Quarterly Report (10-q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the quarterly period ended September 30, 2017

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

Commission File Number: 001-36528

BANK MUTUAL CORPORATION

(Exact name of registrant as specified in its charter)

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

4949 West Brown Deer Road

Milwaukee, Wisconsin 53223

(414) 354-1500

(Address, including Zip Code, and telephone number,

including area code, of registrant’s principal executive offices)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to such filing requirements for the past 90 days.

Yes

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files.)

Yes

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

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

If an emerging growth company, indicate by check mark if the registrant has elected to not use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨

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

Yes

The number of shares outstanding of the issuer’s common stock, $0.01 par value per share, was 46,009,090 shares, at November 7, 2017.

BANK MUTUAL CORPORATION

FORM 10-Q QUARTERLY REPORT

Table of Contents

Item		Page

PART I

Item l.	Financial Statements

	Unaudited Condensed Consolidated Statements of Financial Condition as of September 30, 2017, and December 31, 2016	3

	Unaudited Condensed Consolidated Statements of Income for the Three and Nine Months Ended September 30, 2017 and 2016	4

	Unaudited Condensed Consolidated Statements of Total Comprehensive Income for the Three and Nine Months Ended September 30, 2017 and 2016	6

	Unaudited Condensed Consolidated Statements of Equity for the Nine Months Ended September 30, 2017 and 2016	7

	Unaudited Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2017 and 2016	8

	Notes to Unaudited Condensed Consolidated Financial Statements	9

Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	33

Item 3.	Quantitative and Qualitative Disclosures about Market Risk	47

Item 4.	Controls and Procedures	50

PART II

Item 1	Legal Proceedings	51

Item 1A.	Risk Factors	51

Item 6.	Exhibits	51

SIGNATURES		52

PART I

Item 1. Financial Statements

Bank Mutual Corporation and Subsidiaries

Unaudited Condensed Consolidated Statements of Financial Condition

	September 30			December 31
	2017			2016
	(Dollars in thousands)
Assets
Cash and due from banks	$	27,695		$	31,284
Interest-earning deposits		27,837			18,803
Cash and cash equivalents		55,532			50,087
Mortgage-related securities available-for-sale, at fair value		386,481			371,880
Mortgage-related securities held-to-maturity, at amortized cost (fair value of $92,561 in 2017 and $94,266 in 2016)		91,617			93,234
Loans held-for-sale		4,026			5,952
Loans receivable (net of allowance for loan losses of $21,326 in 2017 and $19,940 in 2016)		1,984,823			1,942,907
Mortgage servicing rights, net		6,278			6,569
Other assets		164,917			177,895

Total assets	$	2,693,674		$	2,648,524

Liabilities and shareholders’ equity

Liabilities:
Deposit liabilities	$	1,924,552		$	1,864,730
Borrowings		408,022			439,150
Advance payments by borrowers for taxes and insurance		30,458			4,770
Other liabilities		38,292			53,233
Total liabilities		2,401,324			2,361,883
Shareholders’ equity:
Preferred stock–$0.01 par value:
Authorized–20,000,000 shares in 2017 and 2016 Issued and outstanding–none in 2017 and 2016		–			–
Common stock–$0.01 par value:
Authorized–200,000,000 shares in 2017 and 2016 Issued–78,783,849 shares in 2017 and 2016
Outstanding–45,938,464 shares in 2017 and 45,691,790 in 2016		788			788
Additional paid-in capital		483,592			484,940
Retained earnings		175,731			171,633
Accumulated other comprehensive loss		(11,234	)		(11,139	)
Treasury stock–32,845,385 shares in 2017 and 33,092,059 in 2016		(356,527	)		(359,581	)
Total shareholders’ equity		292,350			286,641

Total liabilities and shareholders’ equity	$	2,693,674		$	2,648,524

Refer to Notes to Unaudited Condensed Consolidated Financial Statements

Bank Mutual Corporation and Subsidiaries

Unaudited Condensed Consolidated Statements of Income

	Three Months Ended September 30
	2017			2016
	*(Dollars in thousands,* *except per share data)*
Interest income:
Loans	$	20,557		$	18,209
Mortgage-related securities		2,483			3,139
Investment securities		163			117
Interest-earning deposits		25			5
Total interest income		23,228			21,470
Interest expense:
Deposit liabilities		1,773			1,468
Borrowings		1,767			1,290
Total interest expense		3,540			2,758
Net interest income		19,688			18,712
Provision for loan losses		472			1,395
Net interest income after provision for loan losses		19,216			17,317
Non-interest income:
Deposit-related fees and charges		2,935			2,991
Mortgage banking revenue, net		788			1,354
Brokerage, advisory, and insurance revenue		824			816
Loan-related fees		381			1,136
Income from bank-owned life insurance (“BOLI”)		442			460
Gain on real estate held for investment		56			12
Net loss on sale of retail branch offices, loans. and deposits		(197	)		–
Other non-interest income		26			98
Total non-interest income		5,255			6,867
Non-interest expense:
Compensation, payroll taxes, and other employee benefits		10,619			10,452
Occupancy, equipment, and data processing costs		3,428			3,317
Advertising and marketing		535			737
Federal insurance premiums		350			273
Losses and expenses on foreclosed real estate, net		15			169
Merger-related expenses		1,263			–
Other non-interest expense		2,169			2,298
Total non-interest expense		18,379			17,246
Income before income taxes		6,092			6,938
Income tax expense		2,250			2,484

Net income	$	3,842		$	4,454

Per share data:
Earnings per share–basic	$	0.08		$	0.10
Earnings per share–diluted	$	0.08		$	0.10
Cash dividends per share paid	$	0.055		$	0.055

Refer to Notes to Unaudited Condensed Consolidated Financial Statements

Bank Mutual Corporation and Subsidiaries

Unaudited Condensed Consolidated Statements of Income

	Nine Months Ended September 30
	2017			2016
	(Dollars in thousands, except per share data)
Interest income:
Loans	$	58,725		$	52,505
Mortgage-related securities		7,503			9,122
Investment securities		452			338
Interest-earning deposits		52			23
Total interest income		66,732			61,988
Interest expense:
Deposit liabilities		4,770			4,319
Borrowings		4,679			3,790
Advance payment by borrowers for taxes and insurance		1			1
Total interest expense		9,450			8,110
Net interest income		57,282			53,878
Provision for loan losses		1,552			1,986
Net interest income after provision for loan losses		55,730			51,892
Non-interest income:
Deposit-related fees and charges		8,492			8,685
Mortgage banking revenue, net		2,401			3,321
Brokerage, advisory, and insurance revenue		2,362			2,529
Loan-related fees		1,483			4,001
Income from bank-owned life insurance (“BOLI”)		1,317			1,387
Gain on real estate held for investment		325			12
Net loss on sale of retail branch offices, loans, and deposits		(197	)		–
Other non-interest income		181			186
Total non-interest income		16,364			20,121
Non-interest expense:
Compensation, payroll taxes, and other employee benefits		32,521			31,155
Occupancy, equipment, and data processing costs		10,657			10,133
Advertising and marketing		1,829			2,292
Federal insurance premiums		1,029			1,078
Losses and expenses on foreclosed real estate, net		286			80
Merger-related expenses		1,263			–
Other non-interest expense		6,350			6,993
Total non-interest expense		53,935			51,731
Income before income taxes		18,159			20,282
Income tax expense		6,485			7,406

Net income	$	11,674		$	12,876

Per share data:

Earnings per share–basic	$	0.25		$	0.28
Earnings per share–diluted	$	0.25		$	0.28
Cash dividends per share paid	$	0.165		$	0.160

Refer to Notes to Unaudited Condensed Consolidated Financial Statements

Bank Mutual Corporations and Subsidiaries

Unaudited Condensed Consolidated Statements of Total Comprehensive Income

	Three Months Ended September 30
	2017			2016
	(Dollars in thousands)

Net income	$	3,842		$	4,454
Other comprehensive income (loss), net of tax:
Change in net unrealized gain on securities available-for-sale, net of deferred income taxes of $(52) in 2017 and $(539) in 2016		(78	)		(805	)
Change in net unrealized loss on interest rate swaps, net of deferred income taxes of $0 in 2017 and $57 in 2016		-			84
Amortization of net prior service costs and unrecognized loss included in net periodic benefit cost, net of deferred income taxes of $36 in 2017 and $34 in 2016		54			51
Total other comprehensive income (loss), net of tax		(24	)		(670	)

Total comprehensive income	$	3,818		$	3,784

	Nine Months Ended September 30
	2017			2016
	(Dollars in thousands)

Net income	$	11,674		$	12,876
Other comprehensive income (loss), net of tax:
Change in net unrealized gain (loss) on securities available-for-sale, net of deferred income taxes of $(162) in 2017 and $1,599 in 2016		(242	)		2,386
Change in net unrealized loss on interest rate swaps, net of deferred income taxes of $(11) in 2017 and $(76) in 2016		(17	)		(114	)
Amortization of net prior service costs and unrecognized loss included in net periodic benefit cost, net of deferred income taxes of $109 in 2017 and $101 in 2016		164			152
Total other comprehensive income (loss), net of tax		(95	)		2,424

Total comprehensive income	$	11,579		$	15,300

Refer to Notes to Unaudited Condensed Consolidated Financial Statements

Bank Mutual Corporations and Subsidiaries

Unaudited Condensed Consolidated Statements of Equity

									Accumulated
			Additional						Other
	Common		Paid-In			Retained			Comprehensive			Treasury
	Stock		Capital			Earnings			Income (Loss)			Stock			Total
	(Dollars in thousands, except per share data)

Balance at January 1, 2017	$	788	$	484,940		$	171,633		$	(11,139	)	$	(359,581	)	$	286,641
Net income		–		–			11,674			–			–			11,674
Other comprehensive loss		–		–			–			(95	)		–			(95	)
Issuance of restricted stock		–		(1,487	)		–			–			1,487			–
Exercise of stock options		–		(1,105	)		–			–			1,567			462
Share based payments		–		1,244			–			–			–			1,244
Cash dividends ($0.165 per share)		–		–			(7,576	)		–			–			(7,576	)

Balance at September 30, 2017	$	788	$	483,592		$	175,731		$	(11,234	)	$	(356,527	)		292,350

Balance at January 1, 2016	$	788	$	486,273		$	164,482		$	(9,365	)	$	(362,784	)	$	279,394
Net income		–		–			12,876			–			–			12,876
Other comprehensive income		–		–			–			2,424			–			2,424
Purchase of treasury stock		–		–			–			–			(221	)		(221	)
Issuance of restricted stock		–		(1,469	)		–			–			1,469			–
Exercise of stock options		–		(1,029	)		–			–			1,707			678
Share based payments		–		1,013			–			–			–			1,013
Cash dividends ($0.16 per share)		–		–			(7,291	)		–			–			(7,291	)

Balance at September 30, 2016	$	788	$	484,788		$	170,067		$	(6,941	)	$	(359,829	)	$	288,873

Refer to Notes to Unaudited Condensed Consolidated Financial Statements

Bank Mutual Corporation and Subsidiaries

Unaudited Condensed Consolidated Statements of Cash Flows

	Nine Months Ended September 30
	2017			2016
	(Dollars in thousands)
Operating activities:
Net income	$	11,674		$	12,876
Adjustments to reconcile net income to net cash from operating activities:
Provision for loan losses		1,552			1,986
Provision for depreciation		2,446			2,527
Amortization of mortgage servicing rights		1,100			1,636
Net premium amortization on securities		1,791			2,039
Loans originated for sale		(64,532	)		(112,500	)
Proceeds from loan sales		67,311			109,816
Gain on loan sales activities, net		(1,662	)		(3,042	)
Deferred income tax expense (benefit)		(183	)		2,956
Gain on real estate held for investment		(325	)		(12	)
Net loss on sale of retail branch offices, loans, and deposits		197			–
Other, net		(11,707	)		(10,244	)
Net cash provided by operating activities		7,662			8,038
Investing activities:
Principal repayments on mortgage-related securities available-for-sale		83,020			86,977
Principal repayments on mortgage-related securities held-to-maturity		1,374			17,493
Purchases of mortgage-related securities available-for-sale		(99,574	)		(56,137	)
Purchases of FHLB of Chicago stock		(17,471	)		(1,614	)
Redemptions of FHLB of Chicago stock		19,371			–
Net increase in loans receivable		(44,179	)		(188,675	)
Proceeds from sale of foreclosed properties		2,754			2,048
Proceeds from sale of real estate held for investment		1,020			–
Net (purchases) dispositions of premises and equipment		4,200			(1,339	)
Net cash used by investing activities		(49,485	)		(141,247	)
Financing activities:
Net increase in deposit liabilities		59,822			71,524
Net increase in short-term borrowings		15,000			115,000
Repayments of long-term borrowings		(46,128	)		(72,011	)
Net increase in advance payments by borrowers for taxes and insurance		25,688			26,837
Cash dividends		(7,576	)		(7,291	)
Purchases of treasury stock		–			(221	)
Other, net		462			678
Net cash provided by financing activities		47,268			134,516
Increase in cash and cash equivalents		5,445			1,307
Cash and cash equivalents at beginning of period		50,087			44,501
Cash and cash equivalents at end of period	$	55,532		$	45,808
Supplemental information:
Cash paid in period for:
Interest on deposit liabilities and borrowings	$	9,591		$	8,035
Income taxes		5,795			4,278
Non-cash transactions:
Loans transferred to foreclosed properties and repossessed assets		711			1,252

Refer to Notes to Unaudited Condensed Consolidated Financial Statement

Bank Mutual Corporation and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements

September 30, 2017

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

Basis of Presentation

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

The accompanying Unaudited Condensed Consolidated Financial Statements have been prepared in accordance with United States generally accepted accounting principles (“GAAP”) for interim financial information, Rule 10-01 of Regulation S-X, and the instructions to Form 10-Q. The financial statements do not include all of the information and footnotes required by GAAP for complete financial information. However, in the opinion of management, all adjustments (consisting of normal recurring entries) necessary for a fair presentation of operations, cash flows, and financial position have been included in the accompanying financial statements. This report should be read in conjunction with the Company’s 2016 Annual Report on Form 10-K. Operating results for the three and nine months ended September 30, 2017, are not necessarily indicative of the results that may be expected for the full year ending December 31, 2017.

