OREO valuation allowance is as follows:

 

     Three Months Ended June 30,      Six Months Ended June 30,  
     2015      2014      2015      2014  
     (In thousands)  

Balance at beginning of period

   $ 17,775       $ 29,653       $ 20,583       $ 30,842   

Valuation adjustments (1)

     594         1,824         446         2,279   

Sales

     (2,589      (6,962      (5,249      (8,606
  

 

 

    

 

 

    

 

 

    

 

 

 

Balance at end of period

   $ 15,780       $ 24,515       $ 15,780       $ 24,515   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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

Net OREO expense consisted of the following components:

 

     Three Months Ended June 30,      Six Months Ended June 30,  
     2015      2014      2015      2014  
     (In thousands)  

Valuation adjustments

   $ 594       $ 1,824       $ 446       $ 2,279   

Foreclosure cost expense

     86         187         195         331   

Expenses from operations, net

     57         256         332         842   
  

 

 

    

 

 

    

 

 

    

 

 

 

OREO expense, net

   $ 737       $ 2,267       $ 973       $ 3,452   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents

Note 7 - Mortgage Servicing Rights

Accounting for mortgage loan servicing rights (MSRs) is based on the amortization method. Under this method, servicing assets are amortized in proportion to and over the period of net servicing income. Income generated as the result of the capitalization of new servicing assets is reported as net gain on sale of loans and the amortization of servicing assets is reported as a reduction to loan servicing income in the Consolidated Statements of Income. Ancillary income is recorded in other non-interest income.

Information regarding the Company’s MSRs is as follows:

 

     Three Months Ended June 30,      Six Months Ended June 30,  
     2015      2014      2015      2014  
     (In thousands)  

Balance at beginning of period

   $ 20,323       $ 22,341       $ 20,685       $ 23,041   

Additions

     908         353         1,500         599   

Amortization

     (1,050      (922      (2,004      (1,868
  

 

 

    

 

 

    

 

 

    

 

 

 

Balance at end of period - before valuation allowance

     20,181         21,772         20,181         21,772   

Valuation allowance

     (860      (843      (860      (843
  

 

 

    

 

 

    

 

 

    

 

 

 

Balance at end of period

   $ 19,321       $ 20,929       $ 19,321       $ 20,929   
  

 

 

    

 

 

    

 

 

    

 

 

 

The projections of amortization expense for mortgage servicing rights set forth below are based on asset balances as of June 30, 2015 and an assumed amortization rate of 21.7% per year. Future amortization expense may be significantly different depending upon changes in the mortgage servicing portfolio, mortgage interest rates and market conditions.

 

     MSR
Amortization
 
     (In thousands)  

Six months ended June 30, 2015

   $ 2,004   
  

 

 

 

Estimate for the year ended December 31,

  

2015

   $ 4,360   

2016

     3,415   

2017

     2,674   

2018

     2,094   

2019

     1,640   

Thereafter

     5,998   
  

 

 

 

Total

   $ 20,181   
  

 

 

 

The unpaid principal balance of mortgage loans serviced for others is not included in the Consolidated Balance Sheets. The unpaid principal of mortgage loans serviced was approximately $2.37 billion and $2.47 billion at June 30, 2015 and December 31, 2014, respectively.

 

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Table of Contents

Note 8 – Deposits

Deposits are summarized as follows:

 

     June 30, 2015     December 31, 2014  
     Carrying
Amount
     Weighted
Average
Rate
    Carrying
Amount
     Weighted
Average
Rate
 
     (Dollars in thousands)  

Non-interest-bearing checking

   $ 281,621         —      $ 291,248         —   

Interest-bearing checking

     288,683         0.05        305,004         0.06   
  

 

 

      

 

 

    

Total checking accounts

     570,304         0.03        596,252         0.03   

Money market accounts

     470,220         0.23        455,594         0.20   

Regular savings

     330,707         0.10        312,544         0.10   

Advance payments by borrowers for taxes and insurance

     37,744         0.07        2,568         0.07   

Certificates of deposit

     411,817         0.57        447,213         0.52   
  

 

 

      

 

 

    

Total deposits

   $ 1,820,792         0.22   $ 1,814,171         0.21
  

 

 

      

 

 

    

Annual maturities of certificates of deposit outstanding at June 30, 2015, are summarized as follows:

 

     Amount  
     (In thousands)  

Matures During Year Ending December 31:

  

2015

   $ 137,850   

2016

     175,037   

2017

     56,808   

2018

     20,809   

2019

     13,625   

2020

     7,688   
  

 

 

 

Total

   $ 411,817   
  

 

 

 

At June 30, 2015 and December 31, 2014, certificates of deposit with balances greater than or equal to $100,000 totaled $66.1 million and $69.2 million, respectively.

 

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At June 30, 2015, the scheduled maturities of certificates of deposit of $100,000 or more are as follows:

 

     June 30, 2015  
     (In thousands)  

3 months or less

   $ 13,528   

Over 3 months through 6 months

     8,518   

Over 6 months through 12 months

     15,041   

Over 12 months

     29,021   
  

 

 

 

Total

   $ 66,108   
  

 

 

 

Certificates of deposit with balances greater than or equal to the FDIC insurance limit of $250,000 totaled $6.7 million and $7.9 million at June 30, 2015 and December 31, 2014, respectively.

The Bank has previously entered into agreements with certain brokers that will provide deposits obtained from their customers at specified interest rates for an identified fee, or so called “brokered deposits.” The Bank had no active broker deposit arrangements or outstanding brokered deposits at June 30, 2015 or December 31, 2014.

Note 9 – Other Borrowed Funds

Other borrowed funds consist of the following:

 

            June 30, 2015     December 31, 2014  
     Maturing      Amount      Weighted
Average
Rate
    Amount      Weighted
Average
Rate
 
            (Dollars in thousands)  

FHLB advances

     Dec 19, 2018       $ 10,000         2.33   $ 10,000         2.33

Repurchase agreements

        2,554         0.10        3,569         0.10   

Long term lease obligation

        183         2.46        183         2.46   
     

 

 

      

 

 

    
      $ 12,737         1.88   $ 13,752         1.75
     

 

 

      

 

 

    

FHLB Advances

The Bank pledges certain loans that meet underwriting criteria established by the Federal Home Loan Bank of Chicago (“FHLB of Chicago”) as collateral for outstanding advances. The unpaid principal balance of loans pledged to secure FHLB of Chicago borrowings totaled $622.3 million and $652.3 million at June 30, 2015 and December 31, 2014, respectively. The FHLB of Chicago borrowings are also collateralized by mortgage-related securities totaling $65.9 million and $88.9 million at June 30, 2015 and December 31, 2014, respectively. At June 30, 2015, there were no FHLB of Chicago borrowings with call features that may be exercised by the FHLB of Chicago.

Repurchase Agreements (Securities Sold Under Agreements to Repurchase)

The Company enters into agreements under which it sells securities subject to an obligation to repurchase the same or similar securities. Under these arrangements, the Company may transfer legal control over the assets but still retain effective control through an agreement that both entitles and obligates the Company to repurchase the assets. As a result, these repurchase agreements are accounted for as collateralized financing arrangements (i.e., secured borrowings) and not as a sale and subsequent repurchase of securities. The obligation to repurchase the securities is reflected as a liability in the Company’s Consolidated Balance Sheet, while the securities underlying the repurchase agreements remain in the respective investment securities asset accounts.

 

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Table of Contents

Long term lease obligation

The Company enters into agreements from time to time that give the right to use property in exchange for making a series of payments. The terms of the lease obligations typically exceed three years and provide an opportunity to purchase the leased item at the end of the lease term at a price below market rate. These types of leases are considered a capital lease because the Company has in essence accepted the risks and benefits of ownership. As a result a capital lease requires the asset to be subsequently depreciated and included as property and equipment on the balance sheet.

Note 10 – Regulatory Capital

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

In connection with the effectiveness of Basel III Capital Rules, most banks are required to decide whether to elect to opt-out of the inclusion of Accumulated Other Comprehensive Income (“AOCI”) in their Common Equity Tier 1 Capital. This is a one-time election and generally irrevocable. If electing to opt-out, most AOCI items will not be included in the calculation of Common Equity Tier 1 Capital. In other words, most AOCI items will be treated, for regulatory capital purposes, in the same manner in which they were prior to Basel III Capital Rules. The Bank has elected to opt-out of the inclusion.

Among other things, the Basel III Capital Rules: (i) introduce a new capital measure entitled “Common Equity Tier 1” (“CET1”); (ii) specify that Tier 1 capital consist of CET1 and additional financial instruments satisfying specified requirements that permit inclusion in Tier 1 capital; (iii) define CET1 narrowly by requiring that most deductions or adjustments to regulatory capital measures be made to CET1 and not to the other components of capital; and (iv) expand the scope of the deductions or adjustments from capital as compared to the existing regulations.

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

The Basel III Capital Rules became effective as applied to the Company and the Bank on January 1, 2015, with a phase in period that generally extends from January 1, 2015 through January 1, 2019.

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

Qualitative measures established by regulation to ensure capital adequacy require the Company and Bank to maintain minimum amounts and ratios of CET1, Tier 1 capital, Total capital and Tier 1 leverage. As of January 1, 2015, the requirements are:

 

    4.5% based upon CET1

 

    6.0% based upon Tier 1 capital

 

    8.0% based on total regulatory capital

 

    Leverage ratio of Tier 1 Capital assets equal to 4%

 

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Table of Contents

The following table summarizes the Company’s and Bank capital ratios:

 

     June 30, 2015     December 31, 2014  
     Ratio     Minimum
Required
    Ratio     Minimum
Required
 
     (Dollars in thousands)  

Common Equity Tier 1 ratio (1)

        

Anchor Bancorp

     19.18     4.50     N/A        N/A   

AnchorBank, fsb

     18.26     4.50     N/A        N/A   

Tier 1 capital ratio (2)

        

Anchor Bancorp

     19.18     6.00     N/A        N/A   

AnchorBank, fsb

     18.26     6.00     16.97     4.00

Total capital ratio (3)

        

Anchor Bancorp

     20.50     8.00     N/A        N/A   

AnchorBank, fsb

     19.58     8.00     18.25     8.00

Tier 1 leverage ratio (4)

        

Anchor Bancorp

     12.64     4.00     N/A        N/A   

AnchorBank, fsb

     12.03     4.00     10.43     4.00

 

(1)  CET1 capital divided by total risk-weighted assets
(2) Tier 1 capital divided by total risk-weighted assets
(3) Total capital divided by total risk-weighted assets
(4)  Tier 1 capital divided by adjusted total assets

Prior to January 1, 2015, the Company as a Savings & Loan Holding Company (“SLHC”) was not subject to calculating regulatory capital ratios, as required under the Basel III Capital Rules. For December 31, 2014, regulatory capital ratios were calculated under Basel I rules. See the Company’s annual report on Form 10-K for the year ended December 31, 2014 for further discussion of Basel I and Basel III.

Note 11 – Employee Benefit Plans

Defined Contribution Plan

The Company maintains a defined contribution plan under Sections 401(a) and 401(k) of the Internal Revenue Code, the AnchorBank, fsb Retirement Plan, in which all employees are eligible to participate. Employees become eligible on the first of the month following 60 days of employment. Participating employees may contribute up to 100% of their base compensation on a pre-tax basis up to annual internal revenue service limits. The company matches the first 2% contributed with a dollar-for-dollar match, the next 2% is matched at a rate of $0.50 for each dollar and the next 4% is matched at $0.25 for each dollar. The plan offers 14 investment choices in addition to 5 model portfolios. Employees are allowed to self-direct their investments on a daily basis. The Company may also contribute additional amounts at its discretion. The Company contributed $268,000 and $597,000 for the three and six month periods ending June 30, 2015, compared to contributions of $257,000 and $492,000 for the three and six months ended June 30, 2014, respectively.

 

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Table of Contents

Omnibus Incentive Plan

On August 12, 2014, the Board of Directors (“Board”) of the Company approved a new incentive plan, the Anchor BanCorp Wisconsin Inc. 2014 Omnibus Incentive Plan (the“Omnibus Plan”) which was subsequently approved by stockholders. The Omnibus Plan provides for the issuance of awards of incentive or nonqualified stock options, stock appreciation rights, performance and restricted stock awards or units, dividend equivalent units and other stock based awards as determined by the Board or the Plan Administrator. The purpose of the Omnibus Plan is to promote the interest of the Company and its stockholders by attracting, retaining and motivating executives and other selected employees, directors, consultants and advisors by enabling such individuals to participate in the long-term growth and financial success of the Company.

The maximum number of shares of common stock (each, a “share”) that may be issued to participants pursuant to awards under the Omnibus Plan will be equal to 600,000. Such shares may be either authorized and unissued shares or shares reacquired at any time and now or hereafter held as treasury stock. At June 30, 2015, 345,886 shares were available to grant pursuant to the Omnibus Plan.

Restricted stock grants vest over various periods of time typically from one to three years and are included in outstanding shares at the time of grant. The fair value of restricted stock grants determined at the grant date is amortized to compensation and benefits expense over the vesting period. The restricted stock grant plan expense for the three and six months ending June 30, 2015, was $641,000 and $1.2 million, respectively. Dividends, if declared, will accrue for the benefit of the individuals who are granted restricted stock and will be paid out as the stock vests. Unvested shares will be voted by the employees in the same manner as the vested shares.

The restricted stock activity is summarized as follows:

 

     Shares      Weighted
Average
Grant Date
Fair Value
 

Nonvested balance as of December 31, 2013

     —         $ —     

Granted

     200,200         21.17   

Vested

     (12,500      20.95   

Forfeited

     (8,400      20.95   
  

 

 

    

Nonvested balance as of December 31, 2014

     179,300       $ 21.20   
  

 

 

    

Granted

     67,047         34.77   

Vested

     (58,983      21.21   

Forfeited

     (4,733      27.84   
  

 

 

    

Nonvested balance as of June 30, 2015

     182,631       $ 26.01   
  

 

 

    

During the six month period ending June 30, 2015, 8,010 shares of the Company’s common stock was retired under this plan to satisfy the withholding taxes due upon the vesting of certain previously awarded shares. As of June 30, 2015 and December 31, 2014, respectively, there was approximately $4.0 million and $3.1 million of unrecognized compensation expense related to nonvested restricted stock awards granted under the Plan. The remaining weighted average term of nonvested awards is 1.4 years as of June 30, 2015.

