##### Table of Contents



SECURITIES AND EXCHANGE COMMISSION  FORM 10-Q [X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934  or [  ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 
 Commission file Number 0-21292 MERCHANTS AND MANUFACTURERS BANCORPORATION, INC. 
  Wisconsin
    
    39-1413328(State or other jurisdiction of
    
    (I.R.S. Employer Identification Number)incorporation or organization)
 19105 West Capitol Drive, Suite 200
Brookfield, Wisconsin 53045 
  (262) 790-2120 
  Indicate by check mark whether the Registrant (1) has filed all reports
required by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [  ]. Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2) Yes [X] No [  ]. As of November 1, 2004, 3,670,145 shares of Common Stock were outstanding.




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MERCHANTS AND MANUFACTURERS BANCORPORATION, INC. FORM 10-Q INDEX Page NumberPart I. Financial InformationItem 1. Financial StatementsUnaudited Consolidated Statements of Financial Condition as of September 30, 2004, December 31, 2003, and September 30, 2003
    
    
    3Unaudited Consolidated Statements of Income for the Three Months and Nine Months ended September 30, 2004 and 2003
    
    
    4Unaudited Consolidated Statements of Cash Flows for the Nine Months ended September 30, 2004 and 2003
    
    
    5Notes to Unaudited Consolidated Financial Statements
    
    
    6Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    13Item 3. Quantitative and Qualitative Disclosure About Market Risk
    
    
    27Item 4. Controls and Procedures
    
    
    28Part II. Other InformationItems 1-6
    
    
    29Signatures
    
    
    30Employment Agreement with Jeffrey A. MuellerConsulting Agreement with Harold J. Mueller302 Certification of Principal Executive Officer302 Certification of Chief Financial Officer906 Certification of Principal Executive Officer906 Certification of Chief Financial Officer
 2




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##### Table of Contents



Part I. Financial Information Merchants and Manufacturers Bancorporation, Inc. 
 Unaudited Consolidated Statements of Financial Condition
 September 30,
    
    December 31,
    
    September 30,2004
    
    2003
    
    2003(Amounts In Thousands, ExceptShare and Per Share Amounts)ASSETSCash and due from banks
    
    $
    31,400
    
    
    $
    29,376
    
    
    $
    22,947Interest bearing deposits in banks
    
    
    1,364
    
    
    
    2,647
    
    
    
    4,449Federal funds sold
    
    
    4,288
    
    
    
    15,632
    
    
    
    8,222Cash and cash equivalents
    
    
    37,052
    
    
    
    47,655
    
    
    
    35,618Available-for-sale securities
    
    
    176,225
    
    
    
    156,597
    
    
    
    122,214Loans, less allowance for loan losses of $10,725 at
September 30, 2004, $9,136 at December 31, 2003
and $7,927 at September 30, 2003
    
    
    996,774
    
    
    
    847,938
    
    
    
    727,548Accrued interest receivable
    
    
    5,706
    
    
    
    4,421
    
    
    
    4,408FHLB stock
    
    
    19,443
    
    
    
    16,245
    
    
    
    15,488Premises and equipment
    
    
    30,099
    
    
    
    20,591
    
    
    
    15,535Goodwill and intangible assets
    
    
    35,881
    
    
    
    30,502
    
    
    
    11,778Other assets
    
    
    22,280
    
    
    
    21,658
    
    
    
    17,413Total assets
    
    $
    1,323,460
    
    
    $
    1,145,607
    
    
    $
    950,002LIABILITIES AND STOCKHOLDERS EQUITYLiabilities:Deposits:Non-interest bearing
    
    $
    127,292
    
    
    $
    109,755
    
    
    $
    95,055Interest bearing
    
    
    871,329
    
    
    
    802,193
    
    
    
    665,064Total deposits
    
    
    998,621
    
    
    
    911,948
    
    
    
    760,119Short-term borrowings
    
    
    56,554
    
    
    
    34,007
    
    
    
    21,021Long-term borrowings
    
    
    112,467
    
    
    
    72,346
    
    
    
    63,064Subordinated debentures
    
    
    46,394
    
    
    
    36,084
    
    
    
    20,620Accrued interest payable
    
    
    1,847
    
    
    
    1,417
    
    
    
    1,140Other liabilities
    
    
    14,077
    
    
    
    9,831
    
    
    
    10,900Total liabilities
    
    
    1,229,960
    
    
    
    1,065,633
    
    
    
    876,864Stockholders equityPreferred stock, $1.00 par value; 250,000 shares authorized,
Shares issued and shares outstanding  none
    
    
    
    
    
    
    
    
    
    
    Common stock $1.00 par value; 25,000,000 shares authorized
at September 30, 2004, 6,000,000 shares authorized at December 31,
2003 and September 30, 2003; Shares issued: 3,770,250 at
September 30, 2004 , 3,436,036 at December 31, 2003, 3,274,954
at September 30, 2003; shares outstanding: 3,670,145 at
September 30, 2004, 3,326,089 at December 31, 2003 and
3,163,193 at September 30, 2003
    
    
    3,770
    
    
    
    3,436
    
    
    
    2,977Additional paid-in capital
    
    
    53,470
    
    
    
    43,691
    
    
    
    26,302Retained earnings
    
    
    37,959
    
    
    
    35,007
    
    
    
    46,000Accumulated other comprehensive income
    
    
    852
    
    
    
    663
    
    
    
    736Treasury stock, at cost (100,106 shares at September 30, 2004,
109,947 shares at December 31, 2003 and 111,761 shares
at September 30, 2003)
    
    
    (2,551
    )
    
    
    (2,823
    )
    
    
    (2,877
    )Total stockholders equity
    
    
    93,500
    
    
    
    79,974
    
    
    
    73,138Total liabilities and stockholders equity
    
    $
    1,323,460
    
    
    $
    1,145,607
    
    
    $
    950,002
 See Notes to Unaudited Consolidated Financial Statements. 3




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Merchants and Manufacturers Bancorporation, Inc. 
 Unaudited Consolidated Statements of Income
 Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003(In Thousands, except per share data)Interest income:Interest and fees on loans
    
    $
    14,079
    
    
    $
    11,228
    
    
    $
    39,835
    
    
    $
    33,258Interest and dividends on securities:Taxable
    
    
    311
    
    
    
    465
    
    
    
    1,215
    
    
    
    1,549Tax-exempt
    
    
    545
    
    
    
    334
    
    
    
    1,316
    
    
    
    1,012Interest on mortgage-backed securities
    
    
    867
    
    
    
    406
    
    
    
    2,282
    
    
    
    1,471Interest on interest bearing deposits in
banks and federal funds sold
    
    
    75
    
    
    
    30
    
    
    
    173
    
    
    
    149Total interest income
    
    
    15,877
    
    
    
    12,463
    
    
    
    44,821
    
    
    
    37,439Interest expense:Interest on deposits
    
    
    3,176
    
    
    
    2,747
    
    
    
    9,292
    
    
    
    8,728Interest on short-term borrowings
    
    
    244
    
    
    
    83
    
    
    
    540
    
    
    
    404Interest on long-term borrowings
    
    
    1,001
    
    
    
    615
    
    
    
    2,522
    
    
    
    1,905Interest on subordinated debentures
    
    
    582
    
    
    
    325
    
    
    
    1,694
    
    
    
    632Total interest expense
    
    
    5,003
    
    
    
    3,770
    
    
    
    14,048
    
    
    
    11,669Net interest income
    
    
    10,874
    
    
    
    8,693
    
    
    
    30,773
    
    
    
    25,770Provision for loan losses
    
    
    431
    
    
    
    372
    
    
    
    1,332
    
    
    
    1,014Net interest income after provision for
Loan losses
    
    
    10,443
    
    
    
    8,321
    
    
    
    29,441
    
    
    
    24,756Non-interest income:Service charges on deposit accounts
    
    
    1,003
    
    
    
    661
    
    
    
    2,512
    
    
    
    1,896Service charges on loans
    
    
    742
    
    
    
    771
    
    
    
    1,523
    
    
    
    2,120Securities gains, net
    
    
    7
    
    
    
    0
    
    
    
    190
    
    
    
    1Gain on sale of loans, net
    
    
    70
    
    
    
    568
    
    
    
    364
    
    
    
    1,744Net gain on sale of fixed assets
    
    
    0
    
    
    
    0
    
    
    
    158
    
    
    
    2Other
    
    
    1,387
    
    
    
    1,043
    
    
    
    3,811
    
    
    
    2,613Total noninterest income
    
    
    3,209
    
    
    
    3,043
    
    
    
    8,558
    
    
    
    8,376Noninterest expenses:Salaries and employee benefits
    
    
    6,013
    
    
    
    4,728
    
    
    
    17,640
    
    
    
    13,619Premises and equipment
    
    
    1,663
    
    
    
    1,260
    
    
    
    4,491
    
    
    
    3,725Data processing fees
    
    
    533
    
    
    
    268
    
    
    
    1,294
    
    
    
    857Marketing and business development
    
    
    684
    
    
    
    383
    
    
    
    1,592
    
    
    
    1,151Federal deposit insurance premiums
    
    
    36
    
    
    
    31
    
    
    
    118
    
    
    
    97Other
    
    
    2,113
    
    
    
    1,508
    
    
    
    6,130
    
    
    
    4,333Total noninterest expense
    
    
    11,042
    
    
    
    8,178
    
    
    
    31,265
    
    
    
    23,782Income before income taxes
    
    
    2,610
    
    
    
    3,186
    
    
    
    6,734
    
    
    
    9,350Income taxes
    
    
    676
    
    
    
    1,083
    
    
    
    1,921
    
    
    
    3,200Net income
    
    $
    1,934
    
    
    $
    2,103
    
    
    $
    4,813
    
    
    $
    6,150Basic earnings per share
    
    $
    0.55
    
    
    $
    0.66
    
    
    $
    1.42
    
    
    $
    1.95Diluted earnings per share
    
    $
    0.55
    
    
    $
    0.66
    
    
    $
    1.41
    
    
    $
    1.94Dividends per share
    
    $
    0.18
    
    
    $
    0.17
    
    
    $
    0.54
    
    
    $
    0.52
 See notes to unaudited consolidated financial statements. 4




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Merchants and Manufacturers Bancorporation, Inc. and Subsidiaries 
 Unaudited Consolidated Statements of Cash Flows
 Nine Months Ended September 30,2004
    
    2003(In Thousands)Cash Flows From Operating ActivitiesNet income
    
    $
    4,813
    
    
    $
    6,150Adjustments to reconcile net income to cashProvided by operating activities:Provision for loan losses
    
    
    1,332
    
    
    
    1,014Depreciation
    
    
    1,375
    
    
    
    1,209Amortization and accretion of premiums and discounts, net
    
    
    790
    
    
    
    634Securities gains, net
    
    
    (190
    )
    
    
    (1
    )Gain on sale of loans, net
    
    
    (364
    )
    
    
    (1,744
    )Increase in accrued interest receivable
    
    
    (857
    )
    
    
    (160
    )Increase (decrease) in accrued interest payable
    
    
    158
    
    
    
    (263
    )Other
    
    
    12,204
    
    
    