In 2014 the Financial Accounting Standards Board (“FASB”) issued new accounting guidance related to the recognition of revenue from contracts with customers. In 2015 the FASB deferred the effective date one year from the date in the original guidance. The guidance is effective for fiscal years and interim periods beginning after December 15, 2017, which will be the first quarter of 2018 for the Company. The Company’s adoption of this item is not expected to have a material impact on its results of operations or financial condition.

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

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

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

In 2017 the FASB issued new accounting guidance related to the accounting for premiums on purchased callable debt securities. For the Company this guidance is effective for periods beginning after December 15, 2018, which will be the first quarter of 2019. The Company’s adoption of this item is not expected to have a material impact on its results of operations or financial condition.

In 2017 the FASB issued new accounting guidance related to improving the presentation of net periodic pension costs and net periodic postretirement benefit costs. For the Company this guidance is effective for periods beginning after December 15, 2017, which will be the first quarter of 2018. The Company’s adoption of this item is not expected to have a material impact on its results of operations or financial condition.

In 2017 the FASB issued new accounting guidance related to the accounting for modifications of share-based payment awards. For the Company this guidance is effective for periods beginning after December 15, 2017, which will be the first quarter of 2018. The Company’s adoption of this item is not expected to have a material impact on its results of operations or financial condition.

Bank Mutual Corporation and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements

September 30, 2017

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

Basis of Presentation (continued)

In 2017 the FASB issued new accounting guidance related to improving the accounting for hedging activities. For the Company this guidance is effective for periods beginning after December 15, 2018, which will be the first quarter of 2019. The Company’s adoption of this item is not expected to have a material impact on its results of operations, financial condition, or other comprehensive income.

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

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

	September 30, 2017
			Gross		Gross			Estimated
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value
Securities available-for-sale:
Federal Home Loan Mortgage Corporation	$	185,816	$	510	$	(877	)	$	185,449
Federal National Mortgage Association		175,284		374		(928	)		174,730
Government National Mortgage Association		13,823		3		(143	)		13,683
Private-label CMOs		12,488		219		(88	)		12,619
Total available-for-sale	$	387,411	$	1,106	$	(2,036	)	$	386,481
Securities held-to-maturity:
Federal National Mortgage Association	$	91,617	$	944		–		$	92,561
Total held-to-maturity	$	91,617	$	944		–		$	92,561

	December 31, 2016
			Gross		Gross			Estimated
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value
Securities available-for-sale:
Federal Home Loan Mortgage Corporation	$	187,958	$	929	$	(1,049	)	$	187,838
Federal National Mortgage Association		162,936		759		(1,085	)		162,610
Government National Mortgage Association		5,279		3		(80	)		5,202
Private-label CMOs		16,233		220		(223	)		16,230
Total available-for-sale	$	372,406	$	1,911	$	(2,437	)	$	371,880
Securities held-to-maturity:
Federal National Mortgage Association	$	93,234	$	1,032		–		$	94,266
Total held-to-maturity	$	93,234	$	1,032		–		$	94,266

Bank Mutual Corporation and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements

September 30, 2017

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

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

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

	September 30, 2017
	Less Than 12 Months						Greater Than 12 Months
	in an Unrealized Loss Position						in an Unrealized Loss Position						Gross		Total
	Unrealized Loss Amount		Number of Securities		Estimated Fair Value		Unrealized Loss Amount		Number of Securities		Estimated Fair Value		Unrealized Loss Amount		Estimated Fair Value
Securities available-for-sale:
Federal Home Loan Mortgage Corporation	$	825		36	$	122,852	$	52		3	$	3,715	$	877	$	126,567
Federal National Mortgage Association		479		31		84,129		449		7		17,866		928		101,995
Government National Mortgage Association		143		6		13,665		–		–		–		143		13,665
Private-label CMOs		11		1		656		77		8		5,753		88		6,409
Total available-for-sale	$	1,458		74	$	221,302	$	578		18	$	27,334	$	2,036	$	248,636

	December 31, 2016
	Less Than 12 Months						Greater Than 12 Months
	in an Unrealized Loss Position						in an Unrealized Loss Position						Gross		Total
	Unrealized Loss Amount		Number of Securities		Estimated Fair Value		Unrealized Loss Amount		Number of Securities		Estimated Fair Value		Unrealized Loss Amount		Estimated Fair Value
Securities available-for-sale:
Federal Home Loan Mortgage Corporation	$	459		14	$	35,938	$	590		17	$	75,151	$	1,049	$	111,089
Federal National Mortgage Association		345		11		33,559		740		17		58,366		1,085		91,925
Government National Mortgage Association		80		2		5,182		–		–		–		80		5,182
Private-label CMOs		18		2		2,398		205		11		9,286		223		11,684
Total available-for-sale	$	902		29	$	77,077	$	1,535		45	$	142,803	$	2,437	$	219,880

The Company determined that the unrealized losses on its mortgage-related securities were temporary as of September 30, 2017, and December 31, 2016. The Company does not intend to sell these securities and it is unlikely that it will be required to sell these securities before the recovery of their amortized cost. The Company believes it is probable that it will receive all future contractual cash flows related to these securities. This determination was based on management’s judgment regarding the nature of the loan collateral that supports the securities, a review of the current ratings issued on the securities by various credit rating agencies, recent trends in the fair market values of the securities and, in the case of private-label collateralized mortgage obligations (“CMOs”), a review of the actual delinquency and/or default performance of the loan collateral that supports the securities.

As of September 30, 2017, and December 31, 2016, the Company had private-label CMOs, with a fair value of $8,911 and $11,625, respectively, and unrealized gains of $138 and $37, respectively, that were rated less than investment grade. These private-label CMOs were analyzed using modeling techniques that considered the priority of cash flows in the CMO structure and various default and loss rate scenarios that management considered appropriate given the nature of the loan collateral.

Bank Mutual Corporation and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements

September 30, 2017

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

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

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

	Three Months Ended September 30						Nine Months Ended September 30
	2017			2016			2017			2016
Beginning balance of unrealized OTTI related to credit losses	$	369		$	522		$	460		$	592
Reductions for increase in cash flows expected to be received		(1	)		(31	)		(92	)		(101	)
Ending balance of unrealized OTTI related to credit losses	$	368		$	491		$	368		$	491
Adjusted cost at end of period	$	2,648		$	3,653		$	2,648		$	3,653
Estimated fair value at end of period	$	2,836		$	3,922		$	2,836		$	3,922

Results of operations included no gross realized gains or losses on the sale of securities during the three and nine months ended September 30, 2017 or 2016.

Mortgage-related securities available-for-sale with a fair value of approximately $37,741 and $44,155 at September 30, 2017, and December 31, 2016, respectively, were pledged to secure deposits, borrowings, and for other purposes as permitted or required by law.

Bank Mutual Corporation and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements

September 30, 2017

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

Loans Receivable

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

	September 30			December 31
	2017			2016
Commercial loans:
Commercial and industrial	$	272,283		$	241,689
Commercial real estate		359,168			375,459
Multi-family real estate		569,739			506,136
Construction and development loans:
Commercial real estate		27,229			34,125
Multi-family real estate		219,568			328,186
Land and land development		10,077			12,484
Total construction and development		256,874			374,795
Total commercial loans		1,458,064			1,498,079
Retail loans:
One- to four-family first mortgages:
Permanent		460,907			457,014
Construction		54,686			42,961
Total one- to four-family first mortgages		515,593			499,975
Home equity loans:
Fixed term home equity		96,009			105,544
Home equity lines of credit		63,898			70,043
Total home equity loans		159,907			175,587
Other consumer loans:
Student		5,995			6,810
Other		10,724			11,373
Total other consumer loans		16,719			18,183
Total retail loans		692,219			693,745
Gross loans receivable		2,150,283			2,191,824
Undisbursed loan proceeds		(142,824	)		(227,537	)
Allowance for loan losses		(21,326	)		(19,940	)
Deferred fees and costs, net		(1,310	)		(1,440	)
Total loans receivable, net	$	1,984,823		$	1,942,907

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

At September 30, 2017, and December 31, 2016, certain one- to four-family mortgage loans, multi-family mortgage loans, and home equity loans with aggregate carrying values of approximately $544,000 and $586,000 were pledged to secure advances from the Federal Home Loan Bank (“FHLB”) of Chicago.

The unpaid principal balance of loans serviced for others was $957,819 and $996,985 at September 30, 2017, and December 31, 2016, respectively. These loans are not reflected in the consolidated financial statements.

Bank Mutual Corporation and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements

September 30, 2017

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

Loans Receivable (continued)

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

	At or for the Nine Months Ended September 30, 2017
	Commercial and Industrial			Commercial Real Estate		Multi- Family Real Estate		Construction and Development			One- to Four- Family			Home Equity and Other Consumer			Total
Allowance for loan losses:
Beginning balance	$	3,840		$	4,630	$	5,307	$	2,680		$	2,518		$	965		$	19,940
Provision (recovery)		1,198			223		853		(768	)		7			39			1,552
Charge-offs		(31	)		–		–		–			(55	)		(295	)		(381	)
Recoveries		–			13		32		–			67			103			215
Ending balance	$	5,007		$	4,866	$	6,192	$	1,912		$	2,537		$	812		$	21,326
Loss allowance individually evaluated for impairment		–		$	130		–		–		$	2		$	45		$	177
Loss allowance collectively evaluated for impairment	$	5,007		$	4,736	$	6,192	$	1,912		$	2,535		$	767		$	21,149

Loan receivable balances at the end of the period:
Loans individually evaluated for impairment	$	8,367		$	11,094	$	3,808	$	1,001		$	3,687		$	230		$	28,187
Loans collectively evaluated for impairment		263,916			348,074		565,931		149,319			475,636			176,396			1,979,272
Total loans receivable	$	272,283		$	359,168	$	569,739	$	150,320		$	479,323		$	176,626		$	2,007,459

	At or for the Nine Months Ended September 30, 2016
	Commercial and Industrial		Commercial Real Estate			Multi- Family Real Estate		Construction and Development			One- to Four- Family			Home Equity and Other Consumer			Total
Allowance for loan losses:
Beginning balance	$	3,658	$	4,796		$	3,337	$	2,835		$	1,835		$	1,180		$	17,641
Provision (recovery)		166		(608	)		2,112		(48	)		291			73			1,986
Charge-offs		–		(179	)		–		–			(84	)		(334	)		(597	)
Recoveries		5		28			30		–			42			67			172
Ending balance	$	3,829	$	4,037		$	5,479	$	2,787		$	2,084		$	986		$	19,202
Loss allowance individually evaluated for impairment	$	167		–			–	$	1		$	11		$	44		$	223
Loss allowance collectively evaluated for impairment	$	3,662	$	4,037		$	5,479	$	2,786		$	2,073		$	942		$	18,979

Loan receivable balances at the end of the period:
Loans individually evaluated for impairment	$	5,658	$	6,250		$	3,957	$	1,889		$	4,616		$	644		$	23,014
Loans collectively evaluated for impairment		224,456		358,101			521,782		146,802			472,735			199,585			1,923,461
Total loans receivable	$	230,114	$	364,351		$	525,739	$	148,691		$	477,351		$	200,229		$	1,946,475

The Company adjusts certain factors used to determine the allowance for loan losses on loans that are collectively evaluated for impairment. Management considered these adjustments necessary and prudent in light of trends in net charge-offs, real estate values, economic conditions, and unemployment. The Company estimates that these changes, as well as overall changes in the balance of loans to which these factors were applied, resulted in an increase in the total allowance for loan losses of $399 and $1,367 during the three and nine months ended September 30, 2017, and of $1,213 and $1,873 during the three and nine months ended September 30, 2016.