Note 12 – Offsetting Assets and Liabilities

Accounting Standards Codification (“ASC”) 210-20-50 requires entities to provide disclosures of both gross information and net information about instruments and transactions eligible for offset in the statement of financial position and instruments and transactions subject to an agreement similar to a master netting arrangement. The objective of this disclosure is to facilitate comparison between those entities that prepare their financial statements on the basis of GAAP and those entities that prepare their financial statements on the basis of International Financial Reporting Standards, (“IFRS”).

Offsetting, otherwise known as netting, takes place when entities present their rights and obligations to each other as a net amount in their statement of financial condition. The Company has certain assets and liabilities on the Consolidated Balance Sheets which could be subject to the right of setoff and related arrangements associated with

 

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Table of Contents

financial instruments and derivatives. Derivative instruments reported are used as part of a risk management strategy to address exposure to changes in interest rates inherent in the Company’s origination and sale of certain residential mortgages into the secondary market, as presented in Note 14 – Derivative Financial Instruments. In addition, the Company enters into interest rate-related instruments to facilitate the interest rate risk management strategies of commercial customers. The interest agreements are derivatives and are recorded at fair value in the Company’s Consolidated Balance Sheet. A repurchase agreement is a transaction that involves the “sale” of financial assets by one party to another, subject to an agreement by the “seller” to repurchase the assets at a specified date or in specified circumstances.

The following table reflects the gross and net amounts of such assets and liabilities as of June 30, 2015 and December 31, 2014.

 

    Gross Amounts of
Recognized Assets or
Liabilities
    Gross Amounts Offset
in the Consolidated
Balance Sheets
    Net Amount of Assets
Presented in the
Consolidated Balance
Sheets
 
          (In thousands)        

As of June 30, 2015

     

Assets

     

Interest rate swap contracts

  $ 79      $ —        $ 79   

Interest rate commitments

    120        —          120   

Forward sale contracts

    520        —          520   

Liabilities

     

Interest rate swap contracts

    79        —          79   

Interest rate commitments

    121        —          121   

Repurchase agreements

    2,554        —          2,554   

As of December 31, 2014

     

Assets

     

Interest rate commitments

  $ 154      $ —        $ 154   

Forward sale contracts

    2        —          2   

Liabilities

     

Interest rate commitments

    14        —          14   

Forward sale contracts

    174        —          174   

Repurchase agreements

    3,569        —          3,569   

Note 13 – Commitments and Contingent Liabilities

The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and financial guarantees which involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the Consolidated Balance Sheets. The contract amounts of those instruments reflect the extent of involvement and exposure to credit loss the Company has in particular classes of financial instruments. The same credit policies are used in making commitments and conditional obligations as for on-balance-sheet instruments.

 

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

 

     June 30, 2015      December 31, 2014  
     (In thousands)  

Commitments to extend credit

   $ 75,830       $ 39,251   

Unused lines of credit:

     

Home equity

     112,124         111,365   

Credit cards

     —           23,249   

Commercial

     132,896         144,333   

Letters of credit

     4,574         8,564   

Credit enhancement under the Federal Home Loan Bank of Chicago Mortgage Partnership Finance Program

     7,641         7,644   

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

The Bank previously participated in the Mortgage Partnership Finance Program of the FHLB of Chicago (“MPF Program”). Pursuant to the credit enhancement feature of the MPF Program, the Bank retained a secondary credit loss exposure in the amount of $7.6 million at June 30, 2015, related to approximately $144.6 million of residential mortgage loans that the Bank has originated and are still outstanding. The Bank acts as a servicing agent for the FHLB of Chicago. Under the credit enhancement, the FHLB of Chicago is liable for losses on loans up to one percent of the original delivered loan balances in each pool up to the point the credit enhancement is reset. After the credit enhancement resets, the FHLB of Chicago and the Bank’s loss contingency could be reduced depending upon losses experienced and loan balances remaining. The Bank is liable for losses over and above the FHLB of Chicago first loss position up to a contractually agreed-upon maximum amount in each pool that was delivered to the MPF Program. The Bank receives a monthly fee for this credit enhancement obligation based on the outstanding loan balances. The monthly fee received is net of losses under the MPF Program. The Bank discontinued funding loans through the MPF Program in 2008.

Unfunded Commitments and Repurchase Loan Reserve

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

 

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The balances of these reserves for the periods presented are as follows:

 

     Three months ended June 30,      Six months ended June 30,  
     2015      2014      2015      2014  
     (In thousands)  

Reserve for unfunded commitment losses beginning balance

   $ 2,678       $ 4,844       $ 2,557       $ 4,664   

Provision for unfunded commitments

     170         600         291         780   
  

 

 

    

 

 

    

 

 

    

 

 

 

Ending reserve for unfunded commitment losses

   $ 2,848       $ 5,444       $ 2,848       $ 5,444   
  

 

 

    

 

 

    

 

 

    

 

 

 

Reserve for repurchased loans beginning balance

   $ 1,148       $ 2,600       $ 1,338       $ 2,600   

Charge off

     (11      —           (164      —     

Recovery

     1         —           64         —     

Provision for repurchased loans

     (273      (249      (373      (249
  

 

 

    

 

 

    

 

 

    

 

 

 

Ending reserve for repurchased loans

   $ 865       $ 2,351       $ 865       $ 2,351   
  

 

 

    

 

 

    

 

 

    

 

 

 

The amount of the allowance for unfunded loan commitments is determined using the respective trailing four quarter gross reserve rate that applies to the associated funded loan category multiplied by the unfunded commitment amount at an estimated utilization rate. The reserve also covers potential loss on letters of credit outstanding for which the Bank may be unable to recover the amount outstanding. At June 30, 2015, a liability of $2.8 million was required as compared to a liability of $5.4 million at June 30, 2014.

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

If it is determined at a later date that a loan did not meet these requirements or was a fraudulent transaction, the investor may require the Bank to either repurchase the loan or make the investor whole in the event of a loss. The unpaid principal balance of loans repurchased from investors totaled zero and $689,000 for the three and six months ended June 30, 2015, respectively, and $469,000 and $648,000 for the three and six months ended June 30, 2014, respectively. Alternatively, investors make requests to be made whole on a loan whereby the property has been disposed of at a loss. The related amounts for requests by the investor to be made whole was zero and $125,000 for the three and six months ended June 30, 2015, respectively, and $1,000 and $163,000 for the three and six months ended June 30, 2014, respectively. All losses incurred are recorded against the reserve for repurchased loans on the Consolidated Balance Sheets.

The amount of the reserve for repurchased loans is determined using the serviced portfolio balances multiplied by historical and expected loss rates to provide for the probable losses related to sold mortgage loans. The reserve declined $283,000 and $473,000 during the three and six months ended June 30, 2015, compared to $249,000 during both the three and six months ended June 30, 2014. Investor loss reimbursement expense recorded a reserve release of $273,000 and $373,000 for the three and six months ended June 30, 2015. Total expense incurred for investor loss reimbursements, including any provision recorded or reserve released, was ($273,000) and ($373,000) for the three and six months ended June 30, 2014, respectively and ($248,000) and ($86,000) for the three and six months ended June 30, 2014, respectively. Losses, as previously stated, may result from the repurchase of loans or indemnification of losses incurred upon foreclosure and disposition of related collateral. The analysis of the reserve at June 30, 2015, required a liability of $865,000.

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

 

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Note 14 – Derivative Financial Instruments

The Company enters into contracts that meet the definition of derivative financial instruments in accordance with ASC 815 - Derivative and Hedging. Derivatives are used as part of a risk management strategy to address exposure to changes in interest rates inherent in the Company’s origination and sale of certain residential mortgages into the secondary market. These derivative contracts used for risk management purposes include: (1) interest rate lock commitments provided to customers to fund mortgage loans intended to be sold; (2) forward sale contracts for the future delivery of funded residential mortgages; and (3) interest swap products offered directly.

Forward sale contracts are entered into when interest rate lock commitments are granted to customers in an effort to economically hedge the effect of future changes in interest rates on the commitments to fund mortgage loans intended to be sold (the “pipeline”), as well as on the portfolio of funded mortgages not yet sold (the “warehouse”). For accounting purposes, these derivatives are not designated as being in a hedging relationship. The contracts are carried at fair value on the Consolidated Balance Sheets with changes in fair value recorded in the Consolidated Statements of Income.

The Company has developed a program to enter 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 derivative financial instruments under GAAP. None of these derivative financial instruments would be designated by the Company as accounting hedges as specified in GAAP. As such, the fair market value of the interest rate swaps and embedded derivatives will be carried on the Company’s balance sheet as derivative assets or liabilities, as the case may be, and periodic changes in fair market value of such financial instruments will be recorded through periodic earnings in other non-interest income.

Derivative financial instruments are summarized as follows:

 

          June 30, 2015      December 31, 2014  
     Balance
Sheet
Location
   Notional
Amount
     Estimated
Fair
Value
     Notional
Amount
     Estimated
Fair
Value
 
          (In thousands)  

Derivative assets:

              

Interest rate lock commitments (1)

   Other assets    $ 20,834       $ 120       $ 14,633       $ 154   

Forward contracts to sell mortgage loans (2)

   Other assets      46,000         520         4,000         2   

Interest rate swap contracts

   Other assets      15,649         79         —           —     

Derivative liabilities:

              

Interest rate lock commitments (1)

   Other liabilities      18,257         121         2,108         14   

Forward contracts to sell mortgage loans (2)

   Other assets      —           —           16,000         174   

Interest rate swap contracts

   Other liabilities      15,649         79         —           —     

 

(1)  Interest rate lock commitments include $26.8 million and $7.9 million of commitments not yet approved in the credit underwriting process at June 30, 2015 and December 31, 2014, respectively, yet represent potential interest rate risk exposure to the extent of those mortgage loan applications eventually approved for funding.
(2)  The Company has elected to offset the fair value of individual forward sale contracts and present a net amount on the Consolidated Balance Sheets in accordance with ASC 815-45, Derivatives and Hedging.

 

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

 

     Three Months Ended June 30,      Six Months Ended June 30,  
     2015      2014      2015      2014  
     (In thousands)  

Interest rate lock commitments

   $ (562    $ 36       $ (141    $ 156   

Unused commitments

     —           15         —           (11

Forward contracts to sell mortgage loans

     1,035         (304      577         (330
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 473       $ (253    $ 436       $ (185
  

 

 

    

 

 

    

 

 

    

 

 

 

Note 15 - Fair Value of Financial Instruments

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

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

 

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

 

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

 

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

 

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Fair Value on a Recurring Basis

The table below presents the financial instruments carried at fair value by the valuation hierarchy (as described above):

 

     Level 1      Level 2      Level 3      Total  
     (In thousands)  

June 30, 2015

  

Financial assets

           

Investment securities available for sale:

           

U.S. government sponsored and federal agency obligations

   $ —         $ 3,213       $ —         $ 3,213   

Government sponsored agency mortgage-backed securities

     —           203,127         —           203,127   

GNMA mortgage-backed securities

     —           138,893         —           138,893   

Other securities

     4         24         —           28   

Loans held for sale

     —           13,513         —           13,513   

Other assets:

           

Interest rate lock commitments

     —           120         —           120   

Forward contracts to sell mortgage loans

     —           520         —           520   

Interest rate swap contracts

     —           79         —           79   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 4       $ 359,489       $ —         $ 359,493   
  

 

 

    

 

 

    

 

 

    

 

 

 

Financial liabilities

           

Other liabilities:

           

Interest rate lock commitments

   $ —         $ 121       $ —         $ 121   

Interest rate swap contracts

     —           79         —           79   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ —         $ 200       $ —         $ 200   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

     Level 1      Level 2      Level 3      Total  
     (In thousands)  

December 31, 2014

  

Financial assets

           

Investment securities available for sale:

           

U.S. government sponsored and federal agency obligations

   $ —         $ 3,261       $ —         $ 3,261   

Government sponsored agency mortgage-backed securities

     —           120,621         —           120,621   

GNMA mortgage-backed securities

     —           170,687         —           170,687   

Other securities

     3         27         —           30   

Loans held for sale

     —           6,594         —           6,594   

Other assets:

           

Interest rate lock commitments

     —           154         —           154   

Forward contracts to sell mortgage loans

     —           2         —           2   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 3       $ 301,346       $ —         $ 301,349   
  

 

 

    

 

 

    

 

 

    

 

 

 

Financial liabilities

           

Other liabilities:

           

Interest rate lock commitments

   $ —         $ 14       $ —         $ 14   

Forward contracts to sell mortgage loans

     —           174         —           174   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ —         $ 188       $ —         $ 188   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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

 

     June 30, 2015     Weighted
Average
    December 31, 2014     Weighted
Average
 
     From     To           From     To        

Coupon rate

     2.0     4.6     2.5     2.0     4.6     2.5

Duration (in years)

     0.2        6.9        3.5        0.5        5.4        3.5   

PSA prepayment speed (in months)

     142        390        269        142        399        259   

The Bank has one remaining non-agency CMO which is not validated by an independent pricing service.

Other assets and other liabilities include interest rate lock commitments provided to customers to fund mortgage loans intended to be sold and forward sale contracts for future delivery of funded residential mortgages to investors.

The Company relies on an internal valuation model to estimate the fair value of its interest rate lock commitments, which includes applying an estimated pull-through rate (the percentage of commitments expected to result in a closed loan) based on historical experience; multiplied by quoted investor prices on closed loans for future delivery determined to be reasonably applicable to the loan commitment based on interest rate, terms and rate lock expiration.

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

The fair value of off-balance-sheet instruments (held for investment lending commitments and unused lines of credit) are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements, the counterparties’ credit standing and discounted cash flow analyses. The fair value of these off-balance-sheet items approximates the recorded amounts of the related fees and is not material at June 30, 2015 and December 31, 2014.

The carrying amount and fair value of existing derivative financial instruments are based upon independent valuation models, which use widely accepted valuation techniques, including discounted cash flow analysis on the expected cash flows of each derivative contract. This analysis reflects the contractual terms of the derivatives, including the period to maturity, and uses observable market-based inputs, including interest rate curves and implied volatilities and have been categorized as Level 2.

There were no transfers out of Level 3 to Level 2 for the three and six months ended June 30, 2015 and 2014, respectively. The Company’s policy for determining transfers between levels occurs at the end of the reporting period when circumstances in the underlying valuation criteria changes and result in transfers between levels.

Fair Value on a Nonrecurring Basis

Certain assets are measured at fair value on a nonrecurring basis; that is, the instruments are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment). Mortgage servicing rights includes only those items that were adjusted to fair value as of the dates indicated.

