**UNITED STATES 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 March 31, 2012

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

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

Commission file number 0-18542

**MID-WISCONSIN FINANCIAL SERVICES, INC.**

 (Exact name of registrant as specified in its charter)

WISCONSIN

06-1169935

(State or other jurisdiction of incorporation or organization)

          (IRS Employer Identification No.)

   

132 West State Street

Medford, WI  54451

(Address of principal executive offices) (Zip Code)

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

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

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

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

     Large accelerated filer  £      

                                   Accelerated filer  £        

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

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

As of May 3, 2012 there were 1,657,119 shares of $0.10 par value common stock outstanding.  

1

MID-WISCONSIN FINANCIAL SERVICES, INC.
TABLE OF CONTENTS

PART I

FINANCIAL INFORMATION

 

PAGE

 

Item 1.

Financial Statements:

 

 

 

Consolidated Balance Sheets 

March 31, 2012 (unaudited) and December 31, 2011 (derived from audited financial statements)

3

 

 

Consolidated Statements of Operations

Three Months Ended March 31, 2012 and 2011 (unaudited) 

4

 

 

Consolidated Statements of Comprehensive Income (Loss)

Three Months Ended March 31, 2012 and 2011 (unaudited)

5

 

 

Consolidated Statements of Changes in Stockholders’ Equity 

Three Months Ended March 31, 2012 and 2011 (unaudited)

Consolidated Statements of Cash Flows

Three Months Ended March 31, 2012 and 2011 (unaudited)

6

7

 

 

Notes to Consolidated Financial Statements

8-23

 

Item 2.

Management’s Discussion and Analysis of Financial Condition 

and Results of Operations

23-46

Item 3. 

Quantitative and Qualitative Disclosures About Market Risk

46

 

Item 4.

Controls and Procedures

46

PART II

OTHER INFORMATION

 

 

 

Item 1.

Legal Proceedings

46

 

Item 1A.

Risk Factors

 

46

 

Item 2.

Unregistered Sales of Equity Securities and Use of  Proceeds

46

 

Item 3.

Defaults Upon Senior Securities

46

 

Item 4.

Mine Safety Disclosures

47

 

Item 5.

Other Information

47

 

Item 6.   

Exhibits

47

 

      

Signatures

47

 

 

Exhibit Index

48

 

2

**PART I – FINANCIAL INFORMATION**

**Item 1. Financial Statements:**

Mid-Wisconsin Financial Services, Inc. and Subsidiary

Consolidated Balance Sheets 

                                                                     (In thousands, except share data)

 

March 31, 2012

December 31, 2011

 

(Unaudited)

(Audited)

**Assets**

 

 

Cash and due from banks

$

11,212 

$

18,278 

Interest-bearing deposits in other financial institutions

22,985 

10 

Federal funds sold and securities purchased under agreements to sell

1,412 

13,072 

Investment securities available-for-sale, at fair value

107,658 

110,376 

Loans held for sale

612 

2,163 

Loans

326,001 

329,863 

Less:  Allowance for loan losses

(10,068)

(9,816)

Loans, net

315,933 

320,047 

Accrued interest receivable

1,790 

1,640 

Premises and equipment, net

7,785 

7,943 

Other investments, at cost

2,151 

2,616 

Other real estate owned net of valuation allowances of $335 and $410 at March 31, 2012 and December 31, 2011, respectively

4,164 

4,404 

Deferred tax asset, net of valuation allowance of $3,081 at March 31, 2012 and December 31, 2011

1,250 

1,179 

Other assets

6,143 

6,448 

**Total assets**

$

483,095 

$

488,176 

**Liabilities and Stockholders' Equity:**

 

 

Noninterest-bearing deposits

$

66,140 

$

70,790 

Interest-bearing deposits

310,748 

310,830 

  Total deposits

376,888 

381,620 

Short-term borrowings

15,611 

13,655 

Long-term borrowings

38,061 

40,061 

Subordinated debentures

10,310 

10,310 

Accrued interest payable

833 

878 

Accrued expenses and other liabilities

2,102 

2,139 

Total liabilities

443,805 

448,663 

Stockholders' equity:

 

 

Series A preferred stock

9,773 

9,745 

Series B preferred stock 

523 

526 

Common Stock

166 

166 

Additional paid-in capital

11,945 

11,945 

Retained earnings

15,386 

15,526 

Accumulated other comprehensive income 

1,497 

1,605 

Total stockholders' equity

39,290 

39,513 

**Total liabilities and stockholders' equity**

$

483,095 

$

488,176 

 

 

 

Series A preferred stock authorized (no par value)

10,000 

10,000 

Series A preferred stock issued and outstanding

10,000 

10,000 

Series B preferred stock authorized (no par value)

500 

500 

Series B preferred stock issued and outstanding

500 

500 

Common stock authorized (par value $0.10 per share)

6,000,000 

6,000,000 

Common stock issued and outstanding

1,657,119 

1,657,119 

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

 

3

**ITEM 1.  Financial Statements Continued**:

 

Mid-Wisconsin Financial Services, Inc. and Subsidiary

 

Consolidated Statements of Operations

 

(In thousands, except per share data)

 

(Unaudited)

 

Three months ended

Three months ended

 

March 31, 2012

March 31, 2011

Interest Income

 

 

  Loans, including fees

$

4,453 

$

4,826 

  Securities:

 

 

     Taxable

549 

638 

     Tax-exempt 

96 

101 

  Other 

15 

80 

Total interest income

5,113 

5,645 

Interest Expense

 

 

  Deposits

895 

1,286 

  Short-term borrowings

35 

25 

  Long-term  borrowings

382 

405 

  Subordinated debentures

51 

45 

Total interest expense

1,363 

1,761 

Net interest income

3,750 

3,884 

Provision for loan losses

750 

1,050 

Net interest income after provision for loan losses

3,000 

2,834 

Noninterest Income

 

 

  Service fees

189 

253 

  Trust service fees

271 

266 

  Investment product commissions

38 

44 

  Mortgage banking

176 

149 

  Loss on sale of investments

0 

(55)

  Other 

311 

765 

Total noninterest income

985 

1,422 

Noninterest Expense

 

 

  Salaries and employee benefits

1,998 

2,131 

  Occupancy

434 

484 

  Data processing 

154 

173 

  Foreclosure/OREO expense

237 

42 

  Legal and professional fees

189 

167 

  FDIC expense

257 

314 

  Other 

695 

808 

Total noninterest expense

3,964 

4,119 

Income before income taxes

21 

137 

 Income tax benefit

0 

(3)

Net income 

$

21 

$

140 

Preferred stock dividends, discount and premium

(162)

(160)

Net loss available to common equity

($141)

($20)

Loss Per Common Share:

 

 

Basic and diluted

($0.09)

($0.01)

Cash dividends declared per common share

$

0.00 

$

0.00 

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

 

4

**ITEM 1.  Financial Statements Continued**:

 

Mid-Wisconsin Financial Services, Inc. and Subsidiary

 

Consolidated Statements of Comprehensive Income (Loss) (unaudited)

 

Three Months Ended March 31, 2012 and 2011

 

(In thousands)

 

March 31,

March 31,

 

2012

2011

Net income

$

21 

$

140 

Other comprehensive loss, net of tax:

 

 

Investment securities available-for-sale:

 

 

  Net unrealized losses

(180)

(45)

  Reclassification adjustment for net losses realized in earnings

0 

(33)

  Income tax (expense) benefit

72 

(28)

      Total other comprehensive loss net of tax

(108)

(50)

Comprehensive income (loss) 

($87)

$

90 

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

 

5

**ITEM 1.  Financial Statements Continued**:

 

 

Mid-Wisconsin Financial Services, Inc. and Subsidiary

 

Consolidated Statements of Changes in Stockholders' Equity (unaudited)

 

(In thousands)

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

Additional

 

Other

 

 

Preferred Stock

Common Stock

Paid-In

Retained

Comprehensive

 

** **

Shares

Amount

Shares

Amount

Capital

Earnings

Income (Loss)

Totals

Balance, December 31, 2010

10.5

$

10,172 

1,652

$

165

$

11,916

$

20,127 

$

590 

$

42,970 

Comprehensive Income:

 

 

 

 

 

 

 

 

Net income

 

 

 

 

 

140 

 

140 

Other comprehensive loss

 

 

 

 

 

 

(50)

(50)

Comprehensive income 

 

 

 

 

 

 

 

90 

Accretion of preferred stock discount

 

27 

 

 

 

(27)

 

0 

Amortization of preferred stock premium

 

(3)

 

 

 

3 

 

0 

Issuance of common stock:

 

 

 

 

 

 

 

 

Proceeds from stock purchase plans

 

 

1

0

7

 

 

7 

Dividends - Preferred stock

 

 

 

 

 

(136)

 

(136)

Stock-based compensation

 

 

 

 

6

 

 

6 

Balance, March 31, 2011

10.5

$

10,196 

1,653

$

165

$

11,929

$

20,107 

$

540 

$

42,937 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accumulated 

 

 

 

 

 

 

Additional

 

Other

 

 

      Preferred Stock

         Common Stock

Paid-In

Retained

Comprehensive

 

** **

Shares

Amount

Shares

Amount

Capital

Earnings

Income (Loss)

Totals

Balance, December 31, 2011

10.5

$

10,271 

1,657

$

166

$

11,945

$

15,526 

$

1,605 

$

39,513 

Comprehensive Income (loss):

 

 

 

 

 

 

 

 

Net income

 

 

 

 

 

21 

 

21 

Other comprehensive loss

 

 

 

 

 

 

(108)

(108)

Comprehensive loss

 

 

 

 

 

 

 

(87)

Accretion of preferred stock discount

 

28 

 

 

 

(28)

 

0 

Amortization of preferred stock premium

 

(3)

 

 

 

3 

 

0 

Dividends - Preferred stock

 

 

 

 

 

(136)

 

(136)

Balance, March 31, 2012

10.5

$

10,296 

1,657

$

166

$

11,945

$

15,386 

$

1,497 

$

39,290 

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

 

 

 

6

**ITEM 1.  Financial Statements Continued:**

Mid-Wisconsin Financial Services, Inc. and Subsidiary

Consolidated Statements of Cash Flows (unaudited)

(In thousands)

 

Three months ended

Three months ended

 

March 31, 2012

March 31, 2011

  Cash flows from operating activities:

 

 

     Net income

$

21 

$

140 

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

 

 

        Depreciation and amortization

289 

284 

        Provision for loan losses

750 

1,050 

        Provision for valuation allowance OREO

80 

6 

        Loss on sale of investment securities

0 

55 

        (Gain) loss on sale of foreclosed OREO

73 

(51)

        Stock-based compensation

0 

6 

        Changes in operating assets and liabilities:

 

 

                        Loans held for sale

1,551 

6,211 

                        Other assets

154 

76 

                        Other liabilities

(218)

(849)

  Net cash provided by operating activities

2,700 

6,928 

  Cash flows from investing activities:

 

 

     Net increase in interest-bearing deposits in other financial institutions

(22,975)

0 

     Net (increase) decrease in federal funds sold

11,660 

(1,647)

     Securities available for sale:

 

 

                       Proceeds from sales

0 

641 

                       Proceeds from maturities

9,984 

7,054 

                       Payment for purchases

(7,558)

(12,465)

     FHLB stock redemption

465 

0 

     Net decrease in loans

2,900 

3,475 

     Capital expenditures

(18)

(296)

     Proceeds from sale of OREO

552 

447 

  Net cash used in investing activities

(4,990)

(2,791)

  Cash flows from financing activities:

 

 

     Net decrease in deposits

(4,732)

(6,396)

     Net increase in short-term borrowings

1,956 

241 

     Principal payments on long-term borrowings

(2,000)

0 

     Proceeds from stock benefit plans

0 

7 

     Cash dividends paid preferred stock

0 

(136)

   Net cash used in financing activities

(4,776)

(6,284)

Net decrease in cash and due from banks

(7,066)

(2,147)

Cash and due from banks at beginning of period

18,278 

9,502 

Cash and due from banks at end of period

$

11,212 

$

7,355 

  Supplemental disclosures of cash flow information:

 

 

     Cash paid during the period for:

 

 

          Interest

$

1,408 

$

1,801 

          Income taxes

0 

250 

  Noncash investing and financing activities:

 

 

          Loans transferred to OREO

$

465 

$

45 

          Loans charged-off

652 

965 

          Dividends declared but not yet paid on preferred stock

136 

68 

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

 

7

**Mid-Wisconsin Financial Services, Inc. and Subsidiary**

**Notes to Unaudited Consolidated Financial Statements**

**Note 1 – Basis of Presentation**

**General**

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

These interim consolidated financial statements have been prepared according to the rules and regulations of the Securities and Exchange Commission and, therefore, certain information and footnote disclosures normally presented in accordance with generally accepted accounting principles in the United States of America (“U.S. GAAP”) have been omitted or abbreviated.  The information contained in the consolidated financial statements and footnotes in our Annual Report on Form 10-K for the year ended December 31, 2011 (the “2011 Form 10-K”) should be referred to in connection with the reading of these unaudited interim financial statements.

Preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying disclosures. These estimates are based on management’s best knowledge of current events and actions the Company may undertake in the future. Estimates are used in accounting for, among other items, fair value of financial instruments, the allowance for loan losses, useful lives for depreciation and amortization, deferred tax assets, uncertain income tax positions and contingencies. Management does not anticipate any material changes to estimates in the near term. Factors that may cause sensitivity to the aforementioned estimates include but are not limited to:  external market factors such as market interest rates and employment rates, changes to operating policies and procedures, and changes in applicable banking regulations. Actual results may ultimately differ from estimates, although management does not generally believe such differences would materially affect the consolidated financial statements in any individual reporting period.

**Recent Accounting Pronouncements  **

In April 2011, the FASB issued clarifying guidance regarding which loan modifications constitute troubled debt restructurings.  In evaluating whether a restructuring constitutes a troubled debt restructuring, the guidance maintains a creditor must separately conclude that the restructuring constitutes a concession and the debtor is experiencing financial difficulties.  The accounting standard provides further guidance with respect to whether a creditor has granted a concession and whether a debtor is experiencing financial difficulties.  The measurement guidance is effective for interim and annual periods beginning on or after June 15, 2011, while the disclosure guidance is effective for interim and annual periods beginning on or after June 15, 2011 with retrospective application to restructurings occurring on or after the beginning of the fiscal year.  The Company adopted the accounting standard as of the beginning of the third quarter of 2011, as required, with no material impact on its results of operations, financial position, and liquidity.

In April 2011, the FASB issued an accounting standard that modifies the criteria for determining when repurchase agreements would be accounted for as a secured borrowing rather than as a sale.  Currently, an entity that maintains effective control over transferred financial assets must account for the transfer as a secured borrowing rather than as a sale.  The provisions remove from the assessment of effective control the criterion requiring the transferor to have the ability to repurchase or redeem the financial assets on substantially the agreed terms, even in the event of default by the transferee.  The FASB believes that contractual rights and obligations determine effective control and that there does not need to be a requirement to assess the ability to exercise those rights.  The accounting standard does not change the other existing criteria used in the assessment of effective control and is effective prospectively for transactions, or modifications of existing transactions, that occur on or after January 1, 2012.  As the Company accounts for all of its repurchase agreements as collateralized financing arrangements, the adoption of this accounting standard had no material impact on the consolidated financial statements of the Company.

 

8

In May 2011, the FASB issued an accounting standard that provides a consistent definition of fair value and common requirements for measurement of and disclosure about fair value between U.S. GAAP and International Financial Reporting Standards (“IFRS”).  The changes to U.S. GAAP as a result of the accounting standard are as follows:  (i) the concepts of highest and best use and valuation premise are only relevant when measuring the fair value of nonfinancial assets (that is, it does not apply to financial assets or any liabilities); (ii) U.S. GAAP currently prohibits application of a blockage factor in valuing financial instruments with quoted prices in active markets, while the new accounting standard extends that prohibition to all fair value measurements; (iii) an exception is provided to the basic fair value measurement principles for an entity that holds a group of financial assets and financial liabilities with offsetting positions in market risks or counterparty credit risk that are managed on the basis of the entity’s net exposure to either of those risks, which such exception allows the entity, if certain criteria are met, to measure the fair value of the net asset or liability position in a manner consistent with how market participants would price the net risk position; (iv) the fair value measurement of instruments classified within an entity’s shareholders’ equity have been aligned with the guidance for liabilities; and (v) disclosure requirements have been enhanced for recurring Level 3 fair value measurements to disclose quantitative information about unobservable inputs and assumptions used, to describe the valuation processes used by the entity, and to describe the sensitivity of fair value measurements to changes in unobservable inputs and interrelationships between those inputs.  In addition, entities must report the level in the fair value hierarchy of items that are not measured at fair value in the statement of condition but whose fair value must be disclosed. These new disclosures were adopted during the quarter ended March 31, 2012 and did not have a material impact on the consolidated financial statements of the Company.