Bank Mutual Corporation and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements

September 30, 2017

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

Loans Receivable (continued)

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

	September 30, 2017
	Loans Receivable Balance, Net		Unpaid Principal Balance		Related Allowance for Loss		Average Loan Receivable Balance, Net		Interest Income Recognized
Impaired loans with an allowance recorded:
Commercial and industrial:
Term loans		–		–		–		–		–
Lines of credit		–		–		–		–		–
Total commercial and industrial		–		–		–		–		–
Commercial real estate:
Office		–		–		–		–		–
Retail/wholesale/mixed	$	715	$	729	$	130	$	456	$	20
Industrial/warehouse		–		–		–		–		–
Other		–		–		–		–		–
Total commercial real estate		715		729		130		456		20
Multi-family real estate		–		–		–		–		–
Construction and development:
Commercial real estate		–		–		–		–		–
Multi-family real estate		–		–		–		–		–
Land and land development		–		–		–		–		–
Total construction and development		–		–		–		–		–
One- to four-family		1,277		1,277		2		1,884		–
Home equity and other consumer:
Home equity		151		151		45		122		–
Student		–		–		–		–		–
Other		–		–		–		–		–
Total home equity and other consumer		151		151		45		122		–
Total with an allowance recorded	$	2,143	$	2,157	$	177	$	2,462	$	20

Impaired loans with no allowance recorded:
Commercial and industrial:
Term loans	$	3	$	53		–	$	47		–
Lines of credit		400		431		–		475		22
Total commercial and industrial		403		484		–		522		22
Commercial real estate:
Office		2,428		3,003		–		2,244		130
Retail/wholesale/mixed		812		1,536		–		884		72
Industrial/warehouse		174		265		–		200		7
Other		–		147		–		37		9
Total commercial real estate		3,414		4,951		–		3,365		218
Multi-family real estate		257		292		–		274		16
Construction and development:
Commercial real estate		–		–		–		–		–
Multi-family real estate		–		–		–		–		–
Land and land development		501		578		–		450		25
Total construction and development		501		578		–		450		25
One- to four-family		2,946		3,148		–		2,849		62
Home equity and other consumer:
Home equity		869		924		–		869		4
Student		–		–		–		–		–
Other		62		89		–		65		1
Total home equity and other consumer		931		1,013		–		934		5
Total with no allowance recorded	$	8,452	$	10,466		–	$	8,394	$	348

Bank Mutual Corporation and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements

September 30, 2017

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

Loans Receivable (continued)

	December 31, 2016
	Loans Receivable Balance, Net		Unpaid Principal Balance		Related Allowance for Loss		Average Loan Receivable Balance, Net		Interest Income Recognized
Impaired loans with an allowance recorded:
Commercial and industrial:
Term loans	$	354	$	360	$	96	$	144	$	20
Lines of credit		–		–		–		–		–
Total commercial and industrial		354		360		96		144		20
Commercial real estate:
Office		–		–		–		–		–
Retail/wholesale/mixed		–		–		–		–		–
Industrial/warehouse		–		–		–		–		–
Other		–		–		–		–		–
Total commercial real estate		–		–		–		–		–
Multi-family real estate		–		–		–		–		–
Construction and development:
Commercial real estate		–		–		–		–		–
Multi-family real estate		–		–		–		–		–
Land and land development		119		119		1		48		–
Total construction and development		119		119		1		48		–
One- to four-family		2,214		2,214		17		889		–
Home equity and other consumer:
Home equity		152		148		44		46		–
Student		–		–		–		–		–
Other		–		–		–		–		–
Total home equity and other consumer		152		148		44		46		–
Total with an allowance recorded	$	2,839	$	2,841	$	158	$	1,127	$	20

Impaired loans with no allowance recorded:
Commercial and industrial:
Term loans	$	67	$	103		–	$	94	$	3
Lines of credit		567		578		–		983		28
Total commercial and industrial		634		681		–		1,077		31
Commercial real estate:
Office		1,967		2,413		–		2,044		146
Retail/wholesale/mixed		691		1,381		–		1,348		96
Industrial/warehouse		181		265		–		188		14
Other		–		151		–		4		14
Total commercial real estate		2,839		4,210		–		3,584		270
Multi-family real estate		274		292		–		226		24
Construction and development:
Commercial real estate		–		–		–		–		–
Multi-family real estate		–		–		–		–		–
Land and land development		260		322		–		203		16
Total construction and development		260		322		–		203		16
One- to four-family		3,054		3,316		–		2,739		20
Home equity and other consumer:
Home equity		798		835		–		805		9
Student		–		–		–		–		–
Other		46		62		–		75		–
Total home equity and other consumer		844		897		–		880		9
Total with no allowance recorded	$	7,905	$	9,718		–	$	8,709	$	370

Bank Mutual Corporation and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements

September 30, 2017

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

Loans Receivable (continued)

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

	September 30, 2017
	Pass		Watch		Special Mention		Substandard		Total
Commercial and industrial:
Term loans	$	64,666	$	11,677	$	1,382	$	1,474	$	79,199
Lines of credit		155,816		14,631		15,744		6,893		193,084
Total commercial and industrial		220,482		26,308		17,126		8,367		272,283
Commercial real estate:
Office		109,627		12,954		–		3,353		125,934
Retail/wholesale/mixed use		136,086		1,874		15,167		2,760		155,887
Industrial/warehouse		43,094		19,372		4,228		4,981		71,675
Other		5,672		–		–		–		5,672
Total commercial real estate		294,479		34,200		19,395		11,094		359,168
Multi-family real estate		530,955		27,316		7,660		3,808		569,739
Construction and development:
Commercial real estate		10,804		1,842		–		–		12,646
Multi-family real estate		110,448		17,172		–		–		127,620
Land and land development		8,999		54		–		1,001		10,054
Total construction/development		130,251		19,068		–		1,001		150,320
One- to four-family		474,362		368		906		3,687		479,323
Home equity and other consumer:
Home equity		159,739		–		–		168		159,907
Student		5,995		–		–		–		5,995
Other		10,650		12		–		62		10,724
Total home equity and other consumer		176,384		12		–		230		176,626
Total	$	1,826,913	$	107,272	$	45,087	$	28,187	$	2,007,459

Bank Mutual Corporation and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements

September 30, 2017

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

Loans Receivable (continued)

	December 31, 2016
	Pass		Watch		Special Mention		Substandard		Total
Commercial and industrial:
Term loans	$	59,774	$	3,215	$	174	$	733	$	63,896
Lines of credit		139,517		22,806		11,356		4,114		177,793
Total commercial and industrial		199,291		26,021		11,530		4,847		241,689
Commercial real estate:
Office		119,792		4,549		14,379		2,703		141,423
Retail/wholesale/mixed use		141,223		11,639		14,847		3,913		171,622
Industrial/warehouse		42,921		7,242		4,976		576		55,715
Other		6,699		–		–		–		6,699
Total commercial real estate		310,635		23,430		34,202		7,192		375,459
Multi-family real estate		494,437		–		7,783		3,916		506,136
Construction and development:
Commercial real estate		15,232		1,200		–		–		16,432
Multi-family real estate		145,097		–		–		–		145,097
Land and land development		10,945		181		–		1,355		12,481
Total construction/development		171,274		1,381		–		1,355		174,010
One- to four-family		467,237		437		881		4,668		473,223
Home equity and other consumer:
Home equity		175,145		–		–		442		175,587
Student		6,810		–		–		–		6,810
Other		11,309		18		–		46		11,373
Total home equity and other consumer		193,264		18		–		488		193,770
Total	$	1,836,138	$	51,287	$	54,396	$	22,466	$	1,964,287

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

Loans rated “substandard” involve a distinct possibility that the Company could sustain some loss if deficiencies associated with the loan are not corrected. Loans rated “doubtful” indicate that full collection is highly questionable or improbable. The Company did not have any loans that were rated doubtful at September 30, 2017, or December 31, 2016. Loans rated substandard or doubtful that are also considered in management’s judgment to be impaired are generally analyzed individually to determine an appropriate allowance for loan loss. A loan rated “loss” is considered uncollectible, even if a partial recovery could be expected in the future. The Company generally charges off loans that are rated as a loss. As such, the Company did not have any loans that were rated loss at September 30, 2017, or December 31, 2016.

Bank Mutual Corporation and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements

September 30, 2017

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

Loans Receivable (continued)

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

	September 30, 2017
	Past Due Status												Total
	30-59 Days		60-89 Days		> 90 Days		Total Past Due		Total Current		Total Loans		Non- Accrual
Commercial and industrial:
Term loans	$	750		–	$	3	$	753	$	78,446	$	79,199	$	3
Lines of credit		1,286	$	373		–		1,659		191,425		193,084		400
Total commercial and industrial		2,036		373		3		2,412		269,871		272,283		403
Commercial real estate:
Office		–		–		–		–		125,934		125,934		2,428
Retail/wholesale/mixed		–		715		–		715		155,172		155,887		1,527
Industrial/warehouse		–		–		–		–		71,675		71,675		174
Other		–		–		–		–		5,672		5,672		–
Total commercial real estate		–		715		–		715		358,453		359,168		4,129
Multi-family real estate		389		–		–		389		569,350		569,739		257
Construction and development:
Commercial real estate		–		–		–		–		12,646		12,646		–
Multi-family real estate		–		–		–		–		127,620		127,620		–
Land and land development				–		–				10,054		10,054		501
Total construction		–		–		–		–		150,320		150,320		501
One- to four-family		6,197		1,629		2,146		9,972		469,351		479,323		2,291
Home equity and other consumer:
Home equity		834		177		168		1,179		158,728		159,907		169
Student		112		114		231		457		5,538		5,995		–
Other		57		28		62		147		10,577		10,724		62
Total home equity and other consumer		1,003		319		461		1,783		174,843		176,626		231
Total	$	9,625	$	3,036	$	2,610	$	15,271	$	1,992,188	$	2,007,459	$	7,812

Bank Mutual Corporation and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements

September 30, 2017

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

Loans Receivable (continued)

	December 31, 2016
	Past Due Status												Total
	30-59 Days		60-89 Days		> 90 Days		Total Past Due		Total Current		Total Loans		Non- Accrual
Commercial and industrial:
Term loans		–		–	$	48	$	48	$	63,848	$	63,896	$	422
Lines of credit		–		–		–		–		177,793		177,793		567
Total commercial and industrial		–		–		48		48		241,641		241,689		989
Commercial real estate:
Office		–		–		1,667		1,667		139,756		141,423		1,967
Retail/wholesale/mixed	$	852	$	235		–		1,087		170,535		171,622		691
Industrial/warehouse		–		–		181		181		55,534		55,715		181
Other		–		–		–		–		6,699		6,699		–
Total commercial real estate		852		235		1,848		2,935		372,524		375,459		2,839
Multi-family real estate		438		–		–		438		505,698		506,136		274
Construction and development:
Commercial real estate		–		–		–		–		16,432		16,432		–
Multi-family real estate		–		–		–		–		145,097		145,097		–
Land and land development		–		–		–		–		12,481		12,481		148
Total construction		–		–		–		–		174,010		174,010		148
One- to four-family		5,803		2,195		3,082		11,080		462,143		473,223		3,191
Home equity and other consumer:
Home equity		330		237		442		1,009		174,578		175,587		442
Student		168		98		295		561		6,249		6,810		–
Other		61		40		46		147		11,226		11,373		46
Total home equity and other consumer		559		375		783		1,717		192,053		193,770		488
Total	$	7,652	$	2,805	$	5,761	$	16,218	$	1,948,069	$	1,964,287	$	7,929

As of September 30, 2017, and December 31, 2016, $231 and $295 in student loans, respectively, were 90-days past due, but remained on accrual status because such loans were originated under programs guaranteed by the federal government. No other loans 90-days past due were in accrual status as of either date.

The Company classifies a loan modification as a troubled debt restructuring (“TDR”) when it has granted a borrower experiencing financial difficulties a concession that it would otherwise not consider. Loan modifications that result in insignificant delays in the receipt of payments (generally six months or less) are not considered TDRs under the Company’s TDR policy. TDRs are relatively insignificant and/or infrequent in the Company and generally consist of loans placed in interest-only status for a short period of time or payment forbearance for greater than six months. As of September 30, 2017, and December 31, 2016, TDRs were $6,042 and $5,772, respectively, and consisted primarily of nonresidential commercial real estate and one- to four-family mortgage loans. TDRs in accrual status as of those same dates were $2,783 and $2,815, respectively. Additions to TDRs during the nine months ended September 30, 2017 and 2016, were immaterial. In addition, TDRs that experienced a payment default within one year of their restructuring during these same periods were also immaterial. TDRs are evaluated for impairment and appropriate credit losses are recorded in accordance with the Company’s accounting policies and GAAP.

Bank Mutual Corporation and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements

September 30, 2017

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

Mortgage Servicing Rights

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

	Nine Months Ended September 30
	2017			2016
MSRs at beginning of the period, net	$	6,569		$	7,205
Additions		809			1,042
Amortization		(1,100	)		(1,636	)
MSRs at end of the period, net	$	6,278		$	6,611

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

		Amount
Estimate for three months ending December 31:	2017	$	244
Estimate for years ending December 31:	2018		889
	2019		783
	2020		677
	2021		582
	2022		518
	Thereafter		2,585
	Total	$	6,278

The projection of amortization for mortgage servicing rights is based future contractual principal and interest cash flows expected as of September 30, 2017. Future amortization expense may be significantly different depending upon changes in the mortgage servicing portfolio, mortgage interest rates, and market conditions.

Other Assets

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

	September 30		December 31
	2017		2016
Accrued interest:
Loans receivable	$	5,344	$	5,357
Mortgage-related securities		1,067		1,015
Total accrued interest		6,411		6,372
Foreclosed properties and repossessed assets:
Commercial real estate		186		1,559
Land and land development		–		598
One-to four-family		659		787
Total foreclosed properties and repossessed assets		845		2,944
Bank-owned life insurance		64,826		63,494
Premises and equipment, net		40,697		47,343
Federal Home Loan Bank stock, at cost		18,361		20,261
Deferred tax asset, net		14,281		14,543
Other assets		19,496		22,938
Total other assets	$	164,917	$	177,895

Bank Mutual Corporation and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements

September 30, 2017

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

Other Assets (continued)

Residential one-to four-family mortgage loans that were in the process of foreclosure were $803 and $2,424 at September 30, 2017, and December 31, 2016, respectively.