    (260
    )Net cash provided by operations before loan originations and sales
    
    
    19,261
    
    
    
    6,579Loans originated for sale
    
    
    (49,157
    )
    
    
    (161,182
    )Proceeds from sales of loans
    
    
    47,252
    
    
    
    163,231Net cash provided by operating activities
    
    
    17,356
    
    
    
    8,628Cash Flows From Investing ActivitiesPurchase of available-for-sale securities
    
    
    (84,976
    )
    
    
    (43,621
    )Proceeds from sales of available-for-sale securities
    
    
    10,032
    
    
    
    7,353Proceeds from redemptions and maturities of available-for-sale securities
    
    
    66,361
    
    
    
    42,385Net increase in loans
    
    
    (76,866
    )
    
    
    (71,405
    )Purchase of premises and equipment
    
    
    (8,999
    )
    
    
    (1,338
    )Purchase of Federal Home Loan Bank stock
    
    
    (3,198
    )
    
    
    (848
    )Cash received in acquisition
    
    
    4,837
    
    
    
    0Net cash used in investing activities
    
    
    (97,646
    )
    
    
    (67,474
    )Cash Flows From Financing ActivitiesNet increase in deposits
    
    
    7,134
    
    
    
    30,663Net increase in short-term borrowings
    
    
    20,737
    
    
    
    2,933Dividends paid
    
    
    (1,861
    )
    
    
    (1,639
    )Proceeds from long-term borrowings
    
    
    54,941
    
    
    
    15,000Repayment of long-term borrowings
    
    
    (21,770
    )
    
    
    (24,258
    )Issuance of subordinated debentures
    
    
    10,310
    
    
    
    10,000Purchase of Treasury Stock
    
    
    0
    
    
    
    (1
    )Proceeds from sale of treasury stock
    
    
    196
    
    
    
    11Net cash provided by financing activities
    
    
    69,687
    
    
    
    32,709Decrease in cash and cash equivalents
    
    
    (10,603
    )
    
    
    (26,137
    )Cash and cash equivalents at beginning of period
    
    
    47,655
    
    
    
    61,755Cash and cash equivalents at end of period
    
    $
    37,052
    
    
    $
    35,618Supplemental Cash Flow Information and Noncash Transactions:Interest paid
    
    $
    13,618
    
    
    $
    11,933Income taxes paid
    
    
    3,353
    
    
    
    3,503Loans transferred to other real estate owned
    
    
    554
    
    
    
    313Supplemental Schedules of Noncash Investing Activities,
change in accumulated other comprehensive income, unrealized
gains on available-for-sale securities, net
    
    $
    189
    
    
    ($
    712
    )
 See notes to unaudited consolidated financial statements 5




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Merchants and Manufacturers Bancorporation, Inc.
 
 
 NOTE A  Basis of Presentation The accompanying unaudited consolidated financial statements include the
accounts of Merchants and Manufacturers Bancorporation, Inc. and its wholly
owned subsidiaries: Lincoln State Bank, Franklin State Bank, Grafton State
Bank, Community Bank Financial, The Reedsburg Bank, Fortress Bank of Westby,
Fortress Bank of Cresco, Fortress Bank, Minnesota., Wisconsin State Bank
(collectively, the Banks), Merchants Merger Corp., CFG Financial Services,
Inc., Merchants New Merger Corp., CFG Mortgage, Inc. and Lincoln Neighborhood
Redevelopment Corporation. Lincoln State Bank also includes the accounts of
its wholly owned subsidiary, M&M Lincoln Investment Corporation. Grafton State
Bank also includes the accounts of its wholly owned subsidiary, GSB
Investments, Inc. and Community Bank Financial also includes the accounts of
its wholly owned subsidiary, CBOC Investments, Inc. The Reedsburg Bank also
includes the accounts of its wholly owned subsidiary, Reedsburg Investments,
Inc. Fortress Bank of Westby also includes the accounts of its wholly owned
subsidiary, Westby Investment Company, Inc. Wisconsin State Bank also includes
the accounts of its wholly owned subsidiary Random Lake Investments, Inc. CFG
Financial Services, Inc. also includes the accounts of its wholly owned
subsidiaries Community Financial Services, Inc. and Keith C. Winters &
Associates. LTD (KCW). All significant intercompany balances and transactions
have been eliminated. The accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with accounting principles generally accepted in
the United States of America for interim financial information and with the
instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they
do not include all of the information and footnotes required by accounting
principles generally accepted in the United States of America for complete
financial statements. In the opinion of management, all adjustments
(consisting of normal recurring accruals) considered necessary for a fair
presentation have been included. Operating results for the three and nine
month periods ended September 30, 2004 are not necessarily indicative of the
results that may be expected for the year ending December 31, 2004. For
further information, refer to the consolidated financial statements and
footnotes thereto included in our Form 10-K for the year ended December 31,
2003. The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions which affect the reported amounts
of assets and liabilities and disclosure of contingent assets and liabilities
as of date of the financial statements, as well as the reported amounts of
income and expenses during the reported periods. Actual results could differ
from those estimates. 6




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##### Table of Contents



NOTE B  Earnings Per Share Presented below are the calculations for basic and diluted earnings per share: Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003(In Thousands, except per share data)BasicNet income
    
    $
    1,934
    
    
    $
    2,103
    
    
    $
    4,813
    
    
    $
    6,150Weighted average shares outstanding
    
    
    3,518
    
    
    
    3,164
    
    
    
    3,395
    
    
    
    3,161Basic earnings per share
    
    $
    0.55
    
    
    $
    0.66
    
    
    $
    1.42
    
    
    $
    1.95
 (In Thousands, except per share data)Diluted:Net income
    
    $
    1,934
    
    
    $
    2,103
    
    
    $
    4,813
    
    
    $
    6,150Weighted average shares outstanding
    
    
    3,518
    
    
    
    3,164
    
    
    
    3,395
    
    
    
    3,161Effect of dilutive stock options outstanding
    
    
    13
    
    
    
    18
    
    
    
    26
    
    
    
    15Diluted weighted average shares outstanding
    
    
    3,531
    
    
    
    3,182
    
    
    
    3,421
    
    
    
    3,176Diluted earnings per share
    
    $
    0.55
    
    
    $
    0.66
    
    
    $
    1.41
    
    
    $
    1.94
 NOTE C  Comprehensive Income The following table presents our comprehensive income. Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003(In Thousands)Net income
    
    $
    1,934
    
    
    $
    2,103
    
    
    $
    4,813
    
    
    $
    6,150Other comprehensive income
Change in unrealized securities
gains (losses)
    
    
    3,153
    
    
    
    (1,551
    )
    
    
    69
    
    
    
    (1,132
    )Reclassification adjustment for gains
included in net income
    
    
    7
    
    
    
    0
    
    
    
    190
    
    
    
    1Income tax effect
    
    
    (1,097
    )
    
    
    546
    
    
    
    (70
    )
    
    
    419Total comprehensive income
    
    $
    3,997
    
    
    $
    1,098
    
    
    $
    5,002
    
    
    $
    5,438
 7




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NOTE D  Loans Receivable In 2004, the Corporation performed an evaluation of the purpose and collateral
of each loan. This evaluation resulted in a reallocation of loan dollars
between primarily commercial real estate and commercial loans. The following
table shows the composition of our loan portfolio on the dates indicated
(dollars in thousands): September 30,
    
    December 31,
    
    September 30,2004
    
    2003
    
    2003First Mortgage:Conventional single-family residential
    
    $
    140,399
    
    
    $
    113,479
    
    
    $
    88,895Commercial and multifamily residential
    
    
    417,585
    
    
    
    283,433
    
    
    
    230,534Construction
    
    
    68,043
    
    
    
    47,894
    
    
    
    48,792Farmland
    
    
    54,350
    
    
    
    43,676
    
    
    
    26,371680,377
    
    
    
    488,482
    
    
    
    394,592Commercial business loans
    
    
    244,795
    
    
    
    294,645
    
    
    
    278,484Consumer and installment loans
    
    
    48,998
    
    
    
    51,886
    
    
    
    44,297Home equity loans
    
    
    25,066
    
    
    
    14,664
    
    
    
    14,300Other
    
    
    8,263
    
    
    
    7,397
    
    
    
    3,802327,122
    
    
    
    368,592
    
    
    
    340,883Total loans
    
    
    1,007,499
    
    
    
    857,074
    
    
    
    735,475Less allowance for loan losses
    
    
    10,725
    
    
    
    9,136
    
    
    
    7,927Loans, net
    
    $
    996,774
    
    
    $
    847,938
    
    
    $
    727,548
 NOTE E  Stock-Based Compensation Plan At September 30, 2004 we had a stock-based key officer and employee
compensation plan. We account for this plan under the recognitions and
measurement principles of APB Opinion No. 25, Accounting for Stock Issued to
Employees, and related Interpretations. No stock-based employee compensation
cost is reflected in the income, as all options granted under this plan had an
exercise price equal to the market value of the underlying common stock on the
date of grant. The following table illustrates the effect on net income and
earnings per share if we had applied the fair value recognition provisions of
the Financial Accounting Standards Board (FASB) Statement No. 123, Accounting
for Stock-Based Compensation, to stock-based employee compensation. Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003(Amounts In Thousands, Except Per Share Data)Net income, as reported
    
    $
    1,934
    
    
    $
    2,103
    
    
    $
    4,813
    
    
    $
    6,150Deduct total stock-based
employee compensation
expense determined under
fair value based method
for all awards, net of
related tax effects
    
    
    0
    
    
    
    0
    
    
    
    334
    
    
    
    0Pro forma net income
    
    $
    1,934
    
    
    $
    2,103
    
    
    $
    4,479
    
    
    $
    6,150Earnings per share:Basic:As reported
    
    $
    0.55
    
    
    $
    0.66
    
    
    $
    1.42
    
    
    $
    1.95Pro forma
    
    $
    0.55
    
    
    $
    0.66
    
    
    $
    1.32
    
    
    $
    1.95Diluted:As reported
    
    $
    0.55
    
    
    $
    0.66
    
    
    $
    1.41
    
    
    $
    1.94Pro forma
    
    $
    0.55
    
    
    $
    0.66
    
    
    $
    1.31
    
    
    $
    1.94
 In determining compensation cost using the fair value method prescribed in
Statement No. 123, the value of each grant is estimated at the grant date with
the following weighted-average assumptions used for grants at September 30,
2004: dividend yield of 1.60%; expected price volatility of 19.74%; blended
risk-free interest rates of 3.76%; and expected life of 10 years. 8