 

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The following table presents such assets carried on the Consolidated Balance Sheet by caption and by level within the fair value hierarchy:

 

     Level 1      Level 2      Level 3      Total  
     (In thousands)  

June 30, 2015

           

Impaired loans, with an allowance recorded, net

   $ —         $ —         $ 14,454       $ 14,454   

Mortgage servicing rights

     —           —           6,208         6,208   

Other real estate owned

     —           —           27,255         27,255   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total assets at fair value

   $ —         $ —         $ 47,917       $ 47,917   
  

 

 

    

 

 

    

 

 

    

 

 

 

December 31, 2014

  

Impaired loans, with an allowance recorded, net

   $ —         $ —         $ 32,331       $ 32,331   

Mortgage servicing rights

     —           —           18,918         18,918   

Other real estate owned

     —           —           35,491         35,491   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total assets at fair value

   $ —         $ —         $ 86,740       $ 86,740   
  

 

 

    

 

 

    

 

 

    

 

 

 

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

 

    

June 30, 2015

    

Method

  

Inputs

Impaired loans, with an allowance recorded, net    Appraised Values    External appraised values- adjustments made to values due to management factors including age of appraisal, age of comparables, known changes in the market and in the collateral and selling and commission cost of 15 % to 35%.
Mortgage servicing rights    Discounted Cash Flow    Weighted average prepayment speed 8.07%; weighted average discount rate 11.41%.
Other real estate owned    Appraised Values    External appraised values- adjustments made to values due to management factors including age of appraisal, age of comparables, known changes in the market and in the collateral and selling and commission cost of 15 % to 35%.

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

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

 

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Critical assumptions used in the MSR discounted cash flow model include mortgage prepayment speeds, discount rates, costs to service, ancillary and late fee income. Variations in the assumptions could materially affect the estimated fair values. Changes to the assumptions are made when market data indicate that new trends have developed. Current market participant assumptions based on loan product types – fixed rate, adjustable rate and balloon loans - include discount rates in the range of 11.0% to 24.5% as well as portfolio weighted average prepayment speeds of 6.6% to 37.1% annual Conditional Prepayment Rate (“CPR”). Many of these assumptions are subjective and involve a high degree of management judgment. MSR valuation assumptions are reviewed and approved by management on a quarterly basis.

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

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

Fair Value Summary

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

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

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

Investment securities held to maturity: The fair value of investment securities are determined by an independent pricing service. In accordance with ASC 820, investment securities held to maturity have been categorized as a Level 2 fair value measurement.

Loans held for investment, net: The fair value of residential mortgage loans held for investment, commercial real estate loans, commercial and industrial loans, and consumer and other loans held for investment are estimated using observable inputs including estimated cash flows and discount rates based on interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. In accordance with ASC 820, loans held for investment that are not included with impaired loans in the preceding section titled Fair Value on a Nonrecurring Basis have been categorized as a Level 2 fair value measurement.

 

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

Deposits: The fair value of checking, savings and money market accounts are reported at book value, which is the amount payable on demand. The fair values of fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies current interest rates being offered on certificates of deposit to a schedule of aggregated expected monthly maturities of the outstanding certificates of deposit. In accordance with ASC 820, deposits have been categorized as a Level 2 fair value measurement.

Other borrowed funds: The fair value of FHLB advances and repurchase agreements are estimated using discounted cash flow analysis, based on the Company’s current incremental borrowing rates for similar types of borrowing arrangements. The fair value of the long-term lease obligation is reported at book value, which represents the present value of the cash flows at the time of inception and is indicative of the fair value in the current stable rate environment. In accordance with ASC 820, other borrowed funds have been categorized as a Level 2 fair value measurement.

 

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

 

     June 30, 2015      December 31, 2014  
     Carrying      Fair      Carrying      Fair  
     Amount      Value      Amount      Value  
     (In thousands)  

Financial assets:

           

Cash and cash equivalents

   $ 110,734       $ 110,734       $ 147,273       $ 147,273   

Investment securities available for sale

     345,261         345,261         294,599         294,599   

Investment securities held to maturity

     5,491         5,524         —           —     

Loans held for sale

     13,513         13,513         6,594         6,594   

Loans held for investment, net

     1,521,534         1,482,572         1,524,439         1,496,791   

Mortgage servicing rights

     19,321         19,896         19,404         19,590   

Federal Home Loan Bank stock

     11,940         11,940         11,940         11,940   

Accrued interest receivable

     7,555         7,555         7,627         7,627   

Interest rate lock commitments

     120         120         154         154   

Unused commitments

     —           —           —           —     

Forward contracts to sell mortgage loans (1)

     520         520         2         2   

Interest rate swap contracts

     79         79         —           —     

Financial liabilities:

           

Non-maturity deposits

     1,408,975         1,408,975         1,366,958         1,366,958   

Deposits with stated maturities

     411,817         410,363         447,213         445,938   

Other borrowed funds

     12,737         13,164         13,752         14,077   

Accrued interest payable

     357         357         316         316   

Interest rate lock commitments

     121         121         14         14   

Unused commitments

     —           —           —           —     

Forward contracts to sell mortgage loans (1)

     —           —           174         174   

Interest rate swap contracts

     79         79         —           —     

 

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

Note 16 – Income Taxes

As of June 30, 2015, the net deferred tax asset was $109.0 million and as of December 31, 2014, the net deferred tax asset, prior to any valuation allowance, was $113.1 million. Management recorded a full valuation allowance against the deferred tax asset in September 2009 based largely on negative evidence represented by the losses in prior years caused by significant provisions associated with its loan portfolio coupled with excessive debt costs associated with the credit facility. As of December 31, 2014, the Company determined that a full valuation allowance was still necessary. The realization of the deferred tax asset is assessed and a valuation allowance is recorded if it is “more likely than not” that all or a portion of the DTA will not be realized. The determination of the realizability of the deferred tax asset is highly subjective and dependent upon management’s evaluation and judgement of both positive and negative evidence, the forecasts of future income, applicable tax planning strategies and assessments of the current and future economic and business conditions. All available evidence, both positive and negative, is considered to determine whether, based on the weight of that evidence, a valuation allowance against the net deferred tax asset is required.

Based on the Company’s periodic assessment of all of the positive and negative evidence regarding the deferred tax asset position in the second quarter of 2015, it has determined that it is more likely than not that the Company will be able to realize all of the federal deferred tax asset, including all net operating loss carryforwards. The Company has also determined that it is more likely than not that it will be able to realize substantially all of the state deferred

 

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tax asset, with the exception of $5.9 million pertaining to certain multi state loss carryforwards, including states we no longer do business in. Consequently, as of June 30, 2015, the Company has substantially reversed this valuation allowance on the deferred tax asset.

The positive evidence considered by management in arriving at the conclusion to reverse substantially all of the valuation allowance included: (1) eight consecutive quarters of pre-tax earnings; (2) a three-year cumulative pre-tax book income position; (3) significant reductions in the level of non-performing assets since their peak, which was the primary source of the losses generated in prior periods; (4) the successful execution of operational efficiency initiatives in the second quarter of 2015; (5) adequacy of capital to fund balance sheet and future asset growth; and (6) forecasted positive core earnings trends which allow for the utilization of substantially all net operating losses before the statutory expiration periods. The negative evidence considered by management included: (1) operating losses and the lack of taxes paid in prior years; (2) the charges in the quarter ended June 30, 2015, and the expected charges in the quarter ended September 30, 2015, pertaining to the operational efficiency initiatives; and (3) classified asset levels relative to peers. All these factors were given the appropriate weighting based on the extent to which the positive and negative evidence can be objectively verified. Based on management’s analysis, it was concluded that the positive evidence was sufficient to overcome the weight of negative evidence.

The Company’s ultimate realization of the deferred tax asset is dependent upon the generation of future taxable income during the periods in which temporary differences become deductible. Management considers the nature and amount of historical and projected future taxable income, the scheduled reversal of deferred tax assets and liabilities and available tax planning strategies in making this assessment. The amount of deferred taxes recognized could be impacted by changes to any of these variables.

At June 30, 2015 and December 31, 2014, the Company and its affiliated entities had a federal net operating loss and tax credit carryover of $193.8 million and $200.6 million, respectively, and at June 30, 2015 and December 31, 2014, certain subsidiaries had state net operating loss carryovers of $310.2 million and $320.1 million, respectively. These carryovers expire in varying amounts in 2015 through 2034.

 

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

 

     June 30,      December 31,  
     2015      2014  
     (In thousands)  

Deferred tax assets:

     

Allowance for loan losses

   $ 18,870       $ 18,871   

OREO valuation allowance and other loss reserves

     8,076         10,307   

Federal NOL carryforwards

     69,253         72,630   

State NOL carryforwards

     16,151         16,657   

Unrealized securities gains (losses), net

     848         963   

Other

     4,832         2,964   
  

 

 

    

 

 

 

Total deferred tax assets

     118,030         122,392   

Valuation allowance

     (5,900      (113,099
  

 

 

    

 

 

 

Adjusted deferred tax assets

     112,130         9,293   

Deferred tax liabilities:

     

FHLB stock dividends

     (833      (833

Mortgage servicing rights

     (7,751      (7,785

Other

     (474      (675
  

 

 

    

 

 

 

Total deferred tax liabilities

     (9,058      (9,293
  

 

 

    

 

 

 

Net deferred tax assets

   $ 103,072       $ —     
  

 

 

    

 

 

 

The Company is subject to U.S. federal income tax as well as income tax of various state jurisdictions. The tax years 2011-2014 remain open to examination by the Internal Revenue Service and certain state jurisdictions while the years 2010-2014 remain open to examination by certain other state jurisdictions.

Note 17 – Earnings Per Share

Basic earnings per share for the three and six months ended June 30, 2015 and 2014 have been determined by dividing net income for the respective periods by the weighted average number of shares of common stock outstanding. Unvested shares of restricted stock are not considered outstanding for purposes of basic earnings per share. Diluted earnings per share is computed by dividing net income by the weighted average number of common shares outstanding plus the effect of dilutive securities. The effects of dilutive securities, if any, are computed using the treasury stock method.

 

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The computation of earnings per share is as follows:

 

     Three Months Ended June 30,      Six Months Ended June 30,  
     2015      2014      2015      2014  
     (in thousands, except per share data)      (in thousands, except per share data)  

Numerator:

     

Numerator for basic and diluted earnings per share - net income

   $ 107,521       $ 2,607       $ 113,666       $ 4,537   

Denominator:

           

Denominator for basic earnings per share - weighted average shares

     9,418         9,050         9,393         9,050   

Effect of dilutive securities:

           

Restricted stock

     41         —           43         —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Denominator for diluted earnings per share - weighted average shares

     9,459         9,050         9,436         9,050   
  

 

 

    

 

 

    

 

 

    

 

 

 

Basic income per common share

   $ 11.42       $ 0.29       $ 12.10       $ 0.50   

Diluted income per common share

   $ 11.37       $ 0.29       $ 12.05       $ 0.50   

 

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ANCHOR BANCORP WISCONSIN INC.

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

RESULTS OF OPERATIONS

CRITICAL ACCOUNTING ESTIMATES AND JUDGMENTS

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

Fair Value Measurements

In preparing the consolidated financial statements, management is required to make estimates, assumptions and judgments when assets and liabilities are required to be recorded at, or adjusted to reflect, fair value under Generally Accepted Accounting Principles (“GAAP”) that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the fair value of investment securities, the determination of the allowance for loan losses, the valuation of OREO, the net carrying value of mortgage servicing rights and deferred tax assets. The valuation of both financial and nonfinancial assets and liabilities in these transactions requires numerous assumptions and estimates and the use of third-party sources including appraisers and valuation specialists.

Assets and liabilities carried at fair value inherently result in a higher degree of financial statement volatility. Assets and liabilities measured at fair value on a recurring basis include investment securities available for sale, loans held for sale, interest rate lock commitments, forward contracts to sell mortgage loans and interest rate swaps. Assets and liabilities measured at fair value on a non-recurring basis may include certain impaired mortgage servicing rights, loans and other real estate owned (“OREO”). Fair values and the information used to record valuation adjustments for certain assets and liabilities are based on either quoted market prices or are provided by other independent third-party sources, when available. When such third-party information is not available, fair value is estimated primarily by using cash flow and other financial modeling techniques. Changes in underlying factors, assumptions or estimates in any of these areas could materially impact future financial condition and results of operations. For a more detailed discussion, see Note 15 in the Notes to Unaudited Consolidated Financial Statements contained in Item 1.

Investment Securities Available for Sale

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

 

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Allowance for Loan Losses

The allowance for loan losses is a valuation account for probable and inherent losses incurred in the loan portfolio. Management maintains an allowance for loan losses, at levels that we believe to be adequate to absorb estimated probable credit losses incurred in the loan portfolio. The adequacy of the allowance for loan losses is determined based on periodic evaluations of the loan portfolios and other relevant factors. The allowance for loan losses is comprised of general and specific components. Even though the entire allowance is available to cover losses on any loan, specific allowances are provided on impaired loans pursuant to accounting standards. The general allowance is based on historical loss experience, adjusted for qualitative factors. At least quarterly, management reviews the assumptions and methodology related to the general and specific allowance in an effort to update and refine the estimate. See Note 5 in the Notes to Unaudited Consolidated Financial Statements contained in Item 1.

Valuation of OREO

Real estate acquired by foreclosure or by deed in lieu of foreclosure and other repossessed assets are held for sale and are initially recorded at fair value less estimated selling costs at the date of foreclosure, establishing a new cost basis. When a loan is transferred to OREO the write down to fair value less estimated selling costs is charged to the allowance for loan losses. Subsequent to foreclosure, valuations are periodically performed and a valuation allowance is established if the carrying value exceeds the fair value less estimated selling costs. See Note 6 in the Notes to Unaudited Consolidated Financial Statements contained in Item 1.

Mortgage Servicing Rights

Mortgage servicing rights (“MSR”) are initially recorded as an asset, measured at fair value, when loans are sold to third parties with servicing rights retained. MSR assets are amortized in proportion to, and over the period of, estimated net servicing revenues. The carrying value of these assets is periodically reviewed for impairment using a lower of amortized cost or fair value methodology. See Note 7 in the Notes to Unaudited Consolidated Financial Statements contained in Item 1.

Deferred Tax Assets

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

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

As a result of this evaluation, the Company has substantially reversed its valuation allowance against the deferred tax asset during the quarter ended June 30, 2015. For additional information regarding our deferred taxes, see Note 16 of the Notes to Unaudited Consolidated Financial Statements contained in Item 1.

