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 June 30, 2016

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 x No ¨

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 x No ¨

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

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

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

Yes ¨ No x

The number of shares outstanding of the issuer’s common stock, $0.01 par value per share, was 45,590,282 shares, at August 1, 2016.

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 June 30, 2016, and December 31, 2015	3

	Unaudited Condensed Consolidated Statements of Income for the Three and Six Months Ended June 30, 2016 and 2015	4

	Unaudited Condensed Consolidated Statements of Total Comprehensive Income for the Three and Six Months Ended June 30, 2016 and 2015	6

	Unaudited Condensed Consolidated Statements of Equity for the Six Months Ended June 30, 2016 and 2015	7

	Unaudited Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2016 and 2015	8

	Notes to Unaudited Condensed Consolidated Financial Statements	9

Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	34

Item 3.	Quantitative and Qualitative Disclosures about Market Risk	49

Item 4.	Controls and Procedures	52

PART II

Item 1A.	Risk Factors	53

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	53

Item 6.	Exhibits	53

SIGNATURES		54

PART I

Item 1. Financial Statements

Bank Mutual Corporation and Subsidiaries

Unaudited Condensed Consolidated Statements of Financial Condition

	June 30			December 31
	2016			2015
	(Dollars in thousands)
Assets

Cash and due from banks	$	29,753		$	27,971
Interest-earning deposits		11,454			16,530
Cash and cash equivalents		41,207			44,501
Mortgage-related securities available-for-sale, at fair value		413,871			407,874
Mortgage-related securities held-to-maturity, at amortized cost (fair value of $114,479 in 2016 and $121,641 in 2015)		110,474			120,891
Loans held-for-sale		5,453			3,350
Loans receivable (net of allowance for loan losses of $17,962 in 2016 and $17,641 in 2015)		1,858,059			1,740,018
Mortgage servicing rights, net		6,834			7,205
Other assets		184,244			178,328

Total assets	$	2,620,142		$	2,502,167

Liabilities and shareholders’ equity

Liabilities:
Deposit liabilities	$	1,836,737		$	1,795,591
Borrowings		422,554			372,375
Advance payments by borrowers for taxes and insurance		19,921			3,382
Other liabilities		54,084			51,425
Total liabilities		2,333,296			2,222,773
Shareholders’ equity:
Preferred stock–$0.01 par value:
Authorized–20,000,000 shares in 2016 and 2015 Issued and outstanding–none in 2016 and 2015		–			–
Common stock–$0.01 par value:
Authorized–200,000,000 shares in 2016 and 2015 Issued–78,783,849 shares in 2016 and 2015
Outstanding–45,590,282 shares in 2016 and 45,443,548 in 2015		788			788
Additional paid-in capital		485,041			486,273
Retained earnings		168,121			164,482
Accumulated other comprehensive loss		(6,271	)		(9,365	)
Treasury stock–33,193,567 shares in 2016 and 33,340,301 in 2015		(360,833	)		(362,784	)
Total shareholders’ equity		286,846			279,394

Total liabilities and shareholders’ equity	$	2,620,142		$	2,502,167

Refer to Notes to Unaudited Condensed Consolidated Financial Statements

Bank Mutual Corporation and Subsidiaries

Unaudited Condensed Consolidated Statements of Income

	Three Months Ended June 30
	2016			2015
	(Dollars in thousands, except per share data)
Interest income:
Loans	$	17,360		$	16,337
Mortgage-related securities		2,722			2,871
Investment securities		119			57
Interest-earning deposits		10			6
Total interest income		20,211			19,271
Interest expense:
Deposit liabilities		1,446			1,152
Borrowings		1,247			1,157
Total interest expense		2,693			2,309
Net interest income		17,518			16,962
Provision for (recovery of) loan losses		1,164			(752	)
Net interest income after recovery of loan losses		16,354			17,714
Non-interest income:
Deposit-related fees and charges		2,928			2,949
Loan-related fees		1,607			490
Brokerage and insurance commissions		846			822
Mortgage banking revenue, net		1,142			974
Income from bank-owned life insurance (“BOLI”)		463			473
Gain on real estate held for investment		–			154
Other non-interest income		23			45
Total non-interest income		7,009			5,907
Non-interest expense:
Compensation, payroll taxes, and other employee benefits		10,236			11,066
Occupancy, equipment, and data processing costs		3,284			3,315
Advertising and marketing		970			555
Federal insurance premiums		383			358
Losses (gains) and expenses on foreclosed real estate, net		(131	)		393
Other non-interest expense		2,327			2,255
Total non-interest expense		17,069			17,942
Income before income taxes		6,294			5,679
Income tax expense		2,345			2,090

Net income	$	3,949		$	3,589

Per share data:
Earnings per share–basic	$	0.09		$	0.08
Earnings per share–diluted	$	0.09		$	0.08
Cash dividends per share paid	$	0.055		$	0.050

Refer to Notes to Unaudited Condensed Consolidated Financial Statements

Bank Mutual Corporation and Subsidiaries

Unaudited Condensed Consolidated Statements of Income

	Six Months Ended June 30
	2016			2015
	(Dollars in thousands, except per share data)
Interest income:
Loans	$	34,296		$	32,854
Mortgage-related securities		5,983			5,713
Investment securities		221			104
Interest-earning deposits		18			10
Total interest income		40,518			38,681
Interest expense:
Deposit liabilities		2,851			2,246
Borrowings		2,500			2,309
Total interest expense		5,351			4,555
Net interest income		35,167			34,126
Provision for (recovery of) loan losses		591			(1,716	)
Net interest income after recovery of loan losses		34,576			35,842
Non-interest income:
Deposit-related fees and charges		5,693			5,752
Loan-related fees		2,865			927
Brokerage and insurance commissions		1,714			1,988
Mortgage banking revenue, net		1,967			1,841
Income from bank-owned life insurance (“BOLI”)		927			942
Loss on real estate held for investment		–			(166	)
Other non-interest income		88			170
Total non-interest income		13,254			11,454
Non-interest expense:
Compensation, payroll taxes, and other employee benefits		20,703			22,230
Occupancy, equipment, and data processing costs		6,816			7,115
Advertising and marketing		1,555			868
Federal insurance premiums		805			728
Losses (gains) and expenses on foreclosed real estate, net		(89	)		539
Other non-interest expense		4,697			4,520
Total non-interest expense		34,487			36,000
Income before income taxes		13,343			11,296
Income tax expense		4,921			4,154

Net income	$	8,422		$	7,142

Per share data:
Earnings per share–basic	$	0.18		$	0.15
Earnings per share–diluted	$	0.18		$	0.15
Cash dividends per share paid	$	0.105		$	0.090

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 June 30
	2016			2015
	(Dollars in thousands)

Net income	$	3,949		$	3,589
Other comprehensive income (loss), net of tax:
Change in net unrealized gain on securities available-for-sale, net of deferred income taxes of $511 in 2016 and $(984) in 2015		763			(1,469	)
Change in net unrealized loss on interest rate swaps, net of deferred income taxes of $(27)		(40	)		–
Amortization of net prior service costs and unrecognized loss included in net periodic benefit cost, net of deferred income taxes of $33 in 2016 and $271 in 2015		50			409
Total other comprehensive income (loss), net of tax		773			(1,060	)

Total comprehensive income	$	4,722		$	2,529

	Six Months Ended June 30
	2016			2015
	(Dollars in thousands)

Net income	$	8,422		$	7,142
Other comprehensive income (loss), net of tax:
Change in net unrealized gain on securities available-for-sale, net of deferred income taxes of $2,138 in 2016 and $(567) in 2015		3,191			(846	)
Change in net unrealized loss on interest rate swaps, net of deferred income taxes of $(133)		(198	)		–
Amortization of net prior service costs and unrecognized loss included in net periodic benefit cost, net of deferred income taxes of $67 in 2016 and $536 in 2015		101			804
Total other comprehensive income (loss), net of tax		3,094			(42	)

Total comprehensive income	$	11,516		$	7,100

Refer to Notes to Unaudited Condensed Consolidated Financial Statements

Bank Mutual Corporations and Subsidiaries

Unaudited Condensed Consolidated Statements of Equity

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

Balance at January 1, 2016	$	788	$	486,273		$	164,482		$	(9,365	)	$	(362,784	)		–		$	279,394
Net income		–		–			8,422			–			–			–			8,422
Other comprehensive income		–		–			–			3,094			–			–			3,094
Purchase of treasury stock		–		–			–			–			(221	)		–			(221	)
Issuance of restricted stock		–		(1,469	)		–			–			1,469			–			–
Exercise of stock options		–		(422	)		–			–			703			–			281
Share based payments		–		659			–			–			–			–			659
Cash dividends ($0.105 per share)		–		–			(4,783	)		–			–			–			(4,783	)

Balance at June 30, 2016	$	788	$	485,041		$	168,121		$	(6,271	)	$	(360,833	)		–		$	286,846

Balance at January 1, 2015	$	788	$	488,467		$	159,065		$	(11,136	)	$	(356,467	)	$	3,774		$	284,491
Net income		–		–			7,142			–			–			–			7,142
Other comprehensive income		–		–			–			(42	)		–			–			(42	)
Decrease in non-controlling interest in real estate partnership		–		–			–			–			–			(3,774	)		(3,774	)
Purchase of treasury stock		–		–			–			–			(5,605	)		–			(5,605	)
Issuance of restricted stock		–		(2,366	)		–			–			2,366			–			–
Exercise of stock options		–		(558	)		–			–			884			–			326
Share based payments		–		697			–			–			–			–			697
Cash dividends ($0.09 per share)		–		–			(4,196	)		–			–			–			(4,196	)

Balance at June 30, 2015	$	788	$	486,240		$	162,011		$	(11,178	)	$	(358,822	)		–		$	279,039

