Bank Mutual Corporation (BKMU) - Description of business

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Company Description
Loans. At December 31, 2006, our commercial business loan portfolio consisted of loans totaling $52.1 million or 2.5% of our total loans receivable. The commercial loan portfolio consists of loans to businesses for equipment purchases, working capital lines of credit, debt refinancing, SBA loans and domestic stand-by letters of credit. Typically, these loans are secured by business assets and personal guarantees. We offer variable, adjustable and fixed rate loans. Approximately 34.2% of the commercial business loans have an interest rate adjusted monthly or immediately, with the majority based on the prevailing prime rate. We also have commercial business loans that have an initial period where interest rates are fixed, generally one to five years, and thereafter are adjustable based on various indexes. Fixed rate loans are priced at either a margin over the yield on U.S. Treasury issues with maturities that correspond to the maturities of the notes or to match competitive conditions and yield requirements. Term loans are generally amortized over a three to seven year period and line-of-credit commercial business loans generally have a term of one year, at which point they mature. All borrowers having an exposure to the Bank of $500,000 or more are reviewed annually, unless it is investment real estate at which point the annual review is on anything over $1.0 million. The largest commercial business loan at December 31, 2006 had an outstanding balance of $6.4 million and was secured by real estate and a general business security agreement.Loan Approval AuthorityFor one- to four-family residential loans intended for sale into the secondary market, the underwriters are authorized by the board of directors to approve loans processed through the Fannie Mae “Desktop Underwriter” automated underwriting system up to the Fannie Mae conforming loan limits (in 2007, $417,000 for a single family residential units; higher limits for two-, three-, and four-family units). For residential loans intended to be held in the Bank’s portfolio, the underwriters are authorized to approve loans processed through the Fannie Mae “Desktop Underwriter” automated underwriting system up to $500,000, provided the loan-to-value is 80% or less (with mortgage insurance, 90% or less) and the loan meets other specific underwriting criteria. All portfolio loans in excess of $500,000, with a loan-to-value greater than 80% (with mortgage insurance, 90% or less), or failing to meet other specific underwriting criteria must be approved by a senior officer.The Bank has delegated lending authority of up to $650,000 to lenders approved for the Bank’s correspondent program whose loans are to be purchased for the Bank’s portfolio. That approval is made in conjunction with the loan receiving an “approve” from Fannie Mae’s Desktop Underwriter or Freddie Mac’s Loan Prospector and an approval from the correspondent’s underwriter only after the Bank has reviewed a minimum of 50 loans submitted to the Bank for purchase. For those correspondents who have been delegated lending authority, the Bank does an ongoing sample of 20% of the loans being submitted by the correspondent for purchase by the Bank from correspondents who have been delegated lending authority.Consumer loan underwriters have individual approval authority for secured loans ranging from $25,000 to $150,000 provided the loan-to-value on real estate does not exceed 80%, or 90% on personal property, and that the loan meets other specific underwriting criteria. All consumer loans in excess of $150,000, with a loan-to-value greater than 80% on real estate, 90% on personal property, or failing to meet other specific underwriting criteria must be approved by a senior officer. Consumer loan underwriters have individual approval authority for unsecured loans ranging from $10,000 to $25,000 provided the loan meets other specific underwriting criteria. All unsecured consumer loans in excess of $25,000, or not meeting specific underwriting criteria, must be approved by a senior officer.Certain individual lenders and senior officers in the multi-family and commercial real estate department have lending authority of $500,000 for both existing and proposed construction of multi-family and commercial real estate properties. Two senior officers together have lending authority of $750,000 and three senior officers togetherhave lending authority of $1,000,000 for multi-family and commercial real estate loans. All multi-family and commercial real estate loans over $1,000,000 require approval of the executive committee of the board of directors.Individual lenders in the commercial banking department have individual lending authority ranging from $50,000 to $250,000 for secured commercial business loans. Senior officers have individual lending authority of $250,000 and two senior officers together have lending authority of $500,000 for secured commercial business loans. Three senior officers together have lending authority