Deposit Liabilities

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

	September 30		December 31
	2017		2016
Checking accounts:
Non-interest-bearing	$	305,565	$	309,137
Interest-bearing		240,650		238,142
Total checking accounts		546,215		547,279
Money market accounts		529,871		558,905
Savings accounts		238,409		234,038
Certificates of deposit:
Due within one year		447,694		325,408
After one but within two years		137,203		162,138
After two but within three years		21,392		31,938
After three but within four years		2,303		2,246
After four but within five years		1,465		2,778
Total certificates of deposits		610,057		524,508
Total deposit liabilities	$	1,924,552	$	1,864,730

Borrowings

The following table summarizes borrowings as of the dates indicated:

	September 30, 2017					December 31, 2016
			Weighted-					Weighted-
			Average					Average
	Balance		Rate			Balance		Rate
FHLB short-term advances	$	320,000		1.16	%	$	285,000		0.70	%
FHLB term advances maturing in:
2017		–					63,397		0.89
2018		22,547		1.60			22,547		1.60
2019		15,308		2.88			16,838		3.09
2020		23,547		3.67			24,338		3.72
2021		14,520		3.01			14,674		3.03
2022		5,838		5.11			5,967		5.11
Thereafter		6,262		4.04			6,389		4.04
Total borrowings	$	408,022		1.56	%	$	439,150		1.22	%

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

Bank Mutual Corporation and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements

September 30, 2017

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

Borrowings (continued)

The Company is required to pledge certain unencumbered mortgage loans and mortgage-related securities as collateral against its outstanding advances from the FHLB of Chicago. Advances are also collateralized by the shares of capital stock of the FHLB of Chicago that are owned by the Company. The Company’s borrowings at the FHLB of Chicago are limited to the lesser of: (i) 35% of total assets; (ii) 22.2 times the FHLB of Chicago capital stock owned by the Company; or (iii) the total of 73% of the book value of one- to four-family mortgage loans, 73% of the book value of certain multi-family mortgage loans, 56% of certain commercial real estate loans, 51% of the book value of certain home equity loans, and 98% of the fair value of certain mortgage-related securities.

Regulatory Capital Requirements

The Company and Bank are subject to various regulatory capital requirements administered by federal banking agencies and as defined in applicable regulations. Failure to meet minimum capital requirements can initiate certain mandatory actions and possible additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and Bank must meet specific capital guidelines that involve quantitative measures of assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Company and Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Management believes that, as of September 30, 2017, and December 31, 2016, the Company and the Bank met or exceeded all regulatory capital adequacy requirements to which it is subject. The following table presents the Company and the Bank’s actual and required regulatory capital amounts and ratios as of the dates indicated.

	Actual					Required to be Adequately Capitalized					Required to be Well Capitalized
	Amount		Ratio			Amount		Ratio			Amount		Ratio
As of September 30, 2017:
At the Company:
Total risk-weighted capital	$	320,491		16.02	%	$	160,074		8.00	%	$	200,093		10.00	%
Tier 1 risk-weighted capital		299,165		14.95			120,056		6.00			160,074		8.00
CET1 risk-weighted capital		299,165		14.95			90,042		4.50			130,060		6.50
Tier 1 leverage capital		299,165		11.08			108,001		4.00			135,002		5.00
At the Bank:
Total risk-weighted capital	$	296,003		14.80	%	$	160,021		8.00	%	$	200,026		10.00	%
Tier 1 risk-weighted capital		274,677		13.73			120,016		6.00			160,021		8.00
CET1 risk-weighted capital		274,677		13.73			90,012		4.50			130,017		6.50
Tier 1 leverage capital		274,677		10.18			107,937		4.00			134,921		5.00

	Amount		Ratio			Amount		Ratio			Amount		Ratio
As of December 31, 2016:
At the Company:
Total risk-weighted capital	$	312,503		15.50	%	$	161,329		8.00	%	$	201,661		10.00	%
Tier 1 risk-weighted capital		292,563		14.51			120,997		6.00			161,329		8.00
CET1 risk-weighted capital		292,563		14.51			90,747		4.50			131,080		6.50
Tier 1 leverage capital		292,563		11.11			105,333		4.00			131,666		5.00
At the Bank:
Total risk-weighted capital	$	285,016		14.14	%	$	161,247		8.00	%	$	201,559		10.00	%
Tier 1 risk-weighted capital		265,076		13.15			120,936		6.00			161,247		8.00
CET1 risk-weighted capital		265,076		13.15			90,702		4.50			131,014		6.50
Tier 1 leverage capital		265,076		10.09			105,108		4.00			131,385		5.00

Bank Mutual Corporation and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements

September 30, 2017

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

Earnings Per Share

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

	Three Months Ended				Nine Months Ended
	September 30				September 30
	2017		2016		2017		2016

Net income	$	3,842	$	4,454	$	11,674	$	12,876
Weighted average shares outstanding		45,401,416		45,116,082		45,392,526		45,077,767
Vested restricted stock for period		160,649		123,485		145,601		111,223
Basic shares outstanding		45,562,065		45,239,567		45,538,127		45,188,990
Net dilutive effect of:
Stock option shares		447,208		379,310		454,435		392,738
Non-vested restricted stock		55,777		45,972		61,064		49,190
Diluted shares outstanding		46,065,050		45,664,849		46,053,626		45,630,918
Basic earnings per share	$	0.08	$	0.10	$	0.25	$	0.28
Diluted earnings per share	$	0.08	$	0.10	$	0.25	$	0.28

The Company had stock options for 82,000 and 359,834 shares outstanding as of September 30, 2017 and 2016, respectively that were not included in the computation of diluted earnings per share because they were anti-dilutive. These options had weighted average exercise prices of $11.69 and $8.18 per share as of those dates, respectively.

10.

Employee Benefit Plans

The Company has a discretionary, defined contribution savings plan (the “Savings Plan”). The Savings Plan is qualified under Sections 401(a) and 401(k) of the Internal Revenue Code and provides employees meeting certain minimum age and service requirements the ability to make contributions to the Savings Plan on a pretax basis. The Company then matches a percentage of the employee’s contributions. Matching contributions expensed by the Company were $280 and $205 during the three months ended September 30, 2017 and 2016, respectively, and $881 and $630 during the nine months ended September 30, 2017 and 2016, respectively.

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

Bank Mutual Corporation and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements

September 30, 2017

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

10.

Employee Benefit Plans (continued)

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

	Three Months Ended September 30						Nine Months Ended September 30
	2017			2016			2017			2016
Service cost		–			–			–			–
Interest cost	$	647		$	669		$	1,941		$	2,007
Expected return on plan assets		(801	)		(861	)		(2,403	)		(2,583	)
Amortization of net loss from earlier periods		70			57			210			171
Net periodic benefit cost	$	(84	)	$	(135	)	$	(252	)	$	(405	)

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

	Three Months Ended September 30				Nine Months Ended September 30
	2017		2016		2017		2016
Interest cost	$	85	$	93	$	255	$	279
Amortization of net loss from earlier periods		20		26		60		78
Net periodic benefit cost	$	105	$	119	$	315	$	357

A contribution of $1,750,000 to the qualified plan was made in the third quarter of 2017. This contribution was determined based on a number of factors, including the results of an actuarial valuation report as of January 1, 2017. No contribution is necessary for the supplemental plan.

11.

Stock-Based Benefit Plans

In 2004 the Company’s shareholders approved the 2004 Stock Incentive Plan (the “2004 Plan”). Options and restricted stock granted under the 2004 Plan vested over five years and options had expiration terms of ten years. The 2004 Plan terminated in 2014 in accordance with the terms of the plan. Options awarded under the 2004 Plan will remain outstanding until exercised, forfeited, or expired.

In 2014 the Company’s shareholders approved the 2014 Incentive Compensation Plan (the “2014 Plan”), which provides for the award of stock options, stock appreciation rights, restricted stock, restricted stock units, performance shares, and cash awards. Stock-related awards under the 2014 Plan vest over a period of three or more years, subject to earlier vesting on a change in control, and, if applicable, have a maximum term of ten years. The number of shares of common stock of the Company that may be issued under the 2014 Plan is limited to 3,000,000 shares. As of September 30, 2017, 2,372,560 shares remained eligible for award under the 2014 Plan.

Restricted stock grants are amortized to compensation expense as the Company’s employees and directors become vested in the granted shares. The amount amortized to expense was $342 and $265 for the three months ended September 30, 2017 and 2016, respectively. The amount amortized to expense was $1,033 and $744 for the nine months ended September 30, 2017 and 2016, respectively. Outstanding non-vested restricted stock grants had a fair value of $3,321 and an unamortized cost of $1,586 at September 30, 2017. The cost of these shares is expected to be recognized over a weighted-average period of 0.97 years.

During the three months ended September 30, 2017 and 2016, the Company recorded stock option compensation expense of $67 and $89, respectively. During the nine months ended September 30, 2017 and 2016, the Company recorded stock option compensation expense of $211 and $270, respectively. As of September 30, 2017, there was $222 in total unrecognized stock option compensation expense related to non-vested options. This cost is expected to be recognized over a weighted-average period of 0.60 years.

Bank Mutual Corporation and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements

September 30, 2017

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

11.

Stock-Based Benefit Plans (continued)

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

	Nine Months Ended September 30
	2017					2016
	Stock Options			Weighted Average Exercise Price		Stock Options			Weighted Average Exercise Price
Outstanding at beginning of period		1,303,434		$	5.5923		1,421,500		$	5.4378
Granted		–			–		56,300			7.2900
Exercised		(135,534	)		4.0201		(138,834	)		4.8840
Forfeited		(4,967	)		7.2900		(13,132	)		5.0412
Outstanding at end of period		1,162,933		$	5.7683		1,325,834		$	5.5783

The following table provides additional information regarding the Company’s outstanding options as of September 30, 2017.

	Remaining		Non-Vested Options				Vested Options
	Contractual Life		Stock Options		Intrinsic Value		Stock Options		Intrinsic Value
Exercise price:
$11.160		0.6		–		–		32,000		–
$12.025		0.9		–		–		50,000		–
$7.226		2.6		–		–		50,000	$	147
$4.740		3.2		–		–		70,000		379
$5.050		3.3		–		–		149,000		760
$3.720		3.8		–		–		2,500		16
$3.390		4.3		–		–		220,500		1,491
$3.800		4.5		–		–		10,000		64
$4.820		5.3		46,600	$	248		173,600		925
$5.360		5.6		4,000		19		8,000		38
$5.700		5.7		4,000		18		16,000		71
$6.340		5.8		2,000		8		8,000		30
$7.170		6.3		73,200		218		107,700		321
$6.010		6.6		3,000		12		4,500		19
$5.850		6.6		–		–		20,000		86
$6.100		6.9		–		–		20,000		81
$6.700		7.3		9,995		34		20,005		69
$7.190		7.8		2,333		7		4,667		14
$7.290		8.3		33,739		96		17,594		50
Total				178,867	$	660		984,066	$	4,561
Weighted-average remaining contractual life				6.50 Years				4.40 Years
Weighted-average exercise price			$	6.4523			$	5.6440

There were 135,534 options exercised during the nine months ended September 30, 2017, which had an intrinsic value of $762. There were 138,834 options exercised during the nine months ended September 30, 2016, which had an intrinsic value of $367. The weighted average grant date fair value of non-vested options at September 30, 2017, was $1.99 per share. During the nine months ended September 30, 2017, no options were granted, options for 206,961 shares became vested, and 4,967 non-vested options shares were forfeited.

Bank Mutual Corporation and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements

September 30, 2017

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

11.

Stock-Based Benefit Plans (continued)

The Company uses the Black-Scholes option-pricing model to estimate the fair value of granted options. This model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. However, the Company's stock options have characteristics significantly different from traded options and changes in the subjective input assumptions can materially affect the fair value estimate. Option valuation models such as Black-Scholes require the input of highly subjective assumptions including the expected stock price volatility, which is computed using ten years of actual price activity in the Company’s stock. The Company uses historical data of employee behavior as a basis to estimate the expected life of the options, as well as forfeitures due to employee terminations. The Company also uses its actual dividend yield at the time of the grant, as well as actual U.S. Treasury yields in effect at the time of the grant to estimate the risk-free rate. The following weighted-average assumptions were used to value 56,300 options granted during the nine month period ended September 30, 2016: risk free rate of 1.80%, dividend yield of 2.74%, expected stock volatility of 31%, and expected term to exercise of 7.5 years. These options had a weighted-average value of $2.28 per option using these assumptions. No options were granted during the nine months ended September 30, 2017.

12.

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

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

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

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

	September 30		December 31
	2017		2016
Unused commercial lines of credit	$	184,439	$	177,672
Commercial loans		2,412		3,709
Standby letters of credit		7,446		7,821
Real estate loan commitments:
Fixed rate		22,715		34,074
Adjustable rate		228,188		303,546
Unused consumer lines of credit		163,438		160,898

The Company sells substantially all of its long-term, fixed-rate, one- to four-family loan originations in the secondary market. The Company uses interest rate lock commitments (“IRLCs”) and forward commitments to sell loans to manage interest rate risk associated with its loan sales activities, both of which are considered to be free-standing derivative financial instruments under GAAP. Changes in the fair value of the derivative instruments are

Bank Mutual Corporation and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements

September 30, 2017

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

12.

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

recognized currently through earnings. During the three months ended September 30, 2017 and 2016, net unrealized gains (losses) of $(37) and $86, respectively, were recognized in net gain on loan sales activities on these derivative instruments. During the nine months ended September 30, 2017 and 2016, net unrealized gains (losses) of $(170) and $119, respectively, were recognized in net gain on loan sales activities on these derivative instruments. These amounts were exclusive of net unrealized gains (losses) of $(31) and $36 on loans held-for-sale for the three months ended September 30, 2017 and 2016, respectively, and $119 and $172 for the nine months ended September 30, 2017 and 2016, respectively, which were also included in net gain on loan sales activities.

The Company enters into interest rate swap arrangements to manage the interest rate risk exposure associated with specific commercial loan relationships at the time such loans are originated. These interest rate swaps, as well as the embedded derivatives associated with certain of its commercial loan relationships, are free-standing derivative instruments under GAAP. As such, changes in the fair value of these derivative instruments are recognized currently through earnings. During the three months ended September 30, 2017 and 2016, net unrealized gains of $235 and $206, respectively, and net losses of $235 and $206, respectively, related to interest rate swaps and embedded derivatives were recorded in loan-related fees. During the nine months ended September 30, 2017 and 2016, net unrealized gains of $2,443 and $247 respectively, and net losses of $2,443 and $247, respectively, related to interest rate swaps and embedded derivatives were recorded in loan-related fees.