Refer to Notes to Unaudited Condensed Consolidated Financial Statements

Bank Mutual Corporation and Subsidiaries

Unaudited Condensed Consolidated Statements of Cash Flows

	Six Months Ended June 30
	2016			2015
	(Dollars in thousands)
Operating activities:
Net income	$	8,422		$	7,142
Adjustments to reconcile net income to net cash from operating activities:
Provision for (recovery of) loan losses		591			(1,716	)
Loss (gain) on foreclosed real estate, net		(299	)		328
Provision for depreciation		1,667			1,576
Amortization of mortgage servicing rights		987			1,000
Net premium amortization on securities		1,326			1,020
Loans originated for sale		(64,548	)		(56,595	)
Proceeds from loan sales		63,500			56,947
Gain on loan sales activities, net		(1,671	)		(1,499	)
Deferred income tax expense		2,047			3,857
Loss on real estate held for investment		–			166
Other, net		(7,324	)		(10,239	)
Net cash provided by operating activities		4,698			1,987
Investing activities:
Principal repayments on mortgage-related securities available-for-sale		54,470			54,438
Principal repayments on mortgage-related securities held-to-maturity		10,092			1,141
Purchases of mortgage-related securities available-for-sale		(56,137	)		(149,257	)
Purchases of FHLB of Chicago stock		(774	)		(1,992	)
Net (increase) decrease in loans receivable		(119,531	)		3,377
Proceeds from sale of foreclosed properties		1,735			1,713
Proceeds from sale of real estate held for investment		–			427
Net purchases of premises and equipment		(988	)		(1,943	)
Net cash used by investing activities		(111,133	)		(92,096	)
Financing activities:
Net increase in deposit liabilities		41,146			13,312
Net increase in short-term borrowings		75,000			77,200
Repayments of long-term borrowings		(24,821	)		(640	)
Net increase in advance payments by borrowers for taxes and insurance		16,539			16,288
Cash dividends		(4,783	)		(4,196	)
Purchases of treasury stock		(221	)		(5,605	)
Other, net		281			410
Net cash provided by financing activities		103,141			96,769
Increase (decrease) in cash and cash equivalents		(3,294	)		6,660
Cash and cash equivalents at beginning of period		44,501			46,177
Cash and cash equivalents at end of period	$	41,207		$	52,837
Supplemental information:
Cash paid in period for:
Interest on deposit liabilities and borrowings	$	5,282		$	4,323
Income taxes		938			1,282
Non-cash transactions:
Loans transferred to foreclosed properties and repossessed assets		899			1,151

Refer to Notes to Unaudited Condensed Consolidated Financial Statements

Bank Mutual Corporation and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements

June 30, 2016

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

1. 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 2015 Annual Report on Form 10-K. Operating results for the three and six months ended June 30, 2016, are not necessarily indicative of the results that may be expected for the full year ending December 31, 2016.

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, 2018, which will be the first quarter of 2019 for the Company. In 2016 the FASB issued two new pronouncements to amend and clarify the original guidance with no change to the effective date. The Company’s adoption of this item is not expected to have a material impact on its results of operations or financial condition.

In 2015 the FASB issued new accounting guidance relating to the consolidation of legal entities for financial reporting purposes. For public companies, the guidance is effective for periods beginning after December 15, 2015, which was the first quarter of 2016 for the Company. The Company’s adoption of this new guidance did not 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 accounting for employee share-based compensation. For public companies the guidance is effective for periods beginning after December 15, 2016, with early adoption permitted. The Company adopted this guidance in the first quarter of 2016. The Company’s adoption of this item did not 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 yet completed the complex analysis required to determine the impact adoption of this new guidance could have on the Company’s results of operations or financial condition.

Bank Mutual Corporation and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements

June 30, 2016

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

2. 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:

	June 30, 2016
			Gross		Gross			Estimated
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value
Securities available-for-sale:
Federal Home Loan Mortgage Corporation	$	208,327	$	3,543	$	(3	)	$	211,867
Federal National Mortgage Association		177,429		3,070		(124	)		180,375
Government National Mortgage Association		2,518		28		–			2,546
Private-label CMOs		19,061		307		(285	)		19,083
Total available-for-sale	$	407,335	$	6,948	$	(412	)	$	413,871
Securities held-to-maturity:
Federal National Mortgage Association	$	110,474	$	4,005		–		$	114,479
Total held-to-maturity	$	110,474	$	4,005		–		$	114,479

	December 31, 2015
			Gross		Gross			Estimated
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value
Securities available-for-sale:
Federal Home Loan Mortgage Corporation	$	215,255	$	1,823	$	(800	)	$	216,278
Federal National Mortgage Association		169,792		853		(874	)		169,771
Government National Mortgage Association		21		3		–			24
Private-label CMOs		21,600		446		(245	)		21,801
Total available-for-sale	$	406,668	$	3,125	$	(1,919	)	$	407,874
Securities held-to-maturity:
Federal National Mortgage Association	$	120,891	$	750		–		$	121,641
Total held-to-maturity	$	120,891	$	750		–		$	121,641

Bank Mutual Corporation and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements

June 30, 2016

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

2. 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:

	June 30, 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		–		–		–	$	3		1	$	193	$	3	$	193
Federal National Mortgage Association	$	62		1	$	3,005		62		5		16,681		124		19,686
Private-label CMOs		6		3		2,991		279		11		10,786		285		13,777
Total available-for-sale	$	68		4	$	5,996	$	344		17	$	27,660	$	412	$	33,656

	December 31, 2015
	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	$	777		17	$	107,807	$	23		3	$	7,937	$	800	$	115,744
Federal National Mortgage Association		634		16		79,273		240		4		10,679		874		89,952
Private-label CMOs		1		1		1,357		244		10		10,574		245		11,931
Total available-for-sale	$	1,412		34	$	188,437	$	507		17	$	29,190	$	1,919	$	217,627

The Company determined that the unrealized losses on its mortgage-related securities were temporary as of June 30, 2016, and December 31, 2015. 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 June 30, 2016, and December 31, 2015, the Company had private-label CMOs, with a fair value of $13,696 and $15,725, respectively, and unrealized gains of $84 and $237, 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

June 30, 2016

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

2. 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 June 30						Six Months Ended June 30
	2016			2015			2016			2015
Beginning balance of unrealized OTTI related to credit losses	$	557		$	692		$	592		$	789
Reductions for increase in cash flows expected to be received		(35	)		(35	)		(70	)		(132	)
Ending balance of unrealized OTTI related to credit losses	$	522		$	657		$	522		$	657
Adjusted cost at end of period	$	3,810		$	4,911		$	3,810		$	4,911
Estimated fair value at end of period	$	4,098		$	5,390		$	4,098		$	5,390

Results of operations included no gross realized gains or losses on the sale of securities during the three and six months ended June 30, 2016 or 2015.

Mortgage-related securities available-for-sale with a fair value of approximately $86,952 and $67,923 at June 30, 2016, and December 31, 2015, 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

June 30, 2016

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

3. Loans Receivable

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

	June 30			December 31
	2016			2015
Commercial loans:
Commercial and industrial	$	233,597		$	235,313
Commercial real estate		332,514			299,550
Multi-family real estate		517,703			409,674
Construction and development loans:
Commercial real estate		34,001			28,156
Multi-family real estate		263,701			291,380
Land and land development		10,583			11,143
Total construction and development		308,285			330,679
Total commercial loans		1,392,099			1,275,216
Retail loans:
One- to four-family first mortgages:
Permanent		449,800			461,797
Construction		40,106			42,357
Total one- to four-family first mortgages		489,906			504,154
Home equity loans:
Fixed term home equity		114,695			122,985
Home equity lines of credit		72,569			75,261
Total home equity loans		187,264			198,246
Other consumer loans:
Student		7,490			8,129
Other		11,336			11,678
Total other consumer loans		18,826			19,807
Total retail loans		695,996			722,207
Gross loans receivable		2,088,095			1,997,423
Undisbursed loan proceeds		(210,269	)		(238,124	)
Allowance for loan losses		(17,962	)		(17,641	)
Deferred fees and costs, net		(1,805	)		(1,640	)
Total loans receivable, net		1,858,059		$	1,740,018

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 June 30, 2016, and December 31, 2015, certain one- to four-family mortgage loans, multi-family mortgage loans, and home equity loans with aggregate carrying values of approximately $563,000 and $496,000 were pledged to secure advances from the Federal Home Loan Bank (“FHLB”) of Chicago.

The unpaid principal balance of loans serviced for others was $1,016,474 and $1,038,588 at June 30, 2016, and December 31, 2015, respectively. These loans are not reflected in the consolidated financial statements.

Bank Mutual Corporation and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements

June 30, 2016

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

3. 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 Six Months Ended June 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)		(337	)		(487	)		1,564		(369	)		133			87			591
Charge-offs		–			(99	)		–		–			(84	)		(223	)		(406	)
Recoveries		4			19			30		–			33			50			136
Ending balance	$	3,325		$	4,229		$	4,931	$	2,466		$	1,917		$	1,094		$	17,962
Loss allowance individually evaluated for impairment	$	196			–			–		–			–			–		$	196
Loss allowance collectively evaluated for impairment	$	3,129		$	4,229		$	4,931	$	2,466		$	1,917		$	1,094		$	17,766

Loan receivable balances at the end of the period:
Loans individually evaluated for impairment	$	8,632		$	6,391		$	3,993	$	2,021		$	3,511		$	876		$	25,424
Loans collectively evaluated for impairment		224,965			326,123			513,710		116,299			466,091			205,214			1,852,402
Total loans receivable	$	233,597		$	332,514		$	517,703	$	118,320		$	469,602		$	206,090		$	1,877,826

	At or for the Six Months Ended June 30, 2015
	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	$	2,349		$	6,880		$	6,078		$	2,801	$	3,004		$	1,177		$	22,289
Provision (recovery)		33			(370	)		(1,678	)		60		(253	)		492			(1,716	)
Charge-offs		(74	)		(69	)		–			–		(218	)		(348	)		(709	)
Recoveries		6			83			–			–		41			46			176
Ending balance	$	2,314		$	6,524		$	4,400		$	2,861	$	2,574		$	1,367		$	20,040
Loss allowance individually evaluated for impairment		–		$	262		$	621			–		–			–		$	883
Loss allowance collectively evaluated for impairment	$	2,314		$	6,262		$	3,779		$	2,861	$	2,574		$	1,367		$	19,157

Loan receivable balances at the end of the period:
Loans individually evaluated for impairment	$	8,032		$	9,815		$	9,538		$	2,136	$	4,786		$	549		$	34,856
Loans collectively evaluated for impairment		202,658			263,403			339,750			111,473		470,984			226,709			1,614,977
Total loans receivable	$	210,690		$	273,218		$	349,288		$	113,609	$	475,770		$	227,258		$	1,649,833

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 (decrease) in the total allowance for loan losses of $1,149 and $660 during the three and six months ended June 30, 2016, and of $(1,097) and $(2,228) during the three and six months ended June 30, 2015.

Bank Mutual Corporation and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements

June 30, 2016

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

3. 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).