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NOTE F  Recent Acquisitions On August 12, 2004, we acquired Random Lake Bancorp, Ltd. (Random Lake) and
its wholly-owned subsidiary, Wisconsin State Bank (WSB). The purchase price
for Random Lake was $11.5 million including $1.3 million in cash and 334,200
shares of Merchants common stock valued at $10.2 million based on a $30.50
price. At the date of the acquisition Random Lake had assets of $102.3
million, loans of $72.9 million and deposits of $80.0 million. The
quarter-to-quarter and year-to-year comparisons are impacted by our completion
of the acquisition of Random Lake. The acquisition was accounted for using the
purchase method of accounting, and accordingly, the assets and liabilities of
Random Lake were recorded at their respective fair values on August 12, 2004
and account balances acquired are included in our financial results. On November 1, 2003, we acquired Reedsburg Bancorporation, Inc. (Reedsburg)
and its wholly-owned subsidiary, The Reedsburg Bank. The purchase price for
Reedsburg was $36.0 million including $17.8 million in cash and 146,800 shares
of Merchants common stock valued at $5.4 million based on the average price
over the contractual pricing period. At the date of the acquisition Reedsburg
had assets of $141.8 million, loans of $97.2 million and deposits of $120.6
million. The quarter-to-quarter and year-to-year comparisons are impacted by
our completion of the acquisition of Reedsburg. The acquisition was accounted
for using the purchase method of accounting, and accordingly, the assets and
liabilities of Reedsburg were recorded at their respective fair values on
November 1, 2003 and account balances acquired are included in our financial
results. NOTE G  Recent Accounting Pronouncements FIN No. 46, Consolidation of Variable Interest Entities, an Interpretation of
Accounting Research Bulletin No. 51 (Revised December 2003): FIN 46
establishes accounting guidance for consolidation of variable interest entities
(VIE) that function to support the activities of the primary beneficiary. The
primary beneficiary of a VIE entity is the entity that absorbs a majority of
the VIEs expected losses, receives a majority of the VIEs expected residual
returns, or both, as a result of ownership, controlling interest, contractual
relationship or other business relationship with a VIE. Prior to the
implementation of FIN 46, VIEs were generally consolidated by an enterprise
when the enterprise had a controlling financial interest through ownership of a
majority of voting interest in the entity. The provisions of FIN 46 were
effective immediately for all arrangements entered into after January 31, 2003.
However, subsequent revisions to the interpretation deferred the
implementation date of FIN 46 until the first period ending after March 15,
2004. 9




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##### Table of Contents



The Corporation adopted FIN 46, as revised, in connection with its consolidated
financial statements for the quarter ended March 31, 2004. The Corporation has
previously formed five statutory trusts (the Trusts) to issue an aggregate of
$45,000,000 of trust preferred securities. The implementation of FIN 46
required the Corporation to de-consolidate its investment in the Trusts because
the Corporation is not the primary beneficiary. There was no impact on
stockholders equity or net income upon adoption of the standard. The trust preferred securities issued by the Trusts are currently included in
the Tier 1 capital of the Corporation for regulatory capital purposes.
However, because the financial statements of the Trusts will no longer be
included in the Corporations consolidated financial statements, the Federal
Reserve Board may in the future disallow inclusion of the trust preferred
securities in Tier 1 capital for regulatory capital purposes. In July 2003,
the Federal Reserve Board issued a supervisory letter instructing bank holding
companies to continue to include the trust preferred securities in their Tier 1
capital for regulatory capital purposes until notice is given to the contrary.
The Federal Reserve Board intends to review the regulatory implications of the
change in accounting treatment of subsidiary trusts that issue trust preferred
securities and, if necessary or warranted, provide further appropriate
guidance. There can be no assurance that the Federal Reserve Board will
continue to permit institutions to include trust preferred securities in Tier I
capital for regulatory capital purposes. On May 6, 2004, the Board of Governors of the Federal Reserve System (the
Board) issued a Notice of Proposed Rulemaking in which it proposed to allow
the continued inclusion of trust preferred securities in the tier 1 capital of
bank holding companies, subject to stricter standards. The Board is proposing
to limit the aggregate amount of a bank holding companys cumulative perpetual
preferred stock, trust preferred securities and other minority interests to 25%
of the companys core capital elements, net of goodwill. Current regulations
do not require the deduction of goodwill. The proposal also provides that
amounts of qualifying trust preferred securities and certain minority interests
in excess of the 25% limit may be included in tier 2 capital but would be
limited, together with subordinated debt and limited-life preferred stock, to
50% of tier 1 capital. The proposal provides a three-year transition period
for bank holding companies to meet these quantitative limitations. At this
time, it is not possible to predict the impact that this proposal would have on
the Company. The Accounting Standards Executive Committee has issued Statement of Position
(SOP) 03-3 Accounting for Certain Loans or Debt Securities Acquired in a
Transfer. This Statement applies to all loans acquired in a transfer,
including those acquired in the acquisition of a bank or a branch, and provides
that such loans be accounted for at fair value with no allowance for loan
losses, or other valuation allowance, permitted at the time of acquisition.
The difference between cash flows expected at the acquisition date and the
investment in the loan should be recognized as interest income over the life of
the loan. If contractually required payments for principal and interest are
less than expected cash flows, this amount should not be recognized as a yield
adjustment, a loss accrual, or a valuation allowance. For the Corporation
this Statement is effective for calendar year 2005, and early adoption,
although permitted, is not planned. No significant impact is expected on the
consolidated financial statements at the time of adoption. At the March 17-18, 2004 Emerging Issues Task Force (EITF) meeting, the Task
Force reached a consensus on Issue No. 03-1, The Meaning of
Other-Than-Temporary Impairment and its Application to Certain Investments.
EITF 03-1 provides guidance for determining the meaning of
other-than-temporarily impaired and its application to certain debt and
equity securities within the scope of Statement of Financial Accounting
Standards No. 115, Accounting for Certain Investments in Debt and Equity
Securities(SFAS 115) and investments accounted for under the cost
method. The guidance set forth in the Statement was originally effective for
the Company in the September 30, 2004 consolidated financial statements.
However, in September 2004, the effective dates of certain parts of the
Statement were delayed. Management is currently assessing the impact of Issue
03-1 on the consolidated financial statements. 10




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##### Table of Contents



In March 2004, the Financial Accounting Standards Board (FASB) issued an
Exposure Draft, Share-Base Payment  an amendment of Statements No. 123 and 95.
This Statement amends SFAS Statement No. 123, Accounting for Stock-Based
Compensation,SFAS Statement No. 95, Statement of Cash Flows, and APB Opinion
No. 125, Accounting for Stock Issued to Employees. The objective of the
amendment to SFAS No. 123 is to recognize in the financial statements the cost
of employee services received in exchange for equity instruments and
liabilities incurred as the result of such transactions. The grant-date fair
value of stock options would be determined using an option-pricing model, and
expense would be recognized over the vesting period. In October 2004, the FASB
postponed the effective date of the proposed standard from fiscal years
beginning after December 15, 2004 to periods beginning after June 15, 2005. The
FASB is expected to issue a final standard by the end of calendar 2004.
Management is reviewing the proposed standard to determine the impact on the
financial statements. NOTE H  Commitments and Contingent Liabilities In the normal course of business, the Corporation is involved in various legal
proceedings. In the opinion of management, any liability resulting from such
proceedings would not have a material adverse effect on the consolidated
financial statements. The Corporation is party to financial instruments with off-balance-sheet risk
in the normal course of business to meet the financing needs of its customers.
These financial instruments include commitments to extend credit, financial
guarantees, and standby letters of credit. They involve, to varying degrees,
elements of credit risk in excess of amounts recognized on the consolidated
balance sheets. 11




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##### Table of Contents



The Corporations exposure to credit loss in the event of nonperformance by the
other party to the financial instrument for commitments to extend credit and
standby letters of credit is represented by the contractual notional amount of
those instruments. The Corporation uses the same credit policies in making
commitments and issuing letters of credit as they do for on-balance-sheet
instruments. Off-balance-sheet financial instruments whose contracts represented credit
and/or interest rate risk at September 30, 2004, December 31, 2003 and
September 30, 2003, are as follows: September 30,
    
    December 31,
    
    September 30,2004
    
    2003
    
    2003(Amounts In Thousand)Commitments to originate
mortgage loans
    
    $
    35,506
    
    
    $
    29,248
    
    
    $
    21,684Unused lines of credit:Commercial business
    
    
    125,204
    
    
    
    108,163
    
    
    
    86,511Home equity
    
    
    19,634
    
    
    
    13,957
    
    
    
    12,831Credit cards
    
    
    18,199
    
    
    
    17,146
    
    
    
    12,430Standby letters of credit
    
    
    12,115
    
    
    
    10,275
    
    
    
    10,376
 Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination clauses
and may require payment of a fee. Since many of the commitments are expected
to expire without being drawn upon, the total commitment amounts do not
necessarily represent future cash requirements. Standby letters of credit are
conditional commitments issued by the Bank to guarantee the performance of a
customer to a third party. Those guarantees are primarily issued to support
public and private borrowing arrangements and, generally, have terms of one
year or less. The credit risk involved in issuing letters of credit is
essentially the same as that involved in extending loan facilities to
customers. The Bank holds collateral, which may include accounts receivable,
inventory, property, equipment, and income-producing properties, supporting
those commitments if deemed necessary. In the event the customer does not
perform in accordance with the terms of the agreement with the third party, the
Bank would be required to fund the commitment. The maximum potential amount of
future payments the Bank could be required to make is represented by the
contractual amount shown in the summary above. If the commitment is funded,
the Bank would be entitled to seek recovery from the customer. Credit card
commitments are unsecured. At September 30, 2004 no amounts have been recorded
as liabilities for the Banks potential obligations under these guarantees. Except for the above-noted commitments to originate loans in the normal course
of business, the Corporation and the Banks have not undertaken the use of
off-balance-sheet derivative financial instruments for any purpose. 12




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Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations Overview The Corporation had net income of $1.9 million, or $0.55 per diluted share, for
the three months ended September 30, 2004 compared to $2.1 million, or $0.66
per diluted share, for the three months ended September 30, 2003, representing
a 8.0% decrease in net income and a 16.6% decrease in diluted earnings per
share and net income of $4.8 million, or $1.41 per diluted share, for the nine
months ended September 30, 2004 compared to $6.2 million, or $1.94 per diluted
share, for the nine months ended September 30, 2003, representing a 21.7%
decrease in net income and a 27.3% decrease in diluted earnings per share. The
decrease in net income for the current quarter and year-to-date compared to the
prior year periods is attributed to a lower net interest margin, a decrease in
loan fee revenue due primarily to the industry wide slow down in residential
loan refinances, significant costs incurred complying with the Sarbanes-Oxley
Act of 2002 and expenses associated with our company-wide Vision Unlimited
project. The quarter-to-quarter and year-to-year comparisons are impacted by the
Corporations completion of the Random Lake acquisition on August 12, 2004.
The acquisition was accounted for using the purchase method of accounting, and
accordingly, the assets and liabilities of Random Lake were recorded at their
respective fair values on August 12, 2004. The Corporation acquired
approximately $102.3 million in assets, $72.9 million in loans, $80.0 million
in deposits and recognized goodwill and intangible assets of approximately $6.1
million related to the transaction. The quarter-to-quarter and year-to-year
comparisons are also impacted by the Corporations completion of the Reedsburg
acquisition on November 1, 2003. The acquisition was accounted for using the
purchase method of accounting, and accordingly, the assets and liabilities of
Reedsburg were recorded at their respective fair values on November 1, 2003.
The Corporation acquired approximately $141.8 million in assets, $97.2 million
in loans, $120.6 million in deposits and recognized goodwill and intangible
assets of approximately $19.1 million related to the transaction. The
year-to-year comparisons are also impacted by the Corporations May 1, 2003
acquisitions of Keith C. Winters & Associates, LTD. (KCW), a tax preparation
and tax consulting firm with offices located in Franklin, Brookfield and
Milwaukee, Wisconsin, and Integrated Financial Services (IFS), an insurance
agency. The KCW and IFS acquisitions were accounted for using the purchase
method of accounting. 2004 continues to be a year of transition for the Corporation. Through a
company-wide project called Vision Unlimited, the Corporation is in the
process of standardizing policies and procedures across the organization and
centralizing many operational functions. In addition, the Corporation is
converting all of the Banks to a single data processing platform. As of
September 30, 2004 five of the six recently acquired banks have been converted
to the new system. The Corporation expects these changes will allow it to
better manage risk, operate more efficiently and serve customers better. Each
of the Banks will continue to keep its name, charter, board of directors and
management teams but will transition its human resources from the Banks
operational activities to customer related activities. Bank employees will
have the tools and resources they need to effectively focus on customer
service, customer retention and customer prospecting. While the Corporation
expects these changes to enhance shareholder value in the long run, a
transition of this magnitude involves short-term costs which the Corporation
expects will range between $850,000 and $1.0 million before tax in 2004.
Through September 30, 2004 we have expended approximately $475,000 relating to
this project. 13