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

	September 30, 2017					December 31, 2016
	Notional Amount		Fair Value			Notional Amount		Fair Value
Interest rate lock commitments	$	7,150	$	132		$	6,806	$	145
Forward commitments to sell loans		10,066		(105	)		11,861		52
Embedded free-standing derivatives on commercial loans		8,597		184			8,765		258
Receive-fixed free-standing interest rate swaps		323,789		(605	)		299,595		(3,122	)
Pay-fixed free-standing interest rate swaps		332,386		421			308,360		2,864
Pay-fixed cash flow hedge interest rate swaps		–		–			20,000		28
Net unrealized gains			$	27				$	225

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

Bank Mutual Corporation and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements

September 30, 2017

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

13.

Fair Value Measurements

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (exit price). The Company utilizes market data or assumptions that market participants would use in pricing the asset or liability, including assumptions about risk and the risks inherent in the inputs to the valuation technique. These inputs can be readily observable, market corroborated, or generally unobservable. The Company primarily applies the market approach for recurring value measurements and endeavors to utilize the best available information. Accordingly, the Company utilizes valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs. The Company is able to classify fair value measurements based on the observability of those inputs. Accounting guidance establishes a fair value hierarchy that prioritizes the inputs used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1), the next highest priority is given to prices based on models, methodologies, and/or management judgments that rely on direct or indirect observable inputs (Level 2), and the lowest priority to prices derived from models, methodologies, and/or management judgments that rely on significant unobservable inputs (Level 3). There were no transfers of assets or liabilities between categories of the fair value hierarchy during the nine months ended September 30, 2017.

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

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

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

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

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

Bank Mutual Corporation and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements

September 30, 2017

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

13.

Fair Value Measurements (continued)

The following table summarizes the significant inputs utilized by the Company to estimate the fair value of its MSRs as of September 30, 2017:

	Weighted- Average			Range
Loan size	$	139			$14-$424
Contractual interest rate		3.64	%		2.50%-7.10%
Constant prepayment rate (“CPR”)		8.08	%		1.44%-22.38%
Remaining maturity in months		210			1-480
Servicing fee		0.25	%		–
Annual servicing cost per loan (not in thousands)	$	60			–
Annual ancillary income per loan (not in thousands)	$	30			–
Discount rate		9.54	%		9.50%-11.25%

MSR pools with an amortized cost basis greater than fair value are carried at fair value in the Company’s financial statements. There were no pools determined to be impaired at September 30, 2017, or December 31, 2016. Accordingly, the Company had no valuation allowance as of September 30, 2017, or December 31, 2016.

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

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

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

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

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

Bank Mutual Corporation and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements

September 30, 2017

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

13.

Fair Value Measurements (continued)

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

	September 30 2017						December 31 2016
	Carrying Value			Fair Value			Carrying Value			Fair Value
Cash and cash equivalents	$	55,532		$	55,532		$	50,087		$	50,087
Mortgage related securities available-for-sale		386,481			386,481			371,880			371,880
Mortgage related securities held-to-maturity		91,617			92,561			93,234			94,266
Loans held-for-sale		4,026			4,026			5,952			5,952
Loans receivable, net		1,984,823			2,000,290			1,942,907			1,949,534
Mortgage servicing rights, net		6,278		$	9,073			6,569			9,329
Federal Home Loan Bank stock		18,361			18,361			20,261			20,261
Accrued interest receivable		6,411			6,411			6,372			6,372
Deposit liabilities		1,924,552			1,862,077			1,864,730			1,823,592
Borrowings		408,022			411,708			439,150			443,732
Advance payments by borrowers		30,458			30,458			4,770			4,770
Accrued interest payable		894			894			1,124			1,124
Unrealized gain (loss) on off-balance-sheet items:
Interest rate lock commitments		132			132			145			145
Forward commitments to sell loans		(105	)		(105	)		52			52
Embedded free-standing derivatives on commercial loans		184			184			258			258
Receive-fixed free-standing interest rate swaps		(605	)		(605	)		(3,122	)		(3,122	)
Pay-fixed free-standing interest rate swaps		421			421			2,864			2,864
Pay-fixed cash flow hedge interest rate swaps		–			–			28			28

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

At September 30, 2017

Level 1

Level 2

Level 3

Total

Loans held-for-sale

–

4,026

–

4,026

Mortgage-related securities available-for-sale

–

386,481

–

386,481

At December 31, 2016

Level 1

Level 2

Level 3

Total

Loans held-for-sale

–

5,952

–

5,952

Mortgage-related securities available-for-sale

–

371,880

–

371,880

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

Bank Mutual Corporation and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements

September 30, 2017

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

13.

Fair Value Measurements (continued)

operating income of the property or business. Selling costs are generally estimated at 10%. Appraised values may be further discounted based on management judgment regarding changes in market conditions and other factors since the time of the appraisal. A significant unobservable input in using net operating income to estimate fair value is the capitalization rate. At September 30, 2017, the range of capitalization rates utilized to determine the fair value of the underlying collateral on certain loans was 5% to 11%. The Company considers these fair values to be Level 3 in the fair value hierarchy. For those loans individually evaluated for impairment using the collateral value method, a valuation allowance of $177 was recorded for loans with a recorded investment of $28,187 at September 30, 2017. These amounts were $158 and $22,466 at December 31, 2016, respectively. Provision for loan losses related to these loans was $19 and $222 during the nine months ended September 30, 2017 and 2016, respectively. Provision for loan losses related to these loans was of $158 during the twelve month period ended December 31, 2016.

Foreclosed Properties Foreclosed properties acquired through, or in lieu of, loan foreclosure are recorded at the lower of cost or fair value less estimated costs to sell. In determining fair value, the Company generally obtains appraisals to support the fair value of foreclosed properties, as described in the previous paragraph. In certain instances, the Company may also use the selling list price, less estimated costs to sell, as the fair value of foreclosed properties. In such instances, the list price is generally less than the appraised value. The Company considers these fair values to be Level 3 in the fair value hierarchy. As of September 30, 2017, $239 in foreclosed properties was valued at collateral value compared to $1,882 at December 31, 2016. Losses of $21 and $137 related to these foreclosed properties were recorded during the nine months ended September 30, 2017 and 2016, respectively. Losses on foreclosed properties valued at collateral value at December 31, 2016, were $197 for the twelve months ended December 31, 2016.

14.

Pending Merger

On July 20, 2017, the Company entered into a definitive merger agreement with Associated Banc-Corp (“Associated”). On October 24, 2017, the shareholders of the Company approved the agreement and other related matters. However, the merger remains subject to regulatory approval and other closing conditions. Upon receipt of regulatory approval and satisfaction of all other closing conditions the Company will be merged into Associated. Upon the completion of the merger each share of common stock of the Company will be converted into 0.422 shares of common stock of Associated in accordance with the terms of the merger agreement.

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

Cautionary Statement

This report contains or incorporates by reference various forward-looking statements concerning the Company's prospects that are based on the current expectations and beliefs of management. Forward-looking statements may contain, and are intended to be identified by, words such as “anticipate,” “believe,” “estimate,” “expect,” “objective,” “projection,” “intend,” and similar expressions; the use of verbs in the future tense and discussions of periods after the date on which this report is issued are also forward-looking statements. The statements contained herein and such future statements involve or may involve certain assumptions, risks, and uncertainties, many of which are beyond the Company's control, that could cause the Company's actual results and performance to differ materially from what is stated or expected. In addition to the assumptions and other factors referenced specifically in connection with such statements, the following factors could impact the business and financial prospects of the Company: the possibility that the proposed merger with Associated may not be completed in a timely manner or at all; general economic conditions, including volatility in credit, lending, and financial markets; weakness and declines in the real estate market, which could affect both collateral values and loan activity; periods of relatively high unemployment or economic weakness and other factors which could affect borrowers’ ability to repay their loans; negative developments affecting particular borrowers, which could further adversely impact loan repayments and collection; legislative and regulatory initiatives and changes, including action taken, or that may be taken, in response to difficulties in financial markets and/or which could negatively affect the rights of creditors; monetary and fiscal policies of the federal government; the effects of further regulation and consolidation within the financial services industry; regulators’ strict expectations for financial institutions’ capital levels and restrictions imposed on institutions, as to payments of dividends, share repurchases, or otherwise, to maintain or achieve those levels; recent, pending, and/or potential rulemaking or various federal regulatory agencies that could affect the Company or the Bank, particularly as such relates to guidelines concerning certain types of lending; increased competition and/or disintermediation within the financial services industry; changes in tax rates, deductions and/or policies; potential further changes in Federal Deposit Insurance Corporation (“FDIC”) premiums and other governmental assessments; changes in deposit flows; changes in the cost of funds; fluctuations in general market rates of interest and/or yields or rates on competing loans, investments, and sources of funds; demand for loan or deposit products; illiquidity of financial markets and other negative developments affecting particular investment and mortgage-related securities, which could adversely impact the fair value of and/or cash flows from such securities; changes in customers’ demand for other financial services; the Company’s potential inability to carry out business plans or strategies; changes in accounting policies or guidelines; natural disasters, acts of terrorism, or developments in the war on terrorism or other global conflicts; the risk of failures in computer or other technology systems or data maintenance, maintenance, or breaches of security relating to such systems; and the factors discussed in the Company’s filings with the Securities and Exchange Commission, particularly under Part I, Item 1A, “Risk Factors,” of the Company’s 2016 Annual Report on Form 10-K, under the caption “Forward Looking Statements” in the Company’s Current Report on Form 8-K dated and filed on July 20, 2017, and under the caption “Risk Factors” in the Company’s definitive proxy statement for its special meeting of shareholders on October 24, 2017, filed on Schedule 14A on September 15, 2017.

Pending Merger

On July 20, 2017, the Company entered into a definitive merger agreement with Associated Banc-Corp (“Associated”). At a special meeting held on October 24, 2017, the shareholders of the Company approved the merger and other related matters. However, the merger is also subject to regulatory approval and other closing conditions. Upon receipt of regulatory approval and satisfaction of all other closing conditions the Company will be merged into Associated. Upon the completion of the merger each share of common stock of the Company will be converted into 0.422 shares of common stock of Associated in accordance with the terms of the merger agreement.

Results of Operations

Overview The Company reported net income of $3.8 million or $0.08 per diluted share in the third quarter of 2017 compared to $4.5 million or $0.10 per diluted share in the same quarter of last year. Year-to-date in 2017, the Company reported net income of $11.7 million or $0.25 per diluted share compared to $12.9 million or $0.28 per diluted share in the same nine-month period in 2016. During the third quarter of 2017 the Company recorded $1.3 million in expenses related to its pending merger with Associated Banc-Corp (“Associated”), which was announced on July 20, 2017. The Company’s results in the 2017 periods were favorably impacted by higher net interest income, reduced provision for loan losses, higher gains on sales of real estate held for investment, lower advertising and marketing expenses, and a decline in other non-interest expenses in the 2017 periods compared to the same periods in 2016. In addition, the third quarter of 2017 was favorably impacted by lower net losses and expenses on foreclosed real estate compared to net losses in the same period of the previous year. These favorable developments were largely offset by lower deposit-related fees, reduced mortgage banking revenue, and a decrease in loan-related fees compared to the same periods in 2016. In addition, the 2017 periods included a $197,000 loss on the sale of five retail branch offices and related loans and deposits to another financial institution, as well as higher compensation and benefit expenses and increased occupancy and data processing costs. Finally, the 2017 year-to-date period was also impacted by lower brokerage, advisory, and insurance revenue and higher net losses and expenses on foreclosed real estate. The following paragraphs describe these changes in greater detail, along with other matters affecting the Company’s results of operations during the three months ended September 30, 2017 and 2016.

Net Interest Income The Company’s net interest income increased by $976,000 or 5.2% and $3.4 million or 6.3% during the three- and nine-month periods ended September 30, 2017, respectively, compared to the same periods in 2016. Included in the three- and nine-month periods in 2016 were $577,000 and $1.1 million, respectively, in call premiums that the Company received on a mortgage-related securities that were called by the issuer in those periods. Excluding these call premiums, net interest income in the first three- and nine-month periods of 2017 increased by $1.6 million or 8.6% and $4.5 million or 8.4% compared to the same periods in 2016. Most of this increase was caused by an increase in the Company’s average earning assets, which increased by $122.5 million or 5.2% during the nine months ended September 30, 2017, compared to the same period in 2016. This increase was primarily attributable to an increase in average loans receivable. Also contributing to the increase in net interest income in the 2017 periods was an improvement in the Company’s net interest margin, excluding the impact of the aforementioned call premiums. Finally, an increase in funding from non-interest bearing checking accounts also contributed to the increase in net interest income in the 2017 periods.

The Company’s net interest margin was 3.12% and 3.07% during the three- and nine-month periods ended September 30, 2017, respectively, which compared to 2.98% and 2.97% during the same periods in 2016 (excluding ten and six basis points of benefit related to the aforementioned call premiums in the three- and nine-month periods of 2016, respectively). Management has noted in recent periods that increases in the yield on the Company’s earning assets have been modestly greater than the increases in its cost of funds. This has occurred in an environment of rising interest rates, due in part to recent increases in the fed funds rate by the Federal Reserve. Management attributes the modest increases in the Company’s net interest margin to an overall interest rate risk exposure that it is slightly asset sensitive. That is, management believes that the sensitivity of the Company’s earning assets to changes in market interest rates is slightly greater than its interest-bearing liabilities. As such, management anticipates that the Company’s net interest margin may continue to show slight improvement in the immediate future, although there can be no assurances.