June 30, 2016

Impaired loans with an allowance recorded:

Loans
Receivable
Balance, Net

Unpaid
Principal
Balance

Related
Allowance
for Loss

Average Loan
Receivable
Balance, Net

Interest
Income
Recognized

Commercial and industrial:

Term loans

–

Lines of credit

1,898

1,960

196

3,042

Total commercial and industrial

1,898

1,960

196

3,042

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

–

Total construction and development

–

One- to four-family

–

Home equity and other consumer:

Home equity

–

Student

–

Other

–

Total home equity and other consumer

–

Total with an allowance recorded

1,898

1,960

196

3,042

Impaired loans with no allowance recorded:

Commercial and industrial:

Term loans

107

–

105

Lines of credit

2,273

2,352

–

1,440

Total commercial and industrial

2,365

2,459

–

1,545

Commercial real estate:

Office

2,043

2,418

–

2,084

Retail/wholesale/mixed

1,472

2,254

–

1,549

Industrial/warehouse

187

265

–

191

Other

153

–

Total commercial real estate

3,704

5,090

–

3,831

148

Multi-family real estate

286

292

–

193

Construction and development:

Commercial real estate

548

597

–

581

–

Multi-family real estate

–

Land and land development

157

215

–

162

Total construction and development

705

812

–

743

One- to four-family

2,764

3,132

–

2,549

Home equity and other consumer:

Home equity

816

898

–

729

Student

–

Other

166

–

Total home equity and other consumer

876

1,064

–

801

Total with no allowance recorded

10,700

12,849

–

9,662

270

Bank Mutual Corporation and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements

June 30, 2016

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

3. Loans Receivable (continued)

December 31, 2015

Impaired loans with an allowance recorded:

Loans
Receivable
Balance, Net

Unpaid
Principal
Balance

Related
Allowance
for Loss

Average Loan
Receivable
Balance, Net

Interest
Income
Recognized

Commercial and industrial:

Term loans

–

Lines of credit

2,783

2,795

535

557

142

Total commercial and industrial

–

Commercial real estate:

Office

Retail/wholesale/mixed

–

1,538

–

Industrial/warehouse

–

Other

–

Total commercial real estate

–

1,538

–

Multi-family real estate

–

1,112

–

Construction and development:

Commercial real estate

–

Multi-family real estate

–

Land and land development

–

Total construction and development

–

One- to four-family

–

Home equity and other consumer:

Home equity

–

Student

–

Other

–

Total home equity and other consumer

–

Total with an allowance recorded

2,783

2,795

535

3,207

142

Impaired loans with no allowance recorded:

Commercial and industrial:

Term loans

116

133

–

129

Lines of credit

2,016

2,032

–

422

117

Total commercial and industrial

2,132

2,165

–

551

120

Commercial real estate:

Office

2,126

2,426

–

833

148

Retail/wholesale/mixed

1,637

2,348

–

1,672

Industrial/warehouse

194

265

–

204

Other

155

–

Total commercial real estate

3,968

5,194

–

2,731

259

Multi-family real estate

–

Construction and development:

Commercial real estate

597

–

597

–

Multi-family real estate

–

Land and land development

169

220

–

187

Total construction and development

766

817

784

One- to four-family

2,703

3,168

–

3,744

Home equity and other consumer:

Home equity

703

805

–

509

Student

–

Other

184

–

Total home equity and other consumer

785

989

–

596

Total with no allowance recorded

10,354

12,333

–

8,406

488

Bank Mutual Corporation and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements

June 30, 2016

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

3. 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):

	June 30, 2016
	Pass		Watch		Special Mention		Substandard		Total
Commercial and industrial:
Term loans	$	65,776	$	6,846	$	110	$	665	$	73,397
Lines of credit		116,310		34,189		1,734		7,967		160,200
Total commercial and industrial		182,086		41,035		1,844		8,632		233,597
Commercial real estate:
Office		100,397		4,634		14,517		2,043		121,591
Retail/wholesale/mixed use		109,709		27,050		14,566		3,896		155,221
Industrial/warehouse		43,341		4,325		–		450		48,116
Other		7,584		–		–		2		7,586
Total commercial real estate		261,031		36,009		29,083		6,391		332,514
Multi-family real estate		505,841		–		7,869		3,993		517,703
Construction and development:
Commercial real estate		6,541		–		–		548		7,089
Multi-family real estate		100,666		–		–		–		100,666
Land and land development		8,901		191		–		1,473		10,565
Total construction/development		116,108		191		–		2,021		118,320
One- to four-family		463,781		441		1,869		3,511		469,602
Home equity and other consumer:
Home equity		186,448		–		–		816		187,264
Student		7,490		–		–		–		7,490
Other		11,276		–		–		60		11,336
Total home equity and other consumer		205,214		–		–		876		206,090
Total	$	1,734,061	$	77,676	$	40,665	$	25,424	$	1,877,826

Bank Mutual Corporation and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements

June 30, 2016

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

3. Loans Receivable (continued)

	December 31, 2015
	Pass		Watch		Special Mention		Substandard		Total
Commercial and industrial:
Term loans	$	53,785	$	5,536	$	252	$	2,605	$	62,178
Lines of credit		145,118		17,086		1,299		9,632		173,135
Total commercial and industrial		198,903		22,622		1,551		12,237		235,313
Commercial real estate:
Office		69,223		5,567		15,063		2,126		91,979
Retail/wholesale/mixed use		103,634		28,091		14,510		6,599		152,834
Industrial/warehouse		46,545		1,326		588		1,598		50,057
Other		4,669		–		–		11		4,680
Total commercial real estate		224,071		34,984		30,161		10,334		299,550
Multi-family real estate		394,097		7,338		–		8,239		409,674
Construction and development:
Commercial real estate		13,928		–		–		597		14,525
Multi-family real estate		93,635		–		–		–		93,635
Land and land development		9,411		69		–		1,517		10,997
Total construction/development		116,974		69		–		2,114		119,157
One- to four-family		471,412		2,059		671		3,410		477,552
Home equity and other consumer:
Home equity		197,543		–		–		703		198,246
Student		8,129		–		–		–		8,129
Other		11,596		–		–		82		11,678
Total home equity and other consumer		217,268		–		–		785		218,053
Total	$	1,622,725	$	67,072	$	32,383	$	37,119	$	1,759,299

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 June 30, 2016, or December 31, 2015. 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 June 30, 2016, or December 31, 2015.

Bank Mutual Corporation and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements

June 30, 2016

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

3. 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):

	June 30, 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	$	128		–	$	31	$	159	$	73,238	$	73,397	$	92
Lines of credit		–		–		–		–		160,200		160,200		4,171
Total commercial and industrial		128		–		31		159		233,438		233,597		4,263
Commercial real estate:
Office		1,725		–		–		1,725		119,866		121,591		2,043
Retail/wholesale/mixed		–		–		592		592		154,629		155,221		1,472
Industrial/warehouse		187		–		–		187		47,929		48,116		187
Other		–		–		–		–		7,586		7,586		2
Total commercial real estate		1,912				592		2,504		330,010		332,514		3,704
Multi-family real estate		469		–		–		469		517,234		517,703		286
Construction and development:
Commercial real estate		–		–		548		548		6,541		7,089		548
Multi-family real estate		–		–		–		–		100,666		100,666		–
Land and land development		473		–		–		473		10,092		10,565		157
Total construction		473		–		548		1,021		117,299		118,320		705
One- to four-family		6,394	$	1,711		2,700		10,805		458,797		469,602		2,764
Home equity and other consumer:
Home equity		437		100		816		1,353		185,911		187,264		816
Student		203		121		239		563		6,927		7,490		–
Other		69		63		60		192		11,144		11,336		60
Total home equity and other consumer		709		284		1,115		2,108		203,982		206,090		876
Total	$	10,085	$	1,995	$	4,986	$	17,066	$	1,860,760	$	1,877,826	$	12,598

Bank Mutual Corporation and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements

June 30, 2016

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

3. Loans Receivable (continued)

	December 31, 2015
	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		–		–	$	61	$	61	$	62,117	$	62,178	$	116
Lines of credit	$	8,901		–		–		8,901		164,234		173,135		4,799
Total commercial and industrial		8,901		–		61		8,962		226,351		235,313		4,915
Commercial real estate:
Office		–		–		–		–		91,979		91,979		2,126
Retail/wholesale/mixed		768	$	2		684		1,454		151,380		152,834		1,637
Industrial/warehouse		–		–		–		–		50,057		50,057		194
Other		–		–		–		–		4,680		4,680		11
Total commercial real estate		768		2		684		1,454		298,096		299,550		3,968
Multi-family real estate		721		–		–		721		408,953		409,674		–
Construction and development:
Commercial real estate		–		–		597		597		13,928		14,525		597
Multi-family real estate		–		–		–		–		93,635		93,635		–
Land and land development		–		–		–		–		10,997		10,997		169
Total construction		–		–		597		597		118,560		119,157		766
One- to four-family		6,490		2,959		2,634		12,083		465,469		477,552		2,703
Home equity and other consumer:
Home equity		1,214		217		703		2,134		196,112		198,246		703
Student		178		62		484		724		7,405		8,129		–
Other		38		49		82		169		11,509		11,678		82
Total home equity and other consumer		1,430		328		1,269		3,027		215,026		218,053		785
Total	$	18,310	$	3,289	$	5,245	$	26,844	$	1,732,455	$	1,759,299	$	13,137

As of June 30, 2016, and December 31, 2015, $239 and $484 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 June 30, 2016, and December 31, 2015, TDRs were $8,264 and $8,704, respectively, and consisted primarily of commercial and industrial and one- to four-family mortgage loans. TDRs in accrual status as of those same dates were $2,900 and $2,558, respectively. Additions to TDRs during the six months ended June 30, 2016 and 2015, were immaterial. In addition, TDRs that experienced a payment default within one year of their restructuring during these six months ended June 30, 2016, and twelve months ended June 30, 2015, 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

June 30, 2016

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

4. Mortgage Servicing Rights

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

	Six Months Ended June 30
	2016			2015
MSRs at beginning of the period, net	$	7,205		$	7,867
Additions		616			623
Amortization		(987	)		(1,000	)
MSRs at end of the period, net	$	6,834		$	7,490

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

		Amount
Estimate for six months ending December 31:	2016	$	701
Estimate for years ending December 31:	2017		1,190
	2018		1,003
	2019		816
	2020		661
	2021		591
	Thereafter		1,872
	Total	$	6,834

The projections of amortization expense shown above for MSRs are based on existing asset balances and the existing interest rate environment as of June 30, 2016. Future amortization expense may be significantly different depending upon changes in the mortgage servicing portfolio, mortgage interest rates, and market conditions.