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The Corporation is also facing two other significant challenges in 2004. Like
all public companies, we are working towards compliance with the Sarbanes-Oxley
Act of 2002. While we are utilizing an outside third party at a significant
cost, compliance with Sarbanes-Oxley is largely being accomplished internally
through our Vision Unlimited project. We originally expected our
Sarbanes-Oxley compliance costs would range from $300,000 to $400,000 in 2004.
However, based on the review of tasks completed to date, we now expect this
expense to amount to range from $400,000 to $500,000. Through September 30,
2004 we have expended approximately $333,000 relating to this project. In
addition, like hundreds of other Wisconsin banking organizations, we are in
discussion with the Wisconsin Department of Revenue (WDR) regarding the tax
treatment of our Nevada investment subsidiaries. Nevada does not have an
income tax and historically the earnings of these Nevada investment
subsidiaries have not been subject to taxation in Wisconsin. We believe that
we have complied with private letter rulings the WDR previously issued in
connection with the formation and operation of our Nevada investment
subsidiaries. However, the effect and intent of these rulings is in question
and the WDR may take the position that some or all of the income of our Nevada
investment subsidiaries is allocable to their Wisconsin corporate parents and
taxable in Wisconsin. The WDR may also take the position that such a
reallocation should apply to prior open tax years. The result of these
discussions with the WDR could materially increase our future income tax
expense and could also result in a significant current year tax charge. As of
September 30, 2004 we have not come to an agreement with the WDR and have not
accrued for potential future payments to the WDR. Financial Condition Total Assets Total assets increased $177.9 million, or 15.5%, to $1.3 billion at September
30, 2004 compared to $1.1 billion at December 31, 2003. The asset growth can
be attributed to both internal growth through loans as well as acquisition
growth associated with WSB. At the time of the acquisition, WSB had $102.3
million of assets. Investment Securities Available-for-sale investment securities increased $19.6 million, or 12.5%,
from $156.6 million at December 31, 2003, to $176.2 million at September 30,
2004. The investment security growth can be attributed to purchases of
additional investment securities by the banks as well as acquisition growth
associated with WSB. At the time of the acquisition, WSB had $11.5 million of
investment securities. Loans Receivable Loans receivable, net of allowance for loan losses, increased $148.8 million
from $847.9 million at December 31, 2003 compared to $996.8 million at
September 30, 2004. The growth in loans can be attributed to the growth in
commercial real estate loans that were partially offset by the decrease in
commercial business loans and consumer and installment loans as well as
acquisition growth associated with the WSB acquisition. At the time of the
acquisition, WSB had $72.9 million of loans. Currently, loans receivable
consists mainly of commercial loans secured by business assets, real estate and
guarantees as well as mortgages secured by residential properties located in
our primary market areas. At September 30, 2004 we designated $2.3 million of
loans as held for sale. 14




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Total Deposits and Borrowings Total deposits increased $86.7 million, or 9.5%, from $911.9 million on
December 31, 2003 to $998.6 million on September 30, 2004. The increase in
deposits can be attributed to the growth in retail money market accounts and
commercial checking accounts currently offered by our subsidiary banks as well
as acquisition growth associated with the WSB acquisition. At the time of the
acquisition, WSB had $80.0 million of deposits. Short-term borrowings totaled $56.6 million at September 30, 2004, compared to
$34.0 million at December 31, 2003, an increase of 66.3%. Short-term
borrowings consist of federal funds borrowed from correspondent banks and
repurchase agreements. Long-term debt increased by $40.1 million, or 55.5%,
from $72.3 million on December 31, 2003 to $112.5 million on September 30,
2004. Long-term debt consists of Federal Home Loan Bank advances and
acquisition notes associated with the Reedsburg transaction. Subordinated Debentures totaled $46.4 million at September 30, 2004, compared
to $36.1 million at December 31, 2003, an increase of 28.6%. We had
obligations represented by subordinated debentures at September 30, 2004
totaling $45.0 million with our wholly-owned trusts that were created for the
purpose of issuing trust preferred securities. The subordinated debentures
were the sole assets of the trusts at September 30, 2004. In accordance with
FIN 46, we began deconsolidating the wholly-owned trusts that issued the trust
preferred securities in 2004. As a result, these securities no longer are
consolidated on our balance sheet. Instead, the subordinated debentures held
by the trusts are disclosed on the balance sheet as subordinated debentures. On September 30, 2004, Merchants and Manufacturers Statutory Trust V, a
Connecticut statutory trust wholly owned by the Corporation, issued $10,000,000
of floating rate capital securities to one accredited investor. The Trust used
the proceeds from the capital securities to purchase a like amount of floating
rate junior subordinated debentures of the Corporation. The capital securities
accrue and pay dividends quarterly at a variable rate, reset quarterly, equal
to 3-month LIBOR plus 2.05%. The Corporation has fully and unconditionally
guaranteed all of the obligations of the Trust. The guarantee covers the
quarterly dividends and payments on the liquidation or redemption of the
capital securities, but only to the extent of funds held by the Trust. The
capital securities are mandatorily redeemable upon maturity of the debentures
on September 30, 2034 or earlier as provided in the indenture with respect to
the debentures. The Corporation has the right to redeem the debentures on or
after September 30, 2009. Capital Resources Stockholders equity totaled $93.5 million at September 30, 2004, compared to
$80.0 million in December 31, 2003, an increase of 16.9%. The component
changes in stockholders equity consist of net income of $4.8 million, a
$189,000 net increase in accumulated other comprehensive income, $272,000
decrease in treasury stock less payments of dividends to shareholders of $1.9
million. We and our banks continue to exceed our regulatory capital
requirements. Under the Federal Reserve Boards risk-based guidelines, capital is measured
against our subsidiary banks risk-weighted assets. Our tier 1 capital (common
stockholders equity less goodwill) to risk-weighted assets was 8.15% at
September 30, 2004, above the 4.0% minimum required. Total capital to
risk-adjusted assets was 10.47%; also above the 8.0% minimum requirement. The
leverage ratio was at 7.19% compared to the 4.0% minimum requirement.
According to FDIC capital guidelines, our subsidiary banks are considered to be
well capitalized as well. 15




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Nonperforming Assets and Allowance for Losses Generally a loan is classified as nonaccrual and the accrual of interest on
such loan is discontinued when the contractual payment of principal or interest
has become 90 days past due or management has serious doubts about further
collectibility of principal or interest. Generally, loans are restored to
accrual status when the obligation is brought current, has performed in
accordance with the contractual terms for a reasonable period of time and the
ultimate collectibility of the total contractual principal and interest is no
longer in doubt. Nonperforming assets are summarized, for the dates indicated, as follows
(dollars in thousands): September 30,
    
    December 31,
    
    September 30,2004
    
    2003
    
    2003Non-accrual loans:Conventional single-family residential
    
    $
    687
    
    
    $
    456
    
    
    $
    639Commercial and multifamily residential
    
    
    2,269
    
    
    
    2,344
    
    
    
    1,634Commercial business loans
    
    
    1,549
    
    
    
    1,484
    
    
    
    1,002Consumer and installment loans
    
    
    865
    
    
    
    998
    
    
    
    673Total non-accrual loans
    
    
    5,370
    
    
    
    5,282
    
    
    
    3,948Other real estate owned
    
    
    1,987
    
    
    
    1,945
    
    
    
    1,907Total nonperforming assets
    
    $
    7,357
    
    
    $
    7,227
    
    
    $
    5,855Ratios:Non-accrual loans to total loans
    
    
    0.53
    %
    
    
    0.62
    %
    
    
    0.54
    %Nonperforming assets to total assets
    
    
    0.56
    
    
    
    0.63
    
    
    
    0.63Loan loss allowance to non-accrual loans
    
    
    199.70
    
    
    
    172.96
    
    
    
    200.79Loan loss allowance to total loans
    
    
    1.06
    
    
    
    1.07
    
    
    
    1.08
 Nonperforming assets increased by $130,000 from $7.2 million at December 31,
2003 to $7.4 million at September 30, 2004, an increase of 1.8%. Non-accrual
loans acquired during the WSB acquisition led to the increase. We believe that
any losses on current non-accrual loans balances will be negligible, due to the
collateral position in each situation. However, additional charge offs may
occur upon sale of the other real estate. The following table presents changes in the allowance for loan losses (dollars
in thousands): Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,
    
    September 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Balance at beginning of period
    
    $
    10,461
    
    
    $
    8,009
    
    
    $
    9,881
    
    
    $
    7,663Increase due to acquisition
    
    
    449
    
    
    
    0
    
    
    
    449
    
    
    
    0Provision for loan losses
    
    
    431
    
    
    
    372
    
    
    
    1,332
    
    
    
    1,014Charge-offs:Commercial and multifamily residential
    
    
    64
    
    
    
    99
    
    
    
    159
    
    
    
    128Commercial business loans
    
    
    36
    
    
    
    317
    
    
    
    233
    
    
    
    352Consumer and installment loans
    
    
    633
    
    
    
    143
    
    
    
    816
    
    
    
    457Total charge-offs
    
    
    733
    
    
    
    559
    
    
    
    1,208
    
    
    
    937Recoveries:Commercial and multifamily residential
    
    
    1
    
    
    
    0
    
    
    
    3
    
    
    
    28Commercial business loans
    
    
    94
    
    
    
    62
    
    
    
    163
    
    
    
    82Consumer and installment loans
    
    
    22
    
    
    
    43
    
    
    
    105
    
    
    
    77Total recoveries
    
    
    117
    
    
    
    105
    
    
    
    271
    
    
    
    187Net charge-offs
    
    
    616
    
    
    
    454
    
    
    
    937
    
    
    