The Company’s net interest margin is subject to competitive pricing pressures for loans and deposits, changes in borrower and depositor preferences, and other economic and market factors that are outside of management’s control. Of particular concern to management are possible future changes in the competitive environment for interest rates on interest-bearing checking, savings, and money market deposit accounts. If competitive or market pressures require the Company to increase the interest rates it pays on these deposit accounts, and such increases are not exceeded or matched by increases in the yield on its earning assets, the Company’s net interest margin could be adversely impacted in future periods. Also of concern to management are possible future changes in depositor preferences for certain types of deposit products. Specifically, management believes that the relatively low interest rate environment that has persisted for the past few years has encouraged many deposit customers to switch to transaction deposits in an effort to retain flexibility in the event market interest rates increase. If market interest rates continue to increase in the future, customers’ preferences may shift from transaction deposits to certificates of deposit, which generally have a higher interest cost. This development could also have an adverse impact on the Company’s net interest margin in future periods.

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

	Three Months Ended September 30
	2017								2016
				Interest		Average						Interest		Average
	Average			Earned/		Yield/			Average			Earned/		Yield/
	Balance			Paid		Rate			Balance			Paid		Rate
	(Dollars in thousands)
Assets:
Interest-earning assets:
Loans receivable (1)	$	2,012,117		$	20,557		4.09	%	$	1,896,762		$	18,209		3.84	%
Mortgage-related securities		475,053			2,483		2.09			501,960			3,139		2.50
Investment securities (2)		20,656			163		3.16			18,813			117		2.49
Interest-earning deposits		19,213			25		0.52			15,529			5		0.13
Total interest-earning assets		2,527,039			23,228		3.68			2,433,064			21,470		3.53
Non-interest-earning assets		177,415								205,468
Total average assets	$	2,704,454							$	2,638,532

Liabilities and equity:
Interest-bearing liabilities:
Regular savings deposits	$	242,361			8		0.01		$	229,929			8		0.01
Money market accounts		516,816			324		0.25			540,987			221		0.16
Interest-bearing demand accounts		238,640			14		0.02			257,470			11		0.02
Certificates of deposit		563,188			1,427		1.01			542,009			1,228		0.91
Total deposit liabilities		1,561,005			1,773		0.45			1,570,395			1,468		0.37
Advance payments by borrowers for taxes and insurance		26,241			–		0.00			26,129			–		0.00
Borrowings		455,147			1,767		1.55			418,933			1,290		1.23
Total interest-bearing liabilities		2,042,393			3,540		0.69			2,015,457			2,758		0.55
Non-interest-bearing liabilities:
Non-interest-bearing deposits		307,957								258,720
Other non-interest-bearing liabilities		62,291								76,791
Total non-interest-bearing liabilities		370,248								335,511
Total liabilities		2,412,641								2,350,968
Total equity		291,813								287,564
Total average liabilities and equity	$	2,704,454							$	2,638,532
Net interest income and net interest rate spread				$	19,688		2.99	%				$	18,712		2.98	%
Net interest margin							3.12	%							3.08	%
Average interest-earning assets to average interest-bearing liabilities		1.24	x							1.21	x

(1)

For the purposes of these computations, non-accruing loans and loans held-for-sale are included in loans receivable.

(2)

The carrying value and earnings on stock in the FHLB of Chicago is included in investment securities.

	Nine Months Ended September 30
	2017								2016
				Interest		Average						Interest		Average
	Average			Earned/		Yield/			Average			Earned/		Yield/
	Balance			Paid		Rate			Balance			Paid		Rate
	(Dollars in thousands)
Assets:
Interest-earning assets:
Loans receivable (1)	$	1,981,372		$	58,725		3.95	%	$	1,818,232		$	52,505		3.85	%
Mortgage-related securities		470,781			7,503		2.12			515,183			9,122		2.36
Investment securities (2)		20,113			452		2.99			18,412			338		2.45
Interest-earning deposits		18,607			52		0.37			16,554			23		0.19
Total interest-earning assets		2,490,873			66,732		3.57			2,368,381			61,988		3.49
Non-interest-earning assets		186,955								203,065
Total average assets	$	2,677,828							$	2,571,446

Liabilities and equity:
Interest-bearing liabilities:
Regular savings deposits	$	241,299			25		0.01		$	225,572			22		0.01
Money market accounts		525,492			788		0.20			532,041			620		0.16
Interest-bearing demand accounts		238,433			36		0.02			262,720			36		0.02
Certificates of deposit		540,816			3,921		0.97			545,550			3,641		0.89
Total deposit liabilities		1,546,040			4,770		0.41			1,565,883			4,319		0.37
Advance payments by borrowers for taxes and insurance		17,814			1		0.01			17,237			1		0.01
Borrowings		446,729			4,679		1.40			386,894			3,790		1.31
Total interest-bearing liabilities		2,010,583			9,450		0.63			1,970,014			8,110		0.55
Non-interest-bearing liabilities:
Non-interest-bearing deposits		308,643								237,744
Other non-interest-bearing liabilities		68,668								78,648
Total non-interest-bearing liabilities		377,311								316,392
Total liabilities		2,387,894								2,286,406
Total equity		289,934								285,040
Total average liabilities and equity	$	2,677,828							$	2,571,446
Net interest income and net interest rate spread				$	57,282		2.94	%				$	53,878		2.94	%
Net interest margin							3.07	%							3.03	%
Average interest-earning assets to average interest-bearing liabilities		1.24	x							1.20	x

(1)

For the purposes of these computations, non-accruing loans and loans held-for-sale are included in loans receivable.

(2)

The carrying value and earnings on stock in the FHLB of Chicago is included in investment securities.

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

	Three Months Ended September 30, 2017 Compared to September 30, 2016
	Increase (Decrease)
	Volume			Rate			Net
	(Dollars in thousands)
Interest-earning assets:
Loans receivable	$	1,126		$	1,222		$	2,348
Mortgage-related securities		(162	)		(494	)		(656	)
Investment securities		12			34			46
Interest-earning deposits		1			19			20
Total interest-earning assets		977			781			1,758
Interest-bearing liabilities:
Savings accounts		–			–			–
Money market accounts		(10	)		113			103
Interest-bearing demand accounts		(1	)		4			3
Certificates of deposit		49			150			199
Total deposit liabilities		38			267			305
Advance payments by borrowers for taxes and insurance		–			–			–
Borrowings		118			359			477
Total interest-bearing liabilities		156			626			782
Net change in net interest income	$	821		$	155		$	976

	Nine Months Ended September 30, 2017 Compared to September 30, 2016
	Increase (Decrease)
	Volume			Rate			Net
	(Dollars in thousands)
Interest-earning assets:
Loans receivable	$	4,829		$	1,391		$	6,220
Mortgage-related securities		(735	)		(884	)		(1,619	)
Investment securities		34			80			114
Interest-earning deposits		3			26			29
Total interest-earning assets		4,131			613			4,744
Interest-bearing liabilities:
Savings accounts		3			–			3
Money market accounts		(8	)		176			168
Interest-bearing demand accounts		(4	)		4			–
Certificates of deposit		(32	)		312			280
Total deposit liabilities		(41	)		492			451
Advance payments by borrowers for taxes and insurance		–			–			–
Borrowings		616			273			889
Total interest-bearing liabilities		575			765			1,340
Net change in net interest income	$	3,556		$	(152	)	$	3,404

Provision for Loan Losses The Company’s provision for loan losses was $472,000 in the third quarter of 2017 compared to $1.4 million in the same quarter last year. On a year-to-date basis, provision for loan losses was $1.6 million in 2017 compared to $2.0 million in 2016. The Company’s non-performing and other classified loans have declined in recent periods and its net charge-offs continue to be nominal. As a result, the Company’s provision for loan losses has decreased relative to prior periods.

In general, management believes that overall economic, employment, and real estate conditions are relatively stable in the Company’s local markets. However, trends in the credit quality of the Company’s loan portfolio are subject to many factors that are outside of the Company’s control, such as economic and market conditions that can fluctuate considerably from period to period. As such, there can be no assurances that there will not be significant fluctuations in the Company’s non-performing loans, classified loans, and/or loan charge-off activity from period to period, which may result in significant variability in the Company’s provision for loan losses.

Non-Interest Income Total non-interest income decreased by $1.6 million or 23.5% and $3.8 million or 18.7% during the three and nine months ended September 30, 2017, respectively, compared to the same periods in 2016, respectively. Significant reasons for the changes in the components of non-interest income are discussed in the following paragraphs.

Deposit-related fees and charges declined by $56,000 or 1.9% and $193,000 or 2.2% during the three and nine months ended September 30, 2017, respectively, compared to the same periods in the previous year. Deposit-related fees and charges consist of overdraft fees, ATM and debit card fees, merchant processing fees, account service charges, and other revenue items related to services performed by the Company for its retail and commercial deposit customers. Management attributes the decline in deposit-related fees and charges to changes in customer spending behavior in recent periods which has resulted in lower revenue from overdraft charges and ATM usage. These developments have been partially offset by increased deposit account service charges and increased treasury management fees from commercial depositors.

Mortgage banking revenue, net, was $788,000 and $2.4 million during three- and nine-month periods ended September 30, 2017, respectively. This compared to $1.4 million and $3.3 million during the same periods in 2016, respectively. The following table presents the components of mortgage banking revenue, net, for the periods indicated:

	Three Months Ended September 30						Nine Months Ended September 30
	2017			2016			2017			2016
	(Dollars in thousands)
Gross loan servicing fees	$	608		$	633		$	1,839		$	1,915
MSR amortization		(384	)		(650	)		(1,100	)		(1,636	)
Change in MSR valuation allowance		–			–			–			–
Loan servicing revenue, net		224			(17	)		739			279
Gain on loan sales activities, net		564			1,371			1,662			3,042
Mortgage banking revenue, net	$	788		$	1,354		$	2,401		$	3,321

Loan servicing revenue, net, increased during the three- and nine-month periods in 2017 compared to the same periods in 2016. These increases were primarily caused by a decline in amortization of mortgage servicing rights (“MSRs”). These declines were caused by generally higher market interest rates for one- to four-family loans in 2017, which has resulted in reduced loan prepayment activity and slower amortization of the related MSRs compared to the prior year. The favorable impact of this development was partially offset by declines in gross servicing fees in the 2017 periods due to an overall decline in loans serviced for third-party investors. As of September 30, 2017, the Company serviced $957.8 million in loans for third-party investors compared to $1.0 billion one year earlier.

The change in valuation allowance that the Company establishes against its MSRs is recorded as a recovery or loss, as the case may be, in the period in which the change occurs. As of September 30, 2017, the Company had no valuation allowance against its MSRs, which had a carrying value of $6.3 million as of that date. MSR valuation allowances typically increase in periods of lower market interest rates, which results in a charge to earnings in the period of the increase. During such periods loan refinance activity and expectations for future loan prepayments typically increase, which generally reduces the fair value of MSRs and could result in an increase in the MSR valuation allowance. However, in recent periods market interest rates for one- to four-family loans have generally been higher. As such, there was no requirement for an MSR valuation allowance as of September 30, 2017, and management does not expect one to be necessary in the near future. In addition, management expects that amortization of MSRs may continue to be lower in the near term in response to reduced levels of loan refinance activity. However, these developments cannot be assured, particularly if market interest rates for one- to four-family residential loans decline in the future.

Gain on loan sales activities, net, was $564,000 and $1.7 million during the three- and nine-month periods ended September 30, 2017, respectively, compared to $1.4 million and $3.0 million during the same periods in 2016. The Company typically sells most of the fixed-rate, one- to four-family mortgage loans that it originates. Market interest rates for one- to four-family loans have been higher in recent periods, which is a development that typically results in lower originations and sales of such loans. The origination and sale of residential loans is subject to variations in market interest rates and other factors outside of management’s control. Accordingly, there can be no assurances that such originations and sales will increase or will not vary considerably from period to period.

Brokerage, advisory, and insurance revenue was $824,000 during the third quarter of 2017, which was slightly higher than the same quarter in the previous year. Year-to-date this source of revenue was $2.4 million, which was $167,000 or 6.6% lower than the same period in 2016. This revenue item generally consists of commissions earned on sales of tax-deferred annuities, mutual funds, and certain other securities, fees earned for investment advisory services, and commissions earned on sales of personal and business insurance products. Management attributes the recent fluctuations in this revenue line item to changes in commissions earned from sales of tax-deferred annuities and other sources of transaction-based income. In recent periods management has begun to shift the mix of revenue in this line of business from commission income, which tends to be transaction-based, to advisory fee income, which is generally based on assets under management rather than execution of individual transactions. Management believes that advisory-based fee income will be a more stable source of revenue in the future and expects that it will continue to grow due to new products, services, systems, and investment advisors that the Company has added in prior periods, although there can be no assurances.

Loan-related fees were $381,000 and $1.5 million during the three and nine months ended September 30, 2017, respectively. These amounts compared to $1.1 million and $4.0 million during the same periods in 2016, respectively. The largest source of fees in this revenue category has historically been interest rate swap fees related to commercial loan relationships. The Company mitigates the interest rate risk associated with certain of its loan relationships by executing interest rate swaps, the accounting for which results in the recognition of a certain amount of fee income at the time the swap contracts are executed. The decrease in loan-related fees in the 2017 periods was primarily due to reduced originations of multi-family, commercial real estate, and construction loans, which are the types of loans that generate most of the Company’s interest rate swap fees. Management anticipates that originations of these types of loans will remain lower during the remainder of 2017.

During the three- and nine-month periods ended September 30, 2017, the Company recorded $56,000 and $325,000 in gains on the disposition of real estate that it held for investment purposes, respectively. This compared to $12,000 in both the three- and nine-month periods of the prior year. The Company continues to actively market certain of the properties that it holds for investment purposes. There can be no assurances that the Company will be able to sell such properties for gains or that gains or losses on such sales, if any, will not fluctuate considerably from period to period.