 In June 2011, the FASB issued an accounting standard that allows an entity the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements.  In both choices, an entity is required to present each component of net income along with total net income, each component of other comprehensive income along with a total for other comprehensive income, and a total amount for comprehensive income.  The statement(s) are required to be presented with equal prominence as the other primary financial statements.  The accounting pronouncement eliminates the option to present the components of other comprehensive income as part of the statement of changes in shareholders’ equity but does not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income.  The Company has adopted this standard effective March 31, 2012, electing to present a consolidated statement of comprehensive income separate from, but consecutive to, its statement of operations. 

In July 2010, the FASB issued new accounting guidance requiring extensive new disclosures surrounding the allowance for loan losses although it did not change any credit loss recognition or measurement rules.  The new rules require disclosure to include a breakdown of allowance for loan loss activity by portfolio segment as well as problem loan disclosures by detailed class of loan.  In addition, disclosures on internal credit grading metrics and information on impaired, non-accrual, and restructured loans are also required.  The period-end disclosures were effective for financial periods ending December 31, 2010 but deferred presentation of loan loss allowance by loan portfolio segment until the quarter ended March 31, 2011.  The Company adopted the rules for loan loss allowance disclosures by loan segment effective March 31, 2011.

 

9

**Note 2 – Earnings (Loss) per Common Share**

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

 

 Three Months Ended March 31,

 

2012 

2011 

(In thousands, except per share data)

 

 

Net income

$

21 

$

140 

Preferred dividends, discount and premium

(162)

(160)

Net loss available to common equity

($141)

($20)

Weighted average common shares outstanding

1,657 

1,652 

Effect of dilutive stock options

0 

0 

Diluted weighted average common shares outstanding

1,657 

1,652 

Basic and diluted loss per common share

($0.09)

($0.01)

**Note 3- Securities**

The amortized cost, gross unrealized gains and losses, and fair values of investment securities available-for-sale at March 31, 2012 and December 31, 2011 were as follows:

 

Amortized Cost

Gross Unrealized Gains

Gross Unrealized Losses

Fair Value

 

($ in thousands)

**March 31, 2012**

 

 

 

 

U.S. Treasury securities and obligations of U.S. government corporations and agencies

$

15,961

$

314

$

0

$

16,275

Mortgage-backed securities

66,832

1,158

68

67,922

Obligations of states and political subdivisions

21,388

1,091

1

22,478

Corporate debt securities

831

1

0

832

Total debt securities

105,012

2,564

69

107,507

Equity securities

151

0

0

151

Total securities available-for-sale

$

105,163

$

2,564

$

69

$

107,658

 

Amortized Cost

Gross Unrealized Gains

Gross Unrealized Losses

Fair Value

 

($ in thousands)

**December 31, 2011**

 

 

 

 

U.S. Treasury securities and obligations of U.S. government corporations and agencies

$18,479 

$329 

$0 

$18,808 

Mortgage-backed securities

66,622 

1,110 

79 

67,653 

Obligations of states and political subdivisions

21,619 

1,316 

3 

22,932 

Corporate debt securities

831 

1 

0 

832 

Total debt securities

107,551 

2,756 

82 

110,225 

Equity securities

151 

0 

0 

151 

Total securities available-for-sale

$107,702 

$2,756 

$82 

$110,376 

 

10

 
The following table represents gross unrealized losses and the related fair value of investment securities available-for-sale, aggregated by investment category and length of time individual securities have been in a continuous unrealized loss position, at March 31, 2012 and December 31, 2011. 
 

     Less Than 12 Months

 

        12 Months or More

 

Total

 

Fair Value

Unrealized Losses

 

Fair Value

Unrealized Losses

 

Fair Value

Unrealized Losses

 

($ in thousands)

**March 31, 2012**

 

 

 

 

 

 

 

 

U.S. Treasury securities and obligations of U.S. government corporations and agencies

$

0

$

0

 

$

0

$

0

 

$

0

$

0

Mortgage-backed securities

11,019

63

 

12

5

 

11,031

68

Obligations of states and political subdivisions

166

1

 

0

0

 

166

1

Total 

$

11,185

$

64

 

$

12

$

5

 

$

11,197

$

69

**December 31, 2011**

 

 

 

 

 

 

 

 

U.S. Treasury securities and obligations of U.S. government corporations and agencies

$

0

$

0

 

$

0

$

0

 

$

0

$

0

Mortgage-backed securities

9,730

73

 

12

6

 

9,742

79

Obligations of states and political subdivisions

0

0

 

327

3

 

327

3

Total 

$

9,730

$

73

 

$

339

$

9

 

$

10,069

$

82

The Company reviews the investment securities portfolio on a quarterly basis to monitor its exposure to other-than-temporary impairment (“OTTI”) that may result due to adverse economic conditions or other issuer-specific factors. A determination as to whether a security’s decline in market value is temporary or OTTI takes into consideration numerous factors.  Significant inputs used to measure the amount related to credit loss include, but are not limited to:  (i) the length of time and extent to which fair value has been less than cost; (ii) the financial condition and near-term prospects of the issuer, and (iii) our intent and ability to retain the investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value.  When management identifies a specific security that has a rating lower than “A”, fair value less than 95% of the amortized cost, and has been in a continuous loss position for twelve months a third party vendor may review the specific security for OTTI.  To determine OTTI, a discounted cash flow model is utilized to estimate the fair value of the security.  The use of a discounted cash flow model involves judgment, particularly of interest rates, estimated default rates and prepayment speeds.  Adjustments to market value that are considered temporary are recorded as separate components of equity, net of tax. If an impairment of a security is identified as OTTI it will be recorded in the Consolidated Statement of Operations.  

As of March 31, 2012 the Company has determined that there are no OTTI securities in the investment portfolio.

Based on the Company’s evaluation, management believes that any remaining unrealized losses at March 31, 2012, are primarily attributable to changes in interest rates and the current market conditions, and not credit deterioration.  Management believes that the Company currently has both the intent and ability to hold the securities that are in a continuous unrealized loss position for the time necessary to recover the amortized cost.

The amortized cost and fair values of investment debt securities available-for-sale at March 31, 2012, by contractual maturity, are shown below.  Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.  Fair values of securities are estimated based on financial models or prices paid for similar securities.  It is possible interest rates could change considerably, resulting in a material change in estimated fair value.

 

Amortized Cost

Fair Value

 

($ in thousands)

Due in one year or less

$

1,625

$

1,645

Due after one year but within five years

18,816

19,374

Due after five years but within ten years

16,379

17,182

Due after ten years or more

1,360

1,384

Mortgage-backed securities

66,832

67,922

Total debt securities available-for-sale

$

105,012

$

107,507

 

11** 

**Note 4 – Loans, Allowance for Loan Losses, and Credit Quality**

The period-end loan composition as of March 31, 2012 and December 31, 2011 are summarized as follows:

 

March 31, 2012

December 31, 2011

($ in thousands)

 

 

Commercial business

$

44,927

$

41,347

Commercial real estate

123,792

123,868

Real estate construction

24,828

28,708

Agricultural

43,851

45,351

Real estate residential

84,215

85,614

Installment

4,388

4,975

Total loans 

$

326,001

$

329,863

The allowance for loan losses (“ALLL”) represents management’s estimate of probable and inherent credit losses in the Bank’s loan portfolio. Estimating the amount of the ALLL requires the exercise of significant judgment and the use of estimates related to the amount 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 other qualitative factors, all of which may be susceptible to significant change.  To the extent actual outcomes differ from management estimates, additional provision for loan losses could be required that could adversely affect our earnings or financial position in future periods. Allocations of the ALLL may be made for specific loans but the entire ALLL is available for any loan that, in management’s judgment, should be charged-off or for which an actual loss is realized.

A summary of the changes in the ALLL by portfolio segment for the periods indicated:

 

Beginning Balance at 1/1/2012

Charge-offs

Recoveries

Provision 

Ending Balance at 3/31/12

Ending balance:  individually 

evaluated for impairment

Ending balance:  collectively evaluated for impairment

 

($ in thousands)

**March 31, 2012**

 

 

 

 

 

 

 

Commercial business

$

1,004

($165)

$

6

($11)

$

834

$

222

$

612

Commercial real estate

3,685

(280)

62

517 

3,984

2,260

1,724

Real estate construction

1,320

(28)

5

(224)

1,073

460

613

Agricultural

1,139

(10)

67

(127)

1,069

33

1,036

Real estate residential

2,530

(155)

9

625 

3,009

1,497

1,512

Installment

138

(14)

5

(30)

99

5

94

Total

$

9,816

($652)

$

154

$

750 

$

10,068

$

4,477

$

5,591

 

Beginning Balance at 1/1/2011

Charge-offs

Recoveries

Provision 

Ending Balance at 12/31/2011

Ending balance:  individually evaluated for impairment

Ending balance:  collectively evaluated for impairment

 

($ in thousands)

**December 31, 2011**

 

 

 

 

 

 

 

Commercial business

$

536

($173)

$

37

$

604

$

1,004

$

352

$

652

Commercial real estate

4,320

(2,005)

135

1,235

3,685

1,758

1,927

Real estate construction

1,278

(1,295)

134

1,203

1,320

460

860

Agricultural

1,146

(203)

90

106

1,139

35

1,104

Real estate residential

2,060

(1,067)

101

1,436

2,530

680

1,850

Installment

131

(245)

86

166

138

15

123

Total

$

9,471

($4,988)

$

583

$

4,750

$

9,816

$

3,300

$

6,516

The allocation methodology used by the Company includes specific allocations for impaired loans evaluated individually for impairment and the remaining loan portfolio collectively evaluated for impairment primarily based on historical loss rates and other qualitative factors.  Loan charge-offs and recoveries are based on actual amounts charged-off or recovered by loan category.  Management allocates the ALLL by pools of risk within each loan portfolio.  

 

12 

 

At March 31, 2012, the ALLL allocations for the commercial real estate and real estate residential portfolios increased, with all other loan portfolio allocations declining from December 31, 2011.  The increase in commercial real estate and real estate residential was primarily due to the increase in the amount of impaired loans and the related valuation allowances assigned to these loans during the first three months of 2012.  The allocation of the ALLL by loan portfolio is made for analytical purposes and is not necessarily indicative of the trend of future loan losses in any particular category.  

The following table presents nonaccrual loans by portfolio segment as of the dates indicated as follows:

 

March 31, 2012

December 31, 2011

 

                    ($ in thousands)

Commercial business

$

371

$

734

Commercial real estate

4,208

4,076

Real estate construction

1,142

2,519

Agricultural

322

134

Real estate residential

3,751

3,726

Installment

10

5

Total nonaccrual  loans 

$

9,804

$

11,194

Loans are generally placed on nonaccrual status when management has determined collection of such interest is doubtful or when a loan is contractually past due 90 days or more as to interest or principal payments.  When loans are placed on nonaccrual status or charged-off, all current year unpaid accrued interest is reversed against interest income. The interest on these loans is subsequently accounted for on the cash basis until qualifying for return to accrual status.  If collectability of the principal is in doubt, payments received are applied to loan principal.  Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.  

 

A summary of loans by credit quality indicator based on internally assigned credit grade is as follows:

($ in thousands)

 

 

 

 

 

 

 

 

 

 

**March 31, 2012**

Highest Quality

High Quality

Quality

Moderate Risk

Acceptable

Special Mention

Substandard

Doubtful

Loss

Total

Commercial business

$

91

$

4,636

$

5,405

$

8,812

$

13,363

$

9,373

$

2,859

$

388

$

0

$

44,927

Commercial real estate

0

1,424

15,010

33,637

35,849

15,716

15,925

6,231

0

123,792

Real estate construction

164

2,223

4,325

2,911

9,423

1,417

3,155

1,210

0

24,828

Agricultural

120

440

2,354

7,114

20,817

9,904

2,414

688

0

43,851

Real estate residential

448

5,418

17,865

20,628

20,899

8,467

6,524

3,966

0

84,215

Installment

0

356

1,060

1,879

729

289

65

10

0

4,388

Total

$

823

$

14,497

$

46,019

$

74,981

$

101,080

$

45,166

$

30,942

$

12,493

$

0

$

326,001

**December 31, 2011**

Highest Quality

High Quality

Quality

Moderate Risk

Acceptable

Special Mention

Substandard

Doubtful

Loss

Total

Commercial business

$

188

$

4,268

$

5,153

$

8,688

$

10,898

$

8,333

$

3,068

$

751

$

0

$

41,347

Commercial real estate

0

1,521

15,061

35,596

36,947

14,811

13,828

6,104

0

123,868

Real estate construction

166

2,169

4,680

3,905

11,383

839

2,980

2,586

0

28,708

Agricultural

121

427

2,527

8,052

22,283

8,428

2,812

701

0

45,351

Real estate residential

466

6,273

19,181

20,856

22,300

6,678

5,911

3,949

0

85,614

Installment

6

430

1,258

2,205

759

273

39

5

0

4,975

Total

$

947

$

15,088

$

47,860

$

79,302

$

104,570

$

39,362

$

28,638

$

14,096

$

0

$

329,863

13

Loans risk rated acceptable or better are credits performing in accordance with the original terms, have adequate sources of repayment and little identifiable collectability risk.  Special mention credits have potential weaknesses that deserve management’s attention.  If left unremediated, these potential weaknesses may result in deterioration of the repayment of the credit.  Substandard loans typically have weaknesses in the paying capability of the obligor and/or guarantor or in collateral coverage.  These loans have a well-defined weakness that jeopardizes the liquidation of the debt and are characterized by the possibility that the Bank will sustain some loss if the deficiencies are not corrected.  Loans classified as doubtful have all the weaknesses of substandard loans with the added characteristic that the collection of all amounts due according to the original contractual terms is highly unlikely and the amount of the loss is reasonably estimable.  Loans classified as loss are considered uncollectible.  

The following table represents loans by past due status as of the dates indicated:

 

30 - 59 Days Past Due

60 - 89 Days Past Due

90 Days and Over

Total Past Due

Current

Total Loans

Recorded Investment > 90 Days and Accruing

**March 31, 2012**

 

 

($ in thousands)

 

 

 

Commercial business

$

32

$

25

$

315

$

372

$

44,555

$

44,927

$

0

Commercial real estate

2,186

688

2,828

$

5,702

118,090

123,792

0

Real estate construction

156

0

441

$

597

24,231

24,828

0

Agricultural

16

0

40

$

56

43,795

43,851

0

Real estate residential

724

1,039

2,834

$

4,597

79,618

84,215

0

Installment

12

4

14

$

30

4,358

4,388

13

Total

$

3,126

$

1,756

$

6,472

$

11,354

$

314,647

$

326,001

$

13

 

30 - 59 Days Past Due

60 - 89 Days Past Due

90 Days and Over

Total Past Due

Current

Total Loans

Recorded Investment > 90 Days and Accruing

**December 31, 2011**

 

 

($ in thousands)

 

 

 

Commercial business

$

50

$

14

$

612

$

676

$

40,671

$

41,347

$

0

Commercial real estate

787

830

2,885

4,502

119,366

123,868

0

Real estate construction

114

157

2,519

2,790

25,918

28,708

0

Agricultural

88

120

241

449

44,902

45,351

0

Real estate residential

989

176

3,044

4,209

81,405

85,614

0

Installment

29

0

0

29

4,946

4,975

21

Total

$

2,057

$

1,297

$

9,301

$

12,655

$

317,208

$

329,863

$

21

14

The following table presents impaired loans as of the dates indicated:

 

Recorded Investment

Unpaid Principal Balance

Related Allowance

Average Recorded Investment

Interest Income Recognized

 

 

 

($ in thousands)

 

**March 31, 2012**

 

 

 

 

 

With a related allowance:

 

 

 

 

 

Commercial business

$

1,257

$

1,479

$

222

$

1,157

$

11

Commercial real estate

11,560

13,820

2,260

11,854

127

Real estate construction

2,245

2,705

460

2,634

42

Agricultural

291

324

33

314

1

Real estate residential

5,203

6,700

1,497

5,195

69

Installment

15

20

5

20

0

Total

$

20,571

$

25,048

$

4,477

$

21,174

$

250

**December 31, 2011**

 

 

 

 

 

With no related allowance:

 

 

 

 

 

Commercial business

$

0

$

0

$

0

$

0

$

0

Commercial real estate

0

0

0

349

0

Real estate construction

0

0

0

96

0

Agricultural

0

0

0

8

0

Real estate residential

0

0

0

165

0

Installment

0

0

0

0

0

With a related allowance:

 

 

 

 

 

Commercial business

$

482

$

834

$

352

$

460

$

11

Commercial real estate

8,130

9,888

1,758

7,646

392

Real estate construction

2,103

2,563

460

2,080

51

Agricultural

270

305

35

233

4

Real estate residential

3,010

3,690

680

2,586

103

Installment

6

21

15

8

2

Total:

 

 

 

 

 

Commercial business

$

482

$

834

$

352

$

460

$

11

Commercial real estate

8,130

9,888

1,758

7,995

392

Real estate construction

2,103

2,563

460

2,176

51

Agricultural

270

305

35

241

4

Real estate residential

3,010

3,690

680

2,751

103

Installment

6

21

15

8

2

Total

$

14,001

$

17,301

$

3,300

$

13,631

$

563

At March 31, 2012 there were no impaired loans that did not have a related allowance.