    750Balance at September 30,
    
    $
    10,725
    
    
    $
    7,927
    
    
    $
    10,725
    
    
    $
    7,927
 16




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We believe the allowance for loan losses accounting policy is critical to the
portrayal and understanding of our financial condition and results of
operations. As such, selection and application of this critical accounting
policy involves judgments, estimates, and uncertainties that are susceptible
to change. In the event that different assumptions or conditions were to
prevail, and depending upon the severity of such changes, the possibility of a
materially different financial condition or results of operations is a
reasonable likelihood. We maintain our allowance for loan losses at a level that management believes
will be adequate to absorb probable losses on existing loans based on an
evaluation of the collectibility of loans and prior loss experience. We also
use a risk rating system to evaluate the adequacy of the allowance for loan
losses. With this system, each loan is risk rated between one and ten by the
originating loan officer or loan committee, with one being the best case and
ten being a loss or the worst case. Historical loan loss reserve factors are
multiplied against the balances for each loan type to determine an appropriate
level for the allowance for loan losses. Loans with risk ratings between six
and nine are monitored much closer by the officers. Control of our loan
quality is continually monitored by management and is reviewed by the Board of
Directors. We consistently apply our methodology for determining the adequacy
of the allowance for loan losses, but may make adjustments to its methodologies
and assumptions based on historical information related to charge-offs and
managements evaluation of the current loan portfolio. The allowance for loan losses is based on estimates, and ultimate losses will
vary from current estimates. These estimates are reviewed quarterly, and as
adjustments, either positive or negative, become necessary, a corresponding
increase or decrease is made in the provision for loan losses. The methodology
used to determine the adequacy of the allowance for loan losses for the first
nine months of 2004 is consistent with prior periods. Potential Problem Loans We utilize an internal asset classification system as a means of reporting
problem and potential problem assets. At least quarterly, a watch list is
presented to each subsidiary banks Board of Directors showing all loans listed
as Watch, Special Mention, Substandard, Doubtful, and Loss. A loan
classified as Watch is defined as a loan requiring more than normal management
visibility, while still protected by the current net worth and paying capacity
of the borrower. Watch loans have one or more deficiencies that require
monitoring. A Special Mention loan has potential weaknesses that deserve
managements close attention. If left uncorrected, these potential weaknesses
may result in deterioration of the repayment prospects for the loan at some
future date. An asset is classified Substandard if it is inadequately
protected by the current net worth and paying capacity of the obligor or of the
collateral pledged, if any. Substandard assets include those characterized by
the distinct possibility that we will sustain some loss if the deficiencies are
not corrected. Assets classified as Doubtful have all the weaknesses inherent
in those classified Substandard with the added characteristic that the
weaknesses present make collection or liquidation in full, on the basis of
currently existing facts, conditions and values, highly questionable and
improbable. Assets classified as Loss are those considered uncollectible and
viewed as non-bankable assets, worthy of charge-off. Assets that do not
currently expose us to sufficient risk to warrant classification in one of the
aforementioned categories, but possess weaknesses that may or may not be within
the control of the customer are deemed to be Management Attention (or
equivalent designation at the various subsidiary banks). As of September 30,
2004, loans classified as Watch, Special Mention, Substandard, Doubtful and
Loss loans totaled $76.3 million compared to $51.7 million as of December 31,
2003, an increase of $24.6 million or 47.6%. The increase can not be
attributed to a deterioration in the quality of the loan portfolio, but a
change in the scope of the potential problem loan evaluation from the prior
period. 17




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Our determination as to the classification of our assets and the amount of our
valuation allowances is subject to review by the Banks primary regulators,
which can order the establishment of additional general or specific loss
allowances. The FDIC, in conjunction with the other federal banking agencies,
has adopted an interagency policy statement on the allowance for loan losses.
The policy statement provides guidance for financial institutions on both the
responsibilities of management for the assessment and establishment of adequate
allowances and guidance for banking agency examiners to use in determining the
adequacy of general valuation guidelines. Generally, the policy statement
recommends that (i) institutions have effective systems and controls to
identify, monitor and address asset quality problems; (ii) management has
analyzed all significant factors that affect the collectibility of the
portfolio in a reasonable manner; and (iii) management has established
acceptable allowance evaluation processes that meet the objectives set forth in
the policy statement. We have established an adequate allowance for probable
loan losses. We analyze the process regularly, with modifications made if
needed, and report those results four times per year to each subsidiary banks
Board of Directors. However, there can be no assurance that regulators, in
reviewing our loan portfolio, will not request us to materially increase our
allowance for loan losses at the time. Although management believes that
adequate specific and general loan loss allowances have been established,
actual losses are dependent upon future events and, as such, further additions
to the level of specific and general loan loss allowances may become necessary. Comparison of Three and Nine Months Ended September 30, 2004 and 2003 Net Interest Income Net interest income equals the difference between interest earned on assets and
the interest paid on liabilities and is a measure of how effectively management
has balanced and allocated our interest rate sensitive assets and liabilities
as well being the most significant component of earnings. Net interest income
on a fully taxable-equivalent basis for the three months ended September 30,
2004 was $11.2 million, an increase of 25.8% from the $8.9 million reported for
the same period in 2003, and for nine months ended September 30, 2004 was $31.5
million, an increase of 19.6% from the $26.4 million reported for the same
period in 2003. The increase is due partly from revenue resulting from the
acquisition of Reedsburg and Wisconsin State Bank as well as the increase in
loan and investment volume funded by an increase in deposits and long-term
borrowings. Our net interest margin on a fully taxable-equivalent basis was
3.86% and 4.02% for the third quarters of 2004 and 2003, respectively. The
continued low interest rate environment, the incremental effect of the
acquisitions as well as the increased amortization of purchase accounting
premiums associated with our acquisitions resulted in lower margins. The
reduction in market interest rates and increased premium amortization during
the third quarter caused the average rate on a fully taxable-equivalent basis
earned on interest earning assets to decrease from 5.73% for the three months
ended September 30, 2003 to 5.59% for the three month period ended September
30, 2004, and from 5.91% for the nine months ended September 30, 2003, to 5.57%
for the nine month period ended September 30, 2004. 18




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##### Table of Contents



The following table presents, for the periods indicated, the total dollar
amount of interest income from average interest earning assets and the
resultant yields, as well as the interest expense on average interest bearing
liabilities, and the resultant costs, expressed both in dollars and rates
(dollars in thousands): AVERAGE BALANCES, INTEREST RATES AND YIELDS For the Three Months Ended September 30,2004
    
    2003Average
    
    
    
    
    
    Average
    
    Average
    
    
    
    
    
    AverageBalance
    
    Interest
    
    Rate
    
    Balance
    
    Interest
    
    RateAssetsLoans, net (1)(2)
    
    $
    954,722
    
    
    $
    14,029
    
    
    
    5.85
    %
    
    $
    721,591
    
    
    $
    11,185
    
    
    
    6.15
    %Loans exempt from federal income taxes (3)
    
    
    4,094
    
    
    
    76
    
    
    
    7.36
    %
    
    
    3,278
    
    
    
    65
    
    
    
    7.89
    %Taxable investment securities (4)
    
    
    36,616
    
    
    
    311
    
    
    
    3.38
    %
    
    
    37,693
    
    
    
    465
    
    
    
    4.89
    %Mortgage-related securities (4)
    
    
    96,793
    
    
    
    867
    
    
    
    3.56
    %
    
    
    64,412
    
    
    
    406
    
    
    
    2.50
    %Investment securities exempt from federal income
taxes (3)(4)
    
    
    48,763
    
    
    
    826
    
    
    
    6.74
    %
    
    
    35,058
    
    
    
    506
    
    
    
    5.73
    %Other securities
    
    
    11,442
    
    
    
    75
    
    
    
    2.61
    %
    
    
    14,730
    
    
    
    30
    
    
    
    0.81
    %Interest earning assets
    
    
    1,152,430
    
    
    
    16,184
    
    
    
    5.59
    %
    
    
    876,762
    
    
    
    12,657
    
    
    
    5.73
    %Non interest earning assets
    
    
    100,582
    
    
    
    
    
    
    
    
    
    
    
    70,036Average assets
    
    $
    1,253,012
    
    
    
    
    
    
    
    
    
    
    $
    946,78Liabilities and Stockholders EquityNOW deposits
    
    $
    86,044
    
    
    
    96
    
    
    
    0.44
    %
    
    $
    61,154
    
    
    
    83
    
    
    
    0.54
    %Money market deposits
    
    
    262,227
    
    
    
    718
    
    
    
    1.09
    %
    
    
    240,884
    
    
    
    850
    
    
    
    1.40
    %Savings deposits
    
    
    135,801
    
    
    
    293
    
    
    
    0.86
    %
    
    
    87,129
    
    
    
    127
    
    
    
    0.58
    %Time deposits
    
    
    355,835
    
    
    
    2,069
    
    
    
    2.31
    %
    
    
    267,917
    
    
    
    1,687
    
    
    
    2.50
    %Short-term borrowings
    
    
    43,207
    
    
    
    244
    
    
    
    2.25
    %
    
    
    16,221
    
    
    
    83
    
    
    
    2.03
    %Long-term borrowings
    
    
    107,696
    
    
    
    1,001
    
    
    
    3.70
    %
    
    
    67,489
    
    
    
    615
    
    
    
    3.62
    %Subordinated debentures
    
    
    36,199
    
    
    
    582
    
    
    
    6.40
    %
    
    
    20,000
    
    
    
    325
    
    
    
    6.45
    %Interest bearing liabilities
    
    
    1,027,009
    
    
    
    5,003
    
    
    
    1.94
    %
    
    
    760,794
    
    
    
    3,770
    
    
    
    1.97
    %Demand deposits and other non interest bearing
liabilities
    
    
    140,823
    
    
    
    
    
    
    
    
    
    
    
    113,028Stockholders equity
    
    
    85,180
    
    
    
    
    
    
    
    
    
    
    
    72,976Average liabilities and stockholders equity
    
    $
    1,253,012
    
    
    
    
    
    
    
    
    
    
    $
    946,798Net interest spread (5)
    
    
    
    
    
    $
    11,181
    
    
    
    3.65
    %
    
    
    
    
    
    $
    8,887
    
    
    
    3.76
    %Net interest earning assets
    
    $
    125,421
    
    
    
    
    
    
    
    
    
    
    $
    115,968Net interest margin on a fully tax equivalent
basis (6)
    
    
    
    
    
    
    
    
    
    
    3.86
    %
    
    
    
    
    
    
    
    
    
    
    4.02
    %Net interest margin (6)
    
    
    
    
    
    
    
    
    
    
    3.75
    %
    
    
    
    
    
    
    
    
    
    
    3.93
    %Ratio of average interest-earning assets to
average interest-bearing liabilities
    
    
    
    
    
    
    
    
    
    
    1.12
    
    
    
    
    
    
    
    
    
    
    
    1.15
   (1)
    
    For the purpose of these computations, nonaccrual loans are included in
the daily average loan amounts outstanding.(2)
    
    Interest earned on loans includes loan fees (which are not material in
amount) and interest income which has been received from borrowers whose
loans were removed from nonaccrual status during the period indicated.(3)
    