 

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FORWARD-LOOKING STATEMENTS

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

Although we believe that the anticipated results or other expectations reflected in our forward-looking statements are based on reasonable assumptions, we can give no assurance that those results or expectations will be attained. Forward-looking statements involve risks, uncertainties and assumptions, some of which are beyond our control, and as a result actual results may differ materially from those expressed in forward-looking statements due to several factors more fully described in Item 1A, “Risk Factors,” as well as elsewhere in the Annual Report on Form 10-K for the year ended December 31, 2014. Factors that could cause actual results to differ from forward-looking statements include, but are not limited to, the following, as well as those discussed elsewhere herein:

 

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

 

    our ability to fully utilize our deferred tax assets;

 

    on-going impact of our Recapitalization which occurred in 2013;

 

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

 

    impact of potential impairment in a challenging economy;

 

    the Bank’s ability to pay dividends;

 

    our ability to address our liquidity needs;

 

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

 

    uncertainties about market interest rates;

 

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

 

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

 

    security breaches of our information systems;

 

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

 

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

 

    the performance of third party investment products we offer;

 

    environmental liability for properties to which we take title;

 

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

 

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

 

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

 

    other risk factors included under “Risk Factors” in the Annual Report on Form 10-K for the year ended December 31, 2014 and filed with the Securities and Exchange Commission.

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

Set forth below is management’s discussion and analysis of the consolidated results of operations and financial condition of the Company and its wholly-owned subsidiaries, the Bank and IDI, which includes information regarding significant regulatory developments and the Corporation’s risk management activities, including asset/liability management strategies, sources of liquidity and capital resources. This discussion should be read in conjunction with the unaudited consolidated financial statements and supplemental data contained elsewhere in this quarterly report filed on Form 10-Q.

EXECUTIVE OVERVIEW

Financial Results for the period ended June 30, 2015

 

    Basic and diluted earnings per common share were $11.42 and $11.37, respectively, for the three months ended June 30, 2015, compared to basic and diluted earnings per common share of $0.29 for the quarter ended June 30, 2014;

 

    Net income of $107.5 million for the quarter ended June 30, 2015, compared to $2.6 million for the quarter ended June 30, 2014;

 

    Net income for the quarter ended June 30, 2015, reflects an income tax benefit, net of the current quarter tax provision, of $103.0 million primarily resulting from the reversal of substantially all of the Company’s valuation allowance against its deferred tax asset;

 

    Total non-performing loans decreased $17.5 million, or 50.0%, to $17.6 million at June 30, 2015, from $35.1 million at December 31, 2014;

 

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    Total non-performing assets (total non-performing loans and other real estate owned) decreased $25.8 million, or 36.5%, to $44.8 million, or 2.03% of total assets, at June 30, 2015, from $70.6 million, or 3.39% of total assets, at December 31, 2014, as the Bank continues to reduce problem asset levels;

 

    The Company recorded a $646,000 negative provision for loan losses for the quarter ended June 30, 2015, compared to no provision for loan loss in the quarter ended June 30, 2014 due to net recoveries and improvements in the credit quality of the loan portfolio;

 

    Book value per common share was $35.68 at June 30, 2015, compared to $23.85 at December 31, 2014; and

 

    The Bank’s Tier 1 leverage capital ratio was 12.03% at June 30, 2015, considered “well capitalized” under the regulatory capital framework.

Other Developments

Management regularly and periodically evaluates and assesses all aspects of the Bank’s operations, including, but not limited to, retail branch delivery and placement of its support functions, for opportunities to improve the profitability of the Company. In the case of branch delivery, this could include the closure, sale or other disposal of a branch or addition to the current branch structure.

Commercial Branch

On February 2, 2015, as part of growing our commercial banking efforts in the Fox Valley market, the Bank opened a commercial lending facility, located at 4351 W. College Avenue in Appleton, Wisconsin. The facility has five commercial lending staff members to service the Fox Valley area commercial lending needs. The facility will also have two universal bankers who will be able to process routine teller transactions as well as open new deposit accounts, effective August 3, 2015.

Sale of Branches

The Bank sold its Viroqua branch on May 15, 2015. The sale consisted of selected loans and deposits. In addition, the sale included the building, furniture and equipment. As part of the sale, a lease on the land was terminated. Total deposits sold were $11.2 million and generated a gain of $448,000 on the sale.

The Bank, on April 9, 2015, entered into a definitive agreement for the sale of its Winneconne branch to another financial institution located in Wisconsin. Under the agreement, the purchasing bank will assume approximately $13.4 million in deposits along with loans and other assets. The transaction is subject to regulatory approval and customary closing conditions and is targeted to close by the end of September 2015.

Purchase of New Building

The Bank, on January 28, 2015, completed the purchase of a new building located on the east side of Madison, Wisconsin at a purchase price of $4.0 million. This facility, which houses the Bank’s support departments, became operational during the second quarter of 2015. Management believes this move improves workgroup efficiencies.

Operational Efficiency Measures

The Bank has taken several actions during the second quarter of 2015 to address and improve overall operational efficiency. Management anticipates that these actions will result in an annual net cost savings related to reduced compensation, occupancy and other operating costs of approximately $5.4 million and will be completed by the third quarter of 2015. These actions included:

 

   

Offering a Voluntary Separation Plan (“VSP”) package to eligible employees. The VSP was designed to provide eligible employees with a variety of benefits, including additional compensation, subsidized COBRA health benefits and optional job placement services. The program was offered to a group of 140 of

 

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the Bank’s 705 employees with 78 employees accepting the VSP with agreed-upon exit dates through September 30, 2015. Management anticipates that approximately 30 individuals will be hired to meet the future business needs of the Bank to replace employees who accepted the VSP.

 

    Consolidating six retail bank branches in the third quarter of 2015. The six locations are in the Wisconsin communities of Appleton, Menasha, Oshkosh, Janesville, Franklin, and Madison. Customers have been notified of the transition and will continue to have convenient and uninterrupted access to their deposit, lending and investment accounts at surrounding Bank locations in each of these markets, as well as access to online banking, ATMs and the Bank’s Customer Call Service Center. A total of 23 full and part-time positions not eligible for the VSP will be eliminated through the six-branch consolidation.

 

    Creating a new Universal Banker staffing model in the Bank’s branch delivery system to address consumer shift towards digital products and services which resulted in lower transaction volumes. The Universal Banker will perform most branch transactions for customers resulting in improved customer service. The Universal Bank staffing model will have a core of employees who can process teller transactions, open new accounts and provide customer service. This core group of employees will be further supported with one or more customer service associates. The first phase of this service was launched during the second quarter and a broader rollout will occur during the remainder of 2015.

As a result of these operational efficiency measures, the Bank expects to incur one-time costs of $3.7 million, composed primarily of employment severance and asset disposition costs. During the quarter ended June 30, 2015, $2.3 million of these one-time costs were recognized as expense with an estimated $1.4 million expected to be recorded in the quarter ending September 30, 2015. A gain was recorded in the quarter ended June 30, 2015, for the sale of the Appleton Fox River Drive branch building, one of the six retail bank branch consolidations, of $1.4 million.

Deferred Tax Asset Valuation

During September 2009, the Company established a full deferred tax asset valuation allowance. During the second quarter of 2015, as a result of management’s periodic assessment of the deferred tax asset position, the Company has substantially reversed this deferred tax asset valuation allowance. The Company has determined that it is more likely than not it will be able to realize its deferred tax asset, including its entire federal tax loss carryforwards and a significant portion of its state tax loss carryforwards, with the exception of $5.9 million pertaining to certain multi state loss carryforwards, including states we no longer do business in. This action resulted in the recognition of a $103.0 million income tax benefit, net of current quarter tax provision, during the second quarter of 2015. For a more detailed discussion, see Note 16 in the Notes to Unaudited Consolidated Financial Statements contained in Item 1.

 

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Selected quarterly data is set forth in the following table.

 

     Three Months Ended  
     6/30/2015     3/31/2015     12/31/2014     9/30/2014     6/30/2014  
     (Dollars in thousands - except per share amounts)  

Operations Data:

          

Net interest income

   $ 17,424      $ 17,056      $ 17,501      $ 17,558      $ 17,862   

Provision for loan losses

     (646     (1,354     (3,281     (1,304     —     

Non-interest income

     9,738        8,740        8,962        8,015        7,610   

Non-interest expense

     23,263        20,973        24,621        21,915        22,855   

Income before income tax expense

     4,545        6,177        5,123        4,962        2,617   

Income tax expense (benefit)

     (102,976     32        —          —          10   

Net income

     107,521        6,145        5,123        4,962        2,607   

Selected Financial Ratios (1):

          

Yield on interest-earning assets

     3.65     3.63     3.64     3.68     3.77

Cost of funds

     0.24        0.23        0.22        0.22        0.23   

Interest rate spread

     3.41        3.40        3.42        3.46        3.54   

Net interest margin

     3.43        3.42        3.43        3.47        3.55   

Return on average assets

     20.40        1.19        0.96        0.94        0.49   

Average equity to average assets

     11.40        11.16        10.46        9.99        9.88   

Non-interest expense to average assets

     4.41        4.05        4.63        4.13        4.32   

Per Share:

          

Basic earnings per common share

   $ 11.42      $ 0.66      $ 0.56      $ 0.55      $ 0.29   

Diluted earnings per common share

     11.37        0.65        0.55        0.55        0.29   

Dividends per common share

     —          —          —          —          —     

Book value per common share

     35.68        24.66        23.85        23.22        23.37   

Financial Condition:

          

Total assets

   $ 2,205,595      $ 2,094,161      $ 2,082,379      $ 2,106,520      $ 2,121,249   

Loans receivable

          

Held for sale

     13,513        8,317        6,594        4,937        5,261   

Held for investment, net

     1,521,534        1,510,202        1,524,439        1,509,246        1,506,963   

Deposits

     1,820,792        1,818,999        1,814,171        1,858,807        1,873,240   

Other borrowed funds

     12,737        12,872        13,752        13,060        13,781   

Stockholders’ equity

     342,620        236,857        227,663        214,709        211,507   

Allowance for loan losses

     47,037        47,037        47,037        47,037        49,175   

Non-performing assets(2)

     44,805        55,686        70,606        85,077        98,337   

 

(1)  Annualized when appropriate.
(2) Non-performing assets consists of non-performing loans and OREO.

 

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RESULTS OF OPERATIONS

Overview – Three months Ended June 30, 2015

Net income from operations for the three months ended June 30, 2015, increased $104.9 million to $107.5 million from $2.6 million in the quarter ended June 30, 2014. The increase in net income was primarily the result of an income tax benefit, net of current quarter tax provision, of $103.0 million from the reversal of substantially all of the Company’s valuation allowance against its deferred tax asset. See Note 16 in the Notes to Unaudited Consolidated Financial Statements contained in Item 1. Net interest income decreased $438,000 and a negative provision for loan loss of $646,000 was recorded due to net recoveries and improvements in the credit quality of the loan portfolio in the second quarter of 2015. Non-interest income increased $2.1 million and non-interest expense increased $408,000 as a result of $2.3 million in one-time costs related to the operational efficiency measures announced on April 9, 2015, and recorded in the second quarter of 2015. The discussion that follows in this section provides details regarding these results for the three month period ended June 30, 2015.

Net Interest Income

The following table shows the Company’s average balances, interest, average rates, the spread between the average rates earned on interest-earning assets and average cost of interest-bearing liabilities, net interest margin, which represents net interest income as a percentage of average interest-earning assets, and the ratio of average interest-earning assets to average interest-bearing liabilities for the three months ended June 30, 2015 and 2014, respectively. The average balances are derived from daily balances.

 

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     Three Months Ended June 30,  
     2015     2014  
     Average
Balance
    Interest      Average
Yield/
Cost(1)
    Average
Balance
    Interest      Average
Yield/
Cost(1)
 
     (Dollars in thousands)  

Interest-Earning Assets

              

Mortgage loans

   $ 1,209,743      $ 12,523         4.14   $ 1,185,347      $ 12,922         4.36

Consumer loans

     321,784        3,700         4.60        351,332        4,185         4.76   

Commercial business loans

     37,406        677         7.24        21,454        214         3.99   
  

 

 

   

 

 

      

 

 

   

 

 

    

Total loans held for investment (2) (3)

     1,568,933        16,900         4.31        1,558,133        17,321         4.45   

Investment securities - AFS (4)

     339,184        1,544         1.82        290,578        1,520         2.09   

Investment securities - HTM

     943        11         4.67        —          —           N/A   

Interest-earning deposits

     110,935        71         0.26        153,033        94         0.25   

Federal Home Loan Bank stock

     11,940        15         0.50        11,940        21         0.70   
  

 

 

   

 

 

      

 

 

   

 

 

    

Total interest-earning assets

     2,031,935        18,541         3.65        2,013,684        18,956         3.77   

Non-interest-earning assets

     76,367             102,264        
  

 

 

        

 

 

      

Total assets

   $ 2,108,302           $ 2,115,948        
  

 

 

        

 

 

      

Interest-Bearing Liabilities

              

Demand deposits

   $ 1,049,098        397         0.15      $ 1,020,155        296         0.12   

Regular savings

     358,597        87         0.10        346,070        94         0.11   

Certificates of deposit

     421,697        574         0.54        503,916        643         0.51   
  

 

 

   

 

 

      

 

 

   

 

 

    

Total deposits

     1,829,392        1,058         0.23        1,870,141        1,033         0.22   

Other borrowed funds

     14,382        59         1.64        15,434        61         1.58   
  

 

 

   

 

 

      

 

 

   

 

 

    

Total interest-bearing liabilities

     1,843,774        1,117         0.24        1,885,575        1,094         0.23   
       

 

 

        

 

 

 

Non-interest-bearing liabilities

     24,114             21,290        
  

 

 

        

 

 

      

Total liabilities

     1,867,888             1,906,865        

Stockholders’ equity

     240,414             209,083        
  

 

 

        

 

 

      

Total liabilities and stockholders’ equity

   $ 2,108,302           $ 2,115,948        
  

 

 

        

 

 

      

Net interest income/interest rate spread (5)

     $ 17,424         3.41     $ 17,862         3.54
    

 

 

    

 

 

     

 

 

    

 

 

 

Net interest-earning assets

   $ 188,161           $ 128,109        
  

 

 

        

 

 

      

Net interest margin (6)

          3.43          3.55
       

 

 

        

 

 

 

Ratio of average interest-earning assets to average interest-bearing liabilities

     110.21          106.79     
  

 

 

        

 

 

      

 

(1)  Annualized
(2)  For the purpose of these computations, non-accrual loans are included in the average loan amounts outstanding.
(3)  Interest earned on loans includes loan fees (which are not material in amount) and interest income which has been received from borrowers whose loans were removed from non-accrual status during the period indicated.
(4)  Average balances of securities available for sale are based on fair value.
(5)  Interest rate spread represents the difference between the weighted-average yield on interest-earning assets and the weighted-average cost of interest-bearing liabilities and is represented on a fully tax equivalent basis if applicable.
(6)  Net interest margin represents net interest income as a percentage of average interest-earning assets.