5. Other Assets

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

	June 30		December 31
	2016		2015
Accrued interest:
Loans receivable	$	5,030	$	4,894
Mortgage-related securities		1,112		1,141
Total accrued interest		6,142		6,035
Foreclosed properties and repossessed assets:
Commercial real estate		1,355		1,685
Land and land development		746		747
One-to four-family		667		874
Total foreclosed properties and repossessed assets		2,768		3,306
Bank-owned life insurance		62,593		61,656
Premises and equipment, net		48,458		49,218
Federal Home Loan Bank stock, at cost		18,365		17,591
Deferred tax asset, net		13,262		16,485
Other assets		32,656		24,037
Total other assets	$	184,244	$	178,328

Bank Mutual Corporation and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements

June 30, 2016

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

5. Other Assets (continued)

Residential one-to four-family mortgage loans that were in the process of foreclosure were $2,012 and $2,576 at June 30, 2016, and December 31, 2015, respectively.

6. Deposit Liabilities

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

	June 30		December 31
	2016		2015
Checking accounts:
Non-interest-bearing	$	236,252	$	213,761
Interest-bearing		269,860		277,606
Total checking accounts		506,112		491,367
Money market accounts		555,549		542,020
Savings accounts		228,520		217,633
Certificates of deposit:
Due within one year		334,844		282,584
After one but within two years		155,504		182,599
After two but within three years		48,687		61,806
After three but within four years		5,772		15,373
After four but within five years		1,749		2,209
Total certificates of deposits		546,556		544,571
Total deposit liabilities	$	1,836,737	$	1,795,591

7. Borrowings

The following table summarizes borrowings as of the dates indicated:

	June 30, 2016					December 31, 2015
			Weighted-					Weighted-
			Average					Average
	Balance		Rate			Balance		Rate
FHLB overnight advances	$	205,000		0.30	%	$	130,000		0.16	%
FHLB term advances maturing in:
2016		60,000		0.59			75,950		0.63
2017		53,866		1.19			56,183		1.20
2018		32,211		2.21			34,607		2.18
2019		17,834		3.04			19,127		2.98
2020		25,448		3.67			26,853		3.62
2021		15,673		3.01			16,971		2.97
Thereafter		12,522		4.55			12,684		4.55
Total borrowings	$	422,554		1.15	%	$	372,375		1.27	%

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

June 30, 2016

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

7. Borrowings (continued)

As discussed in Note 12, “Financial Instruments with Off-Balance Sheet Risk and Derivative Financial Instruments,” the Company has entered into cash flow hedges using interest rate swaps to manage the interest rate risk exposure associated with certain forecasted borrowings from the FHLB of Chicago. Two advances maturing in July 2016 of $10,000 each have corresponding pay-fixed interest rate swaps that mature in 2018 and 2019, respectively. Although these advances have stated interest rates of 0.45%, they have effective interest rates including the impact of the interest rate swaps of 1.09% and 1.35%, respectively. However, these advances have been included in the table, above, at their contractual rates and maturities. If they had been included in the table at their hedge-adjusted rates and maturities, the advances reported as maturing in 2018 and 2019 would have each been $10,000 higher and the weighted average rates for those maturity years would have been 1.94% and 2.43% as of June 30, 2016, respectively. Furthermore, the weighted average rate reported for total borrowings would have been 1.18% as of the same date.

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 80% of the book value of one- to four-family mortgage loans, 72% of the book value of certain multi-family mortgage loans, 51% of the book value of certain home equity loans, and 98% of the fair value of certain mortgage-related securities.

Bank Mutual Corporation and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements

June 30, 2016

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

8. 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 June 30, 2016, and December 31, 2015, 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
As of June 30, 2016:	Amount		Ratio			Amount		Ratio			Amount		Ratio
At the Company:
Total risk-weighted capital	$	303,819		15.32	%	$	158,633		8.00	%	$	198,291		10.00	%
Tier 1 risk-weighted capital		285,857		14.42			118,975		6.00			158,633		8.00
CET1 risk-weighted capital		285,857		14.42			89,231		4.50			128,889		6.50
Tier 1 leverage capital		285,857		11.29			101,312		4.00			126,640		5.00
At the Bank:
Total risk-weighted capital	$	277,153		13.98	%	$	158,613		8.00	%	$	198,266		10.00	%
Tier 1 risk-weighted capital		259,191		13.07			118,960		6.00			158,613		8.00
CET1 risk-weighted capital		259,191		13.07			89,220		4.50			128,873		6.50
Tier 1 leverage capital		259,191		10.14			102,282		4.00			127,853		5.00

As of December 31, 2015:	Amount		Ratio			Amount		Ratio			Amount		Ratio
At the Company:
Total risk-weighted capital	$	296,709		15.83	%	$	149,922		8.00	%	$	187,402		10.00	%
Tier 1 risk-weighted capital		279,068		14.89			112,441		6.00			149,922		8.00
CET1 risk-weighted capital		279,068		14.89			84,331		4.50			121,811		6.50
Tier 1 leverage capital		279,068		11.37			98,197		4.00			122,747		5.00
At the Bank:
Total risk-weighted capital	$	272,568		14.55	%	$	149,900		8.00	%	$	187,375		10.00	%
Tier 1 risk-weighted capital		254,927		13.61			112,425		6.00			149,900		8.00
CET1 risk-weighted capital		254,927		13.61			84,319		4.50			121,794		6.50
Tier 1 leverage capital		254,927		10.48			97,328		4.00			121,660		5.00

Bank Mutual Corporation and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements

June 30, 2016

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

9. Earnings Per Share

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

	Three Months Ended				Six Months Ended
	June 30				June 30
	2016		2015		2016		2015

Net income	$	3,949	$	3,589	$	8,422	$	7,142
Weighted average shares outstanding		45,047,410		45,960,012		45,058,399		46,099,294
Vested restricted stock for period		118,509		65,934		105,025		57,458
Basic shares outstanding		45,165,919		46,025,946		45,163,424		46,156,752
Net dilutive effect of:
Stock option shares		412,784		364,640		399,451		351,327
Non-vested restricted stock		54,410		36,288		50,799		33,265
Diluted shares outstanding		45,633,113		46,426,874		45,613,674		46,541,344
Basic earnings per share	$	0.09	$	0.08	$	0.18	$	0.15
Diluted earnings per share	$	0.09	$	0.08	$	0.18	$	0.15

The Company had stock options for 362,534 and 361,000 shares outstanding as of June 30, 2016 and 2015, 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 $8.17 and $8.07 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 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 $210 and $214 during the three months ended June 30, 2016 and 2015, respectively, and $425 and $408 during the six months ended June 30, 2016 and 2015, respectively.

The Company also has a qualified defined benefit pension plan covering employees meeting 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

June 30, 2016

(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 June 30						Six Months Ended June 30
	2016			2015			2016			2015
Service cost		–		$	242			–		$	484
Interest cost	$	669			660		$	1,338			1,320
Expected return on plan assets		(861	)		(735	)		(1,722	)		(1,470	)
Amortization of net loss from earlier periods		57			656			114			1,312
Net periodic benefit cost	$	(135	)	$	823		$	(270	)	$	1,646

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

	Three Months Ended June 30				Six Months Ended June 30
	2016		2015		2016		2015
Interest cost	$	93	$	99	$	186	$	198
Amortization of net loss from earlier periods		26		23		52		46
Net periodic benefit cost	$	119	$	122	$	238	$	244

A contribution of $650,000 to the qualified plan is expected to be made in the third quarter of 2016. This contribution was determined based on a number of factors, including the results of an actuarial valuation report as of January 1, 2016. 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. No further awards may be made under the 2004 Plan.

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 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 June 30, 2016, 2,497,600 shares remain 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 $204 and $201 for the three months ended June 30, 2016 and 2015, respectively. The amount amortized to expense was $479 and $405 for the six months ended June 30, 2016 and 2015, respectively. Outstanding non-vested restricted stock grants had a fair value of $2,286 and an unamortized cost of $1,986 at June 30, 2016. The cost of these shares is expected to be recognized over a weighted-average period of 1.31 years.

During the three months ended June 30, 2016 and 2015, the Company recorded stock option compensation expense of $90 and $102, respectively. During the six months ended June 30, 2016 and 2015, the Company recorded stock option compensation expense of $180 and $207, respectively. As of June 30, 2016, there was $611 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 1.07 years.

Bank Mutual Corporation and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements

June 30, 2016

(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:

	Six Months Ended June 30
	2016					2015
	Stock Options			Weighted Average Exercise Price		Stock Options			Weighted Average Exercise Price
Outstanding at beginning of period		1,421,500		$	5.4378		1,631,000		$	5.2980
Granted		56,300			7.2900		37,000			6.7000
Exercised		(57,334	)		4.9148		(71,900	)		4.5487
Forfeited		(5,132	)		6.1322		(16,600	)		5.5808
Outstanding at end of period		1,415,334		$	5.5301		1,579,500		$	5.3619

The following table provides additional information regarding the Company’s outstanding options as of June 30, 2016.

	Remaining		Non-Vested Options				Vested Options
	Contractual Life		Stock Options		Intrinsic Value		Stock Options		Intrinsic Value
Exercise price:
$11.160		1.8		–		–		32,000		–
$12.025		2.1		–		–		50,000		–
$7.226		3.8		–		–		50,000	$	23
$4.740		4.5		–		–		70,000		206
$5.050		4.5		–		–		236,000		621
$4.300		4.7		–		–		25,000		85
$3.720		5.1		2,500	$	10		10,000		40
$3.390		5.5		65,000		279		243,000		1,042
$3.800		5.8		2,000		8		8,000		31
$4.820		6.6		95,200		272		148,600		425
$5.360		6.8		8,000		19		12,000		28
$5.700		6.9		8,000		16		12,000		24
$6.340		7.1		6,000		8		4,000		5
$7.170		7.6		109,800		56		77,100		39
$6.010		7.8		4,500		8		3,000		5
$5.850		7.9		6,666		12		13,334		24
$6.100		8.1		13,333		21		6,667		11
$6.700		8.6		19,996		20		10,338		10
$7.190		9.1		7,000		3		–		–
$7.290		9.6		56,300		22		–		–
Total				404,295	$	754		1,011,039	$	2,619
Weighted-average remaining contractual life				7.3 years				5.3 years
Weighted-average exercise price			$	5.8175			$	5.4152

There were 57,334 options exercised during the six months ended June 30, 2016, which had an intrinsic value of $155. There were 71,900 options exercised during the six months ended June 30, 2015, which had an intrinsic value of $190. The weighted average grant date fair value of non-vested options at June 30, 2016, was $1.75 per share. During the six months ended June 30, 2016, options for 56,300 shares were granted, options for 243,038 shares became vested, and 5,132 non-vested options shares were forfeited.