In the third quarter of 2017 the Company completed the sale of five retail branch offices to another financial institution, which included $46.1 million in deposits and $13.0 million in loans associated with the offices. The Company recorded a loss of $197,000 on this transaction. In addition, during the nine months ended September 30, 2017, the Company also recorded $187,000 in one-time costs related to this transaction, as well as its decision to consolidate two other retail branch offices into other offices earlier in the year. These costs consisted primarily of asset disposition costs, employment severance costs, data processing costs, and professional fees.

Non-Interest Expense Total non-interest expense increased by $1.1 million or 6.6% and $2.2 million or 4.3% during the three and nine months ended September 30, 2017, respectively, compared to the same periods in 2016, respectively. During the three months ended September 30, 2017, the Company recorded $1.3 million in expenses related to its pending merger with Associated. These expenses consisted primarily of professional advisory, consulting, and legal fees. Excluding these merger-related expenses, total non-interest expense would have decreased by $130,000 or 0.8% and increased by $941,000 million or 1.8% during the three and nine months ended September 30, 2017, respectively, compared to the same periods in 2016, respectively. Significant reasons for the changes in the components of non-interest expense are discussed in the following paragraphs.

Compensation-related expenses increased by $167,000 or 1.6% and $1.4 million or 4.4% during the three and nine months ended September 30, 2017, respectively, compared to the same periods in 2016. These increases were due in part to normal annual merit increases granted to most employees at the beginning of 2017. Also contributing were certain signing bonuses and commission guarantees that the Company paid to a team of four experienced residential loan originators that it recruited from another financial institution earlier in the year. Finally, contributing to a lesser degree was higher share-based compensation and employer 401k contributions in the 2017 periods compared to the same periods in the prior year. These developments were partially offset in the third quarter of 2017 by reduced compensation and related costs from the aforementioned sale of five retail banking offices, as well as the consolidation of two other retail banking offices earlier in the year.

Occupancy, equipment, and data processing expenses increased by $111,000 or 3.3% and $524,000 or 5.2% during the three and nine months ended September 30, 2017, respectively, compared to the same periods in 2016. These increases were primarily caused by increased data processing, software, and equipment costs associated with various initiatives undertaken by the Company in recent periods. These developments were partially offset in the third quarter of 2017 by reduced occupancy, equipment, and data processing costs from the aforementioned sale of five retail banking offices, as well as the consolidation of two other retail banking offices earlier in the year.

Advertising and marketing-related expense was $535,000 and $1.8 million during the three and nine months ended September 30, 2017, respectively, compared to $737,000 and $2.3 million during the same periods in 2016. Management anticipates that spending on advertising and marketing-related expenses during the full year 2017 will be about 10 to 20% lower than it was in 2016. However, this outcome depends on future management decisions and there can be no assurances.

Net losses and expenses on foreclosed real estate were $15,000 and $169,000 during the three-month periods ended September 30, 2017 and 2016, respectively. Net losses and expenses during the nine-month periods ended as of those same dates were $286,000 and $80,000. In general, the Company has experienced only modest gains, losses, and expenses on foreclosed real estate in recent periods due to relatively low levels of foreclosed properties and improved market conditions.

Other non-interest expense was $2.2 million in the third quarter of 2017 compared to $2.3 million in the same quarter of last year. In a year-to-date comparison, these expenses were $6.4 million in 2017 compared to $7.0 million in 2016. The 2016 quarter and year-to-date periods included $134,000 and $341,000, respectively, in prepayment penalties related to the early retirement of certain fixed-rate advances from the FHLB of Chicago in those periods. Other non-interest expense also declined slightly in the 2017 periods due in part to lower ATM and card processing charges compared to the same periods in 2016.

Income Tax Expense Income tax expense was $2.3 million and $2.5 million during the third quarters of 2017 and 2016, respectively, and was $6.5 million and $7.4 million during the year-to-date periods in 2017 and 2016, respectively. The effective tax rates (“ETRs”) for the quarter periods were 36.9% and 35.8%, respectively, and for the year-to-date periods were 35.7% and 36.5%, respectively. The ETR was lower in the 2017 year-to-date period. The Company’s ETR will vary from period to period because of certain tax deductions related to the impact of non-taxable revenue items, such as earnings from BOLI and tax-exempt interest income, as well as the impact of vesting of restricted stock grants and exercises of certain stock options by employees and directors.

Financial Condition

Overview The Company’s total assets increased by $45.2 million or 1.7% during the nine months ended September 30, 2017. During this period a $59.8 million increase in deposit liabilities and a $25.7 million increase in advance payments for taxes and insurance funded a $41.9 million increase in loans receivable, a $13.0 million increase in aggregate mortgage-related securities, and a $31.1 million decrease in borrowings. The Company’s total shareholders’ equity was $292.4 million at September 30, 2017, compared to $286.6 million at December 31, 2016.

Mortgage-Related Securities Available-for-Sale The Company’s portfolio of mortgage-related securities available-for-sale increased by $14.6 million or 3.9% during the nine months ended September 30, 2017. This increase was due to the purchase of $99.6 million in securities that was substantially offset by normal periodic principal repayments in the portfolio.

Mortgage-Related Securities Held-to-Maturity The Company maintains a portfolio of mortgage-related securities held-to-maturity that consists of securities issued and guaranteed by the Federal National Mortgage Association (“Fannie Mae”) and backed by multi-family residential loans. The Company has classified these securities has held-to-maturity because it has the ability and intent to hold these securities until they mature. The Company’s portfolio of mortgage-related securities held-to-maturity was $91.6 million at September 30, 2017, compared to $93.2 million at December 31, 2017.

Loans Held-for-Sale The Company’s policy is to sell substantially all of its fixed-rate, one- to four-family mortgage loan originations in the secondary market. Loans held-for-sale were $4.0 million and $6.0 million at September 30, 2017, and December 31, 2016, respectively.

Loans Receivable The Company’s loans receivable increased by $41.9 million or 2.2% during the nine months ended September 30, 2017. During this period increases in multi-family loans, commercial and industrial loans, and one- to four-family permanent loans were partially offset by a decline in commercial real estate loans, construction loans (net of the undisbursed portion), and home equity and other consumer loans. The loan portfolio is subject to economic, market, competitive, and regulatory factors outside of the Company’s control and there can be no assurances that expected loan growth will continue or that total loans will not decrease in future periods.

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

	Nine Months Ended September 30
	2017		2016
	(Dollars in thousands)
Commercial loans:
Commercial and industrial	$	66,296	$	56,637
Commercial real estate		9,405		73,579
Multi-family real estate		37,883		118,968
Construction and development		110,973		185,424
Total commercial loans		224,557		434,608
Retail loans:
One- to four-family first mortgages (1)		96,457		81,944
Home equity		27,931		24,261
Other consumer		1,050		1,665
Total retail loans		125,438		107,870
Total loan originations	$	349,995	$	542,478

(1)

Excludes $64.5 million and $112.5 million in loans originated for sale during the nine months ended September 30, 2017 and 2016, respectively.

Mortgage Servicing Rights The carrying value of the Company’s MSRs was $6.3 million at September 30, 2017, and $6.6 million at December 31, 2016, respectively. The Company maintained no valuation allowance against its MSRs as of either of those dates. As of September 30, 2017, the Company serviced $957.8 million in loans for third-party investors compared to $997.0 million at December 31, 2016. Refer to “Results of Operations—Non-Interest Income,” above, for additional discussion related to the Company’s MSRs.

Deposit Liabilities The Company’s deposit liabilities increased by $59.8 million or 3.2% during the nine months ended September 30, 2017. This increase was primarily the result of a $100.0 million increase in brokered certificates of deposits that were drawn by the Company during the period as an alternative funding source to borrowing from the Federal Home Loan Bank of Chicago. The impact of this increase was partially offset by the aforementioned purchase and assumption of $46.1 million in deposit liabilities by another financial institution that was closed in the third quarter of 2017.

Borrowings Borrowings, which consist of advances from the FHLB of Chicago, decreased by $31.1 million or 7.1% during the nine months ended September 30, 2017. This decrease was primarily caused by a decline in overnight borrowings from the FHLB of Chicago. These borrowings were reduced because of an increase in funding from deposit liabilities and advance payments by borrowers for taxes and insurance. Management believes that additional funds are available to be borrowed from the FHLB of Chicago or other sources in the future to fund maturing term advances, loan originations, security purchases, and other corporate purposes, if needed or desirable. However, there can be no assurances of the future availability of borrowings or any particular level of future borrowings.

Advance Payments by Borrowers for Taxes and Insurance Advance payments by borrowers for taxes and insurance (i.e., escrow deposits) were $30.5 million at September 30, 2017, compared to $4.8 million at December 31, 2016. Escrow deposits typically increase during the course of the calendar year until real estate tax obligations are paid, generally in December of each year or January of the following year.

Shareholders' Equity The Company’s shareholders’ equity was $292.4 million at September 30, 2017, compared to $286.6 million at December 31, 2016. This increase was primarily due to $11.7 million in net income that was only partially offset by $7.6 million in regular cash dividends. Also contributing to the increase was periodic amortization related to share-based compensation and the issuance of treasury shares on stock option exercises. The book value of the Company’s common stock was $6.36 per share at September 30, 2017, compared to $6.27 at December 31, 2016.

On November 6, 2017, the Company’s board of directors declared a $0.055 per share dividend payable on November 27, 2017, to shareholders of record on November 17, 2017. For additional discussion relating to the Company’s ability to pay dividends or repurchase its common stock refer to “Liquidity and Capital Resources—Capital Resources,” below.

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

	September 30			December 31
	2017			2016
	(Dollars in thousands)
Non-accrual commercial loans:
Commercial and industrial	$	403		$	989
Commercial real estate		4,129			2,839
Multi-family real estate		257			274
Construction and development		501			148
Total commercial loans		5,290			4,250
Non-accrual retail loans:
One- to four-family first mortgages		2,291			3,191
Home equity		169			442
Other consumer		62			46
Total non-accrual retail loans		2,522			3,679
Total non-accrual loans		7,812			7,929
Accruing loans delinquent 90 days or more (1)		231			295
Total non-performing loans		8,043			8,224
Foreclosed real estate and repossessed assets		845			2,943
Total non-performing assets	$	8,888		$	11,167

Non-performing loans to total loans		0.41	%		0.42	%
Non-performing assets to total assets		0.33	%		0.42	%
Interest income that would have been recognized if non-accrual loans had been current (2)	$	359		$	498
Interest income on non-accrual loans included in interest income (2)	$	368		$	390

(1)

Consists of student loans that are guaranteed under programs sponsored by the U.S. government.

(2)

Amounts shown are for the nine months ended September 30, 2017, and the twelve months ended December 31, 2016, respectively.

The Company’s non-performing loans were $8.0 million or 0.41% of loans receivable as of September 30, 2017, compared to $8.2 million or 0.42% of loans receivable as of December 31, 2016. Non-performing assets, which includes non-performing loans, were $8.9 million or 0.33% of total assets and $11.2 million or 0.42% of total assets as of these same dates, respectively. Non-performing assets are classified as “substandard” in accordance with the Company’s internal risk rating policy. In addition to non-performing assets, at September 30, 2017, management was closely monitoring $65.2 million in additional loans that were classified as either “special mention” or “substandard” in accordance with the Company’s internal risk rating policy. This amount compared to $68.6 million at December 31, 2016. As of September 30, 2017, most of the Company’s additional classified loans were secured by commercial real estate, multi-family real estate, land, and certain commercial business assets. Management does not believe any of these loans were impaired as of September 30, 2017, although there can be no assurances that the loans will not become impaired in future periods.

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

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

	Nine Months Ended September 30
	2017			2016
	(Dollars in thousands)
Balance at beginning of period	$	19,940		$	17,641
Provision for loan losses		1,552			1,986
Charge-offs:
Commercial and industrial		(31	)		–
Commercial real estate		–			(179	)
Multi-family real estate		–			–
Construction and development		–			–
One- to four-family first mortgages		(55	)		(84	)
Home equity		(17	)		(35	)
Other consumer		(278	)		(299	)
Total charge-offs		(381	)		(597	)
Recoveries:
Commercial and industrial		–			5
Commercial real estate		13			28
Multi-family real estate		32			30
Construction and development		–			–
One- to four-family first mortgages		67			42
Home equity		52			15
Other consumer		51			52
Total recoveries		215			172
Net charge-offs		(166	)		(425	)
Balance at end of period	$	21,326		$	19,202

	September 30			December 31
	2017			2016
Allowance for loan losses to total loans		1.07	%		1.03	%
Allowance for loan losses to non-performing loans		265.15	%		242.46	%
Net charge-offs to average loans (1)		0.01	%		0.04	%

(1)

The rate for the nine months ended September 30, 2017, is annualized.

The Company’s allowance for loan losses was $21.3 million or 1.07% of total loans at September 30, 2017, compared to $19.9 million or 1.03% of total loans at December 31, 2016. As a percent of non-performing loans, the Company’s allowance for loan losses was 265.2% at September 30, 2017, compared to 242.5% at December 31, 2016. Management believes the allowance for loan losses at September 30, 2017, was adequate to cover probable and estimable losses in the Company’s loan portfolio as of that date. However, future increases to the allowance may be necessary and results of operations could be adversely affected if future conditions differ from the assumptions used by management to determine the allowance for loan losses as of the end of the period.

Management is responsible for the timely and periodic determination of the amount of the allowance required. Future provisions for loan losses will continue to be based upon management’s assessment of the overall loan portfolio and the underlying collateral, trends in non-performing loans, current economic conditions, and other relevant factors. To the best of management’s knowledge, all known and inherent losses have been provided for in the allowance for loan losses.