 

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Net interest income decreased $438,000, or 2.5%, to $17.4 million for the three months June 30, 2015, from $17.9 million for the comparable prior year period. Interest income decreased $415,000, or 2.2%, for the three months ended June 30, 2015, compared to $19.0 million for the three months ended June 30, 2014, due to a twelve basis point decrease in average yields to 3.65% from the comparable quarter in 2014 of 3.77%. These decreases were offset by the recognition of one-time deferred fees and non-accrual interest related to two commercial loan payoffs totaling $232,000.

The average balance of loans held for investment, net increased $10.8 million to $1.57 billion from June 30, 2014, interest-earning deposits decreased $42.1 million to $110.9 million and the average balance of investment securities available for sale increased $48.6 million to $339.2 million for the three months ended June 30, 2015. These fluctuations were primarily due to loan originations exceeding repayments during the period and the resulting excess liquidity being invested into securities. The decline in the average asset yield was the result of the interest rate environment over the last several years. Non-interest-earning assets decreased $25.8 million.

Interest expense remained stable for the three months ended June 30, 2015 from the same period in 2014. The average cost of interest-bearing liabilities increased 1 basis point to 0.24% for the three months ended June 30, 2015, from 0.23% for the same period in 2014, while the average balance of interest-bearing liabilities decreased $41.8 million to $1.84 billion for the three months ended June 30, 2015, from $1.89 billion for the three months ended June 30, 2014.

The average balance of deposits decreased $40.7 million to $1.83 billion for the three months ended June 30, 2015, from $1.87 billion in the prior year period. The decrease was primarily due to a decrease of $82.2 million, to $421.7 million in average certificates of deposit for the three months ended June 30, 2015, from $503.9 million in the comparable prior year period. The decline in average certificates was offset by a net increase in average checking and money market accounts of $28.9 million and saving accounts of $12.5 million which was the result of customers converting their matured certificates of deposit into more liquid deposit products due to the low interest rate environment. Branch sales resulted in deposit decreases of $16.6 million, on December 31, 2014, and $11.2 million, on May 15, 2015, related to the Richland Center and Viroqua branch sales, respectively, contributing to the decline in the average deposits at June 30, 2015. The average cost of deposits increased 1 basis point to 0.23% for the three month period ended June 30, 2015 from the same period in 2014.

The interest rate spread decreased thirteen basis points to 3.41% for the three months ended June 30, 2015, compared to 3.54% for the prior year period. Net interest margin was 3.43% for the three months ended June 30, 2015, a decrease of twelve basis points from 3.55% for the three months ended June 30, 2014. The decrease in net interest margin was due to a $438,000 decrease in net interest income coupled with a $18.3 million increase in total average interest-earning assets between the three month periods ending June 30, 2015 and 2014.

The ratio of average interest-earning assets to average interest-bearing liabilities increased to 110.21% for the three months ended June 30, 2015, from 106.79% at June 30, 2014. This increase was primarily due to the $41.8 million decrease in average interest-bearing liabilities during the three months ended June 30, 2015 from the same period in 2014.

Provision for Loan Losses

The negative provision for loan loss of $646,000 for the three months ended June 30, 2015, due to net recoveries and improvements in the credit quality of the loan portfolio, was a decrease from no provision for the comparable prior year period. Non-performing loans decreased $17.5 million, or 50.0%, to $17.6 million at June 30, 2015, from $35.1 million at December 31, 2014 and delinquent loans 30 to 89 days past due decreased $1.1 million, or 11.8% to $7.8 million, from December 31, 2014.

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

 

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Non-Interest Income

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

 

     Three Months Ended June 30,      Increase (Decrease)  
     2015      2014      Amount      Percent  
     (Dollars in thousands)  

Service charges on deposits

   $ 2,596       $ 2,523       $ 73         2.9

Investment and insurance commissions

     1,060         1,131         (71      (6.3

Loan fees

     179         222         (43      (19.4

Loan servicing income, net of amortization

     467         740         (273      (36.9

Loan processing fee income

     360         189         171         90.5   

Net impairment losses recognized in earnings

     —           (13      13         (100.0

Net gain on sale of loans

     1,912         698         1,214         173.9   

Net gain on sale of OREO

     743         1,040         (297      (28.6

Net gain (loss) on disposal of premises and equipment

     1,332         (7      1,339         N/M   

Net gain on sale of branch

     448         —           448         N/M   

Other income

     641         1,087         (446      (41.0
  

 

 

    

 

 

    

 

 

    

 

 

 

Total non-interest income

   $ 9,738       $ 7,610       $ 2,128         28.0
  

 

 

    

 

 

    

 

 

    

 

 

 

N/M = Not Meaningful

Non-interest income increased $2.1 million, or 28.0%, to $9.7 million for the three months ended June 30, 2015, from $7.6 million for the prior year period. Net gain on disposal of premises and equipment increased $1.3 million for the three months ended June 30, 2015. A gain was recorded in the quarter ended June 30, 2015, for the sale of the Appleton Fox Drive branch building of $1.4 million as part of the Bank’s strategy to consolidate six retail bank branches to create efficiencies in the branch network. Net gain on sale of loans increased $1.2 million to $1.9 million for the three months ended June 30, 2015, from $698,000 for the prior year period primarily due to higher loan volume in 2015 as a result of lower rates. Net gain on sale of branches of $448,000 in the three months ended June 30, 2015, was recognized on the sale of the Viroqua branch on May 15, 2015. Other income decreased $446,000 due primarily to IDI real estate partnership income of $345,000 in the three months ended June 30, 2014 compared to no IDI real estate partnership income in the three months ended June 30, 2015.

 

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Non-Interest Expense

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

 

     Three Months Ended June 30,      Increase (Decrease)  
     2015      2014      Amount      Percent  
     (Dollars in thousands)  

Compensation and benefits

   $ 13,371       $ 10,739       $ 2,632         24.5

Occupancy

     1,970         1,614         356         22.1   

Furniture and equipment

     760         791         (31      (3.9

Federal deposit insurance premiums

     688         700         (12      (1.7

Data processing

     1,546         1,315         231         17.6   

Communications

     405         463         (58      (12.5

Marketing

     648         879         (231      (26.3

OREO expense, net

     737         2,267         (1,530      (67.5

Investor loss reimbursement

     (273      (248      (25      (10.1

Mortgage servicing rights impairment (recovery)

     (391      84         (475      N/M   

Provision for unfunded commitments

     170         600         (430      (71.7

Loan processing and servicing expense

     655         709         (54      (7.6

Retail operations expense

     643         676         (33      (4.9

Legal services

     402         602         (200      (33.2

Other professional fees

     606         351         255         72.6   

Insurance

     232         206         26         12.6   

Other expense

     1,094         1,107         (13      (1.2
  

 

 

    

 

 

    

 

 

    

 

 

 

Total non-interest expense

   $ 23,263       $ 22,855       $ 408         1.8
  

 

 

    

 

 

    

 

 

    

 

 

 

N/M = Not Meaningful

Non-interest expense increased $408,000, or 1.8%, to $23.3 million for the three months ended June 30, 2015, from $22.9 million for the prior year period. Compensation and benefits increased $2.6 million to $13.4 million due to one-time retention and severance expense of $2.0 million related to the operational efficiency initiatives and an increase in restricted stock grant expense of $641,000 compared to no restricted stock grant expense in the prior year period. The increase was offset with OREO expense decreasing $1.5 million due to a decline in OREO inventory compared to the prior year period. Within OREO expense, the provision for OREO losses declined $1.2 million and OREO operating management fees declined $601,000 compared to the three months ended June 30, 2014. Offsetting these reductions was a decrease in OREO income of $298,000 due to the reduced number of income producing OREO properties.

Income Taxes

Income tax benefit, net of current quarter tax provision, of $103.0 million was recorded for the three month period ended June 30, 2015, compared to income tax expense of $10,000 in the prior year period. During the second quarter of 2015, as a result of management’s periodic assessment of the deferred tax asset position, the Company has substantially reversed its valuation allowance. The Company has also determined that it is more likely than not that it will be able to realize substantially all of the state deferred tax asset, with the exception of $5.9 million pertaining to certain multi state loss carryforwards, including states we no longer do business in. See Note 16 in the Notes to Unaudited Consolidated Financial Statements contained in Item 1.

 

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Overview – Six months Ended June 30, 2015

Net income from operations for the six months ended June 30, 2015, increased $109.2 million to $113.7 million from $4.5 million in the prior year period. The increase in net income was primarily the result of an income tax benefit, net of year-to-date tax provision, of $102.9 million from the reversal of substantially all of the Company’s valuation allowance against its deferred tax asset. See Note 16 in the Notes to Unaudited Consolidated Financial Statements contained in Item 1. Net interest income decreased $1.7 million and a negative provision for loan loss of $2.0 million was recorded due to net recoveries and improvements in the credit quality of the loan portfolio for the six months ended June 30, 2015. Non-interest income increased $4.9 million and non-interest expense decreased $936,000. The discussion that follows in this section provides details regarding these results for the six month period ended June 30, 2015.

Net Interest Income

The following table shows the Company’s average balances, interest, average rates, the spread between the average rates earned on interest-earning assets and average cost of interest-bearing liabilities, net interest margin, which represents net interest income as a percentage of average interest-earning assets, and the ratio of average interest-earning assets to average interest-bearing liabilities for the six months ended June 30, 2015 and 2014, respectively. The average balances are derived from daily balances.

 

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     Six Months Ended June 30,  
     2015     2014  
     Average
Balance
    Interest      Average
Yield/
Cost(1)
    Average
Balance
    Interest      Average
Yield/
Cost(1)
 
     (Dollars in thousands)  

Interest-Earning Assets

              

Mortgage loans

   $ 1,202,683      $ 24,902         4.14   $ 1,199,339      $ 26,116         4.36

Consumer loans

     327,361        7,511         4.59        356,456        8,502         4.77   

Commercial business loans

     37,226        1,104         5.93        21,624        579         5.36   
  

 

 

   

 

 

      

 

 

   

 

 

    

Total loans held for investment (2) (3)

     1,567,270        33,517         4.28        1,577,419        35,197         4.46   

Investment securities - AFS (4)

     316,770        2,920         1.84        286,865        3,027         2.11   

Investment securities - HTM

     474        11         9.28        —          —           N/A   

Interest-earning deposits

     116,290        148         0.25        130,488        159         0.24   

Federal Home Loan Bank stock

     11,940        29         0.49        11,940        35         0.59   
  

 

 

   

 

 

      

 

 

   

 

 

    

Total interest-earning assets

     2,012,744        36,625         3.64        2,006,712        38,418         3.83   

Non-interest-earning assets

     77,306             98,688        
  

 

 

        

 

 

      

Total assets

   $ 2,090,050           $ 2,105,400        
  

 

 

        

 

 

      

Interest-Bearing Liabilities

              

Demand deposits

   $ 1,040,500        723         0.14      $ 1,013,413        602         0.12   

Regular savings

     343,622        167         0.10        328,487        173         0.11   

Certificates of deposit

     430,544        1,136         0.53        519,577        1,346         0.52   
  

 

 

   

 

 

      

 

 

   

 

 

    

Total deposits

     1,814,666        2,026         0.22        1,861,477        2,121         0.23   

Other borrowed funds

     14,612        119         1.63        14,968        120         1.60   
  

 

 

   

 

 

      

 

 

   

 

 

    

Total interest-bearing liabilities

     1,829,278        2,145         0.23        1,876,445        2,241         0.24   
       

 

 

        

 

 

 

Non-interest-bearing liabilities

     24,975             21,650        
  

 

 

        

 

 

      

Total liabilities

     1,854,253             1,898,095        

Stockholders’ equity

     235,797             207,305        
  

 

 

        

 

 

      

Total liabilities and stockholders’ equity

   $ 2,090,050           $ 2,105,400        
  

 

 

        

 

 

      

Net interest income/interest rate spread (5)

     $ 34,480         3.41     $ 36,177         3.59
    

 

 

    

 

 

     

 

 

    

 

 

 

Net interest-earning assets

   $ 183,466           $ 130,267        
  

 

 

        

 

 

      

Net interest margin (6)

          3.43          3.61
       

 

 

        

 

 

 

Ratio of average interest-earning assets to average interest-bearing liabilities

     110.03          106.94     
  

 

 

        

 

 

      

 

(1)  Annualized
(2)  For the purpose of these computations, non-accrual loans are included in the average loan amounts outstanding.
(3)  Interest earned on loans includes loan fees (which are not material in amount) and interest income which has been received from borrowers whose loans were removed from non-accrual status during the period indicated.
(4)  Average balances of securities available for sale are based on fair value.
(5)  Interest rate spread represents the difference between the weighted-average yield on interest-earning assets and the weighted-average cost of interest-bearing liabilities and is represented on a fully tax equivalent basis if applicable.
(6)  Net interest margin represents net interest income as a percentage of average interest-earning assets.

 

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Net interest income decreased $1.7 million, or 4.7%, to $34.5 million for the six months June 30, 2015, from $36.2 million for the comparable prior year period. Interest income decreased $1.8 million, or 4.7%, for the six months ended June 30, 2015, compared to $38.4 million for the six months ended June 30, 2014, due to a nineteen basis point decrease in average yields to 3.64% from the comparable quarter in 2014 of 3.83%. These decreases were offset by the recognition of one-time deferred fees and non-accrual interest related to two commercial loan payoffs totaling $232,000.

The average balance of loans held for investment, net decreased $10.1 million to $1.57 billion from June 30, 2014, interest-earning deposits decreased $14.2 million to $116.3 million and the average balance of investment securities available for sale increased $29.9 million to $316.8 million in the six months ended June 30, 2015. These fluctuations were primarily due to loan repayments exceeding loan originations during the period and the resulting excess liquidity being invested into securities. The decline in the average asset yield was the result of the interest rate environment over the last several years. Non-interest-earning assets decreased $21.4 million.

Interest expense decreased $96,000, or 4.3%, to $2.1 million for the six months ended June 30, 2015, from $2.2 million for the prior year period. The average cost of interest-bearing liabilities decreased 1 basis point to 0.23% for the six months ended June 30, 2015, from 0.24% for the same period in 2014, while the average balance of interest-bearing liabilities decreased $47.2 million to $1.83 billion for the six months ended June 30, 2015, from $1.88 billion for the six months ended June 30, 2014.