**Troubled Debt Restructurings**

A loan is accounted for as a troubled debt restructuring if the Bank, for economic or legal reasons related to the borrower’s financial condition, grants a significant concession to the borrower that it would not otherwise considerto maximize the collection of amounts due.  A troubled debt restructuring may involve the receipt of assets from the debtor in partial or full satisfaction of the loan, or a modification of terms such as a reduction of the stated interest rate, a reduction of accrued interest, an extension of the maturity date at a stated interest rate lower than the current market rate for a new loan with similar risk, or some combination of these concessions.  

Restructured loans can involve loans remaining on nonaccrual, moving to nonaccrual, or continuing on accrual status.  Nonaccrual restructured loans are included with all other nonaccrual loans.  All accruing restructured loans are reported as troubled debt restructurings. Restructured loans remain on nonaccrual status until the customer has attained a sustained period of repayment performance under the modified loan terms, by internal policy usually a minimum of nine months.  Performance prior to the restructuring, or significant events that coincide with the restructuring, are considered in assessing whether the borrower can meet the new terms and whether the loan should 

15

be returned to, or maintained on, accrual status.  If the borrower’s ability to meet the revised payment schedule is not reasonably assured, the loan remains on nonaccrual.  

All restructured loans are considered impaired for reporting and measurement purposes.  A loan that has been modified at a below market rate will return to performing status if it satisfies the nine-month performance requirement; however, it will remain classified as a restructured loan.  

The following table provides the number of loans modified and classified as trouble debt restructurings by loan category during the three months ended March 31, 2012 and year ended December 31, 2011.

 

           Three Months Ended March 31, 2012

           Year Ended December 31, 2011

** **

Number of Loans

Pre-Modification Recorded Balance

Post-Modification Recorded Balance

Number of Loans

Pre-Modification Recorded Balance

Post-Modification Recorded Balance

 

 

 

                      ($ in Thousands)

 

 

Commercial business

2

$

121

$

121

3

$

722

$

721

Commercial real estate

7

3,174

3,174

15

6,160

6,160

Real estate construction

5

1,154

1,154

4

2,839

2,809

Agricultural

0

0

0

4

249

249

Real estate residential

3

583

583

13

2,474

2,473

Installment

0

0

0

1

22

22

 

17

$

5,032

$

5,032

40

$

12,466

$

12,434

During the three months ended March 31, 2012, restructured loan modifications made in the commercial lending segment (commercial business, commercial real estate, and real estate construction loans) primarily included maturity date extensions, and payment schedule modifications.  In addition, the Company may work with the borrowers in identifying other changes that will mitigate loss to the Company, which may include additional collateral or guarantees to support the loan.

Restructured loan modifications made in the consumer lending segment (real estate residential and installment loans) during the three months ended March 31, 2012 included maturity date extensions, interest rate concessions, deferrals of payments, and payment schedule modifications.  

The following table summarizes troubled debt restructuring during the previous twelve months that subsequently defaulted during the three months ended March 31, 2012.

 

    Three Months Ended March 31, 2012

** **

Number of Loans

Recorded Investment

 

                      ($ in thousands)

Commercial business

0

$

0

Commercial real estate

6

972

Real estate construction

0

0

Agricultural

0

0

Real estate residential

0

0

Installment

0

0

 

6

$

972

All loans modified in a troubled debt restructuring are evaluated for impairment.  The nature and extent of impairment of restructured loans, including those which have experienced a subsequent payment default, are considered in the determination of an appropriate level of the ALLL.

16

**Note 5 – Other Real Estate Owned (“OREO”)**

A summary of OREO, net of valuation allowances for the periods indicated is as follows:

 

Three months ended March 31, 2012

Year ended December 31, 2011

 

($ in thousands)

Balance at beginning of period

$

4,404 

$

4,230 

Transfer of loans at net realizable value to OREO

465 

2,631 

Sale proceeds

(552)

(1,995)

Loans made in sale of OREO

0 

(75)

Net gain (loss) from sale of OREO

(73)

241 

Provision for write-downs charged to operations

(80)

(628)

Balance at end of period

$

4,164 

$

4,404 

An analysis of the valuation allowance on OREO, included in the above table, is as follows:

 

Three months ended March 31, 2012

Year ended December 31, 2011

 

                        ($ in thousands)

Balance at beginning of period

$

410 

$

2,788 

Provision for write-downs charged to operations

80 

628 

Amounts related to OREO disposed of

(155)

(3,006)

Balance at end of period

$

335 

$

410 

OREO was $4,164 at March 31, 2012, compared to $4,404 at December 31, 2011.  The properties held as OREO at March 31, 2012 consisted of $3,293 of commercial real estate (the largest being $1,744 related to a hotel/water park project), $718 real estate construction loans, and $153 residential real estate.  OREO as of year -end 2011 consisted of $3,170 of commercial real estate (the largest being $1,744 related to a hotel/water park project), $946 real estate construction, and $288 residential real estate.  Management monitors properties held to minimize the Company’s risk of loss. Evaluations of the fair market value of the OREO properties are done quarterly and valuation adjustments, if necessary, are recorded in our consolidated financial statements. 

For the three months ended March 31, 2012, the Bank acquired OREO of $465 measured at fair value less selling costs.  In addition, an impairment write down of $80 was made against OREO properties acquired in prior years and charged to 2012 earnings.  In 2011, the Bank acquired OREO of $2,631 measured at fair value less selling costs.  In addition, an impairment write down of $628 was made against these properties, as well as some of the OREO properties acquired in prior years and charged to earnings for the year ended December 31, 2011.   

**Note 6- Short-term Borrowings**

Short-term borrowings consisted of $15,611 and $13,655 of securities sold under repurchase agreements at March 31, 2012 and December 31, 2011, respectively.

The Company pledges securities available-for-sale as collateral for repurchase agreements.  The fair value of securities pledged for short-term borrowings totaled $19,229 at March 31, 2012 and $19,481 at December 31, 2011.

The following information relates to federal funds purchased, securities sold under repurchase agreements, and the Bank’s Federal Home Loan Bank of Chicago (“FHLB”) open line of credit for the following periods.

17

 

Three months ended 

Year ended 

 

March 31, 2012

December 31, 2011

 

                         ($ in thousands)

Weighted average rate

0.41%

0.46%

For the period:

 

 

  Highest month-end balance

$

16,914  

$

15,817  

  Daily average balance

$

15,430  

$

12,285  

  Weighted average rate

0.23%

1.00%

**Note 7- Long-term Borrowings**

Long-term borrowings were as follows:

 

Three months ended 

Year ended 

 

March 31, 2012

December 31, 2011

 

                         ($ in thousands)

FHLB advances

$

28,061

$

30,061

Other borrowed funds

10,000

10,000

  Total long-term borrowings

$

38,061

$

40,061

FHLB Advances – Long-term advances from the FHLB have maturities through 2015 and had a weighted-average interest rate of 2.94% and 2.98% at March 31, 2012and December 31, 2011, respectively.  FHLB advances decreased $2,000 from year-end 2011 to March 31, 2012, due to the maturity of an advance that was not renewed because the Company’s liquidity position was sufficient without such advances.

  

Other borrowed funds – Other borrowed funds consist of structured repurchase agreements.  The fixed rate structured repurchase agreements mature in 2014 and 2015, are callable in 2013, and had weighted-average interest rates of 4.24% at March 31, 2012 and December 31, 2011.

**Note 8 - Fair Value Measurements**

Fair value represents the estimated price at which an orderly transaction to sell an asset or to transfer a liability would take place between market participants at the measurement date under current market conditions (i.e., an exit price concept).   As there is no active market for many of the Company’s financial instruments, estimates are made using discounted cash flow or other valuation techniques. Inputs into the valuation methods are subjective in nature, involve uncertainties, and require significant judgment and therefore cannot be determined with precision. Accordingly, the derived fair value estimates presented herein are not necessarily indicative of the amounts the Company could realize in a current market exchange. Assets and liabilities are categorized into three levels based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. In instances where the determination of the fair value measurement is based on inputs from different levels of the fair value hierarchy, the level in the fair value hierarchy in which the entire fair value measurement falls is based on the lowest level input that is significant to the fair value measurement in its entirety. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability. Below is a brief description of each fair value level.

Level 1 – Fair value measurement is based on quoted prices for identical assets or liabilities that the Company has the ability to access.

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

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

 

18

In May 2011, the FASB issued guidance on measuring fair value to create common fair value measurement and disclosure requirements in U.S. GAAP and IFRS. The amendments changes the wording used to describe many of the requirements for measuring fair value and for disclosing information about fair value measurements. The amendment also clarifies the application of existing fair value measurement and disclosure requirements. As a result, certain prior period reclassifications and disclosures have been made to conform to the new requirements. The Company now classifies impaired loans and OREO as a Level 3 fair value measurement, compared to a Level 2 fair value measurement in prior periods, and the prior periods have been reclassified to reflect this change. These reclassifications had no impact on the Corporation’s consolidated results of operations, financial position, or liquidity. 

The following is a description of the valuation methodology used for the Company’s more significant instruments measured on a recurring basis at fair value, including the general classification of such instruments pursuant to the valuation hierarchy. 

Investment securities available-for-sale – Securities available-for-sale may be classified as Level 1, Level 2, or Level 3 measurements within the fair value hierarchy.  The fair value measurement of a Level 1 security is based on the quoted price in an active market.  Level 1 investment securities primarily include U.S. Treasury securities.  The fair value measurement of a Level 2 security is obtained from an independent pricing service and is based on pricing models, quoted prices of securities with similar characteristics or discounted cash flows, with consideration given to the nature of the quote and the relationship of recently evidenced market activity to the fair value estimate. Examples of these investment securities include Federal agency securities, obligations of states and political subdivisions, asset-backed securities, and mortgage related securities.  In certain cases where there is limited activity or less transparency around inputs to the estimated fair value, securities are classified within Level 3 of the fair value hierarchy.  Level 3 securities primarily include trust preferred securities. To validate the fair value estimates, assumptions, and controls, the Company looks to transactions for similar instruments and utilizes relevant market indices. While none of these sources are solely indicative of fair value, they serve as directional indicators for the appropriateness of the Company’s fair value estimates. The Company has determined that the fair value measures of its investment securities are classified predominantly within Level 2 of the fair value hierarchy.  

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

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

The table below presents the Company’s investment securities available-for-sale and loans held for sale measured at fair value on a recurring basis as of March 31, 2012 and December 31, 2011, aggregated by the level in the fair value hierarchy within which those measurements fall.

19

Assets Measured at Fair Value on a Recurring Basis

 

 

 

 

 

Fair Value Measurements Using

 

March 31, 2012

Level 1

Level 2

Level 3

 

 

($ in thousands)

Investment securities available-for-sale:

 

 

 

 

U.S. Treasury securities and obligations of 

U.S. government corporations and agencies

$

16,275

$

0

$

16,275

$

0

Mortgage-backed securities

67,922

0

67,922

0

Obligations of states and political subdivisions

22,478

0

21,951

527

Corporate debt securities

832

0

7

825

Equity securities

151

0

51

100

Loans held for sale

612

0

612

0

 

 

Fair Value Measurements Using

 

December 31, 2011

Level 1

Level 2

Level 3

Investment securities available-for-sale:

 

 

 

 

U.S. Treasury securities and obligations of 

U.S. government corporations and agencies

$

18,808

$

0

$

18,808

$

0

Mortgage-backed securities

67,653

0

67,641

12

Obligations of states and political subdivisions

22,932

0

22,405

527

Corporate debt securities

832

0

7

825

Equity securities

151

0

51

100

Loans held for sale

2,163

0

2,163

0

The table below presents a roll forward of the balance sheet amounts for the three months ended March 31, 2012 and for the year ended December 31, 2011, for assets measured on a recurring basis and classified within Level 3 of the fair value hierarchy.

Assets Measured at Fair Value Using Significant Unobservable Inputs (Level 3)

($ in thousands)

 

 

 

 

Investment Securities Available-for-Sale

Balance at December 31, 2010

 

$

2,299 

Unrealized holding losses arising during the period:

 

  Included in earnings

 

(55)

  Included in other comprehensive income

 

7 

Principal repayments

 

(146)

Sales

 

(641)

Transfers into Level 3

 

0 

Balance at December 31, 2011

 

1,464 

 

 

 

Unrealized holding losses arising during the period:

 

  Included in earnings

 

0 

  Included in other comprehensive income

 

1 

Principal repayments

 

(13)

Sales

 

0 

Transfers in/out Level 3

 

0 

Balance at March 31, 2012

 

$

1,452 

Level 3 available-for-sale securities include corporate debt and equity securities.  The market for these securities was not active as of March 31, 2012.  

20

The following is a description of the valuation methodologies used for the Company’s more significant instruments measured on a nonrecurring basis at fair value.

Impaired loans – The Company considers a loan impaired when it is probable that the Company will be unable to collect all amounts due according to the original contractual terms of the note agreement, including principal and interest.   Loans considered to be impaired are measured at fair value on a nonrecurring basis.  For individually evaluated impaired loans, the amount of impairment is based upon the fair value of the underlying collateral.  

At March 31, 2012 loans with a carrying amount of $25,048 were considered impaired and were written down to their estimated fair value of $20,571.  As a result, the Company recognized a specific valuation allowance against these impaired loans totaling $4,477.  At year end December 31, 2011 loans with a carrying amount of $17,301 were considered impaired and were written down to their estimated fair value of $14,001.  As a result, the Company recognized a specific valuation allowance against these impaired loans totaling $3,300

OREO – Real estate acquired through or in lieu of loan foreclosure is recorded in our consolidated balance sheets at the lower of cost or fair value.  Fair value is determined based on third party appraisals and, if less than the carrying value of the loan, the carrying value of the loan is adjusted to the fair value.  Appraised values are adjusted to consider disposition costs and also to take into consideration the age of the most recent appraisal.  Given the significance of the adjustments made to the appraised values necessary to estimate the fair value of the properties, OREO is considered to be Level 3 in the fair value hierarchy of valuation techniques.  Valuation adjustments to OREO totaled $80 and $6 during the three months ended March 31, 2012 and 2011, respectively and are recorded in Foreclosure/OREO expense.  At March 31, 2012 and December 31, 2011, OREO totaled $4,164 and $4,404, respectively.

The table below presents the Company’s impaired loans and OREO measured at fair value on a nonrecurring basis as of March 31, 2012 and December 31, 2011, aggregated by the level in the fair value hierarchy within those measurements fall.

Assets Measured at Fair Value on a Nonrecurring Basis

 

 

 

 

 

Fair Value Measurements Using

 

March 31, 2012

Level 1

Level 2

Level 3

 

 

 

($ in thousands)

Impaired loans(1)

$

20,571

$

0

$

0

$

20,571

OREO

4,164

0

0

4,164

 

 

Fair Value Measurements Using

 

December 31, 2011

Level 1

Level 2

Level 3

Impaired loans(1)

$

14,001

$

0

$

0

$

14,001

OREO

4,404

0

0

4,404

(1) Represents individually evaluated loans, net of the related allowance for loan losses.

 

 

For Level 3 assets measured at fair value on a recurring or non-recurring basis as of March 31, 2012, the Company utilized the following valuation techniques and significant unobservable inputs.

Investment securities available-for-sale- other securities:  In valuing the investment securities available-for-sale classified within Level 3, the Company reviewed the underlying collateral and other relevant data in developing the assumptions for these investment securities.

Impaired Loans:  Fair value measurement of collateral for collateral-dependent impaired loans primarily relates to discounting criteria applied to independent appraisals received with respect to the collateral.  Discounts applied to the appraisals are dependent on the appraisal.  As of March 31, 2012, discounts applied to appraisals ranged from 15% to 30%. 

OREO:  Fair value measurement of OREO primarily relate to discounting criteria applied to independent appraisals received with respect to the property.  Discounts applied to the appraisals are dependent on the appraisal and marketability of the property.  As of March 31, 2012, discounts applied to appraisals ranged from 15% to 30%. 