of $1,000,000 for secured commercial business loans. All secured business loans over $1,000,000 require approval of the executive committee of the board of directors. Individual lenders in the commercial banking department have individual lending authority ranging from $10,000 to $25,000 for unsecured commercial business loans. Senior officers have individual lending authority of $50,000 and two senior officers together have lending authority of $150,000 for unsecured commercial business loans. Three senior officers together have lending authority of $250,000 for unsecured commercial business loans. All unsecured business loans over $250,000 require approval of the executive committee of the board of directors.All loans approved by individuals and senior officers must be ratified by the board of directors at their next meeting following the approval. Asset QualityOne of our key operating objectives has been and continues to be to maintain a high level of asset quality. Through a variety of strategies, including, but not limited to early intervention, borrower workout arrangements and aggressive marketing of foreclosed properties and repossessed assets, we have been proactive in addressing problem and non-performing assets. These strategies, as well as our emphasis on quality loan underwriting, our maintenance of sound credit standards for new loan originations, annual evaluation of large credits and relatively favorable economic and real estate market conditions have resulted in historically low delinquency ratios. Delinquent Loans and Foreclosed Assets. When a borrower fails to make required payments on a loan, we take a number of steps to induce the borrower to cure the delinquency and restore the loan to a current status. In the case of one- to four-family mortgage loans, our loan servicing department is responsible for collection procedures from the 15th day of delinquency through the completion of foreclosure. Specific procedures include a late charge notice being sent at the time a payment is over 15 days past due with a second notice (in the form of a billing coupon) being sent before the payment becomes 30 days past due. Once the account is 30 days past due, we attempt telephone contact with the borrower. Letters are sent if contact has not been established by the 45th day of delinquency. On the 60th day of delinquency, attempts at telephone contact continue and stronger letters, including foreclosure notices, are sent. If telephone contact cannot be made, we send either a qualified third party inspector or a loan officer to the property in an effort to contact the borrower.When contact is made with the borrower, we attempt to obtain full payment or work out a repayment schedule to avoid foreclosure. All properties are inspected prior to foreclosure approval. Most borrowers pay before the agreed upon payment deadline and it is not necessary to start a foreclosure action. Foreclosure action starts when the loan is between the 90th and 120th day of delinquency following review by a senior officer. In conjunction with commencing a foreclosure action, we evaluate the borrower and collateral to determine any potential loss. If there is a potential loss, a specific loan loss allowance is developed or an appropriate charge-off is taken to bring the loan balance in line with the value of the liquidated real estate. Charge-offs are reported to the board of directors. If the loan is deemed to be uncollectible, we seek the shortest redemption period possible thus waiving our right to collect any deficiency from the borrower. If we obtain the property at the foreclosure sale, we hold the property as real estate owned. We obtain a market evaluation of the property to determine that the carrying balance of the owned real estate is consistent with the market value of the property. Marketing of the property begins immediately following the Bank taking title to the property. The marketing is usually undertaken by a realtor knowledgeable of the particular market. Mortgage insurance claims are filed if the loan had mortgage insurance coverage. It is marketed after a market evaluation is obtained and any mortgage insurance claims are filed. The collection procedures and guidelines as outlined by Fannie Mae, Freddie Mac, Veterans Administration (VA), WHEDA, and Guaranteed Rural Housing are followed.The collection procedures for consumer loans, excluding student loans, indirect consumer loans and credit card loans, include sending periodic late notices to a borrower once a loan is 5 to 15 days past due depending upon the grace period associated with a loan. We attempt to make direct contact with a borrower once a loan becomes 30 days past due. Supervisory personnel review loans 90 days or more delinquent on a regular basis. If collection activity is unsuccessful after 90 days, we may pursue legal remedies ourselves or charge-off a loan or refer the matter to our legal counsel for further collection effort. Loans we deem to be uncollectible, or partially uncollectible are charged off or a specific loan loss allowance is established so that the carrying balance