The average balance of deposits decreased $46.8 million to $1.81 billion for the six months ended June 30, 2015, from $1.86 billion in the prior year period. The decrease was primarily due to a decrease of $89.1 million, to $430.5 million in average certificates of deposit for the six months ended June 30, 2015, from $519.6 million in the prior year period. The decline in average certificates was offset by a net increase in average checking and money market accounts of $27.1 million and saving accounts of $15.1 million which was the result of customers converting their matured certificates of deposit into more liquid deposit products due to the low interest rate environment. Branch sales resulted in deposit decreases of $16.6 million, on December 31, 2014, and $11.2 million, on May 15, 2015, related to the Richland Center and Viroqua branch sales, respectively, contributing to the decline in the average deposits at June 30, 2015. The average cost of deposits decreased 1 basis point to 0.22% in six month period ending June 30, 2015, from 0.23% in 2014.

The interest rate spread decreased eighteen basis points to 3.41% for the six months ended June 30, 2015, compared to 3.59% for the prior year period. Net interest margin was 3.43% for the six months ended June 30, 2015, a decrease of eighteen basis points from 3.61% for the six months ended June 30, 2014. The decrease in net interest margin was due to a $1.7 million decrease in net interest income coupled with a $6.0 million increase in total average interest-earning assets between 2015 and 2014.

The ratio of average interest-earning assets to average interest-bearing liabilities increased to 110.03% for the six months ended June 30, 2015, from 106.94% for the prior year period. This increase was primarily due to the $47.2 million decrease in average interest-bearing liabilities during 2015.

Provision for Loan Losses

The negative provision for loan loss of $2.0 million during the six months ended June 30, 2015, due to net recoveries and improvements in the credit quality of the loan portfolio, was a decrease from no provision for the comparable prior year period. Non-performing loans decreased $17.5 million, or 50.0%, to $17.6 million at June 30, 2015, from December 31, 2014.

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

 

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Non-Interest Income

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

 

     Six Months Ended June 30,      Increase (Decrease)  
     2015      2014      Amount      Percent  
     (Dollars in thousands)  

Service charges on deposits

   $ 4,964       $ 4,789       $ 175         3.7

Investment and insurance commissions

     2,147         1,987         160         8.1   

Loan fees

     910         451         459         101.8   

Loan servicing income, net of amortization

     1,060         1,514         (454      (30.0

Loan processing fee income

     626         339         287         84.7   

Net impairment losses recognized in earnings

     —           (34      34         (100.0

Net gain on sale of loans

     3,513         1,290         2,223         172.3   

Net gain on sale of investment securities

     63         301         (238      (79.1

Net gain on sale of OREO

     2,210         1,201         1,009         84.0   

Net gain (loss) on disposal of premises and equipment

     1,332         (76      1,408         N/M   

Net gain on sale of branch

     448         —           448         N/M   

Other income

     1,205         1,780         (575      (32.3
  

 

 

    

 

 

    

 

 

    

 

 

 

Total non-interest income

   $ 18,478       $ 13,542       $ 4,936         36.4
  

 

 

    

 

 

    

 

 

    

 

 

 

N/M = Not Meaningful

Non-interest income increased $4.9 million, or 36.4%, to $18.5 million for the six months ended June 30, 2015, from $13.5 million for the prior year period. Net gain on sale of loans increased $2.2 million to $3.5 million for the six months ended June 30, 2015, from $1.3 million for the prior year period primarily due to higher loan volume in 2015 as a result of lower rates. Net gain on disposal of premises and equipment increased $1.4 million for the six months ended June 30, 2015, from a $76,000 loss recorded in the prior year period. A gain was recorded in the quarter ended June 30, 2015, for the sale of the Appleton Fox Drive branch building of $1.4 million as part of the Bank’s strategy to consolidate retail banking to create efficiencies in the branch network. Net gain on sale of OREO increased $1.0 million from the prior year period due to sales volume and improved gains per property sold. Loan fees increased $459,000 due to fees collected from the interest rate swap arrangements, starting in the first quarter of 2015, for certain commercial lending customers. Net gain on sale of branches of $448,000 in the six months ended June 30, 2015, was recognized on the sale of the Viroqua branch on May 15, 2015. Other income decreased $575,000 due primarily to IDI real estate partnership income of $346,000 in the six months ended June 30, 2014 compared to no IDI real estate partnership income in the six months ended June 30, 2015.

 

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Non-Interest Expense

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

 

     Six Months Ended June 30,      Increase (Decrease)  
     2015      2014      Amount      Percent  
     (Dollars in thousands)  

Compensation and benefits

   $ 25,158       $ 21,901       $ 3,257         14.9

Occupancy

     3,718         3,852         (134      (3.5

Furniture and equipment

     1,466         1,557         (91      (5.8

Federal deposit insurance premiums

     1,357         1,748         (391      (22.4

Data processing

     2,997         2,686         311         11.6   

Communications

     984         1,036         (52      (5.0

Marketing

     1,187         1,532         (345      (22.5

OREO expense, net

     973         3,452         (2,479      (71.8

Investor loss reimbursement

     (373      (86      (287      N/M   

Mortgage servicing rights impairment (recovery)

     (421      95         (516      N/M   

Provision for unfunded commitments

     291         780         (489      (62.7

Loan processing and servicing expense

     1,438         1,276         162         12.7   

Retail operations expense

     1,251         1,239         12         1.0   

Legal services

     717         955         (238      (24.9

Other professional fees

     1,040         758         282         37.2   

Insurance

     475         516         (41      (7.9

Other expense

     1,978         1,875         103         5.5   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total non-interest expense

   $ 44,236       $ 45,172       $ (936      (2.1 )% 
  

 

 

    

 

 

    

 

 

    

 

 

 

N/M = Not Meaningful

Non-interest expense decreased $936,000, or 2.1%, to $44.2 million for the six months ended June 30, 2015, from $45.2 million for the prior year period. The decrease was primarily the result of OREO expense decreasing $2.5 million due to a decline in OREO inventory compared to the prior year period. Within OREO expense, the provision for OREO losses declined $2.5 million and OREO operating expenses declined $520,000 compared to the six months ended June 30, 2014. Offsetting these reductions was a decrease in OREO income of $788,000 due to the reduced number of income producing OREO properties. In addition, the Bank recorded MSR recovery of $421,000 compared to MSR impairment of $95,000 in the six month periods ended June 30, 2015 and 2014, respectively, as well other smaller reductions in marketing, provision for unfunded commitments and legal services. Offsetting these decreases was an increase in compensation and benefits of $3.2 million to $25.2 million due to an increase in restricted stock grant expense of $1.2 million compared to the prior year period and one-time retention and severance expense of $2.0 million related to the operational efficiency initiatives.

Income Taxes

Income tax benefit, net of year to date tax provision, of $103.0 million was recorded for the six month period ended June 30, 2015, compared to income tax expense of $10,000 in the prior year period. During the second quarter of 2015, as a result of management’s periodic assessment of the deferred tax asset position, the Company has substantially reversed its valuation allowance. The Company has also determined that it is more likely than not that it will be able to realize substantially all of the state deferred tax asset, with the exception of $5.9 million pertaining to certain multi state loss carryforwards, including states we no longer do business in. See Note 16 in the Notes to Unaudited Consolidated Financial Statements contained in Item 1.

 

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FINANCIAL CONDITION

Comparison of Financial Condition at June 30, 2015 and December 31, 2014

Total assets increased $123.2 million, or 5.9%, to $2.21 billion at June 30, 2015, from $2.08 billion at December 31, 2014. The Company’s deferred tax asset increase to $103.1 million was the result of the reversal of substantially all of the Company’s valuation allowance against its net deferred tax asset. See Note 16 in the Notes to Unaudited Consolidated Financial Statements contained in Item 1. In addition, investment securities available for sale increased $50.7 million, investment securities held to maturity increased $5.5 million, loans held for sale increased $6.9 million and premises and equipment, net increased $4.2 million. These increases were partially offset by a $36.5 million decrease in cash and cash equivalents, a $2.9 million decrease in loans held for investment, net and a $8.2 million decrease in other real estate owned, net.

The decrease in loans held for investment, net of $2.9 million, or 0.2%, since December 31, 2014, was primarily due to transfers to OREO of $2.5 million and pay downs on non-performing loans of $18.7 million offset by loan origination activity. The $36.5 million, or 24.8%, decrease in cash and cash equivalents along with the $50.7 million, or 17.2%, increase in investment securities was the result of investment purchases of $100.7 million offset by principal repayments of $31.6 million and sales net of gains/losses of $14.6 million.

Total liabilities increased $8.3 million or 0.4% to $1.86 billion at June 30, 2015, from $1.85 billion at December 31, 2014. The increase was primarily due to a $6.6 million, or 0.4%, increase in deposits with an increase in money market accounts of $14.6 million and an increase in savings accounts of $18.2 million which was the result of customers converting their matured certificates of deposit into more liquid deposit products due to the low interest rate environment. These increases were offset by a decrease in certificates of deposit of $35.4 million and a decrease in checking accounts of $25.9 million. Advance payments by borrowers for taxes and insurance increased $35.2 million between periods, due to the timing of tax and insurance payments. Other liabilities increased $2.1 million since December 31, 2014 primarily due to an accrual of $1.9 million resulting from the recognition of one-time costs associated with the operational efficiency measures undertaken in the second quarter of 2015.

Stockholders’ equity increased $115.1 million, or 50.5%, to $342.6 million at June 30, 2015, from $227.7 million at December 31, 2014. The increase was primarily due to net income for the six months ended June 30, 2015, of $113.7 million due to the reversal of substantially all of the Company’s deferred tax valuation allowance.

RISK MANAGEMENT

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

Risk Management Philosophy

The Bank’s risk management philosophy is to manage to an overall level of risk while still allowing it to capture opportunities and optimize stockholder value. While we have made improvements in reducing the amount of troubled assets, however, due to the general state of the economy and the elevated level of troubled loan assets and OREO, the Bank’s risk profile does not currently meet our desired risk level. While improvements have occurred, the Bank continues to work toward reducing the overall risk level to a more desired risk profile.

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

 

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

 

    Ensuring strong underwriting and credit risk management practices,

 

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    Practicing disciplined capital and liquidity management,

 

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

 

    Avoiding excessive concentrations, and

 

    Helping support external stakeholder confidence.

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

CREDIT RISK MANAGEMENT

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

In addition to credit policies and procedures and setting portfolio objectives for the level of credit risk, the Bank has established guidelines for problem loans, acceptable levels of total borrower exposure and other credit measures. Management continues to focus on loss mitigation and maximization of recoveries in the Bank’s non-performing assets portfolio.

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

The Risk Management group is responsible for monitoring credit risk, while considering regulatory guidance. Internal Audit provides an independent assessment of the effectiveness of the credit risk management process. An external third party vendor also provides loan review services.

 

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Non-Performing Loans

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

 

     June 30, 2015     December 31, 2014  
     Non-
Performing
Loans
     Percent of
Non-
Performing
Loans
    Percent of
Total Gross
Loans (1)
    Non-
Performing
Loans
     Percent of
Non-
Performing
Loans
    Percent of
Total Gross
Loans (1)
 
     (Dollars in thousands)  

Residential

   $ 4,881         27.8     0.31   $ 5,873         16.7     0.37

Commercial and industrial

     150         0.9        0.01        33         0.1        —     

Land and construction

     6,405         36.5        0.40        17,195         48.9        1.09   

Multi-family

     759         4.3        0.05        3,566         10.2        0.23   

Retail/office

     3,024         17.2        0.19        3,970         11.3        0.25   

Other commercial real estate

     1,314         7.5        0.08        3,622         10.3        0.23   

Education (2)

     143         0.8        0.01        205         0.6        0.01   

Other consumer

     874         5.0        0.06        651         1.9        0.04   
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Total

   $ 17,550         100.0     1.11   $ 35,115         100.0     2.22
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

 

(1)  Gross loans are the unpaid principal balance before the reduction for loans in process, unearned interest and loan fees and the allowance for loans losses.
(2)  Excludes the guaranteed portion of education loans 90+ days past due with an unpaid principal balance totaling $4.6 million and $6.6 million at June 30, 2015 and December 31, 2014, respectively.

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

 

     Non-
Performing
Loans
December 31,
2014
     Additions      Transfer
to Accrual
Status
    Transfer
to
OREO
    Paid
Down
    Net
(Charge
Off)/
Recovery
    Non-
Performing
Loans
June 30,
2015
     Remaining
Balance

of Loans
     Associated
ALLL
 
     (In thousands)  

Residential

   $ 5,873       $ 1,577       $ (382   $ (1,021   $ (1,860   $ 694      $ 4,881       $ 523,136       $ 8,487   

Commercial and industrial

     33         62         —          (584     (132     771        150         22,698         1,178   

Land and construction

     17,195         —           —          (41     (9,983     (766     6,405         131,169         14,788   

Multi-family

     3,566         —           —          (249     (2,697     139        759         292,253         7,290   

Retail/office

     3,970         533         (124     (468     (805     (82     3,024         143,820         7,183   

Other commercial real estate

     3,622         559         —          (160     (2,949     242        1,314         133,258         2,415   

Education

     205         —           —          —          (62     —          143         98,687         411   

Other consumer

     651         849         (192     —          (227     (207     874         219,240         5,285   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

    

 

 

 

Total

   $ 35,115       $ 3,580       $ (698   $ (2,523   $ (18,715   $ 791      $ 17,550       $ 1,564,261       $ 47,037   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

    

 

 

 

Non-performing loans decreased $17.5 million during the six months ended June 30, 2015. The loan categories with the largest decline in non-performing loans were land and construction of $10.8 million, multi-family of $2.8 million and other commercial real estate of $2.3 million.

 

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The interest income that would have been recorded during the three and six months ended June 30, 2015, if the Bank’s non-performing loans at the end of the period had been current in accordance with their terms during the period was $70,000 and $290,000, respectively.

Non-Performing Assets

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

 

     June 30,
2015
    December 31,
2014
 
     (Dollars in thousands)  

Non-accrual loans - excluding troubled debt restructurings

   $ 8,959      $ 18,632   

Troubled debt restructurings - non-accrual (1)

     8,591        16,483   

OREO

     27,255        35,491   
  

 

 

   

 

 

 

Total non-performing assets

   $ 44,805      $ 70,606   
  

 

 

   

 

 

 

Non-performing loans to gross loans (2)

     1.11     2.22

Non-performing assets to total assets

     2.03        3.39   

Allowance for loan losses to gross loans (2)

     2.97        2.97   

Allowance for loan losses to non-performing loans

     268.02        133.95   

Allowance for loan losses plus OREO valuation allowance to non-performing assets

     140.20        95.77   

 

(1)  Troubled debt restructurings – non-accrual represent non-accrual loans that have been modified in a troubled debt restructuring.
(2)  Gross loans are the unpaid principal balance before the reduction for loans in process, unearned interest and loan fees and the allowance for loans losses.