21

The estimated fair values of the Company’s financial instruments on the balance sheet at March 31, 2012 and December 31, 2011 were as follows:

 

 

 

March 31, 2012

 

 

Carrying

 

Fair Value Measurements Using

 

Amount

Fair Value

Level 1

Level 2

Level 3

 

 

 

($ in thousands)

 

Financial assets:

 

 

 

 

 

  Cash and short-term investments

$

35,609

$

35,609

$

35,609

$

0

$

0

  Investment securities available-for-sale

107,658

107,658

0

106,206

1,452

  Other investments

2,151

2,151

0

2,151

0

  Loans held for sale

612

612

0

612

0

  Net loans

315,933

314,111

0

0

314,111

  Accrued interest receivable

1,790

1,790

0

0

1,790

Financial liabilities:

 

 

 

 

 

  Deposits

$

376,888

$

377,393

$

0

$

0

$

377,393

  Short-term borrowings

15,611

15,611

0

0

15,611

  Long-term borrowings

38,061

40,425

0

0

40,425

  Subordinated debentures

10,310

4,818

0

0

4,818

  Accrued interest payable

833

833

0

0

833

 

 

 

December 31, 2011

 

 

Carrying

 

Fair Value Measurements Using

 

Amount

Fair Value

Level 1

Level 2

Level 3

 

 

 

($ in thousands)

 

Financial assets:

 

 

 

 

 

  Cash and short-term investments

$

31,360

$

31,360

$

31,360

$

0

$

0

  Investment securities available-for-sale

110,376

110,376

0

108,912

1,464

  Other investments

2,616

2,616

0

2,616

0

  Loans held for sale

2,163

2,163

0

2,163

0

  Net loans

320,047

317,805

0

0

317,805

  Accrued interest receivable

1,640

1,640

0

0

1,640

Financial liabilities:

 

 

 

 

 

  Deposits

$

381,620

$

383,520

$

0

$

0

$

383,520

  Short-term borrowings

13,655

13,655

0

0

13,655

  Long-term borrowings

40,061

42,525

0

0

42,525

  Subordinated debentures

10,310

4,818

0

0

4,818

  Accrued interest payable

878

878

0

0

878

The following is a description of the valuation methodologies used to estimate the fair value of financial instruments.

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

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

Other investments – Other investments consists of FHLB and Bankers’ Bank of Wisconsin stocks.  The carrying amount is a reasonable fair value estimate of other investments giver their “restricted” nature.

Loans held for sale – The estimated fair value of the residential mortgage loans held for sale was based on current secondary market prices for similar loans.

Net loans – Fair values are estimated for portfolios of loans with similar financial characteristics. Loans are segregated by type such as commercial, residential mortgage, and other consumer. The fair value of loans is calculated by discounting scheduled cash flows through the estimated maturity using estimated market discount 

 

22

rates that reflect the credit and interest rate risk inherent in the loan. The estimate of maturity is based on the Company’s repayment schedules for each loan classification. In addition, for impaired loans, marketability and appraisal values for collateral were considered in the fair value determination.

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

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

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

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

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

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

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

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

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

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

The following management’sdiscussion and analysis is presented to assist in the understanding and evaluation of our consolidated financial condition as of March 31, 2012 and December 31, 2011 and results of operations for the three-month periods ended March 31, 2012 and 2011.  It is intended to supplement the unaudited financial statements, condensed footnotes, and supplemental financial data appearing elsewhere in this Form 10-Q and should be read in conjunction therewith.  This discussion should be read in conjunction  with the interim consolidated financial statement and  the condensed notes thereto included with this report and with Management’s Discussion and Analysis of Financial Condition and Results of Operations and the financial statements and notes related thereto included in our 2011 Form 10-K.  Quarterly comparisons reflect continued consistency of operations and do not reflect any significant trends or events other than those noted in the comments.

23

**Forward-Looking Statements**

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

·

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

·

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

·

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

·

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

·

other factors discussed under Item 1A, “Risk Factors” in our 2011 Form 10-K and elsewhere therein and herein, and from time to time in our other filings with the Securities and Exchange Commission after the date of this report. 

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

 

**Critical Accounting Policies**

Our financial statements are prepared in conformity with accounting principles generally accepted in the United States of America and follow general practices within the industry in which we operate.  This preparation requires management to make estimates, assumptions and judgments that affect the amounts reported in the consolidated financial statements and accompanying notes.  These estimates, assumptions and judgments are based on information available as of the date of the financial statements; accordingly, as this information changes, actual results could differ from the estimates, assumptions and judgments reflected in the financial statements.  Certain policies inherently have a greater reliance on the use of estimates, assumptions and judgments and, as such, have a greater possibility of producing results that could be materially different than originally reported.  We believe the following policies are critical to the portrayal of our financial condition and require subjective or complex judgments and, therefore, are critical accounting policies.  For a complete discussion of all significant policies, refer to Note 1, “Summary of Significant Accounting Policies,” to the Consolidated Financial Statements included  in our 2011 Form 10-K.

Available-for-Sale Investment Securities:  Securities are classified as available for sale and are carried at fair value, with unrealized gains and losses reported in other comprehensive income (loss).  Amortization of premiums and accretion of discounts are recognized in interest income using the interest method over the estimated lives of the securities.  We evaluate all investment securities on a quarterly basis, and more frequently when economic conditions warrant, to determine if OTTI exists.  A debt security is considered impaired if the fair value is less than its amortized cost at the report date.  If impaired, we then assess whether the impairment is OTTI.  Current authoritative guidance provides that some portion of unrealized losses may be OTTI and a credit loss is deemed to exist if the present value of the expected future cash flows is less than the amortized cost basis of the debt security.  The credit loss component is recorded in earnings as a component of OTTI in the consolidated statements of operations, while the loss component related to other market factors is recognized in other comprehensive income (loss), provided the Bank does not intend to sell the underlying debt security and it is “more likely than not” that the Bank will not have to sell the debt security prior to recovery of the unrealized loss.  In estimating OTTI, we consider many factors which include: (i) the length of time and the extent to which fair value has been less than cost; (ii) the financial condition and near-term prospects of the issuer; and (iii) our intent and ability to retain the investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value.  

24

To determine OTTI, we utilize a discounted cash flow model to estimate the fair value of the security.  The use of a discounted cash flow model involves judgment, particularly of interest rates, estimated default rates and prepayment speeds.  Interest income on securities for which OTTI has been recognized in earnings is recognized at a rate commensurate with the expected future cash flows and amortized cost basis of the securities after the impairment.

To determine if impairment of a debt security is OTTI the Bank first determines if (i) it intends to sell the security or (ii) 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 Bank will recognize OTTI in earnings equal to the difference between the security’s fair value and its adjusted cost basis.  If neither of the conditions is met, the Bank determines (i) the amount of the impairment related to credit loss and (ii) the amount of the impairment due to all other factors.  The difference between the present values of the cash flows expected to be collected and the amortized cost basis is the credit loss, which represents, the amount of the OTTI that is recognized in earnings and is a reduction to the cost basis of the security.  The amount of the total impairment related to all other factors (excluding credit loss) is included in other comprehensive income (loss).  

For non-agency residential mortgage-backed securities that are considered OTTI and for which we have the ability and intent to hold these securities until the recovery of our amortized cost basis, we recognize OTTI in accordance with accounting principles generally accepted in the United States.  Under these principles, we separate the amount of the OTTI into the amount that is credit related and the amount due to all other factors.  The credit loss component is recognized in earnings and is the difference between the security’s amortized cost basis and the present value of expected future cash flows.  The amount due to other factors is recognized in other comprehensive income (loss).

Gains and losses on the sale of securities are recorded on the trade date and determined using the specific-identification method.

ALLL:   We maintain an ALLL to absorb probable incurred loss in our loan portfolio.  The ALLL is based on ongoing, quarterly assessments of the estimated probable incurred losses in the loan portfolio.  In evaluating the level of the ALLL, we consider numerous factors which are expanded upon below.  We follow all applicable regulator guidance, including the “Interagency Policy Statement on the Allowance for Loan Losses,” issued by the Federal Financial Institutions Examination Council (“FFIEC”).  However, based on periodic examinations by regulators, the amount of the ALLL recorded during a particular period may be adjusted.  

Management’s evaluation process used to determine the adequacy of the ALLL is subject to the use of estimates, assumptions, and judgments. The evaluation process combines several factors including: (i) evaluation of facts and issues related to specific loans; (ii) management’s ongoing review and grading of the loan portfolio; (iii) consideration of historical loan loss and delinquency experience on each portfolio category; (iv) trends in past due and nonperforming loans; (v) the risk characteristics of the various loan segments; (vi) changes in the size and character of the loan portfolio; (vii) concentrations of loans to specific borrowers or industries; (viii) existing and forecasted economic conditions; (ix) the fair value of underlying collateral; and (x) other qualitative and quantitative factors which could affect potential credit losses.  Because current economic conditions can change and future events are inherently difficult to predict, the anticipated amount of estimated loan losses, and therefore the adequacy of the ALLL, could change significantly.  As an integral part of their examination process, various regulatory agencies also review the ALLL. Such agencies may require that certain loan balances be classified differently or charged-off when their credit evaluations differ from those of management, based on their judgments about information available to them at the time of their examination. The Company believes the ALLL as recorded in the consolidated financial statements is adequate.

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

Income taxes:  The assessment of incometax assets and liabilities involves the use of estimates, assumptions, interpretations, and judgment concerning certain accounting pronouncements and federal and state tax codes. There can be no assurance that future events, such as court decisions or positions of federal and state taxing authorities, will not differ from management’s current assessment, the impact of which could be significant to the consolidated results of operations and reported earnings. Quarterly assessments will continue to be performed to determine if additional valuation allowances may be necessary against our deferred tax asset.  At March 31, 2012 the Company believes that tax assets and liabilities are adequate and properly recorded in the consolidated financial statements.

25

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

**RESULTS OF OPERATIONS**

**Overview**

The Company reported a net loss available to common shareholders of $141, or $0.09 per common share, for the three months ended March 31, 2012, compared to a net loss to common shareholders of $20, or $0.01 per common share, in the comparable 2011 period.  Excluding a one-time $500 legal settlement received in the first three months of 2011, the net loss available to common shareholders would have been $320, or $0.19 per common share, after taxes, for that period.

Key factors behind these results are discussed below:

·

Net interest income of $3,750 for the three months ended March 31, 2012, decreased by 3% from the same period in 2011.  On a fully tax-equivalent basis, the net interest margin at March 31, 2012 increased to 3.38% from 3.36% for the same period in 2011.  The increase in net interest margin was primarily due to the decline in the cost of interest-bearing liabilities exceeding the decline in the yield on our earning assets.  The average yield on earning assets was 4.59% at March 31, 2012 compared to 4.86% at March 31, 2011.  The cost of interest-bearing liabilities was 1.47% at March 31, 2012 compared to 1.79% at March 31, 2011.  

·

Loans of $326,001 at March 31, 2012, decreased $3,862 from December 31, 2011.   Much of this decrease was the result of a continued lack of demand for loans in our market areas and the regular pay downs of existing loans, as well as the Company’s current strategic focus on improving credit quality rather than loan growth at this time.

·

Total deposits were $376,888 at March 31, 2012, down $4,732 from the year ended December 31, 2011, primarily due to seasonal fluctuations in noninterest-bearing demand deposits and the Company’s strategy to continue to reduce noncore funding sources.  

 

·

Net charge-offs were $498 in the first three months of 2012, and $814 for the comparable period in 2011. The provision for loan losses was $750 for the first three months of 2012, compared with $1,050 for the first three months of 2011.  The Bank’s ratio of the ALLL to total loans at March 31, 2012 was 3.09% compared to 2.98% at December 31, 2011 and 2.90% at March 31, 2011.  Each of these metrics improved in the first quarter of 2012 as we began to see improvements in our overall asset quality.

·

Noninterest income for the three months ended March 31, 2012 was $985.  Excluding a legal settlement of $500 and a $55 loss on sale of investments in the first three months of 2011, noninterest income was $977 for the three months ended March 31, 2011.  The increase in the “core” noninterest income was due to increased mortgage banking income from the sales of residential real estate loans into the secondary market and an increase in other income from the recovery of loan fees from charged-off loans.  These increases were offset in part by a decline in service fees of $64 primarily due to a general decrease in the amount of NSF/overdraft fees resulting from regulatory changes under the Dodd-Frank Wall Street Reform and Consumer Protection Act.  

·

For the three months ended March 31, 2012, noninterest expense, excluding foreclosure/OREO expense, decreased $350, or 9%, to $3,727, compared to the same period in 2011, primarily due to decreased salaries and employee benefits, occupancy expenses, data processing costs, FDIC expense and marketing expenses, partially offset by a $22 increase in legal and professional fees.  The Company will continue to focus on expense control for the remainder of 2012.  Foreclosure/OREO expense was $237 for the first three months of 2012 compared to $42 for the same period in 2011, primarily due to valuation adjustments on OREO properties and net losses on the sales of various foreclosed OREO properties.  

·

As of March 31, 2012, the Bank’s Tier One Capital Leverage ratio was 8.8% and Total Risk-Based Capital ratio was 14.5%, compared to 8.7% and 14.2%, respectively, at December 31, 2011.  The Company’s Tier One Capital Leverage ratio was 9.8% and Total Risk-Based Capital ratio was 15.9%, compared to 9.6% and 15.6%, respectively, at December 31, 2011.  All ratios are above the regulatory guidelines stipulated in the Bank’s and Company’s agreements with their primary regulators.

26

**Net Interest Income**

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

Table 1:  Year-To-Date Net Interest Income Analysis – Taxable-Equivalent Basis

 

Three months ended March 31, 2012

Three months ended March 31, 2011

 

Average

 

Average

Average

 

Average

 

Balance

Interest

Rate

Balance

Interest

Rate

 

 

 

($ in thousands)

 

 

ASSETS

 

 

 

 

 

 

Earning Assets

 

 

 

 

 

 

Loans (1) (2) (3)

$

329,446 

$

4,469

5.46%

$

339,737 

$

4,843

5.78%

Investment securities:

 

 

 

 

 

 

  Taxable

95,018 

549

2.32%

89,550 

638

2.89%

  Tax-exempt (2)

12,305 

142

4.64%

12,105 

149

4.99%

Interest-bearing deposits in other financial institutions

9,332 

4

0.17%

8 

0

0.00%

Federal funds sold 

4,344 

1

0.09%

11,567 

4

0.14%

Securities purchased under agreements to sell

0 

0

0.00%

19,896 

67

1.37%

Other interest-earning assets

3,247 

10

1.24%

3,615 

9

1.01%

Total earning assets

$

453,692 

$

5,175

4.59%

$

476,478 

$

5,710

4.86%

Cash and due from banks

$

11,978 

 

 

$

7,646 

 

 

Other assets

24,035 

 

 

26,698 

 

 

Allowance for loan losses

(10,026)

 

 

(9,463)

 

 

Total assets

$

479,679 

 

 

$

501,359 

 

 

LIABILITIES AND STOCKHOLDERS' EQUITY

 

 

 

 

 

 

Interest-bearing liabilities

 

 

 

 

 

 

  Interest-bearing demand

$

39,071 

$

42

0.43%

$

40,482 

$

51

0.51%

  Savings deposits

122,440 

221

0.73%

113,632 

219

0.78%

  Time deposits

147,763 

632

1.72%

182,331 

1,016

2.26%

Short-term borrowings

15,430 

35

0.91%

10,209 

25

0.99%

Long-term borrowings

38,412 

382

4.00%

42,561 

405

3.86%

Subordinated debentures

10,310 

51

1.99%

10,310 

45

1.77%

Total interest-bearing liabilities

$

373,426 

$

1,363

1.47%

$

399,525 

$

1,761

1.79%

Noninterest-bearing demand deposits

63,848 

 

 

55,531 

 

 

Other liabilities

2,960 

 

 

3,284 

 

 

Stockholders' equity

39,445 

 

 

43,019 

 

 

Total liabilities and stockholders' equity

$

479,679 

 

 

$

501,359 

 

 

 

 

 

 

 

 

 

Net interest income and rate spread

 

$

3,812

3.12%

 

$

3,949

3.07%

Net interest margin 

 

 

3.38%

 

 

3.36%

(1)  Non-accrual loans are included in the daily average loan balances outstanding.

 

 

 

 

(2)  The yield on tax-exempt loans and tax-exempt investment securities is computed on a tax-equivalent basis using a federal 

        tax rate of 34% and adjusted for the disallowance of interest expense.

(3)   Interest income includes loan fees of $72 in 2012 and $78 in 2011.

 

 

 

 

 

Taxable-equivalent net interest income for the three months ended March 31, 2012, was $3,812, down from $3,949 in the related 2011 period. The decrease in taxable-equivalent net interest income was primarily attributable to unfavorable rate variances (as the impact of changes in the interest rate environment and product pricing reduced taxable-equivalent net interest income by $164) offset by a favorable volume variances (as changes in the balances and mix of earning assets and interest-bearing liabilities increased taxable-equivalent net interest income by $27).

The taxable-equivalent net interest margin for the first three months of 2012 was 3.38%, an increase from 3.36% in the related 2011 period.  Yields on earning assets have compressed year over year as elevated levels of liquidity have been reinvested in lower-yielding investment securities and interest-bearing deposits at other financial institutions as quality loan demand has been weak and levels of nonaccrual loans remain above historical averages.  