Bank Mutual Corporation and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements

June 30, 2016

(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 six month period ended June 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. The following weighted-average assumptions were used to value 37,000 options granted during the six month period ended June 30, 2015: risk free rate of 1.75%, dividend yield of 2.40%, expected stock volatility of 34%, and expected term to exercise of 7.5 years. These options had a weighted-average value of $2.09 per option using these assumptions.

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:

	June 30		December 31
	2016		2015
Unused commercial lines of credit	$	158,779	$	146,183
Commercial loans		10,034		6,772
Standby letters of credit		4,359		4,458
Real estate loan commitments:
Fixed rate		62,917		36,921
Adjustable rate		349,040		308,173
Unused consumer lines of credit		165,730		164,989

Bank Mutual Corporation and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements

June 30, 2016

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

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

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 recognized currently through earnings. During the three months ended June 30, 2016 and 2015, net unrealized gains (losses) of $(42) and $170, respectively, were recognized in net gain on loan sales activities on these derivative instruments. During the six months ended June 30, 2016 and 2015, net unrealized gains of $36 and $206, respectively, were recognized in net gain on loan sales activities on these derivative instruments. These amounts were exclusive of net unrealized gains (losses) of $96 and $16 on loans held-for-sale for the three months ended June 30, 2016 and 2015, respectively, and $137 and $(80) for the six month ended June 30, 2016 and 2015, 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 June 30, 2016 and 2015, net unrealized gains of $85 and $205, respectively, and net losses of $85 and $205, respectively, related to interest rate swaps and embedded derivatives were recorded in loan-related fees. During the six months ended June 30, 2016 and 2015, net unrealized gains of $453 and $55, respectively, and net losses of $453 and $55, respectively, related to interest rate swaps and embedded derivatives were recorded in loan-related fees.

The Company also enters into interest rate swap arrangements to manage the interest rate risk exposure associated with certain forecasted borrowings from the FHLB of Chicago. These interest rate swaps have been designated as forecasted transaction cash flow hedges by management (refer to Note 7, “Borrowings”). As such, the effective portion of the change in the fair value of these derivatives is recorded in other comprehensive income and the ineffective portion was recorded in interest expense. During the three and six months ended June 30, 2016, $40 and $198 in unrealized loss net of tax related to interest rate swaps was recorded in other comprehensive income, respectively. There was no net unrealized gain or loss related to interest rate swaps recorded in other comprehensive income during the three and six months ended June 30, 2015. There was no ineffective portion of this hedge for any of these periods.

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

	June 30, 2016					December 31, 2015
	Notional Amount		Fair Value			Notional Amount		Fair Value
Interest rate lock commitments	$	20,027	$	573		$	7,961	$	166
Forward commitments to sell loans		20,744		(446	)		9,543		(72	)
Embedded free-standing derivatives on commercial loans		23,283		1,157			23,559		705
Receive-fixed free-standing interest rate swaps		195,126		12,183			82,780		2,648
Pay-fixed free-standing interest rate swaps		218,409		(13,340	)		106,339		(3,353	)
Pay-fixed cash flow hedge interest rate swaps		20,000		(331	)		20,000		–
Net unrealized gains (losses)			$	(204	)			$	94

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

June 30, 2016

(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 six months ended June 30, 2016.

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

June 30, 2016

(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 June 30, 2016:

	Weighted- Average			Range
Loan size	$	116		$1-$417
Contractual interest rate		3.72	%	2.50%-7.10%
Constant prepayment rate (“CPR”)		13.12	%	2.56%-24.19%
Remaining maturity in months		218		2-480
Servicing fee		0.25	%	–
Annual servicing cost per loan (not in thousands)	$	60		–
Annual ancillary income per loan (not in thousands)	$	30		–
Discount rate		9.17	%	9.13%-10.88%

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 June 30, 2016, or December 31, 2015. Accordingly, the Company had no valuation allowance as of June 30, 2016, or December 31, 2015.

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

June 30, 2016

(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.

	June 30 2016						December 31 2015
	Carrying Value			Fair Value			Carrying Value			Fair Value
Cash and cash equivalents	$	41,207		$	41,207		$	44,501		$	44,501
Mortgage related securities available-for-sale		413,871			413,871			407,874			407,874
Mortgage related securities held-to-maturity		110,474			114,479			120,891			121,641
Loans held-for-sale		5,453			5,453			3,350			3,350
Loans receivable, net		1,858,059			1,876,576			1,740,018			1,751,670
Mortgage servicing rights, net		6,834			7,358			7,205			9,455
Federal Home Loan Bank stock		18,365			18,365			17,591			17,591
Accrued interest receivable		6,142			6,142			6,035			6,035
Deposit liabilities		1,836,737			1,819,919			1,795,591			1,786,934
Borrowings		422,554			431,592			372,375			378,266
Advance payments by borrowers		19,921			19,921			3,382			3,382
Accrued interest payable		1,145			1,145			1,091			1,091
Unrealized gain (loss) on off-balance-sheet items:
Interest rate lock commitments		573			573			166			166
Forward commitments to sell loans		(446	)		(446	)		(72	)		(72	)
Embedded free-standing derivatives on commercial loans		1,157			1,157			705			705
Receive-fixed free-standing interest rate swaps		12,183			12,183			2,648			2,648
Pay-fixed free-standing interest rate swaps		(13,340	)		(13,340	)		(3,353	)		(3,353	)
Pay-fixed cash flow hedge interest rate swaps		(331	)		(331	)		–			–

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 June 30, 2016

Level 1

Level 2

Level 3

Total

Loans held-for-sale

–

5,453

–

5,453

Mortgage-related securities available-for-sale

–

413,871

–

413,871

At December 31, 2015

Level 1

Level 2

Level 3

Total

Loans held-for-sale

–

3,350

–

3,350

Mortgage-related securities available-for-sale

–

407,874

–

407,874

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

June 30, 2016

(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 June 30, 2016, the range of capitalization rates utilized to determine the fair value of the underlying collateral on certain loans was 5.5% to 12%. 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 $196 was recorded for loans with a recorded investment of $25,424 at June 30, 2016. These amounts were $535 and $37,119 at December 31, 2015, respectively. Provision for (recovery of) loan losses related to these loans was $(339) during the six months ended June 30, 2016, and $535 during the twelve month period ended December 31, 2015. Provision for (recovery of) loan losses related to impaired loans at June 30, 2015, was $(21) for the six months ended June 30, 2015.

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 June 30, 2016, $2,252 in foreclosed properties was valued at collateral value compared to $2,794 at December 31, 2015. Losses of $19 and $330 related to these foreclosed properties were recorded during the six months ended June 30, 2016, and the twelve months ended December 31, 2015, respectively. Losses on foreclosed properties valued at collateral value at June 30, 2015 were $425 for the six months ended June 30, 2015.

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: 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; 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, 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 2015 Annual Report on Form 10-K.

Results of Operations

Overview The Company’s net income was $3.9 million or $0.09 per diluted share in the second quarter of 2016 compared to $3.6 million or $0.08 per diluted share in the same quarter of the previous year. Year-to-date, the Company reported net income of $8.4 million or $0.18 per diluted share in 2016 compared to $7.1 million or $0.15 per diluted share in the same six-month period in 2015. Net income during the three- and six-month periods in 2016 represented a return on assets (“ROA”) of 0.61% and 0.66%, respectively, and a return on equity (“ROE”) of 5.54% and 5.93%, respectively. This figures compared to ROA of 0.60% in both of the 2015 periods, respectively, and an ROE of 5.10% and 5.07% in the 2015 periods, respectively. The improvements in earnings between these periods were principally due to higher net interest income, higher loan-related fees, lower compensation-related expenses, and lower occupancy, equipment, and data processing costs. Also contributing were net gains and expenses on foreclosed real estate in the 2016 periods compared to net losses and expenses in the 2015 periods. These improvements were partially offset by provision for loan losses in the 2016 periods compared to recoveries in the 2015 periods, as well as higher advertising and marketing expenses and higher income tax expense. Also impacting the year-to-date comparison were lower brokerage and insurance commissions in 2016 compared to 2015. 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 June 30, 2016 and 2015.

Net Interest Income The Company’s net interest income increased by $556,000 or 3.3% and by $1.0 million or 3.1% during the three and six months ended June 30, 2016, respectively, compared to the same periods in 2015, respectively. These increases were due in part to an increase in the Company’s average earning assets in the 2016 periods compared to the same periods in the prior year, as well an increase in funding from non-interest bearing checking accounts between the periods. Also contributing to the increase in the 2016 year-to-date period was a call premium of $482,000 that the Company received on a mortgage-related security that was called in the first quarter of the year. These developments were partially offset by a decrease in the Company’s net interest margin in the 2016 periods compared to the same periods in 2015.

The Company’s average earning assets increased by $167.0 million or 7.7% during the six months ended June 30, 2016, compared to the same period in 2015. This increase was primarily attributable to a $160.0 million or 9.9% increase in average loans receivable during the 2016 six-month period compared to the same period in the prior year.

Also contributing favorably to the Company’s net interest income in the 2016 periods, as well as its net interest margin, was an increase in funding from non-interest-bearing checking accounts. The average balance in these accounts increased by $26.5 million or 13.2% during the six months ended June 30, 2016, compared to the same period in 2015.

The Company’s net interest margin was 3.01% during the first six months of 2016. Excluding the impact of the aforementioned call premium, net interest margin during the first six months of 2016 would have been 2.97%, which compares to 3.15% during the same six-month period in 2015. In the 2016 six-month period the average yield on the Company’s earning assets decreased by 14 basis points (excluding the call premium) and its average cost of funds increased by five basis points compared to the prior-year six-month period. The decrease in the average yield on earning assets was largely due to the continued repricing of the Company’s loan portfolio to lower yields in the current interest rate environment, as well as its continued emphasis on the origination of variable-rate loans, which generally have lower initial yields than fixed-rate loans. Also contributing to the decrease in yield on earning assets was the purchase of mortgage-related securities in 2016 at yields that were less than the prevailing rates in the investment portfolio.