Loans modified in a troubled debt restructuring (“TDRs”) that are currently on non-accrual status will remain on non-accrual status for a period of at least six months, or a longer period, sufficient to prove that the borrower demonstrates that they can make the payments under the modified terms. If after this period, the borrower has made payments in accordance with the modified terms, the loan is returned to accrual status but retains its designation as a TDR. Once a TDR loan is returned to accrual, further review of the credit could take place resulting in a further upgrade into the pass category but still remaining as a TDR.

 

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The following is a summary of non-performing asset activity for the six months ended June 30, 2015:

 

     Non-Performing
Loans (1)
     Other Real
Estate Owned
(OREO)
     Total Non-
Performing
Assets
 
     (In thousands)  

Balance at December 31, 2014

   $ 35,115       $ 35,491       $ 70,606   

Additions

     3,580         —           3,580   

Transfer of loans to OREO

     (2,523      2,523         —     

Returned to accrual status

     (698      —           (698

Sales

     —           (10,431      (10,431

Loan (charge-offs)/recoveries and OREO valuation adjustments, net

     791         (446      345   

Capitalized improvements

     —           118         118   

Payments

     (18,715      —           (18,715
  

 

 

    

 

 

    

 

 

 

Balance at June 30, 2015

   $ 17,550       $ 27,255       $ 44,805   
  

 

 

    

 

 

    

 

 

 

 

(1)  Total non-performing loans exclude the guaranteed portion of education loans of $4.6 million and $6.6 million that are 90 days or more past due but still accruing interest at June 30, 2015 and December 31, 2014, respectively.

Loan Delinquencies 30 Days and Over

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

 

     June 30, 2015     December 31, 2014  

Days Past Due

   Balance      % of Total
Gross Loans
    Balance      % of Total
Gross Loans
 
     (Dollars in thousands)         

30 to 59 days

   $ 5,896         0.37   $ 5,795         0.37

60 to 89 days

     1,948         0.12        3,097         0.20   

90 days and over

     8,904         0.57        20,338         1.28   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 16,748         1.06   $ 29,230         1.85
  

 

 

    

 

 

   

 

 

    

 

 

 

Loans delinquent 30 days and over decreased $12.5 million to $16.7 million at June 30, 2015, from $29.2 million at December 31, 2014 as a result of increased monitoring, loss mitigation and improved economic conditions.

Impaired Loans

At June 30, 2015, the Company identified $76.1 million of loans as impaired, which includes $58.6 million of performing TDRs. At December 31, 2014, impaired loans were $95.3 million, which included $60.2 million of performing TDRs. A loan is identified as impaired when, based on current information and events, it is probable that the Bank will be unable to collect all amounts due according to the contractual terms of the loan agreement.

 

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The following is additional information regarding impaired loans.

 

     June 30,
2015
     December 31,
2014
 
     (In thousands)  

Carrying amount of impaired loans

   $ 67,835       $ 86,844   

Recorded investment

     76,116         95,285   

Troubled debt restructurings - accrual (1)

     58,566         60,170   

Loans and troubled debt restructurings on non-accrual status

     17,550         35,115   

Troubled debt restructurings - non-accrual (2)

     8,591         16,483   

Non-accrual loans - excluding troubled debt restructurings

     8,959         18,632   

Troubled debt restructurings valuation allowance

     7,407         8,593   

Loans past due ninety days or more and still accruing (3)

     4,630         6,613   

 

(1)  Includes TDR accruing loans of $54.9 million and $55.4 million at June 30, 2015 and December 31, 2014, respectively that are rated pass.
(2)  Troubled debt restructurings - non-accrual are included in the loans and troubled debt restructurings on non- accural status line item above.
(3)  Represents the guaranteed portion of education loans that were 90+ days past due which continue to accrue interest due to a guarantee provided by government agencies covering approximately 97% of the outstanding balance.

Interest income recognized on impaired loans on a cash basis was $1.5 million and $1.3 million for the six months ended June 30, 2015 and 2014, respectively.

Allowance for Loan Losses

The allowance for loan losses is maintained at a level believed appropriate by management to absorb probable and estimable losses inherent in the held for investment loan portfolio and is based on the size and current risk characteristics of the held for investment loan portfolio; an assessment of individual impaired loans; actual and anticipated loss experience; and current economic events in specific industries and geographical areas. These economic events include unemployment levels, regulatory guidance, and general economic conditions. Determination of the allowance is inherently subjective as it requires significant estimates, including the amounts and timing of expected future cash flows on impaired loans, estimated losses on pools of homogeneous loans based on historical loss experience, and consideration of current economic trends, all of which may be susceptible to significant change. Loan losses are charged off against the allowance, while recoveries of amounts previously charged off are credited to the allowance. A provision for loan losses is recorded in the statement of income based on management’s periodic evaluation of the factors previously mentioned as well as other pertinent factors. Conversely, the provision for loan losses may decline should credit metrics such as net charge offs and the amount of non-performing loans improve in the future.

The allowance for loan losses consists of specific and general components. Specific allowance allocations are established for probable losses resulting from analysis of impaired loans. A loan is considered impaired when it is probable that the Company will be unable to collect all contractual principal and interest due according to the terms of the loan agreement. Impaired loans include all non-accrual loans and troubled debt restructurings. Troubled debt restructurings are loans that have been modified, due to financial difficulties of the borrower, where the terms of the modified loan are more favorable for the borrower than what the Company would normally offer. Impairment is determined when the present value of expected future cash flows discounted at the loan’s effective interest rate or the fair value of the underlying collateral less costs to sell, if the loan is collateral dependent, is less than the carrying value of the loan. Cash collections on impaired loans are generally credited to the loan balance and no interest income is recognized on those loans until the principal balance is current and collection of principal and interest becomes probable. See Note 5 to the Unaudited Consolidated Financial Statements included in Item 1 for additional details.

 

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The specific allowance component relates to impaired loans, loans reported as TDR, and loans graded substandard or below. The Company has certain loans rated substandard which are not classified as impaired based on the facts of the credit. For these non-impaired and substandard loans, the Company does not follow the same allowance methodology as it does for all other non-impaired, collectively evaluated loans. Rather, the Company performs a more detailed analysis including evaluation of the cash flow and collateral valuations. Based upon this evaluation, an estimate of the probable loss in this portfolio is collectively evaluated under Accounting Standards Codification 450-20. These non-impaired substandard loans exist primarily in the commercial and industrial and commercial real estate segments. For impaired loans, an allowance for loan losses is established when the discounted cash flows (or collateral value if repayment relies solely on the operation or sale of the collateral) of the impaired loan are lower than the carrying value of that loan.

The general allowance component is based on historical net loss experience adjusted for qualitative factors. In determining the general allowance, the Company has defined the following segments within its loan portfolio: residential, commercial and industrial, commercial real estate and consumer. The Company has disaggregated those segments into the following classes based on risk characteristics: residential; commercial and industrial; land and construction, multi-family, retail/office and other commercial real estate within the commercial real estate segment; and education and other consumer within the consumer segment. Consistent with the Bank’s allowance for loan losses policy, the appropriateness of the segmentation is periodically reviewed. This additional detail allows management to better identify trends in borrower behavior and loss severity within the segments and classes of the loan portfolio. A historical loss factor is computed for each class of loan and is used as the major determinate of the general allowance for loan losses. In determining the appropriate period of activity to use in computing the historical loss factor, management considers trends in quarterly net charge-off ratios. It is management’s intention to utilize a period of activity that it believes to be most reflective of current experience. Changes in the historical period are made when there is a distinct change in the trend of net charge-off experience. Management reviews each class’ historical losses by quarter for any trends that indicate the most representative look-back period.

On a quarterly basis the Bank analyzes its general allowance methodology and has determined it was necessary to increase the historical loss period by an additional quarter. For the quarter ended June 30, 2015, the Bank utilized a thirteen quarter look-back period compared to a twelve quarter look-back period for the quarter ended March 31, 2015. The modification is being done to reflect a more stable economic environment and to capture additional loss statistics considered reflective of the current portfolio. The impact to the allowance for loan losses at June 30, 2015, was a $238,000 increase in the required reserve as compared to the previous methodology. Management will continue to analyze the historical loss period utilized on a quarterly basis.

Management adjusts historical loss factors based on the following qualitative factors:

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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In determining the impact, if any, of an individual qualitative factor, management compares the current underlying facts and circumstances surrounding a particular factor with those in the historical periods, adjusting the historical loss factor based on changes in the qualitative factor. Management will continue to analyze the qualitative factors on a quarterly basis, adjusting the historical loss factor as necessary, to a factor believed to be appropriate for the probable and inherent risk of loss in the portfolio.

The following table presents the ALLL by component:

 

     June 30,
2015
     December 31,
2014
 
     (In thousands)  

General reserve

   $ 35,503       $ 34,027   

Specific reserve:

     

Substandard rated loans, excluding TDR accrual

     3,253         4,569   

Impaired loans

     8,281         8,441   
  

 

 

    

 

 

 

Total allowance for loan losses

   $ 47,037       $ 47,037   
  

 

 

    

 

 

 

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

 

     June 30,
2015
     December 31,
2014
 
     (In thousands)  

Pass

   $ 1,480,660       $ 1,465,224   

Special mention

     11,815         6,243   
  

 

 

    

 

 

 

Total pass and special mention rated loans

     1,492,475         1,471,467   

Substandard rated loans, excluding TDR accrual (1)

     13,220         16,353   

TDRs - accrual (2)

     58,566         60,170   

Non-accrual

     17,550         35,115   
  

 

 

    

 

 

 

Total impaired loans

     76,116         95,285   
  

 

 

    

 

 

 

Total gross loans

   $ 1,581,811       $ 1,583,105   
  

 

 

    

 

 

 

 

(1)  Includes residential and consumer loans identified as substandard that are not necessarily on non-accrual.
(2)  Includes TDR accruing loans of $54.9 million and $55.4 million at June 30, 2015 and December 31, 2014, respectively, that are rated pass.

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

 

     June 30,
2015
    December 31,
2014
 
     (Dollars in thousands)  

General reserve/pass and special mention loans

     2.4     2.3

Substandard reserve/substandard loans

     24.6     27.9

Other specific reserves/impaired loans

     10.9     8.9

Loans 30 to 89 days past due

   $ 7,844      $ 8,892   

 

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The ratio of the general reserve for loan losses to pass and special mention rated loans has remained relatively stable in 2015 from 2014 as the portfolios have continued to improve during the period. The substandard reserve for loan losses to substandard loans has decreased year over year based on management’s assessment of risk and potential for loss. The ratio of other specific reserves for loan losses to impaired loans has increased in 2015 from 2014 based on significantly lower levels of impaired loans during 2015.

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

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2015     2014     2015     2014  
     (Dollars in thousands)  

Allowance at beginning of period

   $ 47,037      $ 53,497      $ 47,037      $ 65,182   

Charge-offs:

        

Residential

     (183     (566     (421     (1,662

Land and construction

     (862     (46     (862     (3,628

Multi-family

     (9     (506     (37     (883

Retail/office

     (161     —          (409     (6,624

Other commercial real estate

     —          (589     (3     (767

Consumer

     (193     (291     (627     (1,435

Commercial and industrial

     (14     (3,633     (106     (4,955
  

 

 

   

 

 

   

 

 

   

 

 

 

Total charge-offs

     (1,422     (5,631     (2,465     (19,954
  

 

 

   

 

 

   

 

 

   

 

 

 

Recoveries:

        

Residential

     399        125        1,197        356   

Land and construction

     201        89        311        133   

Multi-family

     134        73        190        131   

Retail/office

     347        103        486        252   

Other commercial real estate

     227        386        566        2,042   

Consumer

     152        153        193        257   

Commercial and industrial

     608        380        1,522        776   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total recoveries

     2,068        1,309        4,465        3,947   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net recoveries/(charge-offs)

     646        (4,322     2,000        (16,007
  

 

 

   

 

 

   

 

 

   

 

 

 

Provision for loan losses

     (646     —          (2,000     —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Allowance at end of period

   $ 47,037      $ 49,175      $ 47,037      $ 49,175   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net recoveries/(charge-offs) to average loans held investment (1)

     0.17     (1.11 )%      0.26     (2.03 )% 
  

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) Annualized.

Total charge-offs of $1.4 million and $2.5 million for the three and six months ended June 30, 2015, respectively, decreased $4.2 million and $17.5 million from the three and six months ended June 30, 2014, respectively. Total recoveries of $2.1 million and $4.5 million for the three and six months ended June 30, 2015, respectively increased $759,000 and $518,000 from the three and six months ended June 30, 2014, respectively. The provision for loan loss decreased $646,000 and $2.0 million compared to no provision for loan loss for the three and six months ended June 30, 2014, as a result of net recoveries in the three and six months ended June 30, 2015.

 

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Other Real Estate Owned, Net

OREO, net decreased $8.2 million during the six months ended June 30, 2015 to $27.3 million. Individual properties included in OREO at June 30, 2015, with a recorded balance in excess of $1.0 million are listed below:

 

Description

   Location    Carrying Value  
          (in thousands)  

Raw Land

   Northeast Wisconsin    $ 3,359   

Commercial Building

   Northwest Wisconsin      1,539   

Commercial Building

   South Central Wisconsin      2,805   

Commercial Lot

   South Central Wisconsin      1,071   

Raw Land

   Southeast Wisconsin      3,680   

Commercial Building

   Southeast Wisconsin      2,536   

Raw Land

   Southeast Wisconsin      1,140   

Other properties individually less than $1.0 million

     11,125   
     

 

 

 
      $ 27,255   
     

 

 

 

Foreclosed properties are recorded at fair value less cost to sell upon transfer to OREO with shortfalls, if any, charged to the allowance for loan losses. Subsequent decreases in the valuation of OREO are recorded in a valuation account for the foreclosed property with a corresponding charge to OREO expense, net. The fair value is primarily based on appraisals. On a quarterly basis, the carrying values of OREO properties are reviewed and appropriate adjustments made based upon updated appraisals, evaluations, signed sales contracts or list price reductions. Incremental valuation adjustments may be recognized in the Consolidated Statement of Income if, in the opinion of management, additional losses are deemed probable.

LIQUIDITY RISK MANAGEMENT

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

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

Liquidity and Capital Resources

On an unconsolidated basis, the Company’s typical sources of funds could include dividends from its subsidiaries, including the Bank, interest on its investments and returns on its real estate held for sale. The Company currently finances its operations through cash on hand and, to a lesser extent, interest on investments and dividends from its non-Bank subsidiary. A significant amount of our consolidated operating expenses are incurred by and paid by the Company’s subsidiaries. Net cash provided by operating activities during 2015 was $1.4 million while net cash used in investing activities was $54.7 million and cash provided by financing activities was $16.7 million. The Bank is currently not paying dividends.