approximates the value of the collateral. Charge-offs of consumer loans require the approval of a senior officer and are reported to the board of directors. All student loans are serviced by the Great Lakes Educational Services Inc., which guarantees their servicing to comply with all Department of Education guidelines. Our student loan portfolio is guaranteed by the Great Lakes Educational Loan Services, Inc., which is reinsured by the U.S. Department of Education. Credit card loans are serviced by Elan Financial Services and indirect consumer loans are serviced by SFC.The collection procedures for multi-family, commercial real estate and commercial business loans include sending periodic late notices to a borrower once a loan is past due. We attempt to make direct contact with a borrower once a loan becomes 15 days past due. Our managers of the multi-family and commercial real estate loan areas review loans 10 days or more delinquent on a regular basis. If collection activity is unsuccessful, we may refer the matter to our legal counsel for further collection effort. Within 90 days, loans we deem to be uncollectible are proposed for repossession or foreclosure, a specific reserve may be allocated to that loan, or partial or full charge-offs are taken to bring the loan balance in line with the expected collectibility of the loans. This legal action requires the approval of our board of directors, and charge offs are reported to the board.Our policies require that management continuously monitor the status of the loan portfolio and report to the board of directors on a monthly basis. These reports include information on delinquent loans and foreclosed real estate.The following table presents information regarding non-accrual mortgage, consumer loans, commercial business loans, accruing loans delinquent 90 days or more, and foreclosed properties and repossessed assets as of the dates indicated.                                               At December 31,     2006   2005   2004   2003   2002     (Dollars in thousands) Non-accrual mortgage loans   $ 11,504     $ 2,214     $ 1,485     $ 2,894     $ 1,399   Non-accrual consumer loans     803       616       619       961       527   Non-accrual commercial business loans     1,625       2,517       3,579       5,433       5,357   Accruing loans delinquent 90 days or more     565       487       586       1,084       1,108         Total non-performing loans   $ 14,497       5,834       6,269       10,372       8,391   Foreclosed properties, real estate owned and repossessed assets, net     1,231       708       1,621       630       750         Total non-performing assets   $ 15,728     $ 6,542     $ 7,890     $ 11,002     $ 9,141         Non-performing loans to total loans     0.72 %     0.29 %     0.33 %     0.61 %     0.50 %       Non-performing assets to total assets     0.46 %     0.19 %     0.23 %     0.35 %     0.32 %       Interest income that would have been recognized if non-accrual loans had been current   $ 652     $ 1,159     $ 831     $ 384     $ 375         There were no restructured loans at the dates presented.Total non-performing loans increased as of December 31, 2006, as compared to December 31, 2005, primarily as a result of an increase in non-accrual multi-family mortgage loans, partially offset by a decrease in non-accrual commercial business loans. Total non-performing loans decreased as of December 31, 2005, as compared to December 31, 2004, primarily as a result of a decrease in non-accrual commercial business loans. We believe non-performing loans and assets, expressed as a percentage of total loans and assets, compare favorably with national averages for financial institutions, due in part to our loan underwriting standards.The ultimate results with these and other commercial loans will depend on the success of the related business or projects, economic performance and other factors affecting loans and borrowers.With the exception of mortgage loans insured or guaranteed by the FHA, VA, Guaranteed Rural Housing and student loans, we stop accruing income on loans when interest or principal payments are greater than 90 days in arrears or earlier when the timely collectibility of such interest or principal is doubtful. We designate loans on which we stop accruing income as non-accrual loans and generally, we reverse outstanding interest that we previously credited to income. We may recognize income in the period that we collect it when the ultimate collectibility of principal is no longer in doubt. We return a non-accrual loan to accrual status when factors indicating doubtful collection no longer exist. We had $13.9 million, $5.3 million and $5.7 million of non-accrual loans at December 31, 2006, 2005 and 2004, respectively. Interest income that would have been recognized had such loans been performing in accordance with their contractual terms totaled approximately $652,000, $1.2 million and $831,000 for the years ended December 31, 2006, 2005 and 2004, respectively. A total of approximately $654,000, $464,000, and $83,000 of interest income was actually recorded on such