The increase in the Company’s average cost of funds was primarily due to a six basis point increase in its average cost of deposits during the first six months of 2016 compared to the same period in the prior year. The impact of this increase was offset slightly by a decline in the average cost of borrowings from the FHLB of Chicago. This decline was caused by an increase in overnight borrowings, which were drawn to fund growth in earning assets, as previously noted. Overnight borrowings generally have a lower interest cost than the rates the Company offers on its certificates of deposit.

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 June 30
	2016								2015
				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)	$	1,815,579		$	17,360		3.82	%	$	1,617,213		$	16,337		4.04	%
Mortgage-related securities		519,808			2,722		2.09			530,732			2,871		2.16
Investment securities (2)		18,323			119		2.60			15,973			57		1.43
Interest-earning deposits		18,415			10		0.22			19,192			6		0.13
Total interest-earning assets		2,372,125			20,211		3.41			2,183,110			19,271		3.53
Non-interest-earning assets		204,756								216,403
Total average assets	$	2,576,881							$	2,399,513

Liabilities and equity:
Interest-bearing liabilities:
Regular savings deposits		228,337			7		0.01			222,429			14		0.03
Money market accounts		530,593			211		0.16			504,880			183		0.14
Interest-bearing demand accounts		272,107			13		0.02			247,730			7		0.01
Certificates of deposit		546,553			1,215		0.89			536,860			948		0.71
Total deposit liabilities		1,577,590			1,446		0.37			1,511,899			1,152		0.30
Advance payments by borrowers for taxes and insurance		16,997			–		0.00			18,068			–		0.00
Borrowings		382,396			1,247		1.30			298,470			1,157		1.55
Total interest-bearing liabilities		1,976,983			2,693		0.54			1,828,437			2,309		0.51
Non-interest-bearing liabilities:
Non-interest-bearing deposits		234,390								208,688
Other non-interest-bearing liabilities		80,449								80,920
Total non-interest-bearing liabilities		314,839								289,608
Total liabilities		2,291,822								2,118,045
Total equity		285,059								281,468
Total average liabilities and equity	$	2,576,881							$	2,399,513
Net interest income and net interest rate spread				$	17,518		2.87	%				$	16,962		3.02	%
Net interest margin							2.95	%							3.11	%
Average interest-earning assets to average interest-bearing liabilities		1.20	x							1.19	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.

	Six Months Ended June 30
	2016								2015
				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)	$	1,778,316		$	34,296		3.86		$	1,618,290		$	32,854		4.06	%
Mortgage-related securities		521,904			5,983		2.29			517,623			5,713		2.21
Investment securities (2)		18,209			221		2.43			15,420			104		1.35
Interest-earning deposits		17,075			18		0.21			17,210			10		0.12
Total interest-earning assets		2,335,504			40,518		3.47			2,168,543			38,681		3.57
Non-interest-earning assets		204,564								217,729
Total average assets	$	2,540,068							$	2,386,272

Liabilities and equity:
Interest-bearing liabilities:
Regular savings deposits		223,358			15		0.01			220,454			28		0.03
Money market accounts		527,494			399		0.15			507,717			368		0.14
Interest-bearing demand accounts		265,389			25		0.02			243,428			15		0.01
Certificates of deposit		547,351			2,412		0.88			537,174			1,835		0.68
Total deposit liabilities		1,563,592			2,851		0.36			1,508,773			2,246		0.30
Advance payments by borrowers for taxes and insurance		12,717			0.00		0.00			13,660			0.00		0.00
Borrowings		370,608			2,500		1.35			294,975			2,309		1.57
Total interest-bearing liabilities		1,946,917			5,351		0.55			1,817,408			4,555		0.50
Non-interest-bearing liabilities:
Non-interest-bearing deposits		227,082								200,576
Other non-interest-bearing liabilities		82,214								86,774
Total non-interest-bearing liabilities		309,296								287,350
Total liabilities		2,256,213								2,104,758
Total equity		283,855								281,514
Total average liabilities and equity	$	2,540,068							$	2,386,272
Net interest income and net interest rate spread				$	35,167		2.92	%				$	34,126		3.07	%
Net interest margin							3.01	%							3.15	%
Average interest-earning assets to average interest-bearing liabilities		1.20	x							1.19	x

(3)

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

(4)

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 June 30, 2016 Compared to June 30, 2015
	Increase (Decrease)
	Volume			Rate			Net
	(Dollars in thousands)
Interest-earning assets:
Loans receivable	$	1,946		$	(923	)	$	1,023
Mortgage-related securities		(57	)		(92	)		(149	)
Investment securities		9			53			62
Interest-earning deposits		–			4			4
Total interest-earning assets		1,898			(958	)		940
Interest-bearing liabilities:
Savings accounts		4			(11	)		(7	)
Money market accounts		9			19			28
Interest-bearing demand accounts		1			5			6
Certificates of deposit		17			250			267
Total deposit liabilities		31			263			294
Advance payments by borrowers for taxes and insurance		–			–			–
Borrowings		292			(202	)		90
Total interest-bearing liabilities		323			61			384
Net change in net interest income	$	1,575		$	(1,019	)	$	556

	Six Months Ended June 30, 2016 Compared to June 30, 2015
	Increase (Decrease)
	Volume		Rate			Net
	(Dollars in thousands)
Interest-earning assets:
Loans receivable	$	3,113	$	(1,671	)	$	1,442
Mortgage-related securities		61		209			270
Investment securities		22		95			117
Interest-earning deposits		–		8			8
Total interest-earning assets		3,196		(1,359	)		1,837
Interest-bearing liabilities:
Savings accounts		9		(22	)		(13	)
Money market accounts		14		17			31
Interest-bearing demand accounts		1		9			10
Certificates of deposit		36		541			577
Total deposit liabilities		60		545			605
Advance payments by borrowers for taxes and insurance		–		–			–
Borrowings		540		(349	)		191
Total interest-bearing liabilities		600		196			796
Net change in net interest income	$	2,596	$	(1,555	)	$	1,041

Provision for (recovery of) Loan Losses The Company’s provision for (recovery of) loan losses was $1.2 million in the second quarter of 2016 compared to $(752,000) in the same quarter last year. The provision (recovery) for the six months ended June 30, 2016, was $591,000 compared to $(1.7) million in the same period last year. Management believes that general economic, employment, and real estate conditions continue to be relatively stable in the Company’s local markets. In addition, the Company’s level of non-performing and classified loans, as well as its actual loan charge-offs, have continued to trend lower in recent periods, as noted in “Financial Condition—Asset Quality,” below. However, economic growth in the United States has slowed in recent months and the global economy, in addition to also having slowed, has experienced political-, trade-, and currency-related challenges. Management believes that these developments could be early indications of emerging difficulties in the credit and lending environment for the Company. These conclusions, along with an assessment of the credit risk inherent in the Company’s loan portfolio, have contributed to management’s conclusion that the allowance for loan losses as a percent of total loans has reached a general level that management considers appropriate. As such, the Company’s allowance for loan losses increased from $17.0 million or 0.95% of loans receivable at March 31, 2016, to $18.0 million or 0.97% at June 30, 2016, which is the primary reason for the provision for loan losses in the 2016 periods. Management anticipates that the Company’s provision for loan losses may continue to consist of provisions rather than recoveries for the foreseeable future. This is expected to be particularly true if the Company’s loan portfolio continues to grow as it has in recent 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 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 increased by $1.1 million or 18.7% and $1.8 million or 15.7% during the three and six months ended June 30, 2016, respectively, compared to the same periods in 2015, 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 $21,000 or 0.7% and by $59,000 or 1.0% during the three and six months ended June 30, 2016, respectively, compared to the same periods in the previous year, respectively. 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 from check printing commissions. These developments have been partially offset by increased revenue from treasury management and merchant card processing services that the Company offers to commercial depositors.

Loan-related fees were $1.6 million and $2.9 million during the three and six months ended June 30, 2016, respectively. These amounts compared to $490,000 and $927,000 during the same periods in 2015, respectively. Loan-related fees consist of periodic income from lending activities that are not deferred as yield adjustments under the applicable accounting rules. The largest source of fees in this revenue category is 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 increases in loan-related fees in the 2016 periods were the result of increased loan production, as well as a lower interest rate environment that has increased borrower preference for the types of loan transactions that generate interest rate swap fees. Management believes this source of revenue will vary considerably from period to period depending on the rate environment and on borrower preference for the types of transactions that generate interest rate swaps.

Brokerage and insurance commissions were $846,000 during the second quarter of 2016, which was $24,000 or 2.9% higher than the same quarter in the previous year. Year-to-date this source of revenue was $274,000 or 13.8% lower than the same period in 2015. 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. However, the prior year periods include certain non-recurring incentive payments. Excluding these payments, brokerage and insurance commissions during the three and six months ended June 30, 2016, were over 30% higher in 2016 periods than they were in the same periods of 2015, respectively. Management attributes this increase to new products, services, systems, and investment advisors that the Company has added in recent periods.

Mortgage banking revenue, net, was $1.1 million and $2.0 million during three and six months ended June 30, 2016, respectively. This compared to $974,000 and $1.8 million during the same periods in 2015, respectively. The following table presents the components of mortgage banking revenue, net, for the periods indicated:

	Three Months Ended June 30						Six Months Ended June 30
	2016			2015			2016			2015
	(Dollars in thousands)
Gross loan servicing fees	$	637		$	666		$	1,283		$	1,342
MSR amortization		(554	)		(492	)		(987	)		(1,000	)
Change in MSR valuation allowance		–			–			–			–
Loan servicing revenue, net		83			174			296			342
Gain on loan sales activities, net		1,059			800			1,671			1,499
Mortgage banking revenue, net	$	1,142		$	974		$	1,967		$	1,841

Loan servicing revenue, net, decreased during the three- and six-month periods in 2016 compared to the same periods in 2015. These decreases were caused in part by a decline in gross servicing fees due to an overall decline in loans serviced for third-party investors. As of June 30, 2016, the Company serviced $1.02 billion in loans for third-party investors compared to $1.04 billion at December 31, 2015. Also contributing to the decrease in loan servicing revenue, net, in the second quarter of 2016 was an increase in amortization of mortgage servicing rights (“MSRs”). This increase was caused by lower market interest rates for one- to four-family loans in the second quarter, which resulted in increased loan prepayment activity and faster amortization of the related MSRs.