27

The decline in yields was more than offset by the decline in the cost of interest-bearing deposits due to the reduction in interest rates.  

For 2012, the yield on earning assets of 4.59% was 27 basis points (“bps”) lower than the comparable period last year.  Loan yields decreased 32 bps, to 5.46%, impacted by levels of nonaccrual loans, lower loan yields given the repricing of adjustable rate loans, soft loan demand, and competitive pricing pressures to retain and/or obtain creditworthy borrowers.  The yield on other earning assets decreased 28 bps to 2.29%, impacted by the Company’s excess liquidity position invested in lower-yielding assets resulting from soft loan demand.

The cost of interest-bearing liabilities of 1.47% for the first three months of 2012 was 32 bps lower than the related 2011 period.  The average cost of interest-bearing deposits was 1.16%, down 39 basis points, while the cost of wholesale funding (comprised of short-term borrowings and long-term borrowings) decreased 19 bps to 3.11% for the three months ended March 31, 2012.  The Company’s outstanding $10,310 of subordinated debentures has a floating rate equal to the three-month LIBOR plus 1.43%, adjusted quarterly.  The interest rate at March 31, 2012 was 1.90%.  

Average earning assets of $453,692 for the first three months of 2012 was $22,786 lower than the comparable period last year.   Average investment securities increased $5,668 to $107,323, reflecting the Company’s excess liquidity position invested in lower-yielding assets rather than loans.  Average loans decreased $10,291 to $329,446 as a result of soft loan demand, pay-offs, charge-offs and the Bank’s focus on asset quality rather than loan growth at this time.   Overnight liquidity (comprised of interest-bearing deposits in other financial institutions, federal funds sold, and securities purchased under agreements to sell) decreased $17,795 to $13,676, due to the decrease in total average interest-bearing liabilities without a corresponding liquidation of investment securities.  Taxable-equivalent interest income in 2012 decreased $535 to $5,175 of which $179 was due to unfavorable volume changes and $356 was due to unfavorable rate changes.

Average interest-bearing liabilities of $373,426 for the first three months of 2012 were down $26,099 compared to the related 2011 period. Average interest-bearing deposits decreased $27,171 while noninterest-bearing deposits increased $8,317.  For the first three months of 2012, interest expense decreased $398 of which $192 was due to favorable rate changes and $206 was due to favorable volume changes.

Table 2:  Volume/Rate Variance – Taxable-Equivalent Basis

Comparison of three months ended March 31, 2012 versus 2011

 

 

 

Volume

Due to 

Rate (1)

Net

 

($ in thousands)

  Loans (2)

($148)

($226)

($374)

  Taxable investments

39 

(128)

(89)

  Tax-exempt investments (2)

2 

(9)

(7)

  Interest-bearing deposits in other financial institutions

0 

4 

4 

  Federal funds sold 

(3)

0 

(3)

  Securities purchased under agreements to sell

(68)

1 

(67)

  Other interest-earning assets

(1)

2 

1 

Total earning assets

(179)

(356)

(535)

  Interest-bearing demand

(2)

(7)

(9)

  Savings deposits

17 

(15)

2 

  Time deposits

(194)

(190)

(384)

  Short-term borrowings

13 

(3)

10 

  Long-term borrowings

(40)

17 

(23)

  Subordinated debenture

0 

6 

6 

Total interest-bearing liabilities

(206)

(192)

(398)

Net interest income

$

27 

($164)

($137)

(1)  The change in interest due to both rate and volume has been allocated to rate.

 

(2)  The yield on tax-exempt loans and tax-exempt investment securities is computed on a tax-equivalent

        basis using a federal tax rate of 34% and adjusted for the disallowance of interest expense.

28

**Provision for Loan Losses**

The provision for loan losses for the first three months of 2012 was $750, compared to $1,050 for the same period in2011.  The decrease in provision was due primarily to improving economic factors, decreased delinquencies and decreased levels of nonaccrual loans.  Net charge-offs were $498 for the first three months of 2012, compared to $814 for the same period of 2011.  At March 31, 2012, the ALLL was $10,068, an increase of $252 from December 31, 2011.  The ratio of the ALLL to total loans was 3.09% and 2.98% at March 31, 2012 and December 31, 2011, respectively. Nonperforming loans at March 31, 2012, were $9,817, compared to $11,215 at December 31, 2011, representing 3.01% and 3.40% of total loans, respectively.

The provision for loan losses is predominantly a function of the Company’s methodology and judgment as to qualitative and quantitative factors used to determine the adequacy of the ALLL.  The adequacy of the ALLL is affected by changes in the size and character of the loan portfolio, changes in levels of impaired and other nonperforming loans, historical losses and delinquencies on each portfolio category, the risk inherent in specific loans, concentrations of loans to specific borrowers or industries, existing and future economic conditions, the fair value of underlying collateral, and other factors which could affect potential credit losses.  We believe the provision and level of our ALLL conforms to our policies and was adequate to cover anticipated and unexpected loan losses inherent in our loan portfolio as of March 31, 2012.  However, we may need to increase our provisions for loan losses in the future should the quality of the loan portfolio decline or other factors used to determine the ALLL worsen.  Please refer to the discussion under “Allowance for Loan Losses” also included under Item 2.  “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” for further information.

**Noninterest Income**

Table 3:  Noninterest Income

 

Three months ended

 

March 31,

March 31,

 

 

 

2012 

2011 

$ Change

% Change

 

 

($ in thousands)

 

Service fees 

$

189

$

253 

($64)

(25%) 

Trust service fees

271

266 

5 

2%

Investment product commissions

38

44 

(6)

(14%) 

Mortgage banking 

176

149 

27 

18%

Loss on sale of investments

0

(55)

55 

(100%) 

Other 

311

765 

(454)

(59%) 

Total noninterest income

$

985

$

1,422 

($437)

(31%) 

Noninterest income for the first three months of 2012 was $985, down $437, or 31%, from the same period in 2011.

Excluding a legal settlement of $500, which is included in “Other” for the three months ended March 31, 2011 and a $55 loss on the sale of investments during that period, noninterest income totaled $977 for the three months ended March 31, 2011 and therefore increased by $8 year-over-year.

Service fees on deposit accounts for the first three months of 2012 were $189, down $64, or 25%, from the comparable period last year.  The decline in service fees was primarily due to a general decrease in the amount of NSF/overdraft fees resulting from regulatory changes under the Dodd-Frank Wall Street Reform and Consumer Protection Act.  Core fee based revenues are expected to remain depressed going forward due to these regulatory changes as well.  

The Wealth Management Services Group generates trust service fees and investment product commissions. Wealth Management income was $309 for the first three months of 2012, relatively unchanged from the same period in 2011, primarily due to the level of assets under management, on which trust service fees are based, remaining relatively flat and investment product sales decreasing slightly.

Mortgage banking income represents income received from the sale of residential real estate loans into the secondary market.  Mortgage banking income for the first three months of 2012 was $176, compared to $149 for same period in 2011.  This increase between the three months ended March 31, 2012 and 2011was primarily attributable to higher volume of loans sold to the secondary market.  Secondary mortgage production was $12,361for the three months ended March 31, 2012, compared to $11,826 for the same period in 2011.  

 

29

The Company recognized a $55 loss on the sale of investments in the first quarter 2011.  The security sales were executed in an effort to increase the credit quality of the Company’s investment portfolio.  No such gains were recognized in 2012.  

In the first quarter of 2011 the Company received a $500 legal settlement, the details of which are subject to a confidentiality agreement.  Excluding this legal settlement, other operating income increased $46, or 17%, to $311 for the first three months of 2012 compared to $265 in the same period in 2011, primarily due to $43 of loan fees recovered from charged-off loans.

**Noninterest Expense**

Table 4:  Noninterest Expense

 

Three months ended

 

March 31,

March 31,

 

 

 

2012 

2011 

$ Change

% Change

 

 ($ in thousands) 

Salaries and employee benefits

$

1,998

$

2,131

(133)

(6%) 

Occupancy 

434

484

(50)

(10%) 

Data processing 

154

173

(19)

(11%) 

Foreclosure/OREO expense

237

42

195 

464%

Legal and professional fees

189

167

22 

13%

FDIC expense

257

314

(57)

(18%) 

Other 

695

808

(113)

(14%) 

Total noninterest expense

$

3,964

$

4,119

(155)

(4%) 

Total noninterest expense was $3,964 for the first three months of 2012, a decrease of $155, or 4%, compared to the first three months of 2011, primarily due to decreased salaries and employee benefits, occupancy expenses, data processing costs, FDIC expense and marketing expenses, offset by a $195 increase in foreclosure/OREO expense and $22 increase in legal and professional fees.

Salaries and employee benefits of $1,998 for the first three months of 2012 decreased $133, or 6%, from the same period in 2011, primarily due to the decrease in the number of executive management positions at the Company.  Occupancy expense decreased $50, or 10%, in the first three months of 2012, due to the decreased costs of building maintenance, utility costs, and automobile expense in part due to the February 1, 2011 closing of the Bank’s branch located in Lake Tomahawk, Wisconsin.  Data processing costs decreased $19, or 11%, due to decreased maintenance costs.  

Foreclosure/OREO expense consist of OREO carrying costs (maintenance, utilities, real estate taxes), valuation adjustments against the OREO carrying value, and gains or losses from the sale of OREO.  Foreclosure/OREO expense increased $195 between the comparable three-month periods.  Foreclosure/OREO expense for the first three months of 2012 included $80 of valuation adjustments against the carrying costs of various foreclosed properties based on appraisals obtained during the quarter, compared to $6 in such valuation adjustments in the same period in 2011.  Net losses on the sale of foreclosed properties were $73 for the three months ended March 31, 2012 compared to net gains on the sale of foreclosed properties of $51 for the three months ended March 31, 2011. 

Legal and professional fees of $189 increased $22, or 13%, primarily due to higher legal costs associated with regulatory compliance in 2012.  The decrease in FDIC expense of $57 was primarily due to the decrease in the Bank’s average assets which is the basis of the FDIC assessment calculation. Other operating expenses decreased $113 compared to the first three months of 2011, primarily due to a $61 decrease in marketing costs, which had been elevated in the 2011 period due to the introduction of a new deposit program at that time.  

**Income Taxes**

The basic principles for accounting for income taxes require that deferred income taxes be analyzed to determine if a valuation allowance is required.  A valuation allowance is required if it is more likely than not that some portion of the deferred tax asset will not be realized.  Primarily due to net operating loss carryovers in 2011and 2012, the Bank’s net deferred tax asset (prior to any valuation allowance) increased to $4,311 as of March 31, 2012.  In determining whether any impairment of this asset should be recognized, the Company considers all available 

 

30

evidence, both positive and negative.  Based on consideration of the available evidence including historical losses, which must be treated as substantial negative evidence, and the potential of future taxable income, a $3,081 valuation allowance was determined to be necessary at December 31, 2011 to adjust deferred tax assets to the amount of net operating losses that are expected to be realized.  At March 31, 2012 it was determined that no additional valuation allowance was necessary at this time.  If realized, the tax benefit for this item will reduce current tax expense for that period.  

**FINANCIAL CONDITION**

**Investment Securities Portfolio**

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

At March 31, 2012, the total carrying value of investment securities was $107,658, a decrease of $2,718, or 2%, compared to December 31, 2011, and represented 22% and 23% of total assets at March 31, 2012 and December 31, 2011, respectively.  Primarily due to continued soft loan demand, the Company’s excess liquidity was invested in securities.  As loan demand is anticipated to increase in the future, we anticipate that future investment securities pay downs will be used to fund loans.

Beginning in 2010, the Company determined that OTTI existed in one non-agency mortgage-backed security and two corporate securities held.  The unrealized losses on these securities appeared to be related, in part, to expected credit losses that would not be recovered by the Company.  During 2010, the Company recognized OTTI write-downs of $412 on the two corporate securities.  In the first three months of 2011, the company sold these three OTTI securities, which resulted in net investment security losses of $55, and improved the credit quality within the investment portfolio.  As of March 31, 2012 the Company has determined that there are no securities that would be classified as OTTI in the investment portfolio.

 

31

Table 5:  Investments

 

 

As of

 

As of

 

Investment Category

Rating

March 31, 2012

December 31, 2011

 

 

Amount

%

Amount

%

 

($ in thousands)

U.S. Treasury & Government Agencies Debt

 

 

 

 

 

 

AAA

$

16,275

100%

$

18,808

100%

 

Total

$

16,275

100%

$

18,808

100%

U.S. Treasury & Government Agencies Debt as % of Total Investment Portfolio

 

 

15%

 

17%

Mortgage-Backed Securities

 

 

 

 

 

 

AAA

$

67,869

100%

$

67,588

100%

 

AA3

41

0%

53

0%

 

A+

12

0%

12

0%

 

Total

$

67,922

100%

$

67,653

100%

Mortgage-Backed Securities as % of Total Investment Portfolio

 

 

63%

 

61%

Obligations of State and Political Subdivisions 

 

 

 

 

 

 

AAA

$

494

2%

$

0

0%

 

Aa1

4,145

18%

3,457

15%

 

Aa2

5,326

24%

5,704

25%

 

AA3

3,316

15%

3,363

15%

 

A1

742

3%

990

4%

 

A2

135

1%

0

0%

 

Baa2

335

1%

337

1%

 

NR

7,985

36%

9,081

40%

 

Total

$

22,478

100%

$

22,932

100%

Obligations of State and Political Subdivisions as % of Total Investment Portfolio

 

 

21%

 

21%

Corporate Debt and Equity Securities

 

 

 

 

 

 

NR

$

983

100%

$

983

100%

 

Total

$

983

100%

$

983

100%

Corporate Debt and Equity Securities as % of Total Investment Portfolio

 

 

1%

 

1%

Total Market Value of Securities Available-For-Sale

 

$

107,658

100%

$

110,376

100%

Obligations of States and Political Subdivisions (“municipal securities”):  At March 31, 2012 and December 31, 2011, municipal securities were $22,478 and $22,932, respectively, and represented 21% of total investment securities based on fair value.  The majority of municipal securities held are general obligations or essential service bonds.  Municipal bond insurance company downgrades have resulted in credit downgrades in certain municipal securities; however, it has been determined that due to the large number of small investments in these obligations the Bank’s loss exposure on any particular obligation is minimal.  The municipal portfolio is evaluated periodically for credit risk by a third party.  As of March 31, 2012, the total fair value of municipal securities reflected a net unrealized gain of $1,090.

Mortgage-Backed Securities:  At March 31, 2012 and December 31, 2011, mortgage-related securities (which include predominantly mortgage-backed securities and collateralized mortgage obligations) were $67,922 and $67,653, respectively, and represented 63% and 61%, respectively, of total investment securities based on fair value.  The fair value of mortgage-related securities is subject to inherent risks based upon the future performance of the underlying collateral (mortgage loans) for these securities. Future performance may be impacted byprepayment risk and interest rate changes.  

 

32

Corporate Debt and Equity Securities:  At March 31, 2012 and December 31, 2011, corporate debt securities were $983 and represented 1% of total investment securities based on fair value.  Corporate debt and equity securities include trust preferred debt securities, corporate bonds, and common equity securities.  Corporate debt and equity securities at March 31, 2012 and December 31, 2011, consisted of two trust preferred securities of $800, and other securities of $183.  As of March 31, 2012, the interest payments on the two trust preferred securities were current.

FHLB Stock:  The Company had $1,841 and $2,306 of FHLB stock at March 31, 2012 and December 31, 2011, respectively.  On April 18, 2012 the FHLB announced that the consensual cease and desist order with its regulator was terminated immediately.  The FHLB can now declare quarterly dividends without the consent of its regulator, provided that: (i) the dividend payment must be at or below the average three-month LIBOR for that quarter; and (ii) paying the dividend will not result in the FHLB’s retained earnings to fall below their level at the previous year-end. The FHLB also has the option to seek regulatory approval to pay a higher dividend, if warranted.  The Bank redeemed $465 of its excess FHLB capital stock in February 2012 and has been informed that the FHLB will continue to repurchase excess stock on a quarterly basis.  

**Loans**

The Bank serves a diverse customer base throughout North Central Wisconsin, including the following industries: agriculture (primarily dairy), retail, manufacturing, service, resort properties, timber and businesses supporting the general building industry.  We continue to concentrate our efforts on originating loans in our local markets and assisting our current loan customers.  We are actively utilizing government loan programs such as those provided by the U.S. Small Business Administration, U.S. Department of Agriculture, and USDA Farm Service Agency to help these customers weather current economic conditions and position their businesses for the future. 

Total loans were $326,001 at March 31, 2012, a decrease of $3,862, or 1%, from December 31, 2011.  This decrease was primarily the result of a continued lack of demand in our market areas and the regular pay downs of existing loans, as well as the Bank’s current strategic focus on improving credit quality rather than loan growth at this time.