    Taxable-equivalent adjustments were made using a 34% corporate tax rate
for all years presented in calculating interest income and yields.(4)
    
    Average balances of securities available-for-sale are based on amortized
cost.(5)
    
    Interest rate spread represents the difference between the average yield
on interest earning assets and the average cost of interest bearing
liabilities and is represented on a fully tax equivalent basis.(6)
    
    Net interest margin represents net interest income as a percentage of
average interest earning assets. 19




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##### Table of Contents



The following table presents, for the periods indicated, the total dollar
amount of interest income from average interest earning assets and the
resultant yields, as well as the interest expense on average interest bearing
liabilities, and the resultant costs, expressed both in dollars and rates
(dollars in thousands): AVERAGE BALANCES, INTEREST RATES AND YIELDS For the Nine Months Ended September 30,2004
    
    2003Average
    
    
    
    
    
    Average
    
    Average
    
    
    
    
    
    AverageBalance
    
    Interest
    
    Rate
    
    Balance
    
    Interest
    
    RateAssetsLoans, net (1)(2)
    
    $
    900,651
    
    
    $
    39,682
    
    
    
    5.89
    %
    
    $
    696,826
    
    
    $
    33,120
    
    
    
    6.35
    %Loans exempt from federal income taxes (3)
    
    
    4,154
    
    
    
    232
    
    
    
    7.45
    %
    
    
    3,443
    
    
    
    209
    
    
    
    8.12
    %Taxable investment securities (4)
    
    
    41,346
    
    
    
    1,215
    
    
    
    3.93
    %
    
    
    37,577
    
    
    
    1,549
    
    
    
    5.51
    %Mortgage-related securities (4)
    
    
    89,698
    
    
    
    2,282
    
    
    
    3.40
    %
    
    
    68,979
    
    
    
    1,471
    
    
    
    2.85
    %Investment securities exempt from federal income
taxes (3)(4)
    
    
    45,143
    
    
    
    1,994
    
    
    
    5.90
    %
    
    
    34,506
    
    
    
    1,533
    
    
    
    5.94
    %Other securities
    
    
    12,342
    
    
    
    173
    
    
    
    1.87
    %
    
    
    19,281
    
    
    
    149
    
    
    
    1.03
    %Interest earning assets
    
    
    1,093,334
    
    
    
    45,578
    
    
    
    5.57
    %
    
    
    860,612
    
    
    
    38,031
    
    
    
    5.91
    %Non interest earning assets
    
    
    96,139
    
    
    
    
    
    
    
    
    
    
    
    65,472Average assets
    
    $
    1,189,473
    
    
    
    
    
    
    
    
    
    
    $
    926,084Liabilities and Stockholders EquityNOW deposits
    
    $
    86,244
    
    
    
    302
    
    
    
    0.47
    %
    
    $
    60,229
    
    
    
    303
    
    
    
    0.67
    %Money market deposits
    
    
    260,230
    
    
    
    2,119
    
    
    
    1.09
    %
    
    
    219,039
    
    
    
    2,518
    
    
    
    1.54
    %Savings deposits
    
    
    125,394
    
    
    
    788
    
    
    
    0.84
    %
    
    
    85,741
    
    
    
    417
    
    
    
    0.69
    %Time deposits
    
    
    341,917
    
    
    
    6,083
    
    
    
    2.38
    %
    
    
    275,721
    
    
    
    5,490
    
    
    
    2.66
    %Short-term borrowings
    
    
    38,378
    
    
    
    540
    
    
    
    1.88
    %
    
    
    25,587
    
    
    
    404
    
    
    
    2.11
    %Long-term borrowings
    
    
    91,593
    
    
    
    2,522
    
    
    
    3.68
    %
    
    
    68,742
    
    
    
    1,905
    
    
    
    3.71
    %Subordinated debentures
    
    
    36,122
    
    
    
    1,694
    
    
    
    6.26
    %
    
    
    14,516
    
    
    
    632
    
    
    
    5.82
    %Interest bearing liabilities
    
    
    979,878
    
    
    
    14,048
    
    
    
    1.92
    %
    
    
    749,575
    
    
    
    11,669
    
    
    
    2.08
    %Demand deposits and other non interest bearing
liabilities
    
    
    127,056
    
    
    
    
    
    
    
    
    
    
    
    105,281Stockholders equity
    
    
    82,539
    
    
    
    
    
    
    
    
    
    
    
    71,228Average liabilities and stockholders equity
    
    $
    1,189,473
    
    
    
    
    
    
    
    
    
    
    $
    926,084Net interest spread (5)
    
    
    
    
    
    $
    31,530
    
    
    
    3.65
    %
    
    
    
    
    
    $
    26,362
    
    
    
    3.83
    %Net interest earning assets
    
    $
    113,456
    
    
    
    
    
    
    
    
    
    
    $
    111,037Net interest margin on a fully tax equivalent
basis (6)
    
    
    
    
    
    
    
    
    
    
    3.85
    %
    
    
    
    
    
    
    
    
    
    
    4.10
    %Net interest margin (6)
    
    
    
    
    
    
    
    
    
    
    3.76
    %
    
    
    
    
    
    
    
    
    
    
    4.00
    %Ratio of average interest-earning assets to
average interest-bearing liabilities
    
    
    
    
    
    
    
    
    
    
    1.12
    
    
    
    
    
    
    
    
    
    
    
    1.15
   (1)
    
    For the purpose of these computations, nonaccrual loans are included in
the daily average loan amounts outstanding.(2)
    
    Interest earned on loans includes loan fees (which are not material in
amount) and interest income which has been received from borrowers whose
loans were removed from nonaccrual status during the period indicated.(3)
    
    Taxable-equivalent adjustments were made using a 34% corporate tax rate
for all years presented in calculating interest income and yields.(4)
    
    Average balances of securities available-for-sale are based on amortized
cost.(5)
    
    Interest rate spread represents the difference between the average yield
on interest earning assets and the average cost of interest bearing
liabilities and is represented on a fully tax equivalent basis.(6)
    
    Net interest margin represents net interest income as a percentage of
average interest earning assets. 20




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##### Table of Contents



The following table sets forth the effects of changing interest rates and
volumes of interest earning assets and interest bearing liabilities on our net
interest income. Information is provided with respect to (i) effect on net
interest income attributable to changes in volume (changes in volume multiplied
by prior rate), (ii) effects on net interest income attributable to changes in
rate (changes in rate multiplied by prior volume) and (iii) net change. The
net change attributable to the combined impact of volume and rate has been
allocated proportionately to the change due to volume and the change due to
rate. (dollars in thousands): VOLUME, RATE AND MIX ANALYSIS OF NET INTEREST INCOME Three Months Ended September 30, 2004
    
    Nine Months Ended September 30, 2004Compared to September 30, 2003
    
    Compared to September 30, 2003Change Due
    
    Change Due
    
    
    
    
    
    Change Due
    
    Change Dueto Volume
    
    to Rate
    
    Total Change
    
    to Volume
    
    to Rate
    
    Total ChangeInterest-Earning Assets:Loans, net (1)
    
    $
    3,357
    
    
    ($
    513
    )
    
    $
    2,844
    
    
    $
    8,779
    
    
    ($
    2,217
    )
    
    $
    6,562Loans exempt from federal
income taxes (2)
    
    
    15
    
    
    
    (4
    )
    
    
    11
    
    
    
    38
    
    
    
    (15
    )
    
    
    23Taxable investment securities
    
    
    (13
    )
    
    
    (141
    )
    
    
    (154
    )
    
    
    179
    
    
    
    (513
    )
    
    
    (334
    )Mortgage-related securities
    
    
    250
    
    
    
    211
    
    
    
    461
    
    
    
    495
    
    
    
    316
    
    
    
    811Investment securities exempt
from federal income taxes (2)
    
    
    221
    
    
    
    99
    
    
    
    320
    
    
    
    472
    
    
    
    (11
    )
    
    
    461Other securities
    
    
    (5
    )
    
    
    50
    
    
    
    45
    
    
    
    (19
    )
    
    
    43
    
    
    
    24Total interest-earning assets
    
    $
    3,825
    
    
    ($
    298
    )
    
    $
    3,527
    
    
    $
    9,944
    
    
    ($
    2,397
    )
    
    $
    7,547Interest-Bearing Liabilities:NOW deposits
    
    $
    23
    
    
    ($
    10
    )
    
    $
    13
    
    
    ($
    3
    )
    
    $
    2
    
    
    ($
    1
    )Money market deposits
    
    
    88
    
    
    
    (220
    )
    
    
    (132
    )
    
    
    720
    
    
    
    (1,119
    )
    
    
    (399
    )Savings deposits
    
    
    89
    
    
    
    77
    
    
    
    166
    
    
    
    228
    
    
    
    143
    
    
    
    371Time deposits
    
    
    493
    
    
    
    (111
    )
    
    
    382
    
    
    
    1,072
    
    
    
    (479
    )
    
    
    593Short-term borrowings
    
    
    151
    
    
    
    10
    
    
    
    161
    
    
    
    174
    
    
    
    (38
    )
    
    
    136Long-term borrowings
    
    
    372
    
    
    
    14
    
    
    
    386
    
    
    
    631
    
    
    
    (14
    )
    
    
    617Subordinated debentures
    
    
    260
    
    
    
    (3
    )
    
    
    257
    
    
    
    1,010
    
    
    
    52
    
    
    
    1,062Total interest-bearing
liabilities
    
    $
    1,476
    
    
    ($
    243
    )
    
    $
    1,233
    
    
    $
    3,832
    
    
    ($
    1,453
    )
    
    $
    2,379Net change in net interest income
    
    
    
    
    
    
    
    
    
    $
    2,294
    
    
    
    
    
    
    
    
    
    
    $
    5,168
   (1)
    
    Interest earned on loans includes loan fees (which are not material in
amount) and interest income which has been received from borrowers whose
loans were removed from non-accrual during the period indicated.(2)
    
    Taxable-equivalent adjustments were made using a 34% corporate tax rate
for all years presented in calculating interest income and yields. Provision for Loan Losses For the three months ended September 30, 2004, the provision for loan losses
was $431,000 compared to $372,000 for the same period in 2003. For the nine
months ended September 30, 2004, the provision for loan losses was $1.3 million
compared to $1.0 million for the same period in 2003. We use a risk-based
assessment of our loan portfolio to determine the level of the loan loss
allowance. This procedure is based on internal reviews intended to determine
the adequacy of the loan loss allowance in view of presently known factors.
However, changes in economic conditions in the future financial conditions of
borrowers cannot be predicted and may result in increased future provisions to
the loan loss allowance. 21




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##### Table of Contents



Non-Interest Income Non-interest income for the three months ended September 30, 2004, was $3.2
million compared to $3.1 million for the three months ended September 30, 2003,
an increase of $166,000, or 5.5%. Non-interest income for the nine months
ended September 30, 2004 was $8.6 million, an increase of $182,000, or 2.17%
from the $8.4 million for the nine months ended September 30, 2003. The
composition of non-interest income is shown in the following table (dollars in
thousands). Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Service charges on deposit
accounts
    