The Bank’s primary sources of funds are payments on loans and securities, deposits from retail and commercial banking businesses and wholesale funding sources such as FHLB of Chicago advances, other borrowings and broker/internet CDs. As of June 30, 2015, the Company had outstanding borrowings from the FHLB of Chicago of $10.0 million. The total maximum credit capacity at the FHLB of Chicago based on the existing stock holding as of

 

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June 30, 2015, was $238.8 million, subject to collateral availability. Total remaining credit capacity based on the value of the existing collateral pledged was $532.3 million as of June 30, 2015, after considering other collateral requirements for letters of credit and our participation in the Mortgage Partnership Finance Program of the FHLB of Chicago (“MPF Program”). The Bank has also been granted access to the Federal Reserve Bank of Chicago’s discount window but as of June 30, 2015, the Bank had no borrowings outstanding from this source.

Loan Commitments

At June 30, 2015, the Bank had outstanding commitments to originate loans of $75.8 million, no unused commitments and commitments to extend funds to, or on behalf of, customers pursuant to lines, and unused letters of credit of $249.6 million.

Deposit and Borrowings

Scheduled maturities of certificates of deposits during the six months following June 30, 2015, amounted to $137.9 million. Scheduled maturities of borrowings during the same period in 2015 totaled $2.7 million. Management believes adequate resources are available to fund all Bank commitments to the extent required.

Investment Securities

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

MPF Program

The Bank previously participated in the MPF Program of the FHLB of Chicago. Pursuant to the credit enhancement feature of the MPF Program, the Bank retained a secondary credit loss exposure in the amount of $7.6 million at June 30, 2015, related to approximately $144.6 million of residential mortgage loans that the Bank has originated and are still outstanding. The Bank acts as a servicing agent for the FHLB of Chicago. Under the credit enhancement, the FHLB of Chicago is liable for losses on loans up to one percent of the original delivered loan balances in each pool up to the point the credit enhancement is reset. After the credit enhancement resets, the FHLB of Chicago and the Bank’s loss contingency could be reduced depending upon losses experienced and loan balances remaining. The Bank is liable for losses over and above the FHLB of Chicago first loss position up to a contractually agreed-upon maximum amount in each pool that was delivered to the MPF Program. The Bank receives a monthly fee for this credit enhancement obligation based on the outstanding loan balances. The monthly fee received is net of losses under the MPF Program. The Bank discontinued funding loans through the MPF Program in 2008.

FHLB of Chicago Advances

The Bank pledges certain loans that meet underwriting criteria established by the FHLB of Chicago as collateral for outstanding advances. The unpaid principal balance of loans pledged to secure FHLB of Chicago borrowings totaled $622.3 million and $652.3 million at June 30, 2015 and December 31, 2014, respectively. The FHLB of Chicago borrowings are also collateralized by mortgage-related securities with a fair value of $65.9 million and $88.9 million at June 30, 2015 and December 31, 2014, respectively. At June 30, 2015 and December 31, 2014, there were no FHLB of Chicago borrowings with call features that may be exercised by the FHLB of Chicago.

 

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Other

The Bank has, in the past, entered into agreements with certain brokers that provided deposits obtained from their customers at specified interest rates for an identified fee, or so called “brokered deposits.” At June 30, 2015 and December 31, 2014 the Bank had no brokered deposits.

Regulatory Capital

Under federal law and regulation the Company and the Bank are required to meet the CET1 ratio, Tier 1 capital ratio, Total capital ratio and a Tier 1 leverage ratio. CET1 primarily consists of common stock, related surplus, net of Treasury stock, retained earnings less certain intangible assets and unrealized gains/losses on available for sale securities. Tier 1 capital is CET1 plus non-cumulative perpetual preferred stock less certain regulatory deductions. Total capital primarily consists of Tier 1 capital plus a qualifying portion of the allowance for loan losses. The risk-based capital requirements presently address credit risk related to both recorded and off-balance sheet commitments and obligations.

MARKET RISK MANAGEMENT

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

While the Company attempts to manage its balance sheet to minimize the effect that a change in interest rates has on its net interest margin, it may utilize derivative financial instruments as part of its interest rate risk management strategy. The Company’s Board approved a program for the prudent use of interest rate swap transactions to manage the interest rate risk of commercial loans and to manage other balance sheet interest rate risk. The Company enters into interest rate-related transactions to facilitate the interest rate risk management strategies of commercial customers. The Company then mitigates this risk by entering into equal and offsetting interest rate-related transactions with highly rated third party financial institutions. The Company’s objective with the use of derivatives is to add stability to its net interest margin and to manage its exposure to movements in interest rates. At June 30, 2015, the aggregate notional value of interest rate swaps with various commercial customers was $15.6 million.

Asset/Liability Management

The business of the Company and the composition of its consolidated balance sheet consist of investments in interest-earning assets (primarily loans, mortgage-backed securities and other securities) that are largely funded by interest-bearing liabilities (deposits and borrowings). All of the financial instruments of the Company as of June 30, 2015, were held for other-than-trading purposes. Such financial instruments have varying levels of sensitivity to changes in market rates of interest. The Company’s net interest income is dependent on the amounts of and yields on its interest-earning assets as compared to the amounts of and rates on its interest-bearing liabilities. Net interest income is therefore sensitive to changes in market rates of interest.

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

Interest rate risk results when the maturity or repricing intervals and interest rate indices of the interest-earning assets, interest-bearing liabilities and off-balance-sheet financial instruments are different, thus creating a risk that will result in disproportionate changes in the value of and the net earnings generated from these instruments. The Company’s exposure to interest rate risk is managed primarily through the strategy of selecting the types and terms

 

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

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

Net Interest Income Sensitivity Analysis

The Company performs a net interest income sensitivity analysis as part of its asset/liability management processes. Net interest income sensitivity analysis measures the change in net interest income in the event of hypothetical changes in interest rates. This analysis assesses the risk of change in net interest income in the event of sudden and sustained 100 and 200 basis point increases in market interest rates. The table below presents the projected changes in twelve-month cumulative net interest income for the various rate shock levels at June 30, 2015 and December 31, 2014, respectively.

 

     200 Basis Point
Rate Increase
    100 Basis Point
Rate Increase
 

June 30, 2015

     3.1     1.5

December 31, 2014

     5.0     2.4

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

As shown above, at June 30, 2015, the effect of an immediate 200 basis point increase in interest rates would increase the Company’s net interest income by 3.1%. Overall net interest income sensitivity remains within the Company’s guidelines.

The changes in the Company’s net interest income reflected above were due, in large part, to the optionality on both sides of the balance sheet. The changes in net interest income over the one year horizon for June 30, 2015, under the 100 basis point and 200 basis point increases in market interest rates scenarios are reflective of this optionality. In general, in a rising rate environment, yields on loans and investment securities are expected to re-price upwards more quickly than the cost of funds.

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

 

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The Company also uses these assumptions to estimate the market value of equity and the market risk to this value due to changes in interest rates. This focus helps model risks embedded in the balance sheet over a longer time horizon than the net interest income simulation. The calculation is based on the present value of projected future cash flows. As of June 30, 2015, the projected changes for the market value of equity were within the Company’s policy limits.

Computations of the prospective effects of hypothetical interest rate changes are dependent on numerous assumptions, including relative levels of market interest rates, loan prepayments and deposit decay rates. These computations should not be relied upon as indicative of actual results. Actual values may differ from those projections set forth above should market conditions vary from assumptions used in preparing the analyses. Further, the computations do not contemplate any actions the Company may undertake in response to changes in interest rates. Because such assumptions can be no more than estimates, certain assets and liabilities modeled as maturing or otherwise repricing within a stated period may, in fact, mature or reprice at different times and at different volumes than those estimated. Also, the renewal or repricing of certain assets and liabilities can be discretionary and subject to competitive and other pressures. Therefore, the rate sensitivity results included above do not and cannot necessarily indicate the actual future impact of general interest rate movements on the Company’s net interest income.

COMPLIANCE RISK MANAGEMENT

Compliance risk represents the risk of regulatory sanctions, reputational impact or financial loss resulting from the Company’s failure to comply with regulations and standards of good banking practice. Activities which may expose the Company to compliance risk include, but are not limited to, those dealing with the prevention of money laundering, privacy and data protection, community reinvestment initiatives, fair lending challenges and employment and tax matters. The Company has a separate department with individuals having specialized training and experience tasked with ensuring compliance with state and federal public interest, consumer and civil rights oriented banking laws and regulations.

STRATEGIC AND/OR REPUTATION RISK MANAGEMENT

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

REGULATORY DEVELOPMENTS

The Dodd-Frank Act

The Dodd-Frank Act imposes significant regulatory and compliance requirements on financial institutions, including the designation of certain financial companies as systemically important financial companies, the changing roles of credit rating agencies, the imposition of increased capital, leverage, and liquidity requirements, and numerous other provisions designed to improve supervision and oversight of, and strengthen safety and soundness within, the financial services sector. Additionally, the Dodd-Frank Act established a new framework of authority to conduct systemic risk oversight within the financial system to be distributed among new and existing federal regulatory agencies, including the Financial Stability Oversight Council, the Federal Reserve, the Office of the Comptroller of the Currency (“OCC”), and the Federal Deposit Insurance Company. The following items provide a brief description of certain provisions of the Dodd-Frank Act that are most relevant to the Company and the Bank.

 

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Starting January 2015, under the Dodd-Frank Act, the risk-based and leverage capital standards currently applicable to U.S. insured depository institutions are also applicable to U.S. bank holding companies and savings and loan holding companies (“SLHCs”), and depository institutions and their holding companies are now subject to minimum risk-based and leverage capital requirements on a consolidated basis. In addition, the Dodd-Frank Act requires that SLHCs be well capitalized and well managed in the same manner as bank holding companies in order to engage in the expanded financial activities permissible only for a financial holding company.

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

Basel III Capital Rules

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

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

The Basel III Capital Rules provide for the following minimum capital to risk-weighted assets ratios:

 

    4.5% based upon CET1;

 

    6.0% based upon tier 1 capital; and

 

    8.0% based upon total regulatory capital.

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

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

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

In addition, institutions that seek the freedom to make capital distributions (including dividends and repurchases of stock) and pay discretionary bonuses to executive officers with restriction must also maintain 2.5% of risk-weighted assets in Common Equity Tier 1 attributable to a capital conservation buffer to be phased in over three years

 

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beginning in 2016. The purpose of the conservation buffer is to ensure that banking institutions maintain a buffer of capital that can be used to absorb losses during periods of financials and economic stress. Factoring in fully phased-in conservation buffer increases the minimum ratios depicted above to 7% for Common Equity Tier 1, 8.5% for Tier 1 Capital and 10.5% for Total Capital. The leverage ratio is not impacted by the conservation buffer and a banking institution may be considered well-capitalized while remaining out of compliance with the capital conservation buffer.

As a result of the enactment of the Basel III Capital Rules, the Company and the Bank is subject to increased required capital levels. The Basel III Capital Rules are effective as applied to the Company and the Bank on January 1, 2015, with a phase in period that generally extends from January 1, 2015 through January 1, 2019.

The Company and the Bank are “Well Capitalized” under Basel III Capital Rules.

 

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Item 3 Quantitative and Qualitative Disclosures About Market Risk.

The Company’s market risk has not materially changed from December 31, 2014. See Item 7A in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014. See also “Asset/Liability Management” in Part I, Item 2 of this report.

 

Item 4 Controls and Procedures.

The Company’s management, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this report and, based on this evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are operating in an effective manner.

Changes in Internal Control Over Financial Reporting

There has been no change in the Company’s internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act) that occurred during the Company’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

Management has assessed the effectiveness of the Company’s internal control over financial reporting as of June 30, 2015. In making its assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) Internal Control – Integrated Framework in 2013. These criteria include the control environment, risk assessment, control activities, information and communication and monitoring of each of the above criteria. Based on management’s assessment, it determined that the Company’s internal control over financial reporting was effective as of June 30, 2015.

Part II - Other Information

 

Item 1 Legal Proceedings.

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

 

Item 1A Risk Factors.

In addition to the risk factors and other information discussed elsewhere in this Quarterly Report on Form 10-Q, you should carefully consider the factors described in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2014, filed with the Securities and Exchange Commission (“SEC”) on or about March 19, 2015. Those risks and uncertainties could cause actual results to differ materially from the results contemplated by the forward-looking statements contained in our Annual Report on Form 10–K, this Quarterly Report on Form 10-Q and in other documents we file with the SEC. Additional risks not presently known to us or that we currently deem immaterial may also impair our business operations. Our business, financial condition, results of operations or prospects could be materially and adversely affected by any of these risks. This report, including the documents incorporated by reference herein, also contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors.

 

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

None.

 

Item 3 Defaults Upon Senior Securities.

None.

 

Item 4 Mine Safety Disclosures.

Not applicable.

 

Item 5 Other Information.

None.

 

Item 6 Exhibits.

The following exhibits are filed with this report:

 

Exhibit 31.1    Certification of Principal Executive Officer Pursuant to Rules 13a-14 and 15d-14 of the Securities Exchange Act of 1934 and Section 302 of the Sarbanes-Oxley Act of 2002 is included herein as an exhibit to this Report.
Exhibit 31.2    Certification of Principal Financial Officer Pursuant to Rules 13a-14 and 15d-14 of the Securities Exchange Act of 1934 and Section 302 of the Sarbanes-Oxley Act of 2002 is included herein as an exhibit to this Report.
Exhibit 32.1    Certification of the Principal Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350) is included herein as an exhibit to this Report.
Exhibit 32.2    Certification of the Principal Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350) is included herein as an exhibit to this Report.
Exhibit 101    The following financial statements from the Anchor BanCorp Wisconsin Inc. Quarterly Report on Form 10-Q for the quarter ended June 30, 2015, formatted in Extensive Business Reporting Language (XBRL); (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Income and Comprehensive Income, (iii) Consolidated Statements of Changes in Stockholders’ Equity, (iv) Consolidated Statements of Cash Flows, and (v) the Notes to Unaudited Consolidated Financial Statements are included herein as an exhibit to this report.

 

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SIGNATURES

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

ANCHOR BANCORP WISCONSIN INC.

 

Date: August 12, 2015     By:  

/s/ Chris Bauer

      Chris Bauer, President and Chief Executive Officer
Date: August 12, 2015     By:  

/s/ William T. James

      William T. James, Senior Vice President, Chief Financial Officer and Treasurer

 

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