Table 6:  Loan Composition

 

 

 

 

 

 

As of,

 

 

 

 

 

 

March 31, 2012

 

December 31, 2011

 

September 30, 2011

 

June 30, 2011

 

March 31, 2011

 

 

 

% of

 

% of

 

% of

 

% of

 

% of

 

Amount

Total

Amount

Total

Amount

Total

Amount

Total

Amount

Total

 

($ in thousands)

Commercial business

$

44,927

14%

$

41,347

12%

$

41,756

12%

$

43,987

13%

$

41,263

12%

Commercial real estate

123,792

38%

123,868

37%

128,929

37%

132,780

38%

130,733

39%

Real estate construction

24,828

8%

28,708

9%

28,842

9%

28,824

8%

29,181

9%

Agricultural

43,851

13%

45,351

14%

47,010

14%

46,990

14%

38,610

12%

Real estate residential

84,215

26%

85,614

26%

86,479

26%

85,965

25%

89,399

26%

Installment

4,388

1%

4,975

2%

5,134

2%

5,296

2%

5,650

2%

Total loans 

$

326,001

100%

$

329,863

100%

$

338,150

100%

$

343,842

100%

$

334,836

100%

Owner occupied

$

69,970

57%

$

70,412

57%

$

71,407

55%

$

75,904

57%

$

77,885

60%

Non-owner occupied

53,822

43%

53,456

43%

57,522

45%

56,876

43%

52,848

40%

  Commercial real estate

$

123,792

100%

$

123,868

100%

$

128,929

100%

$

132,780

100%

$

130,733

100%

1-4 family construction

$

1,495

6%

$

1,837

6%

$

1,396

5%

$

863

3%

$

559

2%

All other construction

23,333

94%

26,871

94%

27,446

95%

27,961

97%

28,622

98%

  Real estate construction

$

24,828

100%

$

28,708

100%

$

28,842

100%

$

28,824

100%

$

29,181

100%

Commercial business loans, commercial real estate, real estate construction loans and agricultural loans comprise 73% of our loan portfolio at March 31, 2012.  Such loans are considered to have more inherent risk of default than residential mortgage or installment loans.  The commercial balance per borrower is typically larger than that for residential loans, implying higher potential losses on an individual customer basis.  Commercial loan growth throughout 2011 and 2012 has been negatively impacted by soft loan demand across all markets, the Company’s aggressive approach to recognizing risks associated with specific borrowers and the recognition of charge-offs on nonperforming loans in a timely manner.

33 

Commercial business loans were $44,927 at March 31, 2012, up $3,580, or 9%, since year-end 2011, and comprised 14% of total loans, primarily due to a new loan relationship for multi-family apartment units.  The commercial business loan classification primarily consists of commercial loans to small businesses, multi-family residential income-producing businesses, and loans to municipalities. Loans of this type include a diverse range of industries. The credit risk related to commercial business loans is largely influenced by general economic conditions and the resulting impact on a borrower’s operations, or on the value of underlying collateral, if any. 
The commercial real estate classification primarily includes commercial-based mortgage loans that are secured by nonfarm/nonresidential real estate properties. Commercial real estate loans totaled $123,792 at March 31, 2012, relatively unchanged from $123,868 at December 31, 2011, and comprised 38% and 37% of total loans outstanding at March 31, 2012 and December 31, 2011, respectively.  Future lending in this segment will focus on loans that are secured by commercial income producing properties as opposed to speculative real estate development.  Credit risk is managed by employing sound underwriting guidelines, lending primarily to borrowers in local markets, periodically evaluating the underlying collateral, and formally reviewing the borrower’s financial soundness and overall relationship on an ongoing basis. 

Real estate construction loans declined $3,880, or 14%, to $24,828, representing 8% of the total loan portfolio at March 31, 2012 primarily due to one borrower refinancing its non-performing loan that had been with the Bank at another financial institution and pay downs received from other borrowers.  Loans in this classification provide financing for the acquisition or development of commercial income properties, multi-family residential development, and single-family consumer construction. The Company controls the credit risk on these types of loans by making loans in familiar markets, underwriting the loans to meet the requirements of institutional investors in the secondary market, reviewing the merits of individual projects, controlling loan structure, and monitoring the progress of projects through the analysis of construction advances. 

Agricultural loans totaled $43,851 at March 31, 2012, a decrease of $1,500, or 3%, compared to December 31, 2011, and represented 13% of the loan portfolio.  Loans in this classification include loans secured by farmland and financing for agricultural production.  Credit risk is managed by employing sound underwriting guidelines, periodically evaluating the underlying collateral, and formally reviewing the borrower’s financial soundness and relationship on an ongoing basis. 

Real estate residential loans totaled $84,215 at March 31, 2012, down $1,399, or 2%, from year-end 2011 and comprised 26% of total loans outstanding.  Residential mortgage loans include conventional first lien home mortgages and home equity loans.  Home equity loans consist of home equity lines, and term loans, some of which are first lien positions.  If the declines in market values that have occurred in the residential real estate markets worsen, particularly in our market area, the value of collateral securing our real estate loans could decline further, which could cause an increase in our provision for loan losses.  In light of the uncertainty that exists in the economy and credit markets, there can be no guarantee that we will not experience additional deterioration resulting from a downturn in credit performance by our residential real estate loan customers.   As part of its management of originating residential mortgage loans, nearly all of the Company’s long-term, fixed-rate residential real estate mortgage loans are sold in the secondary market without retaining the servicing rights. At March 31, 2012, $612 of residential mortgages were being held for resale in the secondary market, compared to $2,163 at December 31, 2011. 

Installment loans totaled $4,388 at March 31, 2012, down $587, or 12%, compared to December 31, 2011, and represented 1% of the loan portfolio.  The decline in aggregate installment loan balances is largely a result of the fact that the Company experiences extensive competition from local credit unions offering low rates on installment loans and therefore has directed resources toward more profitable lending segments.  Loans in this classification include short-term and other personal installment loans not secured by real estate. Credit risk is primarily controlled by reviewing the creditworthiness of the borrowers, monitoring payment histories, and taking appropriate collateral and guaranty positions.  

Factors that are important to managing overall credit quality are sound loan underwriting and administration, systematic monitoring of existing loans and commitments, effective loan review on an ongoing basis, early problem loan identification and remedial action to minimize losses, an adequate ALLL, and sound nonaccrual and charge-off policies. An active credit risk management process is used for commercial loans to further ensure that sound and consistent credit decisions are made. The credit management process is regularly reviewed and the process has been modified over the past several years to further strengthen the controls and enhance the direct participation by the Bank’s Board Loan Committee in the credit process.

 

34

The loan portfolio is widely diversified by types of borrowers, industry groups, and market areas. Significant loan concentrations are considered to exist for a financial institution when there are amounts loaned to multiple numbers of borrowers engaged in similar activities that would cause them to be similarly impacted by economic or other conditions. At March 31, 2012, no significant industry concentrations existed in the Company’s portfolio in excess of 30% of total loans.  The Bank has also developed guidelines to manage its exposure to various types of concentration risks.

**Allowance for Loan Losses**

Credit risks within the loan portfolio are inherently different for each loan type. Credit risk is controlled and monitored through the use of lending standards, a thorough review of potential borrowers, and on-going review of loan payment performance. Active asset quality administration, including early problem loan identification and timely resolution of problems, aids in the management of credit risk and minimization of loan losses. 

The ALLL is established through a provision for loan losses charged to expense to appropriately provide for potential credit losses in the exiting loan portfolio.  Loans are charged-off against the ALLL when management believes that the collection of principal is unlikely.  The level of the ALLL represents management’s estimate of an amount of reserves that provides for estimated probable credit losses in the loan portfolio at the balance sheet date. To assess the ALLL, qualitative adjustment factors are applied by the Company which focus on evaluation of qualitative and environmental factors, including but not limited to: (i) evaluation of facts and issues related to specific loans; (ii) management’s ongoing review and grading of the loan portfolio; (iii) consideration of historical loan loss and delinquency experience on each portfolio segment; (iv) trends in past due and nonperforming loans; (v) the risk characteristics of the various loan segments; (vi) changes in the size and character of the loan portfolio; (vii) concentrations of loans to specific borrowers or industries; (viii) existing and forecasted economic conditions; (ix) the fair value of underlying collateral; and (x) other qualitative and quantitative factors which could affect potential credit losses.  Our methodology reflects all current and applicable guidance by regulatory agencies to all financial institutions.

At March 31, 2012, the ALLL was $10,068, compared to $9,816 at December 31, 2011.  The ALLL as a percentage of total loans was 3.09% and 2.98% at March 31, 2012 and December 31, 2011, respectively.  The provision for loan losses for the first three months of 2012 was $750, compared to $1,050 for the first three months of 2011.  Net charge-offs were $498 for the three months ended March 31, 2012, compared to $814 for the comparable period ended March 31, 2011.  The level of the provision for loan losses is correlated to the amount of net charge-offs, as it is the Company’s policy that the loan loss provisions, over time, exceed net charge-offs and provide coverage for potential credit losses in the existing loan portfolio.  Loans charged-off are subject to continuous review, and specific efforts are taken to achieve maximum recovery of principal, accrued interest, and related expenses. 

Management allocates the ALLL by pools of risk within each loan portfolio segment.  The allocation methodology consists of the following components.  First a specific reserve, for the estimated collateral shortfall, is established for all impaired loans.  Impaired loans include all troubled debt-restructurings, loans risk-rated as “substandard” and “doubtful” with balances greater than $100 and loans risk-rated “special mention” with balances greater than $250 determined to be impaired by the Company.  To conservatively provide for unexpected changes within the impaired loans, management adjusted its ALLL methodology in 2011, so that the specific reserve in the ALLL represents the greater of (i) the estimated collateral shortfall calculated in the impairment analysis, or (ii) an amount equal to 50% of the homogenous pool loss rate by loan segment and risk rating.  Second, management allocates ALLL with loss factors by loan segment, primarily based on risk ratings in the larger and more volatile loan segments and the migration of loan balances from the “special mention” risk rating to “substandard” and “doubtful” risk ratings.  During the second quarter of 2011, management refined its process for determining historical loss rates by incorporating default and loss severity rates at a more granular level within each loan segment.  The loss factors applied in the methodology are periodically re-evaluated and adjusted to reflect changes in historical loss levels for the rolling twelve quarters.  Lastly, management allocates ALLL to the remaining loan portfolio using qualitative factors, including but not limited to: (i) delinquency rate of loans 30 days or more past-due; (ii) unemployment rates in the seven counties the Company serves; (iii) consumer disposable income; (iv) loan management; (v) loan segmentation by risk of collectability; and (vi) historical loss history for the rolling 12 quarters, adjusted quarterly.

The ALLL was 103% and 88% of nonperforming loans at March 31, 2012 and December 31, 2011, respectively. Gross charge-offs were $652 for the first three months of 2012 compared to $966 for the first three months of 2011, while recoveries for the corresponding periods were $154 and $152, respectively. As a result, net charge-offs at March 31, 2012 were 0.15% of average loans, compared to 0.24% of average loans at March 31, 2011.  The decrease in net charge-offs of $316 was comprised of a $493 decrease in commercial real estate, real estate construction, agricultural, and real estate residential net charge-offs, offset in part by a $177 increase in commercial 

 

35

business and installment loans.  Issues impacting asset quality included historically depressed economic factors, such as heightened unemployment, depressed commercial and residential real estate markets, volatile energy prices, and depressed consumer confidence. Declining collateral values have significantly contributed to our historicallyelevated levels of nonperforming loans, net charge-offs, and ALLL.  The Company has been focused on implementing enhancements to the credit management process to address and enhance underwriting and risk-based pricing guidelines for commercial real estate and real estate construction lending, as well as on new home equity and residential mortgage loans, to reduce potential exposure within these portfolio segments.  

The largest portion of the ALLL at March 31, 2012 was allocated to commercial real estate loans and was $3,984, representing 39.6% of the ALLL, an increase from 38.0% at year end 2011. The increase in the amount allocated to commercial real estate was attributable to the increase in impaired loans in this category and the $502 increase in the related specific valuation allowance assigned to these loans.  The ALLL allocated to commercial business loans was $834 at March 31, 2012, a decrease of $170 from year end 2011, and represented 8.3% of the ALLL at March 31, 2012, compared to 10.0% at year-end 2011. The decrease in the commercial business allocation was due to a $363 decrease in nonaccrual loans which represented 4% of nonaccrual loans at March 31, 2012, compared to 7% at year-end 2011.  At March 31 2012, the ALLL allocated to real estate construction was $1,073, compared to $1,320 at December 31, 2011, representing 10.7% and 13.0% of the ALLL at March 31, 2012 and December 31, 2011, respectively.  The allocation to real estate construction decreased as the level of nonaccrual loans in the category decreased $1,377, or 55%, from December 31, 2011.  The ALLL allocation to agricultural loans decreased to 10.6% at March 31, 2012 from 12.0% at December 31, 2011.  Agricultural loans as a percent of the total loan portfolio decreased to 13% at March 31, 2012 down from 14% at December 31, 2011.  The ALLL allocation to real estate residential loansincreased to 29.8% at March 31, 2012, compared to 26.0% at December 31, 2011, given the increase in impaired real estate residential loans and the $817 increase in the related specific valuation allowance assigned to these loans.  The ALLL allocation to installment loans remained at 1% at March 31, 2012 and December 31, 2011.  Management performs ongoing intensive analyses of its loan portfolios to allow for early identification of customers experiencing financial difficulties, maintains prudent underwriting standards, understands the economy in its markets, and considers the trend of deterioration in loan quality in establishing the level of the ALLL.

Consolidated net income and stockholders’ equity could be affected if management’s estimate of the ALLL necessary to cover expected losses is subsequently materially different, requiring a change in the level of provision for loan losses to be recorded.  While management uses currently available information to recognize losses on loans, future adjustments to the ALLL may be necessary based on newly received appraisals, updated commercial customer financial statements, rapidly deteriorating customer cash flow, and changes in economic conditions that affect our customers. As an integral part of their examination process, various federal and state regulatory agencies also review the ALLL. Such agencies may require additions to the ALLL or may require that certain loan balances be charged-off or downgraded into criticized loan categories when their credit evaluations differ from those of management based on their judgments about information available to them at the time of their examination.

 

36

Table 7:  Loan Loss Experience

 

For the Three Months Ended

 

March 31, 2012

December 31, 2011

September 30, 2011

June 30, 2011

March 31, 2011

 

($ in thousands)

**Allowance for loan losses:**

 

 

 

 

 

Balance at beginning of period

$

9,816  

$

9,282  

$

9,224  

$

9,707  

$

9,471  

Loans charged-off: 

 

 

 

 

 

Commercial business

165  

73  

62  

35  

3  

Commercial real estate 

280  

149  

479  

955  

422  

Real estate construction

28  

146  

28  

901  

220  

Agricultural

10  

(170) 

112  

108  

153  

  Total commercial

483  

198  

681  

1,999  

798  

Real estate residential

155  

212  

244  

460  

151  

Installment

14  

172  

41  

15  

17  

  Total loans charged-off

652  

582  

966  

2,474  

966  

Recoveries of loans previously charged-off:

 

 

 

 

 

Commercial business

6  

3  

19  

6  

9  

Commercial real estate 

62  

3  

53  

19  

60  

Real estate construction

5  

120  

5  

0  

9  

Agricultural

67  

(17) 

34  

19  

54  

  Total commercial

140  

109  

111  

44  

132  

Real estate residential

9  

60  

6  

35  

0  

Installment

5  

47  

7  

12  

20  

  Total recoveries

154  

216  

124  

91  

152  

Total net charge-offs

498  

366  

842  

2,383  

814  

Provision for loan losses

750  

900  

900  

1,900  

1,050  

Balance at end of period

$

10,068  

$

9,816  

$

9,282  

$

9,224  

$

9,707  

Ratios at end of period:

 

 

 

 

 

Allowance for loan losses to total loans

3.09%

2.98%

2.74%

2.68%

2.90%

Allowance for loan losses to net charge-offs

20.2x

26.8x

11.0x

3.9x

11.9x

Net charge-offs to average loans

0.15%

0.11%

0.25%

0.71%

0.24%

**Net loan charge-offs (recoveries):**

 

 

 

 

 

Commercial business

$

159  

$

70  

$

43  

$

29  

($6) 

Commercial real estate 

218  

146  

426  

936  

362  

Real estate construction

23  

26  

23  

901  

211  

Agricultural

(57) 

(153) 

78  

89  

99  

  Total commercial

343  

89  

570  

1,955  

666  

Real estate residential

146  

152  

238  

425  

151  

Installment

9  

125  

34  

3  

(3) 

  Total net charge-offs (recoveries)

$

498  

$

366  

$

842  

$

2,383  

$

814  

**Commercial Real Estate and Construction**

** net charge-off detail:**

 

 

 

 

 

Owner occupied

$

216  

$

146  

$

411  

$

657  

$

217  

Non-owner occupied

2  

0  

15  

279  

145  

  Commercial real estate

$

218  

$

146  

$

426  

$

936  

$

362  

1-4 family construction

$

0  

$

0  

$

0  

$

0  

$

0  

All other construction

23  

26  

23  

901  

211  

  Real estate construction

$

23  

$

26  

$

23  

$

901  

$

211  

37

The allocation of the ALLL is based on our estimate of loss exposure by category of loans shown in Table 8.