    $
    1,003
    
    
    $
    661
    
    
    $
    2,512
    
    
    $
    1,896Service charges on loans
    
    
    742
    
    
    
    771
    
    
    
    1,523
    
    
    
    2,120Securities gains, net
    
    
    7
    
    
    
    0
    
    
    
    190
    
    
    
    1Gain on sale of loans, net
    
    
    70
    
    
    
    568
    
    
    
    364
    
    
    
    1,744Net gain on sale of fixed assets
    
    
    0
    
    
    
    0
    
    
    
    158
    
    
    
    2Other
    
    
    1,387
    
    
    
    1,043
    
    
    
    3,811
    
    
    
    2,613Total non-interest income
    
    $
    3,209
    
    
    $
    3,043
    
    
    $
    8,558
    
    
    $
    8,376
 Service charges on deposit accounts for the three months ended September 30,
2004 was $1.0 million compared to $661,000 for the three months ended September
30, 2003, an increase of $342,000, or 51.7%. Service charges on deposit
accounts for the nine months ended September 30, 2004 was $2.5 million compared
to $1.9 million for the nine months ended September 30, 2003, an increase of
$616,000, or 32.5%. The increase in 2004 is the result of growth in deposit
accounts, both internal and through acquisition, and fee structure
modifications company wide. Service charges on loans for the three months ended September 30, 2004 was
$742,000 compared to $771,000 for the three months ended September 30, 2003, a
decrease of $29,000, or 3.8%. Service charges on loans for the nine months
ended September 30, 2004 was $1.5 million compared to $2.1 million for the nine
months ended September 30, 2003, a decrease of $597,000, or 28.2%. The
decrease is due directly to the reduction in mortgage and commercial loans
refinanced in 2004 when compared to 2003. We recorded a net gain of $7,000 on the sale of $2.7 million of securities in
the third quarter of 2004 compared to no gain or loss on the sale of securities
during the same period in 2003. We recorded a net gain of $190,000 on the sale
of $12.7 million of securities in the first nine months of 2004 compared to a
gain of $1,000 on the sale of $7.3 million of securities during the same period
in 2003. The proceeds from the sale of the investments were used to fund loan
demand or reduce debt. Gains on the sale of loans were $70,000 for the three months ended September
30, 2004 compared to $568,000 for the three months ended September 30, 2003.
Gains on the sale of loans were $364,000 for the nine months ended September
30, 2004 compared to $1.7 million for the nine months ended September 30, 2003.
All-time low market interest rates led to higher secondary market sales volume
of 15 and 30 year residential mortgage loans in 2003 compared to 2004. Other fee income for the three and nine-month period ending September 30, 2004
included commissions on tax, investment and insurance products generated from
the acquisitions of IFS in April 2003 and KCW in May 2003. 22




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##### Table of Contents



Non-Interest Expense Non-interest expense for the three months ended September 30, 2004 was $11.0
million compared to $8.2 million for the three months ended September 30, 2003,
an increase of $2.9 million, or 35.0%. Non-interest expense for the nine
months ended September 30, 2004 was $31.3 million compared to $23.8 million for
the nine months ended September 30, 2003, an increase of $7.5 million, or
31.5%. The increase in 2004 expenses are in part the result of implementing
our Vision Unlimited program and the cost of complying with the
Sarbanes-Oxley Act of 2002. Vision Unlimited is the company-wide project of
standardizing policies and procedures across the organization and as well as
centralizing many operational functions. The increase in non-interest expense
is also greatly due in part to expenses related to the inclusion of the
Reedsburg and Wisconsin State Banks non-interest expenses in our 2004
operating results. Additionally, non-interest expense increased during the
first quarter of 2004 compared to 2003 from expenses associated with the
activities of KCW and IFS. The major components of non-interest expense are
shown in the following table (dollars in thousands). Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Salaries and employee benefits
    
    $
    6,013
    
    
    $
    4,728
    
    
    $
    17,640
    
    
    $
    13,619Premises and equipment
    
    
    1,663
    
    
    
    1,260
    
    
    
    4,491
    
    
    
    3,725Data processing fees
    
    
    533
    
    
    
    268
    
    
    
    1,294
    
    
    
    857Marketing and business development
    
    
    684
    
    
    
    383
    
    
    
    1,592
    
    
    
    1,151Federal deposit insurance premiums
    
    
    36
    
    
    
    31
    
    
    
    118
    
    
    
    97Other
    
    
    2,113
    
    
    
    1,508
    
    
    
    6,130
    
    
    
    4,333Total noninterest expense
    
    $
    11,042
    
    
    $
    8,178
    
    
    $
    31,265
    
    
    $
    23,782
 Salaries and employee benefits for the three months ended September 30, 2004
was $6.0 million compared to $4.7 million for the three months ended September
30, 2003, an increase of $1.3 million, or 27.2%. Salaries and employee
benefits for the nine months ended September 30, 2004 was $17.6 million
compared to $13.6 million for the nine months ended September 30, 2003, an
increase of $4.0 million, or 29.5%. The increase in salaries and benefits is
due in part to including Reedsburgs, Wisconsin State Banks and KCWs expenses
in our 2004 operating results. Also impacting salaries and employee benefits
in the 2004 were additional staff hires particularly in holding company
management, marketing and information technology areas, higher benefit costs,
changes in personnel and normal pay raises. Premises and equipment expense for the three months ended September 30, 2004
was $1.7 million compared to $1.3 million for the three months ended September
30, 2003, an increase of $403,000, or 32.0%. Premises and equipment expense
for the nine months ended September 30, 2004 was $4.5 million compared to $3.7
million for the nine months ended September 30, 2003, an increase of $766,000,
or 20.6%. Higher utility costs, building lease payments, depreciation,
maintenance of our facilities and acquisitions contributed to the increase. Data processing fees for the three months ended September 30, 2004 was $533,000
compared to $268,000 for the three months ended September 30, 2003, an increase
of $265,000, or 99.0%. Data processing fees for the nine months ended
September 30, 2004 was $1.3 million compared to $857,000 for the nine months
ended September 30, 2003, an increase of $437,000, or 51.0%. The increase was
due to system conversions, the increased reliance on outside consultants for
information technology issues as well as equipment and software upgrades. Marketing and business development expense for the three months ended September
30, 2004 was $684,000 compared to $383,000 for the three months ended September
30, 2003, an increase of $301,000, or 78.6%. Marketing and business
development expense for the nine months ended September 30, 2004 was $1.6
million compared to $1.2 million for the nine months ended September 30, 2003,
an increase of $441,000, or 38.3%. The increase was due to introduction of a
corporate branding campaign, increased donations and contributions and the
inclusion of our acquired banks marketing and development expenses. 23




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##### Table of Contents



Other expenses for the three months ended September 30, 2004 was $2.1 million
compared to $1.5 million for the three months ended September 30, 2003, an
increase of $605,000, or 40.1%. Other expenses for the nine months ended
September 30, 2004 was $6.1 million compared to $4.3 million for the nine
months ended September 30, 2003, an increase of $1.8 million, or 41.5%. The
increase in 2004 other expenses are in part the result of implementing our
Vision Unlimited program. Vision Unlimited is the company-wide project of
standardizing policies and procedures across the organization and as well as
centralizing many operational functions. Through September 30, 2004 we have
expended approximately $475,000 relating to this project. Also included in
other expenses are costs associated with complying with the Sarbanes-Oxley Act
of 2002. Through September 30, 2004 we have expended approximately $333,000
relating to this project. Additionally, the increase in other expense is due
in part to expenses related to the inclusion of Reedsburgs and Wisconsin State
Banks other expenses in our 2004 operating results as well as expenses
associated with the activities of KCW and IFS. Income Taxes Income taxes for the three-month period ended September 30, 2004 was $676,000
compared to $1.1 million for the three months ended September 30, 2003, a
decrease of $407,000, or 37.6%. Income taxes for the nine month period ended
September 30, 2004 was $1.9 million compared to $3.2 million for the nine
months ended September 30, 2003, a decrease of $1.3 million, or 40.0%. The
effective tax rate for the three months ended September 30, 2004 was 25.9%
compared to 34.0% for the same period in 2003. The effective tax rate for the
nine months ended September 30, 2004 was 28.5% compared to 34.2% for the same
period in 2003. The reduced tax rate is due to the decrease in fully taxed
income at CBG Mortgage and the inclusion of Reedsburgs operation in our 2004
results. Net Income On an after tax basis, for the three month period ended September 30, 2004, we
reported net income of $1.9 million compared to $2.1 million for the same
period in 2003, a decrease of 8.0%. While for the nine month period ended
September 30, 2004, we reported net income of $4.8 million compared to $6.2
million for the same period in 2003, a decrease of $1.3 million, or 21.7%. Liquidity Our cash flows are composed of three classifications: cash flows from operating
activities, cash flows from investing activities, and cash flows from financing
activities. Net cash provided by operating activities was $10.4 million for
the nine months ended September 30, 2004, compared to $8.6 million provided by
operating activities in 2003, an increase of $1.6 million. Net cash used in
investing activities increased by $22.6 million, to $90.0 million for the nine
months ended September 30, 2004, from $67.6 million used in the same period in
2003. Net cash provided by financing activities was $69.2 million for the nine
months ended September 30, 2004 compared to $32.7 million provided by financing
activities during the nine month period in 2003 The $36.5 million increase in
net cash provided by financing activities was primarily due to a $40.6 million
net increase in long term borrowings in the 2004 nine-month period. 24




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The Corporation expects to have available cash to meet its liquidity needs.
Liquidity management is monitored by the Asset/Liability Management committee,
which takes into account the marketability of assets, the sources and stability
of funding and the level of unfunded commitments. In the event that additional
short-term liquidity is needed, the Banks have established relationships with
our correspondent banks to provide short-term borrowings in the form of federal
funds purchased. While there are no firm lending commitments in place, we
believe that the Banks could borrow $96.2 million for a short time from these
banks on a collective basis. The Banks are members of the Federal Home Loan
Bank (FHLB) and each has the ability to borrow from the FHLB. As a contingency
plan for significant funding needs, the Asset/Liability Management committee
may also consider the sale of investment securities, selling securities under
agreement to repurchase or the temporary curtailment of lending activities. Asset/Liability Management Financial institutions are subject to interest rate risk to the extent their
interest-bearing liabilities (primarily deposits) mature or reprice at
different times and on a different basis than their interest-earning assets
(consisting primarily of loans and securities). Interest rate sensitivity
management seeks to match maturities on assets and liabilities and avoid
fluctuating net interest margins while enhancing net interest income during
periods of changing interest rates. The difference between the amount of
interest-earning assets maturing or repricing within a specific time period and
the amount of interest-bearing liabilities maturing or repricing within the
same time period is referred to as an interest rate gap. A gap is considered
positive when the amount of interest rate sensitive assets exceeds the amount
of interest rate sensitive liabilities. A gap is considered negative when the
amount of interest rate sensitive liabilities exceeds the amount of interest
rate sensitive assets. During periods of falling interest rates, a negative
gap tends to positively affect net interest income while a positive gap tends
to result in a decrease in net interest income. During a period of rising
interest rates, a positive gap tends to result in an increase in net interest
income while a negative gap tends to adversely affect net interest income. 25