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

Liquidity and Capital Resources

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

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

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

Capital Resources The Company’s ratio of shareholders’ equity to total assets was 10.85% at September 30, 2017, compared to 10.82% at December 31, 2016. This decrease was primarily due to an increase in the Company’s total assets during the period, as previously described. The Company is required to maintain specified amounts of regulatory capital pursuant to regulations promulgated by the Federal Reserve Bank (“FRB”). The Company is “well capitalized” for regulatory capital purposes. As of September 30, 2017, the Company had a total risk-weighted capital ratio of 16.02% and a Tier 1 leverage capital ratio of 11.08%. The minimum ratios to be considered “well capitalized” under current supervisory regulations are 10% for total risk-weighted capital and 5% for Tier 1 capital. The minimum ratios to be considered “adequately capitalized” are 8% and 4%, respectively. For additional discussion refer to “Note 8. Regulatory Capital Requirements” in “Item 1. Financial Statements.”

The payment of dividends or the repurchase of common stock by the Company is highly dependent on the ability of the Bank to pay dividends or otherwise distribute capital to the Company. Such payments are also subject to any requirements imposed by law or regulations and to the application and interpretation thereof by the OCC and FRB. The merger agreement with Associated also limits Company dividends to $.055 per share each quarter and restricts the repurchase of Company shares without Associated’s consent. The Company cannot provide any assurances that dividends will continue to be paid, the amount of any such dividends, or whether the Company will choose to or be able to repurchase its common stock in future periods.

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

Contractual Obligations The following table presents, as of September 30, 2017, significant fixed and determinable contractual obligations to third parties by payment date (excluding interest payments due in the future on deposits and borrowed funds):

	Payments Due In
			One to		Three to		Over
	One Year		Three		Five		Five
	Or Less		Years		Years		Years		Total
	(Dollars in thousands)
Deposits with no stated maturity	$	1,314,495		–		–		–	$	1,314,495
Certificates of deposit		447,694	$	158,595	$	3,768		–		610,057
Borrowed funds		342,547		26,235		32,978	$	6,262		408,022
Operating leases		833		1,477		1,065		2,506		5,881
Purchase obligations		2,640		2,640		–		–		5,280
Deferred retirement plans and deferred compensation plans		789		1,697		711		4,015		7,212

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

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

Commitments to Extend Credit The following table details the amounts and expected maturities of approved commitments as of September 30, 2017:

Payments Due In

One to

Three to

Over

One Year

Three

Five

Or Less

Years

Total

(Dollars in thousands)

Commercial lines of credit

184,439

–

184,439

Commercial loans

1,693

719

–

2,412

Standby letters of credit

7,268

174

–

7,446

Multi-family and commercial real estate loans

195,730

3,330

–

199,060

Residential real estate loans

51,842

–

51,842

Revolving home equity and credit card lines

163,438

–

163,438

Net commitments to sell mortgage loans

10,066

–

10,066

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

Off-Balance Sheet Arrangements At September 30, 2017, the Company had forward commitments to sell one- to four-family mortgage loans of $10.1 million to Fannie Mae. As described in Note 12, “Financial Instruments with Off-Balance Sheet Risk,” to the Company’s Unaudited Condensed Consolidated Financial Statements, the Company uses forward commitments to sell loans to mitigate interest rate risk on one- to four-family IRLCs and loans held-for-sale.

Contingent Liabilities The Company did not have a material exposure to contingent liabilities as of September 30, 2017.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Gap Analysis

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

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

The following table presents the amounts of the Company’s interest-earning assets and interest-bearing liabilities outstanding at September 30, 2017, which management anticipates to reprice or mature in each of the future time periods shown. The information presented in the following table is based on the following assumptions:

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

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

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

Borrowings—based upon final maturity.

	September 30, 2017
	Within			Three to			More than			More than
	Three			Twelve			1 Year to			3 Years -			Over 5
	Months			Months			3 Years			5 Years			Years			Total
	(Dollars in thousands)
Loans receivable:
Commercial loans:
Fixed	$	35,205		$	78,769		$	106,187		$	81,437		$	15,921		$	317,519
Adjustable		892,469			73,279			59,958			12,955			3,889			1,042,550
Retail loans:
Fixed		16,720			33,548			63,627			39,156			60,812			213,863
Adjustable		93,509			112,959			105,309			68,360			52,397			432,534
Interest-earning deposits		27,832			–			–			–			–			27,832
Mortgage-related securities:
Fixed		24,410			65,482			181,338			125,424			71,667			468,321
Adjustable		10,710			–			–			–			–			10,710
Other interest-earning assets		18,361			–			–			–			–			18,361
Total interest-earning assets		1,119,216			364,037			516,419			327,332			204,686			2,531,690

Deposit liabilities:
Non-interest-bearing demand accounts		–			–			–			–			305,577			305,577
Interest-bearing demand accounts		–			–			–			–			240,638			240,638
Savings accounts		–			–			–			–			238,409			238,409
Money market accounts		529,871			–			–			–			–			529,871
Certificates of deposit		192,329			258,040			155,920			3,768			–			610,057
Advance payments by borrowers for taxes and insurance		30,458			–			–			–			–			30,458
Borrowings		320,285			23,424			28,248			30,757			5,308			408,022
Total non-interest- and interest- bearing liabilities		1,072,943			281,464			184,168			34,525			789,932			2,363,032
Interest rate sensitivity gap	$	46,273		$	82,573		$	332,251		$	292,807		$	(585,246	)	$	168,658
Cumulative interest rate sensitivity gap	$	46,273		$	128,846		$	461,097		$	753,904		$	168,658
Cumulative interest rate sensitivity gap as a percent of total assets		1.72	%		4.78	%		17.12	%		27.99	%		6.26	%
Cumulative interest-earning assets as a percentage of non-interest- and interest-bearing liabilities		104.31	%		109.51	%		129.97	%		147.92	%		107.14	%

Based on the above gap analysis, at September 30, 2017, the Company’s interest-bearing assets maturing or repricing within one year exceeds its interest-earning liabilities maturing or repricing within the same period. Based on this information, over the course of the next year net interest income could be favorably impacted by an increase in market interest rates. Alternatively, net interest income could be unfavorably impacted by a decrease in market interest rates. However, it should be noted that the Company’s future net interest income is affected by more than just future market interest rates. Net interest income is also affected by absolute and relative levels of earning assets and interest-bearing liabilities, the level of non-performing loans and other investments, and by other factors outlined in Part I, Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Cautionary Statement,” as well as Part I, Item 1A, “Risk Factors,” of the Company’s 2016 Annual Report on Form 10-K.

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

Present Value of Equity

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

The following table presents the estimated present value ratio over a range of interest rate change scenarios at September 30, 2017. The present value ratio is the PVE as a percent of the present value of total assets in each of the different rate environments. For purposes of this table, management has made assumptions such as prepayment rates and decay rates similar to those used for the gap analysis table.

									Present Value of Equity
									as a Percent of the
Change in	Present Value of Equity								Present Value of Assets
Interest Rates	Dollar		Dollar			Percent			Present Value			Percent
(Basis Points)	Amount		Change			Change			Ratio			Change
	(Dollars in thousands)
+400	$	349,976	$	(19,503	)		(5.3	)%		13.72	%		0.7	%
+300		356,504		(12,975	)		(3.5	)		13.76			1.1
+200		365,224		(4,255	)		(1.2	)		13.88			1.9
+100		365,039		(4,440	)		(1.2	)		13.66			0.3
0		369,479		–			–			13.62			–
-100		348,141		(21,338	)		(5.8	)		12.66			(7.1	)

Based on the above analysis, the Company’s PVE is not expected to be materially impacted from changes in market interest rates. However, it should be noted that the Company’s PVE is impacted by more than changes in market interest rates. Future PVE is also affected by management’s decisions relating to reinvestment of future cash flows, decisions relating to funding sources, and by other factors outlined in Part I, Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Cautionary Statement,” above, as well as Part I, Item 1A, “Risk Factors,” of the Company’s 2016 Annual Report on Form 10-K.

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

Item 4. Controls and Procedures

Disclosure Controls and Procedures

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

Internal Control Over Financial Reporting

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

PART II

Item 1. Legal Proceedings

As disclosed in the Company’s quarterly report on Form 10-Q for the quarter ended June 30, 2017, and in the Proxy Statement/Prospectus dated September 15, 2017, relating to the special meeting of shareholders on October 24, 2017, related to pending merger with Associated (the “Proxy Statement/Prospectus”), on July 28, 2017, two substantially identical purported class action complaints, each by various individual plaintiffs, were filed with the Wisconsin Circuit Court for Milwaukee County on behalf of the respective named plaintiffs and seeking to represent other Company shareholders against the Company, the members of the Company’s board, and Associated in connection with the proposed merger between Associated and the Company. The lawsuits were captioned Schumel et al. v. Bank Mutual Corporation et al., case no. 2017CV006201, and Paquin et al. v. Bank Mutual Corporation et al., case no. 2017CV006202. Both complaints alleged state law breach of fiduciary duty claims against the Bank Mutual board for, among other things, seeking to sell Bank Mutual through an allegedly defective process, for an allegedly unfair price and on allegedly unfair terms. On August 30, 2017, a third purported class action complaint, captioned Wollenburg et al. v. Bank Mutual Corporation et al., case no. 2017CV007312, was filed in the Wisconsin Circuit Court for Milwaukee County, purportedly on behalf of the same class of shareholders and against the same defendants as the prior two complaints. The Wollenburg complaint asserted similar allegations as the prior two complaints, and further alleged that the preliminary proxy statement/prospectus filed with the Securities and Exchange Commission (“SEC”) contained various alleged misstatements or omissions. The Paquin, Schumel, and Wollenburg complaints alleged that Associated aided and abetted the directors’ alleged breaches of fiduciary duty. On September 13, 2017, Associated filed a notice of removal of the Paquin, Schumel, and Wollenburg actions to the United States District Court for the Eastern District of Wisconsin; however, on October 11, 2017, that Court remanded the three actions back to Wisconsin Circuit Court.

On September 6, 2017, a fourth purported class action complaint, captioned Parshall et al. v. Bank Mutual Corporation et al., case no. 17-CV-1209, was filed in the United States District Court for the Eastern District of Wisconsin, purportedly on behalf of the same class of shareholders and against the same defendants as the prior complaints. The Parshall complaint criticized the adequacy of the merger consideration and alleged that Bank Mutual, the members of the Bank Mutual board and Associated allegedly omitted and/or misrepresented certain information in the registration statement of which the Proxy Statement/Prospectus formed a part in violation of securities laws and related SEC regulations.

The Company, Associated and the other defendants believe that the claims asserted in the four lawsuits were without merit and that the disclosures in the Proxy Statement/Prospectus were adequate under the law. However, to avoid the risk that the lawsuits might delay or otherwise adversely affect the consummation of the merger and to minimize the expense of defending such actions, on October 13, 2017 the Company and Associated determined to voluntarily make certain supplemental disclosures related to the merger. It was stated that nothing in those disclosures was to be deemed an admission of the legal necessity or materiality under applicable law of any of such disclosures. The Company and Associated specifically denied that any further disclosure was required to supplement the Proxy Statement/Prospectus under applicable law.

In light of the supplemental disclosures, on October 13, 2017, the plaintiffs in the four lawsuits agreed to dismiss their individual claims with prejudice.

Item 1A. Risk Factors

Refer to “Risk Factors” in Part I, Item 1A, of the Company’s 2016 Annual Report on Form 10-K, under the caption “Forward Looking Statements” in the Company’s Current Report on Form 8-K dated and filed on July 20, 2017, and under the caption “Risk Factors” in the Proxy Statement/ Prospectus, filed by the Company on Schedule 14A on September 15, 2017. Refer also to "Management’s Discussion and Analysis of Financial Condition and Results of Operations—Cautionary Statement" in Part I, Item 2, above.

Item 6. Exhibits

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

SIGNATURES

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

	BANK MUTUAL CORPORATION
	(Registrant)

Date: November 7, 2017	/s/ David A. Baumgarten
	David A. Baumgarten
	President and Chief Executive Officer

Date: November 7, 2017	/s/ Michael W. Dosland
	Michael W. Dosland
	Senior Vice President and
	Chief Financial Officer

EXHIBIT INDEX

BANK MUTUAL CORPORATION

Form 10-Q for Quarter Ended September 30, 2017

Exhibit No.	Description	Incorporated Herein by Reference To	Filed Herewith

2.1	Agreement and Plan of Merger, dated as of July 20, 2017, by and between Associated Banc-Corp and Bank Mutual Corporation*	Exhibit 2.1 to the Company’s Current Report on Form 8-K dated July 20, 2017 and filed on July 26, 2017

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

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

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

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

101	The following materials are provided from Bank Mutual Corporation’s Quarterly Report on Form 10-Q for the period ended September 30, 2017, formatted in Extensible Business Reporting Language (“XBRL”): (i) the Unaudited Condensed Consolidated Statements of Financial Condition, (ii) Unaudited Condensed Consolidated Statements of Income, (iii) Unaudited Condensed Statements of Comprehensive Income (iv) Unaudited Condensed Consolidated Statements of Equity, (v) Unaudited Condensed Consolidated Statements of Cash Flow, and (vi) Notes to Unaudited Condensed Consolidated Financial Statements.

101.INS	XBRL Instance Document		X

Exhibit No.	Description	Incorporated Herein by Reference To	Filed Herewith

101.SCH	XBRL Taxonomy Extension Schema Document		X

101.CAL	XBRL Taxonomy Extension Calculation Linkbase Document		X

101.LAB	XBRL Extension Labels Linkbase Document		X

101.PRE	XBRL Taxonomy Extension Presentation Linkbase Document		X

101.DEF	XBRL Taxonomy Extension Definition Linkbase Document		X

Schedules have been omitted pursuant to Item 601(b)(2) of Regulation S-K. Bank Mutual hereby undertakes to furnish supplemental copies of any of the omitted schedules upon request by the SEC.

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