Table 8: Allocation of the ALLL

 

March 31, 2012

% of Loan Type to Total Loans

December 31, 2011

% of Loan Type to Total Loans

September 30, 2011

% of Loan Type to Total Loans

June 30, 2011

% of Loan Type to Total Loans

March 31, 2011

% of Loan Type to Total Loans

**ALLL allocation:**

 

 

 

 

 

 

 

 

 

 

Commercial business

$

834  

14%

$

1,004  

12%

$

935  

12%

$

782  

13%

$

514  

12%

Commercial real estate 

3,984  

38%

3,685  

37%

3,368  

37%

3,801  

38%

4,586  

39%

Real estate construction

1,073  

8%

1,320  

9%

1,309  

9%

1,184  

8%

1,298  

9%

Agricultural

1,069  

13%

1,139  

14%

1,251  

14%

1,234  

14%

1,183  

12%

  Total commercial

6,960  

73%

7,148  

72%

6,863  

72%

7,001  

73%

7,581  

72%

Real estate residential

3,009  

26%

2,530  

26%

2,299  

26%

2,096  

25%

2,011  

26%

Installment

99  

1%

138  

2%

120  

2%

127  

2%

115  

2%

Total allowance for loan losses

$

10,068  

100%

$

9,816  

100%

$

9,282  

100%

$

9,224  

100%

$

9,707  

100%

**ALLL category as a percent of total ALLL:**

 

 

 

 

 

 

 

 

 

 

Commercial business

8.3%

 

10.2%

 

10.1%

 

8.5%

 

5.3%

 

Commercial real estate

39.6%

 

37.6%

 

36.2%

 

41.2%

 

47.2%

 

Real estate construction

10.7%

 

13.4%

 

14.1%

 

12.8%

 

13.4%

 

Agricultural

10.6%

 

11.6%

 

13.5%

 

13.4%

 

12.2%

 

  Total commercial

69.2%

 

72.8%

 

73.9%

 

75.9%

 

78.1%

 

Real estate residential

29.8%

 

25.8%

 

24.8%

 

22.7%

 

20.7%

 

Installment

1.0%

 

1.4%

 

1.3%

 

1.4%

 

1.2%

 

Total allowance for loan losses

100.0%

 

100.0%

 

100.0%

 

100.0%

 

100.0%

 

**Impaired Loans and Nonperforming Assets**

As part of its overall credit risk management process, management has been committed to an aggressive problem loan identification philosophy. This philosophy has been implemented through the ongoing monitoring and review of all pools of risk in the loan portfolio to ensure that problem loans are identified early and the risk of loss is minimized.

Nonperforming loans are considered one indicator of potential future loan losses. Nonperforming loans are defined as nonaccrual loans, including those defined as impaired under current accounting standards, loans 90 days or more past due but still accruing interest, and nonaccrual restructured loans.  Loans are generally placed on nonaccrual status when contractually past due 90 days or more as to interest or principal payments. Additionally, whenever management becomes aware of facts or circumstances that may adversely impact the collectability of principal or interest on loans, it is management’s practice to place such loans on nonaccrual status immediately. Previously accrued and uncollected interest on such loans is reversed, amortization of related loan fees is suspended, and income is recorded only to the extent that interest payments are subsequently received in cash after a determination has been made that the principal balance of the loan is collectible. If collectability of the principal is in doubt, payments received are applied to loan principal. 

Nonaccrual loans were $9,804 at March 31, 2012, compared to $11,194 at year-end 2011.  Total nonaccrual loans decreased $1,390 since year-end 2011, with real estate construction loans down $1,377 and commercial business loans down $363, primarily due to one borrower refinancing a large loan relationship that had been with the Bank at another financial institution.  

Restructured loans involve the granting of some concession to the borrower as a result of their financial distress involving the modification of terms of the loan, such as changes in payment schedule or interest rate, which generally would not otherwise be considered, to increase the likelihood of long-term loan repayment.  Restructured loans can involve loans remaining on nonaccrual, moving to nonaccrual, or continuing accrual status, depending on the individual facts and circumstances of the borrower.  Generally, restructured loans remain on nonaccrual until the customer has attained a sustained period of repayment performance, generally nine months.  At March 31, 2012, the Company had total restructured loans of $15,778 which consisted of $11,369 performing in accordance with the 

 

38

modified terms and $4,409 classified as nonaccrual, compared to total restructured loans of $12,887 which consisted of $7,541 performing in accordance with the modified terms and $5,346 classified as nonaccrual at December 31, 2011.  The $3,257 increase in restructured commercial loans still accruing was primarily due to the restructuring of two commercial real estate loan relationships involving modifications to interest rates and changes from the original repayment terms during the three months ended March 31, 2012.

The level of potential problem loans is another predominant factor in determining the relative level of risk in the loan portfolio and in determining the adequacy of the ALLL. Potential problem loans are generally defined by management to include performing loans rated as substandard by management, but having circumstances present which might adversely affect the ability of the borrower to comply with present repayment terms. The decision of management to include performing loans in potential problem loans does not necessarily mean that the Company expects losses to occur, but that management recognizes a higher degree of risk associated with these loans. Potential problem loans are predominantly commercial loans covering a diverse range of businesses and real estate property types. At March 31, 2012, potential problem loans totaled $18,391 compared to $23,124 at December 31, 2011.  Identifying potential problem loans requires a heightened management review of the pace at which a credit may deteriorate, the duration of asset quality stress, and uncertainty around the magnitude and scope of economic stress that may be felt by the Company’s customers and on underlying real estate values.

 

39

Table 9:  Nonperforming Loans and OREO

 

 

 

As of

 

 

 

March 31, 2012

December 31, 2011

September 30, 2011

June 30, 2011

March 31, 2011

 

 

 

($ in thousands)

 

Nonaccrual loans not considered impaired:

 

 

 

 

  Commercial 

$

1,003  

$

1,937  

$

5,693  

$

3,637  

$

1,590  

  Agricultural

0  

30  

91  

355  

680  

  Real estate residential

531  

1,447  

685  

1,688  

1,127  

  Installment

10  

5  

6  

1  

1  

Total nonaccrual loans not considered impaired

1,544  

3,419  

6,475  

5,681  

3,398  

Nonaccrual loans considered impaired:

 

 

 

 

 

  Commercial 

4,718  

5,392  

5,205  

7,153  

8,040  

  Agricultural

322  

104  

316  

252  

260  

  Real estate residential

3,220  

2,279  

2,611  

1,679  

2,026  

  Installment

0  

0  

0  

0  

0  

Total nonaccrual loans considered impaired

8,260  

7,775  

8,132  

9,084  

10,326  

Accruing loans past due 90 days or more 

13  

21  

0  

59  

25  

Total nonperforming loans

9,817  

11,215  

14,607  

14,824  

13,749  

OREO

4,164  

4,404  

5,108  

4,225  

3,873  

Other repossessed assets

0  

60  

0  

6  

0  

Total nonperforming assets (1)

$

13,981  

$

15,679  

$

19,715  

$

19,055  

$

17,622  

Restructured loans accruing

 

 

 

 

 

  Commercial 

$

9,165  

$

5,908  

$

4,586  

$

2,720  

$

2,727  

  Agricultural

194  

201  

0  

18  

0  

  Real estate residential

1,991  

1,411  

1,415  

1,201  

987  

  Installment

19  

21  

22  

0  

0  

Total restructured loans accruing

$

11,369  

$

7,541  

$

6,023  

$

3,939  

$

3,714  

**RATIOS**

 

 

 

 

 

Nonperforming loans to total loans

3.01%

3.40%

4.32%

4.31%

4.11%

Nonperforming assets to total loans plus OREO

4.23%

4.69%

5.74%

5.47%

5.20%

Nonperforming assets to total assets

2.89%

3.21%

3.99%

3.92%

3.51%

ALLL to nonperforming loans

102.56%

87.53%

63.54%

62.22%

70.60%

ALLL to total loans at end of period

3.09%

2.98%

2.74%

2.68%

2.90%

**Nonperforming loans by type:**

 

 

 

 

 

Commercial business

$

375  

$

734  

$

765  

$

772  

$

74  

Commercial real estate (CRE)

4,208  

134  

6,904  

7,820  

5,810  

Real estate construction

1,142  

4,076  

3,229  

2,198  

3,746  

    Total commercial

5,725  

4,944  

10,898  

10,790  

9,630  

Agricultural

322  

2,519  

407  

607  

948  

Real estate residential

3,751  

3,726  

3,296  

3,367  

3,153  

Installment

19  

26  

6  

60  

18  

     Total nonperforming loans

9,817  

11,215  

14,607  

14,824  

13,749  

Commercial real estate owned

4,011  

4,116  

4,861  

3,904  

3,627  

Real estate residential owned

153  

288  

247  

321  

246  

    Total OREO

4,164  

4,404  

5,108  

4,225  

3,873  

Other repossessed assets

0  

60  

0  

6  

0  

     Total nonperforming assets

$

13,981  

$

15,679  

$

19,715  

$

19,055  

$

17,622  

**CRE and construction nonperforming loan detail:**

 

 

 

 

 

Owner occupied

$

2,607  

$

2,697  

$

2,848  

$

5,019  

$

4,737  

Non-owner occupied

1,601  

1,379  

4,056  

2,801  

1,073  

  Commercial real estate

$

4,208  

$

4,076  

$

6,904  

$

7,820  

$

5,810  

1-4 family construction

$

0  

$

0  

$

0  

$

0  

$

0  

All other construction

1,142  

2,519  

3,229  

2,198  

3,746  

  Real estate construction

$

1,142  

$

2,519  

$

3,229  

$

2,198  

$

3,746  

 

(1) Beginning in 2012, the Company excluded restructured loans accruing interest from its definition of nonperforming loans.  The definiction of nonperforming assets now consists of  nonaccrual loans, loans past due 90 days or more and still accruing interest, other real estate owned and other repossessed assets.  As a result, certain prior period reclassifications and disclosures have been made to conform to the new definition.

 

40

**Deposits**

Deposits represent the Company’s largest source of funds.  The Company competes with other bank and nonbank institutions for deposits, as well as with a growing number of non-deposit investment alternatives available to depositors, such as mutual funds, money market funds, annuities, and other brokerage investment products. Competition for deposits remains high. Challenges to deposit growth include price changes on deposit products given movements in the rate environment, and customer preferences regarding higher-costing deposit products or non-deposit investment alternatives.  A stipulation of the Bank’s Agreement with the Federal Deposit Insurance Corporation (the “FDIC”) and Wisconsin Department of Financial Institutions (the “WDFI”) limits the rates of interest it may set on its deposit products.  As a result, the Bank’s ability to attract deposits based on rate competition is limited to a certain degree and its focus remains on expanding existing customer relationships.

At March 31, 2012 total deposits were $376,888, down $4,732 from year-end 2011, primarily due seasonal fluctuations in noninterest-bearing demand deposits and the Company’s strategy to continue to reduce noncore funding sources.  

Table 10:  Deposit Distribution

 

March 31,

% of

December 31,

% of

 

2012 

Total

2011 

Total

 

($ in thousands)

Noninterest-bearing demand deposits

$

66,140

18%

$

70,790

19%

Interest-bearing demand deposits

40,749

11%

39,160

10%

Savings deposits

125,893

33%

120,513

32%

Time deposits

131,603

35%

136,140

35%

Brokered certificates of deposit

12,503

3%

15,017

4%

Total 

$

376,888

100%

$

381,620

100%

**Contractual Obligations  **

We are party to various contractual obligations requiring the use of funds as part of our normal operations.  The table below outlines the principal amounts and timing of these obligations, excluding amounts due for interest, if applicable.  Most of these obligations are routinely refinanced into a similar replacement obligation.  However, renewal of these obligations is dependent on our ability to offer competitive interest rates, liquidity needs, or availability of collateral for pledging purposes.  

Table 11:  Contractual Obligations 

 

Payments due by period

 

Total

< 1year

1-3 years

3-5 years

> 5 years

 

 

 

($ in thousands)

 

Subordinated debentures

$

10,310

$

0

$

0

$

0

$

10,310

Other long-term borrowings

10,000

0

0

10,000

0

FHLB borrowings

28,061

2,000

21,061

5,000

0

Total long-term borrowing obligations

$

48,371

$

2,000

$

21,061

$

15,000

$

10,310

**Liquidity**

Liquidity management refers to the ability to ensure that cash is available in a timely and cost-effective manner to meet cash flow requirements of depositors and borrowers and to meet other commitments as they fall due, including the ability to pay dividends to shareholders, service debt, invest in subsidiaries, repurchase common stock, and satisfy other operating requirements.

Funds are available from a number of basic banking activity sources, primarily from the core deposit base and from the repayment and maturity of loans and investment securities. Additionally, liquidity is available from the sale of investment securities and brokered deposits.  Volatility or disruptions in the capital markets may impact the Company’s ability to access certain liquidity sources. 

 

41

While dividends and service fees from the Bank and proceeds from the issuance of capital have historically been the primary funding sources for the Company, these sources could be limited or costly (such as by regulation increasing the capital needs of the Bank, or by limited appetite for new sales of Company stock).  No dividends were received in cash from the Bank since 2006.  Also, as discussed in the “Capital” section, the Company’s written agreement with the Federal Reserve Bank of Minneapolis (the “Federal Reserve Bank”) and the Bank’s written agreement with the FDIC and WDFI places restrictions on the payment of dividends from the Bank to the Company without prior approval from our regulators.  The Company’s written agreement with the Federal Reserve Bank also requires that the written consent of the Federal Reserve Bank to pay dividends to its stockholders.  We are also prohibited from paying dividends on our common stock if we fail to make distributions or required payments on the Company’s junior subordinated debentures or on the TARP Preferred Stock (as defined under “capital” below). In consultation with the Federal Reserve, on May 12, 2011, the Company exercised its rights to suspend dividends on the outstanding TARP Preferred Stock and has also elected to defer interest on the junior subordinated debentures.  

Investment securities are an important tool to the Company’s liquidity objective.  All investment securities are classified as available-for-sale and are reported at fair value on the consolidated balance sheet.  Approximately $70,481 of the $107,658 investment securities portfolio on hand at March 31, 2012, were pledged to secure public deposits, short-term borrowings, and for other purposes as required by law.  The majority of the remaining securities could be sold to enhance liquidity, if necessary.  

The scheduled maturity of loans could also provide a source of additional liquidity.  Factors affecting liquidity relative to loans are loan renewals, origination volumes, prepayment rates, and maturity of the existing loan portfolio.  The Bank’s liquidity position is influenced by changes in interest rates, economic conditions, and competition.  Conversely, loan demand may cause us to acquire other sources of funding which could be more costly than deposits. 

Deposits are another source of liquidity for the Bank.  Deposit liquidity is affected by core deposit growth levels, certificates of deposit maturity structure, and retention and diversification of wholesale funding sources.  Deposit outflows would require the Bank to access alternative funding sources which may not be as liquid and may be more costly than deposits. 

Other funding sources for the Bank are in the form of short-term borrowings (corporate repurchase agreements, and federal funds purchased) and long-term borrowings.  Short-term borrowings can be reissued and do not represent an immediate need for cash.  Long-term borrowings are used for asset/liability matching purposes and to access more favorable interest rates than deposits.  The Bank's liquidity resources were sufficient as of March 31, 2012 to fund our loans and to meet other cash needs when necessary. 

**Capital**

The Company regularly reviews the adequacy of its capital to ensure that sufficient capital is available for current and future needs and is in compliance with regulatory guidelines. Management actively reviews capital strategies for the Company and the Bank in light of perceived business risks associated with current and prospective earning levels, liquidity, asset quality, economic conditions in the markets served, and the level of dividends available to shareholders.  

Management believes that the Company and Bank had strong capital bases at March 31, 2012.  As of March 31, 2012 and December 31, 2011, the Tier One Risk-Based Capital ratio, Total Risk-Based Capital (Tier 1 and Tier 2) ratio, and Tier One Leverage ratio for the Company and Bank were in excess of regulatory minimum requirements, as well as the heightened requirements as set forth in the Bank’s Agreement with the FDIC and WDFI.