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##### Table of Contents



The following table shows the interest rate sensitivity gap for four different
time intervals as of September 30, 2004. Certain assumptions regarding
prepayment and withdrawal rates made are based upon the Corporations
historical experience and management believes such assumptions are reasonable. Amounts Maturing or Repricing as of September 30, 2004Within
    
    Six to Twelve
    
    One to Five
    
    OverSix Months
    
    Months
    
    Years
    
    Five Years
    
    Total(Dollars in Thousands)Interest-earning assets:Fixed-rate mortgage loans
    
    $
    142,875
    
    
    $
    60,086
    
    
    $
    278,875
    
    
    $
    12,319
    
    
    $
    494,155Adjustable-rate mortgage loans
    
    
    161,791
    
    
    
    11,802
    
    
    
    12,629
    
    
    
    0
    
    
    
    186,222Total mortgage loans
    
    
    304,666
    
    
    
    71,888
    
    
    
    291,504
    
    
    
    12,319
    
    
    
    680,377Commercial business loans
    
    
    109,613
    
    
    
    35,469
    
    
    
    92,963
    
    
    
    6,750
    
    
    
    244,795Consumer loans
    
    
    16,508
    
    
    
    6,674
    
    
    
    24,654
    
    
    
    1,162
    
    
    
    48,998Home equity loans
    
    
    24,960
    
    
    
    0
    
    
    
    106
    
    
    
    0
    
    
    
    25,066Other loans
    
    
    5,121
    
    
    
    513
    
    
    
    1,663
    
    
    
    966
    
    
    
    8,263Mortgage-related securities
    
    
    18,268
    
    
    
    11,991
    
    
    
    60,733
    
    
    
    10,264
    
    
    
    101,256Fixed rate investment securities and other
    
    
    3,442
    
    
    
    2,639
    
    
    
    19,694
    
    
    
    49,011
    
    
    
    74,786Variable rate investment securities and other
    
    
    25,278
    
    
    
    0
    
    
    
    0
    
    
    
    0
    
    
    
    25,278Total interest-earning assets
    
    $
    507,856
    
    
    $
    129,174
    
    
    $
    491,317
    
    
    $
    80,472
    
    
    $
    1,208,819Interest-bearing liabilities:DepositsTime deposits
    
    $
    169,837
    
    
    $
    94,545
    
    
    $
    112,019
    
    
    $
    168
    
    
    $
    376,569NOW accounts
    
    
    5,329
    
    
    
    5,329
    
    
    
    53,287
    
    
    
    24,867
    
    
    
    88,812Savings accounts
    
    
    11,074
    
    
    
    8,473
    
    
    
    84,726
    
    
    
    39,543
    
    
    
    143,816Money market accounts
    
    
    34,653
    
    
    
    14,660
    
    
    
    146,600
    
    
    
    68,413
    
    
    
    264,326Short-term borrowings
    
    
    56,554
    
    
    
    0
    
    
    
    0
    
    
    
    0
    
    
    
    56,554Long-term borrowings
    
    
    3,850
    
    
    
    20,859
    
    
    
    83,111
    
    
    
    4,647
    
    
    
    112,467Subordinated debentures
    
    
    28,352
    
    
    
    0
    
    
    
    0
    
    
    
    18,042
    
    
    
    46,394Total interest-bearing liabilities
    
    $
    309,649
    
    
    $
    143,866
    
    
    $
    479,743
    
    
    $
    155,680
    
    
    $
    1,088,938Interest-earning assets less
interest-bearing liabilities
    
    $
    198,207
    
    
    ($
    14,692
    )
    
    $
    11,574
    
    
    ($
    75,208
    )
    
    $
    119,881Cumulative interest rate sensitivity gap
    
    $
    198,207
    
    
    $
    183,515
    
    
    $
    195,089
    
    
    $
    119,881Cumulative interest rate sensitivity gap as a
percentage of total assets
    
    
    14.98
    %
    
    
    13.87
    %
    
    
    14.74
    %
    
    
    9.06
    %
 At September 30, 2004, the Corporations cumulative interest-rate sensitive gap
as a percentage of total assets was a positive 14.98% for six months and a
positive 13.87% for one-year maturities. Therefore, we are positively gapped
at one year and may benefit from rising interest rates. Certain shortcomings are inherent in the method of analysis presented in the
above schedule. For example, although certain assets and liabilities may have
similar maturities or periods of repricing, they may react in different degrees
to changes in market interest rates. Also, the interest rates on certain types
of assets and liabilities may fluctuate in advance of changes in market
interest rates, while interest rates on other types may lag behind changes in
market rates. Additionally, certain assets, such as adjustable rate mortgage
loans, have features that restrict changes in interest rates, on a short-term
basis over the life of the asset. Further, in the event of a change in
interest rates, prepayment and early withdrawal levels would likely deviate
significantly from those assumed in calculating the schedule. 26




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##### Table of Contents



Forward-Looking Statements When used in this Quarterly Report on Form 10-Q and in other filings with the
Securities and Exchange Commission, in press releases or other public
shareholder communications, or in oral statements made with the approval of an
authorized executive officer, the words or phrases believe, will likely
result, are expected to, will continue, is anticipated, estimate,
project, plans, or similar expressions are intended to identify
forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995. You are cautioned not to place undue reliance on
any forward-looking statements, which speak only as of the date made. These
statements may relate to our future financial performance, strategic plans or
objectives, revenues or earnings projections, or other financial items. By
their nature, these statements are subject to numerous uncertainties that could
cause actual results to differ materially from those anticipated in the
statements. Important factors that could cause actual results to differ materially from the
results anticipated or projected include, but are not limited to, the
following: (1) the credit risks of lending activities, including changes in the
level and direction of loan delinquencies and writeoffs; (2) changes in
managements estimate of the adequacy of the allowance for loan losses; (3)
competitive pressures among depository institutions; (4) interest rate
movements and their impact on customer behavior and our net interest margin;
(5) the impact of repricing and competitors pricing initiatives on loan and
deposit products; (6) our ability to adapt successfully to technological
changes to meet customers needs and developments in the market place; (7) our
ability to access cost-effective funding; (8) changes in financial markets and
general economic conditions; (9) new legislation or regulatory changes; (10)
changes in accounting principles, policies or guidelines; and (11) the result
of the Corporations discussions with WDR. We do not undertake any obligation to update any forward-looking statement to
reflect circumstances or events that occur after the date on which the
forward-looking statement is made. 
 Item 3. Quantitative and Qualitative Disclosure About Market Risk The Corporation has not experienced any material changes to its market risk
position since December 31, 2003, from that disclosed in the Corporations 2003
Form 10-K Annual Report. 27




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##### Table of Contents



Item 4. Controls and Procedures As of the end of the period covered by this report, the Corporations Chairman
of the Board and Principal Executive Officer and the Corporations Chief
Financial Officer carried out an evaluation, with the participation of other
members of management as they deemed appropriate, of the effectiveness of the
design and operation of the Corporations disclosure controls and procedures as
contemplated by Exchange Act Rule 13a-15. Based upon, and as of the date of
that evaluation, the Chairman of the Board and Principal Executive Officer and
the Chief Financial Officer concluded that the Corporations disclosure
controls and procedures are effective, in all material respects, in timely
alerting them to material information relating to the Corporation (and its
consolidated subsidiaries) required to be included in the periodic reports the
Corporation is required to file and submit to the SEC under the Exchange Act.
It should be noted that in designing and evaluating the disclosure controls and
procedures, management recognized that any controls and procedures, no matter
how well designed and operated, can provide only reasonable assurance of
achieving the desired control objectives, and management necessarily was
required to apply its judgment in evaluating the cost-benefit relationship of
possible controls and procedures. The Corporation has designed its disclosure
controls and procedures to reach a level of reasonable assurance of achieving
the desired control objectives and, based on the evaluation described above,
the Corporations Chairman of the Board and Principal Executive Officer and the
Corporations Chief Financial Officer concluded that the Corporations
disclosure controls and procedures were effective at reaching that level of
reasonable assurance. There was no change in the Corporations internal control over financial
reporting during the Corporations most recently completed fiscal quarter that
has materially affected, or is reasonably likely to materially affect, the
Corporations internal control over financial reporting. 28




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##### Table of Contents



Part II. Other Information 
 Item 1. Legal Proceedings As of September 30, 2004 there were no material pending legal
proceedings, other than ordinary routine litigation incidental to
the business of the Corporation, to which the Corporation or any
of its subsidiaries was a party or to which any of their property
was subject. Item 2. Unregistered Sales of Equity Securities and Use of Proceeds  NONE Item 3. Defaults upon Senior Securities  NONE Item 4 Submission of Matters to Vote of Security Holders  NONE Item 5 Other Information  NONE Item 6. Exhibits The following exhibits are filed as part of this report: EXHIBIT 10.1
    
    Employment Agreement with Jeffrey A. MuellerEXHIBIT 10.2
    
    Consulting Agreement with Harold J. MuellerEXHIBIT 31.1
    
    Certification pursuant to Section 302 of the Sarbanes-Oxley Act of
2002 by the Principal Executive OfficerEXHIBIT 31.2
    
    Certification pursuant to Section 302 of the Sarbanes-Oxley Act of
2002 by the Chief Financial OfficerEXHIBIT 32.1*
    
    Certification pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002 by the Principal Executive OfficerEXHIBIT 32.2*
    
    Certification pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002 by the Chief Financial Officer
   *These certifications are not filed for purposes of Section 18 of the
Securities Exchange Act of 1934, as amended, or incorporated by reference into
any filing under the Securities Act of 1933, as amended, or the Securities
Exchange Act of 1934, as amended. 29




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##### Table of Contents



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. MERCHANTS AND MANUFACTURERSBANCORPORATION, INC.(Registrant)Date November 9, 2004.
    
    /s/ Michael J. MurryMichael J. MurryChairman of the Board of Directorsand Principal Executive OfficerDate November 9, 2004.
    
    /s/ James C. MroczkowskiJames C. MroczkowskiExecutive Vice President & ChiefFinancial OfficerPrincipal Financial Officer
 30




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##### Table of Contents



10-Q EXHIBIT LIST EXHIBIT NO.
    
    DESCRIPTIONEXHIBIT 10.1
    
    Employment Agreement with Jeffrey A. MuellerEXHIBIT 10.2
    
    Consulting Agreement with Harold J. MuellerEXHIBIT 31.1
    
    Certification pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002 by the Principal Executive OfficerEXHIBIT 31.2
    
    Certification pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002 by the Chief Financial OfficerEXHIBIT 32.1*
    
    Certification pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002 by the Principal Executive OfficerEXHIBIT 32.2*
    
    Certification pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002 by the Chief Financial Officer
   *These certifications are not filed for purposes of Section 18 of the
Securities Exchange Act of 1934, as amended, or incorporated by reference into
any filing under the Securities Act of 1933, as amended, or the Securities
Exchange Act of 1934, as amended. 31