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 June 30, 2016, the Company had no valuation allowance against its MSRs, which had a net book value of $6.8 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 lower market interest rate environments, such as that which has occurred in recent months, loan refinance activity and expectations for future loan prepayments generally increase, which typically reduces the fair value of MSRs and results in an increase in the MSR valuation allowance. However, market interest rates for one- to four-family mortgage loans as of June 30, 2016, were not sufficiently low enough to generate an MSR valuation allowance as of that date. However, there can be no assurances that an increase in the MSR valuation allowance will not be required in the future, particularly if market interest rates for one- to four-family residential loans remain low or decline further.

Gain on loan sales activities, net, was $1.1 million and $1.7 million during the three and six months ended June 30, 2016, respectively, compared to $800,000 and $1.5 million during the same periods in 2015, respectively. The Company typically sells most of the fixed-rate, one- to four-family mortgage loans that it originates. During the first six months of 2016, sales of these loans were $62.6 million, which was $6.6 million or 11.7% higher than the same period of 2015. Management attributes this increase to lower market interest rates for one- to four-family mortgage loans in 2016 compared to 2015. Management expects that lower rates, combined with expectations for an improving housing market in the near term, may result in higher originations and sales of residential loans by the Company during the remainder of 2016 compared to the same period in 2015. As of June 30, 2016, the Company’s pipeline of residential loans intended for sale was the highest it had been since early 2013. However, the origination and sale of residential loans are 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.

During the second quarter of 2015 the Company recorded a $154,000 gain on the disposition of a real estate property that it held for investment purposes. On a year-to-date basis in 2015, this gain was more than offset by a $320,000 loss that the Company recorded in the first quarter of that year on certain other real estate properties that it held for investment purposes. No real estate properties were sold during the first six months of 2016. 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 or that gains or losses on sales, if any, will not fluctuate considerably from period to period.

Non-Interest Expense Total non-interest expense decreased by $873,000 or 4.9% and $1.5 million or 4.2% during the three and six months ended June 30, 2016, respectively, compared to the same periods in 2015, respectively. Significant reasons for the changes in the components of non-interest expense are discussed in the following paragraphs.

Compensation-related expenses decreased by $830,000 or 7.5% and by $1.5 million or 6.9% during the three and six months ended June 30, 2016, respectively, compared to the same periods in 2015, respectively. These decreases were mostly due to lower costs associated with the Company’s defined benefit pension plan, which was due in part to an increase in the discount rate used to determine the present value of the pension obligation, but also to a freeze of the plan’s benefits at the end of 2015. This latter change also resulted in a lengthening of the amortization period for unrealized losses in the pension plan, which further contributed to lower pension costs in 2016. Also contributing to the decreases in compensation-related expenses in the 2016 periods compared to the same periods in the prior year was a decline in the number of employees at the Company. This decline was primarily due to the consolidation of seven retail banking offices in the second quarter of 2015 and an additional four in the first quarter of 2016. These developments were partially offset by normal annual merit increases granted to most employees at the beginning of 2016, as well as higher stock-based compensation and employee commission expense compared to the 2015 periods.

Occupancy, equipment, and data processing expenses were $3.3 million and $6.8 million during the three and six months ended June 30, 2016, respectively. These amounts compared to $3.3 million and $7.1 million during the same periods in 2015, respectively. The six-month period in the prior year included $269,000 in one-time costs associated with the Company’s announcement that it was consolidating seven retail branch offices. Other on-going occupancy costs declined by $243,000 during the first half of 2016 compared to the same period in 2015 due to reduced operating costs related to such consolidations, as well as four other branch consolidations that were completed in the first quarter of 2016. However, these cost reductions were substantially offset by increased data processing, software, and equipment costs associated with other initiatives undertaken by the Company over the past eighteen months.

Advertising and marketing-related expenses were $970,000 and $1.6 million during the three and six months ended June 30, 2016, respectively, compared to $555,000 and $868,000 during the same periods in 2015, respectively. The Company has increased spending on advertising and marketing in 2016 in an effort to increase sales and expand the Company’s overall brand awareness, especially as such relates to the retail deposit business. Management anticipates that for the entire year 2016 the Company’s advertising and marketing-related expenses are likely to be 20% to 25% higher than it was in 2015. However, this increase depends on future management decisions and there can be no assurances.

Federal deposit insurance premiums were $383,000 and $358,000 during the three months ended June 30, 2016 and 2015, respectively. Year-to-date, these premiums were $805,000 and $728,000 in 2016 and 2015, respectively. These increases were due primarily to an increase in the Company’s total assets in the 2016 periods compared to 2015. Earlier in 2016 the FDIC issued a final rule that changes how insured financial institutions less than $10 billion in assets, such as the Company, will be assessed for deposit insurance. Although the new rule became effective on July 1, 2016, deposit insurance assessment rates will not change for insured institutions until the FDIC’s deposit insurance fund reaches a certain level, as specified in the new rule. Industry observers estimates this level could be reached in the third quarter of 2016, although there can be no assurances. Once the new deposit insurance assessment rates become effective, management estimates that the Company’s federal deposit insurance premiums could decline by approximately 25% per quarter. The final rule also established a process for the creation of insurance premium credits for insured institutions with less than $10 billion in assets. These credits would be determined by the FDIC at a future date in accordance with performance measures established for the deposit insurance fund, as specified in the new rule. The credits could be used by insured institutions to offset future premium costs until the credits are exhausted. At this time, management is unable to determine the amount or timing of the credits that it might be awarded, if any.

Net losses (gains) and expenses on foreclosed real estate were $(131,000) and $393,000 during the three months ended June 30, 2016 and 2015, respectively. On a year-to-date basis these amounts were $(89,000) and $539,000 in 2016 and 2015, respectively. In general, the Company has experienced net gains on disposition of foreclosed properties in recent months, as well as lower expenses on foreclosed real estate due to reduced holdings of such properties.

Other non-interest expenses were $2.3 million in the second quarter of 2016 compared to a similar amount in the same quarter of last year. Year-to-date, other non-interest expenses were $4.7 million in 2016 compared to $4.5 million in 2015. In the 2016 year-to-date period the Company prepaid $9.2 million in fixed-rate FHLB of Chicago advances. These advances had originally been drawn to fund the purchase of mortgage-related securities that were called by the issuer during the period, as previously noted. Management elected to prepay these advances concurrent with the call, which resulted in a prepayment penalty of $207,000.

Income Tax Expense Income tax expense was $2.3 million and $2.1 million during the second quarters of 2016 and 2015, respectively, and was $4.9 million and $4.2 million during the year-to-date periods in the same years, respectively. The effective tax rates (“ETRs”) for the quarter periods were 37.3% and 36.8%, respectively, and for the year-to-date periods were $36.9% and 36.8%, respectively. The Company’s ETR will vary from period to period due primarily to the impact of non-taxable revenue items, such as earnings from BOLI and tax-exempt interest income.

Financial Condition

Overview The Company’s total assets increased by $118.0 million or 4.7% during the six months ended June 30, 2016, due principally to an increase in total loans receivable. This increase was primarily funded by additional borrowings, deposit liabilities, and advance payments by borrowers. The Company’s total shareholders’ equity was $286.8 million at June 30, 2016, compared to $279.4 million at December 31, 2015.

Mortgage-Related Securities Available-for-Sale The Company’s portfolio of mortgage-related securities available-for-sale increased by $6.0 million or 1.5% during the six months ended June 30, 2016. This increase was principally due to the purchase of $56.1 million in securities intended by management to maintain the available-for-sale portfolio at a level considered sufficient to sustain liquidity on the Company’s balance sheet. The impact of these purchases was partially offset by normal periodic repayments.

Changes in the fair value of the Company’s mortgage-related securities available-for-sale are recorded through accumulated other comprehensive loss (net of deferred income taxes), which is a component of shareholders’ equity. The fair value adjustment on the Company’s mortgage-related securities available-for-sale was a net unrealized gain of $6.5 million at June 30, 2016, compared to a net unrealized gain of $1.2 million at December 31, 2015. This increase was caused by a decline in market interest rates during the period, which had a favorable impact on the fair value of the Company’s mortgage-related securities.

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 decreased by $10.4 million or 8.6% during the six months ended June 30, 2016. During this period securities with a carrying value of $9.2 million were called by Fannie Mae. As a result, the Company recorded a call premium in interest income of $482,000, as previously described. The Company did not purchase any held-to-maturity securities during the six months ended June 30, 2016.

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 $5.5 million and $3.4 million at June 30, 2016, and December 31, 2015, respectively. For reasons noted previously in this report, management believes that sales of one- to four-family mortgage loans during the remainder of 2016 may exceed the level of sales recorded during the same period in 2015, although there can be no assurances.

Loans Receivable The Company’s loans receivable increased by $118.0 million or 6.8% during the six months ended June 30, 2016. During this period increases in multi-family, commercial real estate, and construction loans (net of the undisbursed portion) were partially offset by declines in the Company’s other loan categories. Management attributes the increases in part to a low interest rate environment that has encouraged loan growth in the Company’s local markets, particularly for loans secured by multi-family and commercial real estate. This rate environment has also improved the competitiveness of the Company’s loan offerings linked to its interest rate swap loan program, as noted earlier in this report. Because of this improvement, the Company has been able to increase new loan production, as well as retain in its loan portfolio a larger portion of construction loans transitioning to permanent financing than it typically has in prior periods. However, management is not certain that the loan growth experienced in recent periods can be sustained in the future. The loan portfolio is subject to economic, market, and competitive 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:

	Six Months Ended June 30
	2016		2015
	(Dollars in thousands)
Commercial loans:
Commercial and industrial	$	21,232	$	46,415
Commercial real estate		45,705		28,216
Multi-family real estate		111,167		35,251
Construction and development		84,102		136,808
Total commercial loans		262,203		246,690
Retail loans:
One- to four-family first mortgages (1)		42,184		40,602
Home equity		15,342		15,829
Other consumer		1,137		752
Total retail loans		58,663		57,183
Total loan originations	$	320,866	$	303,873

(1)

Excludes $64.5 million and $56.6 million in loans originated for sale during the six months ended June 30, 2016 and 2015, respectively.