On November 9, 2010, the Bank entered into a formal written agreement with the FDIC and the WDFI.  Under the terms of the agreement, the Bank is required to: (i) maintain ratios of Tier 1 capital to each of total assets and total risk-weighted assets of at least 8.5% and 12%, respectively; (ii) refrain from declaring or paying any dividend without the written consent of the FDIC and WDFI; and (iii) refrain from increasing its total assets by more than 5% during any three-month period without first submitting a growth plan to the FDIC and WDFI.  Additionally, on May 10, 2011, the Company entered into a formal written agreement with the Federal Reserve Bank.  Pursuant to the Company’s agreement, the Company needs the written consent of the Federal Reserve Bank to pay dividends to our stockholders.  We are also prohibited from paying dividends on our common stock if we fail to make distributions or required payments on our  junior subordinated debentures or on our TARP Preferred Stock.  

 

42

On October 14, 2008, the U.S. Department of the Treasury (“Treasury”) announced details of the Capital Purchase Plan (“CPP”) whereby the Treasury made direct equity investments into qualifying financial institutions in the form of preferred stock, providing an immediate influx of Tier 1 capital into the banking system.   Participants also adopted the Treasury’s standards for executive compensation and corporate governance for the period during which the Treasury holds equity issued under this program. 

On February 20, 2009, under the CPP, the Company issued 10,000 shares of Series A Preferred Stock and a warrant to purchase 500 shares of Series B Preferred Stock (together with the Series A Preferred stock, the “TARP Preferred Stock”), which was immediately exercised, to the Treasury.  Total proceeds received were $10,000.  The proceeds received were allocated between the Series A Preferred Stock and the Series B Preferred Stock based upon their relative fair values, which resulted in the recording of a discount on the Series A Preferred Stock and a premium on the Series B Preferred Stock.  The discount and premium will be amortized over five years.  The allocated carrying value of the Series A Preferred Stock and Series B Preferred Stock on the date of issuance (based on their relative fair values) was $9,442 and $558, respectively.  Cumulative dividends on the Series A Preferred Stock accrue and are payable quarterly at a rate of 5% per annum for five years.  The rate will increase to 9% per annum thereafter if the shares are not redeemed by the Company.  The Series B Preferred Stock dividends accrue and arepayable quarterly at 9%.  All $10,000 of the TARP Preferred Stock qualify as Tier 1 Capital for regulatory purposes at the Company.  

A summary of the Company’s and the Bank’s regulatory capital ratios as of March 31, 2012 and December 31, 2011 are as follows:

Table12:  Capital Ratios 

 

 

 

 

 

To Be Well Capitalized

 

 

 

For Capital Adequacy

 

Under Prompt Corrective

 

Actual

 

Purposes (1)

 

Action Provisions (2)

 

Amount

Ratio

 

Amount

Ratio

 

Amount

Ratio

 

($ in thousands)

**March 31, 2012**

 

 

 

 

 

 

 

 

**Mid-Wisconsin Financial Services, Inc.**

 

 

 

 

 

 

 

 

Tier 1 to average assets

$

46,543

9.8%

 

$

19,074

4.0%

 

 

 

Tier 1 risk-based capital ratio

46,543

14.6%

 

12,761

4.0%

 

 

 

Total risk-based capital ratios

50,606

15.9%

 

25,523

8.0%

 

 

 

**Mid-Wisconsin Bank**

 

 

 

 

 

 

 

 

Tier 1 to average assets

$

41,792

8.8%

 

$

18,938

4.0%

 

$

40,244

8.5%

Tier 1 risk-based capital ratio

41,792

13.2%

 

12,637

4.0%

 

18,956

6.0%

Total risk-based capital ratios

45,817

14.5%

 

25,275

8.0%

 

37,912

12.0%

 

 

 

 

 

 

 

 

 

**December 31, 2011**

 

 

 

 

 

 

 

 

**Mid-Wisconsin Financial Services, Inc.**

 

 

 

 

 

 

 

 

Tier 1 to average assets

$

46,729

9.6%

 

$

19,396

4.0%

 

 

 

Tier 1 risk-based capital ratio

46,729

14.3%

 

13,071

4.0%

 

 

 

Total risk-based capital ratios

50,884

15.6%

 

26,142

8.0%

 

 

 

**Mid-Wisconsin Bank**

 

 

 

 

 

 

 

 

Tier 1 to average assets

$

41,736

8.7%

 

$

19,261

4.0%

 

$

40,929

8.5%

Tier 1 risk-based capital ratio

41,736

12.9%

 

12,946

4.0%

 

19,419

6.0%

Total risk-based capital ratios

45,853

14.2%

 

25,891

8.0%

 

38,837

12.0%

(1) The Bank has agreed with the FDIC and WDFI that, until its formal written agreement with such parties is no longer in effect, 

      it will maintain minimum capital ratios at specified levels higher than those otherwise required by applicable regulations, as follows:  

      Tier 1 capital to total average assets - 8.5% and total capital to risk-weighted assets (total capital) - 12%.

(2) Prompt corrective action provisions are not applicable at the bank holding company level.

The Company’s ability to pay dividends depends in part upon the receipt of dividends from the Bank and these dividends are subject to limitation under banking laws and regulations. Pursuant to the agreement with the FDIC and WDFI, the Bank needs the written consent of the regulators to pay dividends to the Company.  The Bank has not paid dividends to the Company since 2006.  In consultation with the Federal Reserve Bank, on May 12, 2011, the Company exercised its rights to suspend dividends on the outstanding TARP Preferred Stock and has also elected to defer interest on its junior subordinated debentures.  Under the terms of its junior subordinated debentures, the Company is allowed to defer payments of interest for 20 quarterly periods without default or penalty, but such 

 

43

amounts will continue to accrue.  Also during the deferral period, the Company generally may not pay cash dividends on or repurchase its common stock or preferred stock, including the TARP Preferred Stock.  Dividend payments on the TARP Preferred Stock may be deferred without default, but the dividend is cumulative and therefore will continue to accrue and, if the Company fails to pay dividends for an aggregate of six quarters, whether or not consecutive, the holder will have the right to appoint representatives to the Company’s board of directors.  The terms of the TARP Preferred Stock also prevent the Company from paying cash dividends on or repurchasing its common stock while dividends are in arrears.  Therefore, the Company will not be able to pay dividends on its common stock until it has fully paid all accrued and unpaid dividends on its junior subordinated debentures and the TARP Preferred Stock.  On March 31, 2012, the Company had $628 accrued and unpaid dividends on the TARP Preferred Stock and $197 accrued and unpaid interest due on its junior subordinated debentures.

 

44

Table 13: Summary Results of Operations

($ in thousands, except per share data)

 

Three Months Ended,

 

March 31,

December 31,

September 30,

June 30,

March 31, 

 

2012 

2011 

2011 

2011 

2011 

**Results of operations:**

 

 

 

 

 

Interest income

$

5,113  

$

5,507  

$

5,368  

$

5,519  

$

5,645  

Interest expense

1,363  

1,467  

1,594  

1,663  

1,761  

Net interest income

3,750  

4,040  

3,774  

3,856  

3,884  

Provision for loan losses

750  

900  

900  

1,900  

1,050  

Net interest income after provision for loan losses

3,000  

3,140  

2,874  

1,956  

2,834  

Noninterest income

985  

1,018  

915  

932  

1,422  

Noninterest expenses

3,964  

4,747  

4,184  

4,137  

4,119  

Income (loss)  before income taxes

21  

(589) 

(395) 

(1,249) 

137  

Income tax expense (benefit)

0  

2,622  

(209) 

(549) 

(3) 

Net income (loss)

21  

(3,211) 

(186) 

(700) 

140  

Preferred stock dividends, discount, and premium 

(162) 

(162) 

(160) 

(162) 

(160) 

Net income (loss) available to common equity

($141) 

($3,373) 

($346) 

($862) 

($20) 

Earnings (loss) per common share:

 

 

 

 

 

Basic and diluted

($0.09) 

($2.04) 

($0.21) 

($0.52) 

($0.01) 

Cash dividends per common share

$

0.00  

$

0.00  

$

0.00  

$

0.00  

$

0.00  

Weighted average common shares outstanding:

 

 

 

 

 

Basic and diluted

1,657  

1,653  

1,654  

1,653  

1,652  

SELECTED FINANCIAL DATA

 

 

 

 

 

**Period-End Balances:**

 

 

 

 

 

Loans

$

326,001  

$

329,863  

$

338,150  

$

343,842  

$

334,836  

Total assets

483,095  

488,176  

494,085  

487,959  

502,045  

Deposits

376,888  

381,620  

385,973  

379,785  

394,214  

Stockholders' equity

39,290  

39,513  

43,085  

43,070  

42,937  

Book value per common share

$

17.50  

$

17.65  

$

19.84  

$

19.86  

$

19.81  

**Average Balance Sheet**

 

 

 

 

 

Loans 

$

329,446  

$

336,074  

$

342,285  

$

336,330  

$

339,737  

Total assets

479,679  

487,637  

495,270  

491,361  

501,359  

Deposits

373,122  

377,118  

385,037  

382,859  

391,976  

Short-term borrowings

15,430  

14,487  

14,078  

10,298  

10,209  

Long-term borrowings

38,412  

40,061  

40,061  

42,451  

42,561  

Stockholders' equity

39,445  

42,726  

43,010  

43,140  

43,019  

**Financial Ratios:**

 

 

 

 

 

Return on average equity

 (1.44%) 

(31.32%) 

(3.20%) 

(8.01%) 

(0.19%) 

Return on average common equity

(1.94%) 

(10.39%) 

(4.19%) 

(10.53%) 

(0.25%) 

Average equity to average assets

8.22%

8.76%

8.68%

8.78%

8.58%

Common equity to average assets

6.04%

6.00%

6.63%

6.69%

6.53%

Net interest margin (1)

3.38%

3.52%

3.25%

3.37%

3.36%

Total risk-based capital

15.86%

15.57%

15.39%

15.36%

15.69%

Net charge-offs to average loans

0.15%

0.11%

0.25%

0.71%

0.24%

Nonperforming loans to total loans

3.01%

3.40%

4.32%

4.31%

4.11%

Efficiency ratio (1)

83.51%

92.65%

87.98%

85.21%

76.94%

Net interest income to average assets (1)

0.78%

0.83%

0.76%

0.78%

0.77%

Noninterest income to average assets

0.21%

0.21%

0.18%

0.19%

0.28%

Noninterest expenses to average assets

0.83%

0.97%

0.84%

0.84%

0.82%

**Stock Price Information (2)**

 

 

 

 

 

High

$

3.50  

$

5.00  

$

8.00  

$

10.00  

$

8.05  

Low

3.10  

3.50  

4.75  

7.77  

7.80  

Market price at quarter end 

3.10  

3.50  

4.75  

7.77  

8.00  

(1)  Fully taxable-equivalent basis, assuming a Federal tax rate of 34% and adjusted for the disallowance of interest expense.

 

(2)  Bid price

 

 

 

 

 

45

**Legislation Impacting the Financial Services Industry**

On July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Act”), which is perhaps the most significant financial reform since the Great Depression.  While the provisions of the Act receiving the most public attention have generally been those more likely to affect larger institutions, the Act also contains many provisions which will affect smaller institutions such as the Company in substantial and unpredictable ways. Consequently, compliance with the Act’s provisions may curtail the Company’s revenue opportunities, increase its operating costs, and require it to hold higher levels of regulatory capital and/or liquidity or otherwise adversely affect the Company’s business or financial results in the future. However, because many aspects of the Act continue to remain subject to future rulemaking, at this time, it is difficult to precisely anticipate its ultimate overall financial impact on the Company and the Bank.  The Company’s management is staying abreast of continuing developments with respect to the Act and assessing the probable impact of such developments on the Company’s business, financial condition, and result of operations. 

**ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

The Company is a smaller reporting company as defined by Rule 12b-2 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) and is not required to provide the information under this item.

**ITEM 4.  CONTROLS AND PROCEDURES**

As of the end of the period covered by this report, management, under the supervision, and with the participation, of our Principal Executive Officer and our Principal Accounting Officer (our principal financial officer), evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) pursuant to Exchange Act Rule 13a-15.  Based upon, and as of the date of, such evaluation, the Principal Executive Officer and the Principal Accounting Officer concluded that our disclosure controls and procedures were effective with respect to timely communication to them and other members of management responsible for preparing periodic reports and material information required to be disclosed in this report as it relates to us and our subsidiaries.

In designing and evaluating the disclosure controls and procedures, we recognize that any controls and procedures, no matter how well-designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and that management necessarily was required to apply judgment in evaluating the cost-benefit relationship of possible controls and procedures. We believe that the disclosure controls and procedures currently in place provide reasonable assurance of achieving our control objectives.

There were no changes in the internal control over financial reporting during the quarter ended March 31, 2012 that have materially affected, or are reasonably likely to materially affect, internal control over financial reporting.

**PART II - OTHER INFORMATION**

**ITEM 1.   LEGAL PROCEEDINGS**

We may be involved from time to time in various routine legal proceedings incidental to our business. We do not believe there are any threatened or pending legal proceedings against us or our subsidiaries that, if determined adversely, would have a material adverse effect on our results of operations or financial condition.

**ITEM 1A.  RISK FACTORS**

The Company is a smaller reporting company as defined by Rule 12b-2 of the Exchange Act and is not required to provide the information under this item.

**ITEM 2.  UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS**

None

**ITEM 3.  DEFAULTS UPON SENIOR SECURITIES**

None

46

**ITEM 4.  MINE SAFTEY DISCLOSURES**

Not applicable

**ITEM 5.  OTHER INFORMATION**

None

**ITEM 6.  EXHIBITS**

Exhibits required by Item 601 of Regulation S-K.

Exhibit

Number

Description

31.1

Certification of Principal Executive Officer pursuant to Rule 13a-14(a), Rule 15d-14(a)

31.2

Certification of Principal Accounting Officer (principal financial officer) pursuant to Rule 13a-14(a), Rule 15d-14(a)

32.1

Certification of Principal Executive Officer and Principal Accounting Officer (principal financial officer) pursuant to 18 USC Section 1350, as adopted pursuant to Section 906 of Sarbanes-Oxley Act of 2002

101*

Interactive data files pursuant to Rule 405 of Regulation S-T: (i) Consolidated Balance Sheets at March 31, 2012 and December 31, 2011; (ii) Consolidated Statements of Operations for the three months ended March 31, 2012 and March 31, 2011; (iii) Consolidated Statements of Comprehensive Income (Loss) for the three months ended March 31, 2012 and March 31, 2011; (iv) Consolidated Statements of Changes in Stockholders’ Equity for the three months ended March 31, 2012 and March 31, 2011; (iv) Consolidated Statements of Cash Flows for the three months ended March 31, 2012 and March 31, 2011; and (v) Notes to Consolidated Financial Statements, tagged as blocks of text.

* As provided in Rule 406T of Regulation S-T, this information shall not be deemed “filed” for purposes of Sections 11 and 12 of the Securities Act of 1933 and Section 18 of the Securities Exchange Act of 1934, or otherwise subject to liability under those sections. 

**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.

MID-WISCONSIN FINANCIAL SERVICES, INC.

Date:  May 15, 2012

/s/ SCOT G. THOMPSON  

Scot G. Thompson

Principal Executive Officer

Date:   May 15, 2012

/s/ RHONDA R. KELLEY

Rhonda R. Kelley

Principal Accounting Officer

47

**EXHIBIT INDEX**

**to**

**FORM 10-Q**

**of**

**MID-WISCONSIN FINANCIAL SERVICES, INC.**

**for the quarterly period ended March 31, 2012**

**Pursuant to Section 102(d) of Regulation S-T**

**(17 C.F.R. §232.102(d))**

The following exhibits are filed as part this report:

31.1

Certification of Principal Executive Officer pursuant to Rule 13a-14(a)/15d-14(a)

31.2

Certification of Principal Accounting Officer (principal financial officer) pursuant to Rule 13a-14(a)/15d-14(a)

32.1

Certification of Principal Executive Officer and Principal Accounting Officer (principal financial officer) pursuant to 18 USC Section 1350, as adopted pursuant to Section 906 of Sarbanes-Oxley Act of 2002

101*

Interactive data files pursuant to Rule 405 of Regulation S-T: (i) Consolidated Balance Sheets at March 31, 2012 and December 31, 2011; (ii) Consolidated Statements of Operations for the three months ended March 31, 2012 and March 31, 2011; (iii) Consolidated Statements of Comprehensive Income (Loss) for the three months ended March 31, 2012 and March 31, 2011; (iv) Consolidated Statements of Changes in Stockholders’ Equity for the three months ended March 31, 2012 and March 31, 2011; (v) Consolidated Statements of Cash Flows for the three months ended March 31, 2012 and March 31, 2011; and (vi) Notes to Consolidated Financial Statements, tagged as blocks of text.

.

* As provided in Rule 406T of Regulation S-T, this information shall not be deemed “filed” for purposes of Sections 11 and 12 of the Securities Act of 1933 and Section 18 of the Securities Exchange Act of 1934, or otherwise subject to liability under those sections. 

48

 **