loans in 2006, 2005 and 2004, respectively.All commercial business and commercial real estate loans which are greater than 90 days past due are considered to be potentially impaired. In addition, we may declare a loan impaired prior to a loan being 90 days past due, if we determine there is a question as to the collectibility of principal. Impaired loans are individually assessed to determine whether a loan’s carrying value is in excess of the fair value of the collateral or the present value of the loan’s cash flows discounted at the loan’s effective interest rate and if the carrying value is in excess, a loan loss allowance will be established.There were no significant loans considered to be impaired as defined in Statement of Financial Accounting Standards (“SFAS”) No. 114 at December 31, 2003 or 2002. At December 31, 2006, there were loans totaling $17.3 million considered to be impaired as compared to $9.7 million at December 31, 2005 and $8.7 at December 31, 2004. The average impaired loans for the year ended December 31, 2006 were $6.5 million and the interest received and recognized on the impaired loans was $179,000.Foreclosed real estate consists of property we acquired through foreclosure or deed in lieu of foreclosure. Foreclosed properties increased in 2006 as compared to 2005 primarily as a result of an increase in one-to-four family properties owned; however, some of those one-to-four family properties were collateral for commercial loans which we foreclosed. Foreclosed real estate properties are initially recorded at the lower of the recorded investment in the loan or fair value. Thereafter, we carry foreclosed real estate at fair value less estimated selling costs. Foreclosed real estate is inspected periodically. Additional outside appraisals are obtained as deemed necessary. Additional write-downs may occur if the property value deteriorates. These additional write-downs are charged directly to current operations. Charge-offs. The Company will charge off a loan when the fair market value of the underlying collateral or anticipated cash flow discounted at the contract rate, is less than the loan amount. Charge-offs of commercial loans increased in 2005 as compared to 2004 primarily as a result of one large commercial loan. All charge-offs are recorded through the allowance for loan losses. Allowance for Loan Losses. The following table presents the activity in our allowance for loan losses at or for the periods indicated.                                               At or for the Years Ended December 31,       2006     2005     2004     2003     2002               (Dollars in thousands)           Balance at beginning of period   $ 12,090     $ 13,923     $ 13,771     $ 12,743     $ 12,245   Provision for loan losses     632       541       1,330       1,304       760   Charge-offs:                                         Mortgage loans     (44 )     —       (64 )     (67 )     (14 ) Consumer loans     (271 )     (327 )     (373 )     (415 )     (428 ) Commercial business loans     (52 )     (2,104 )     (816 )     (19 )     (39 )       Total charge-offs     (367 )     (2,431 )     (1,253 )     (501 )     (481 ) Recoveries:                                         Mortgage loans     —       —       9       113       66   Consumer loans     81       49       66       107       40   Commercial business loans     138       8       —       5       113         Total recoveries     219       57       75       225       219         Net (charge-offs) recoveries     (148 )     (2,374 )     (1,178 )     (276 )     (262 )       Balance at end of period   $ 12,574     $ 12,090     $ 13,923     $ 13,771     $ 12,743                                                   Net charge-offs to average loans     (0.01 )%     (0.12 )%     (0.07 )%     (0.02 )%     (0.01 )% Allowance for loan losses to total loans     0.62 %     0.61 %     0.74 %     0.80 %     0.76 % Allowance for loan losses to non-performing loans     86.74 %     207.23 %     222.09 %     132.77 %     151.87 % The allowance for loan losses has been determined in accordance with generally accepted accounting principles. We are responsible for the timely and periodic determination of the amount of the allowance required. We believe that our allowance for loan losses is adequate to cover specifically identifiable loan losses, as well as estimated losses inherent in our portfolio for which certain losses are probable but not specifically identifiable.Loan loss allowances are reviewed monthly. General allowances are maintained by the following categories for performing loans to provide for unidentified inherent losses in the portfolios:  •   One- to four-family residential mortgage loans    •   Consumer    •   Multi-family and commercial real estate    •   Commercial business Various factors are taken into consideration in establishing the loan loss allowance including: historical loss experience, economic factors, loans without escrow accounts and other factors, that, in management’s judgment would affect the collectibility of the portfolio as of the evaluation date. Adjustments to the