Mortgage Servicing Rights The carrying value of the Company’s MSRs was $6.8 million at June 30, 2016, and $7.2 million at December 31, 2015, respectively. The Company maintained no valuation allowance against its MSRs as of either of those dates. As of June 30, 2016, the Company serviced $1.02 billion in loans for third-party investors compared to $1.04 billion at December 31, 2015. 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 $41.1 million or 2.3% during the six months ended June 30, 2016. Transaction deposits, which consist of checking, savings, and money market accounts, increased by $39.2 million or 3.1% during the period and certificates of deposit increased by $1.9 million or 0.4%. Management believes that the low interest rate environment that has persisted for the past few years has encouraged some customers to switch to transaction deposits in an effort to retain flexibility in the event interest rates increase in the future. If interest rates increase in the future, customer preference may shift from transaction deposits back to certificates of deposit, which typically have a higher interest cost to the Company. This development could increase the Company’s cost of funds in the future, which would also have an adverse impact on its net interest margin.

Borrowings Borrowings, which consist of advances from the FHLB of Chicago, increased by $50.2 million or 13.5% during the six months ended June 30, 2016. This increase was primarily caused by overnight borrowings from the FHLB of Chicago, which were drawn to fund growth in the Company’s earning assets during the period, as previously described. 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 $19.9 million at June 30, 2016, compared to $3.4 million at December 31, 2015. 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 $286.8 million at June 30, 2016, compared to $279.4 million at December 31, 2015. This increase was due to $8.4 million in net income and a $3.1 million decrease in accumulated other comprehensive loss. These developments were only partially offset by $4.8 million in regular cash dividends. The decrease in accumulated other comprehensive loss was mostly due to an increase in the fair value of available-for-sale securities (net of income tax effect), which was caused by a decline in market interest rates during the period. The Company did not repurchase a significant amount of its common stock during the six months ended June 30, 2016. The book value of the Company’s common stock was $6.29 per share at June 30, 2016, compared to $6.15 at December 31, 2015.

On August 1, 2016, the Company’s board of directors declared a $0.055 per share dividend payable on August 29, 2016, to shareholders of record on August 12, 2016. 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:

	At June 30			At December 31
	2016			2015
	(Dollars in thousands)
Non-accrual commercial loans:
Commercial and industrial	$	4,263		$	4,915
Commercial real estate		3,704			3,968
Multi-family real estate		286			–
Construction and development		705			766
Total commercial loans		8,958			9,649
Non-accrual retail loans:
One- to four-family first mortgages		2,764			2,703
Home equity		816			703
Other consumer		60			82
Total non-accrual retail loans		3,640			3,488
Total non-accrual loans		12,598			13,137
Accruing loans delinquent 90 days or more (1)		239			484
Total non-performing loans		12,837			13,621
Foreclosed real estate and repossessed assets		2,768			3,306
Total non-performing assets	$	15,605		$	16,927

Non-performing loans to total loans		0.69	%		0.78	%
Non-performing assets to total assets		0.60	%		0.68	%
Interest income that would have been recognized if non-accrual loans had been current (2)	$	428		$	637
Interest income on non-accrual loans included in interest income (2)	$	322		$	630

(1)

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

(2)

Amounts shown are for the six months ended June 30, 2016, and the twelve months ended December 31, 2015, respectively.

The Company’s non-performing loans were $12.8 million or 0.69% of loans receivable as of June 30, 2016, compared to $13.6 million or 0.78% of loans receivable as of December 31, 2015. Non-performing assets, which includes non-performing loans, were $15.6 million or 0.60% of total assets and $16.9 million or 0.68% 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 these non-performing assets, at June 30, 2016, management was closely monitoring $53.3 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 $55.9 million at December 31, 2015. As of June 30, 2016, most of these 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 June 30, 2016, although there can be no assurances that the loans will not become impaired in future periods.

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

	Six Months Ended June 30
	2016			2015
	(Dollars in thousands)
Balance at beginning of period	$	17,641		$	22,289
Provision for (recovery of) loan losses		591			(1,716	)
Charge-offs:
Commercial and industrial		–			(74	)
Commercial real estate		(99	)		(69	)
Multi-family real estate		–			–
Construction and development		–			–
One- to four-family first mortgages		(84	)		(218	)
Home equity		(35	)		(42	)
Other consumer		(188	)		(306	)
Total charge-offs		(406	)		(709	)
Recoveries:
Commercial and industrial		4			6
Commercial real estate		19			83
Multi-family real estate		30			–
Construction and development		–			–
One- to four-family first mortgages		33			41
Home equity		9			21
Other consumer		41			25
Total recoveries		136			176
Net charge-offs		(270	)		(533	)
Balance at end of period	$	17,962		$	20,040

	June 30			December 31
	2016			2015
Allowance for loan losses to total loans		0.97	%		1.01	%
Allowance for loan losses to non-performing loans		139.92	%		129.51	%
Net charge-offs to average loans (1)		0.03	%		0.06	%

(1)

The rate for the six months ended June 30, 2016, is annualized.

The Company’s allowance for loan losses was $18.0 million or 0.97% of loans receivable at June 30, 2016, compared to $17.6 million or 1.01% at December 31, 2015. As a percent of non-performing loans, the Company’s allowance for loan losses was 139.9% at June 30, 2016, compared to 129.5% at December 31, 2015. The reason for the increase in the Company’s allowance for loan losses during the six months ended June 30, 2016, was described earlier in this report. Management believes the allowance for loan losses at June 30, 2016, 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 10.95% at June 30, 2016, compared to 11.17% at December 31, 2015. The 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 FRB. The Company is “well capitalized” for regulatory capital purposes. As of June 30, 2016, the Company had a total risk-based capital ratio of 15.32% and a Tier 1 leverage capital ratio of 11.29%. The minimum ratios to be considered “well capitalized” under current supervisory regulations are 10% for total risk-based 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 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 June 30, 2016, 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	$	1,290,181		–		–		–	$	1,290,181
Certificates of deposit		334,844	$	204,191	$	7,521		–		546,556
Borrowed funds		288,866		77,793		43,374	$	12,522		422,554
Operating leases		930		1,605		1,542		3,165		7,242
Purchase obligations		2,640		5,280		660		–		8,580
Deferred retirement plans and deferred compensation plans		781		1,604		1,381		4,398		8,164

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 June 30, 2016:

Payments Due In

One to

Three to

Over

One Year

Three

Five

Or Less

Years

Total

(Dollars in thousands)

Commercial lines of credit

158,779

–

158,779

Commercial loans

10,034

–

10,034

Standby letters of credit

3,848

236

275

–

4,359

Multi-family and commercial real estate loans

383,402

–

383,402

Residential real estate loans

28,555

–

28,555

Revolving home equity and credit card lines

165,730

–

165,730

Net commitments to sell mortgage loans

20,744

–

20,744

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 June 30, 2016, the Company had forward commitments to sell one- to four-family mortgage loans of $20.7 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 June 30, 2016.

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 June 30, 2016, 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.

	June 30, 2016
	Within			Three to			More than			More than
	Three			Twelve			1 Year to			3 Years -			Over 5
	Months			Months			3 Years			5 Years			Years			Total
Loans receivable:	(Dollars in thousands)
Commercial loans:
Fixed	$	31,201		$	57,525		$	165,273		$	89,378		$	18,543		$	361,920
Adjustable		682,037			39,376			103,877			19,125			1,242			845,657
Retail loans:
Fixed		19,698			38,023			72,710			43,668			61,845			235,944
Adjustable		104,718			122,754			81,988			67,620			50,325			427,405
Interest-earning deposits		11,449			–			–			–			–			11,449
Mortgage-related securities:
Fixed		40,104			99,514			209,341			70,351			83,029			502,339
Adjustable		15,470			–			–			–			–			15,470
Other interest-earning assets		18,365			–			–			–			–			18,365
Total interest-earning assets		923,042			357,192			633,189			290,142			214,984			2,418,549

Deposit liabilities:
Non-interest-bearing demand accounts		–			–			–			–			236,271			236,271
Interest-bearing demand accounts		–			–			–			–			267,224			267,224
Savings accounts		–			–			–			–			228,520			228,520
Money market accounts		558,165			–			–			–			–			558,165
Certificates of deposit		116,203			224,196			198,638			7,521			–			546,558
Advance payments by borrowers
for taxes and insurance		–			19,921			–			–			–			19,921
Borrowings		245,341			44,884			69,699			51,952			10,678			422,554
Total non-interest- and interest- bearing liabilities		919,709			289,001			268,337			59,473			742,693			2,279,213
Interest rate sensitivity gap	$	3,333		$	68,191		$	364,852		$	230,669		$	(527,709	)	$	139,336
Cumulative interest rate sensitivity gap	$	3,333		$	71,524		$	436,376		$	667,045		$	139,336
Cumulative interest rate sensitivity gap
as a percent of total assets		0.13	%		2.73	%		16.66	%		25.46	%		5.32	%
Cumulative interest-earning assets as a
percentage of non-interest- and interest-bearing liabilities		100.36	%		105.92	%		129.54	%		143.41	%		106.11	%

Based on the above gap analysis, at June 30, 2016, 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 2015 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 June 30, 2016. 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	$	337,742	$	13,320		4.1	%		13.62	%		11.3	%
+300		339,443		15,021		4.6			13.45			9.9
+200		337,635		13,213		4.1			13.15			7.5
+100		329,114		4,692		1.4			12.62			3.1
0		324,422		–		–			12.24			–
-100		345,905		21,483		6.6			12.81			4.7

Based on the above analysis, the Company’s present value ratio is not expected to be materially impacted by changes in 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 2015 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 1A. Risk Factors

Refer to “Risk Factors” in Part I, Item 1A, of the Company’s 2015 Annual Report on Form 10-K. Refer also to "Management’s Discussion and Analysis of Financial Condition and Results of Operations—Cautionary Statement" in Part I, Item 2, above.

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

The following discloses information regarding the shares of the Company’s common stock repurchased by the Company during the second quarter of 2016, all of which were purchased pursuant to stock repurchase plans authorized by its board of directors.

Period	Shares Purchased		Average Price per Share		Shares Purchased as Part of Announced Plans		Shares Remaining to be Purchased Under Announced Plans
April 2016		24,387	$	7.35		24,387		970,332
May 2016		–		–		–		970,332
June 2016		–		–		–		970,332
Total/Average		24,387	$	7.35		24,387

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:	August 2, 2016	/s/ David A. Baumgarten
		David A. Baumgarten
		President and Chief Executive Officer

Date:	August 2, 2016	/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 June 30, 2016

Exhibit No.	Description	Incorporated Herein by Reference To	Filed Herewith

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 June 30, 2016, 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

101.SCH	XBRL Taxonomy Extension Schema Document		X

101.CAL	XBRL Taxonomy Extension Calculation		X

Exhibit No.	Description	Incorporated Herein by Reference To	Filed Herewith

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