allowance for loan losses are charged against operations as provision for loan losses.The appropriateness of the allowance is reviewed by senior management based upon its evaluation of then-existing economic and business conditions affecting the key lending areas of the Bank. Other outside factors such as credit quality trends, collateral values, loan volumes and concentrations, specific industry conditions within portfolio segments and recent loss experience in particular segments of the portfolio that existed as of the balance sheet date and the impact that such conditions were believed to have had on the collectibility of the loan are also considered. Non-performing and Delinquent Loans. One- to four-family loans delinquent more than 90 days, multi-family and commercial real estate loans delinquent more than 30 days, consumer loans delinquent more than 90 days and commercial business loans delinquent more than 30 days are reviewed and analyzed by senior officers on an individual basis. Any probable loss is charged against the general loan loss allowance by establishing a corresponding specific allowance for that loan.By following careful underwriting guidelines, we have historically maintained low levels of non-performing loans to total loans. Our ratio of non-performing loans to total loans at December 31, 2002 was 0.50% and has remained well below 1.0% since that date. At December 31, 2006, the ratio was 0.72%. This recent increase as compared to December 31, 2005 and 2004 was the result of increased delinquencies in the multi-family portfolio. At December 31, 2006, the recorded investment in loans that are considered to be impaired under SFAS No. 114 was $17.3 million.We believe the primary risks inherent in our portfolio are possible increases in interest rates, a possible weak economy, and a possible decline in real estate market values. Any one or a combination of these events may adversely affect our loan portfolio resulting in increased delinquencies and loan losses. At December 31, 2006, the allowance for loan losses as a percentage of total loans was 0.62% compared with 0.76% at December 31, 2002. The allowance for loan losses each year from 2002 to 2006 reflects our strategy of providing allowances for inherent losses in the portfolio, identifying potential losses in a timely manner, and providing an allowance to reflect changes in the components of the portfolio during that period.Although we have established and maintained the allowance for loan losses at an amount that reflects management’s best estimate of the amount necessary to provide for probable and estimable losses on loans, future additions may be necessary if economic and other conditions in the future differ substantially from the current operating environment and as the loan portfolio grows and its composition changes. In addition, various regulatory agencies, as an integral part of their examination process, periodically review our loan and foreclosed real estate portfolios and the related allowance for loan losses and valuation allowance for foreclosed real estate. One or more of these agencies, specifically the OTS or the Federal Deposit Insurance Corporation (“FDIC”), may require us to increase the allowance for loan losses or the valuation allowance for foreclosed real estate based on their judgments of information available to them at the time of their examination, thereby adversely affecting our results of operations.See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Comparison of Operating Results for the Years Ended December 31, 2006 and 2005—Provision for Loan Losses.” The following table represents our allocation of allowance for loan losses by loan category on the dates indicated:                                                                                       At December 31,     2006   2005   2004   2003   2002             Percentage           Percentage           Percentage           Percentage           Percentage             of Loans           of Loans           of Loans           of Loans           of Loans             in Category           in Category           in Category           in Category           in Category             to Total           to Total           to Total           to Total           to Total Loan Category   Amount   Loans   Amount   Loans   Amount   Loans   Amount   Loans   Amount   Loans     (Dollars in thousands) Mortgage loans                                                                                 One- to four-family   $ 3,531       53.03 %   $ 3,294       50.94 %   $ 2,488       46.34 %   $ 4,001       44.69 %   $ 4,701       47.37 % Other     3,049       24.16       2,424       23.61       3,222       25.58       3,150       25.70       3,160       24.40         Total mortgage loans     6,580       77.19       5,718       74.55       5,710       71.92       7,151       70.39       7,861       71.77   Home equity lines     496       4.33       483       4.29       663       4.54       481       4.43       496       4.45   Consumer     2,060       16.02  

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