News Column

BANK MUTUAL CORP - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations

August 5, 2014

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 further 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, including substantial changes under the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act"); regulators' strict expectations for financial institutions' capital levels and restrictions imposed on institutions, as to payments of dividends or otherwise, to maintain or achieve those levels, including the possible effects of new regulatory capital requirements under Basel III; recent, pending, and/or potential rulemaking or other actions by the Consumer Financial Protection Bureau ("CFPB"); potential regulatory or other actions affecting the Company or the Bank; potential changes in Fannie Mae and the Federal Home Loan Mortgage Corporation ("Freddie Mac"), which could impact the home mortgage market; 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; 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 2013 Annual Report on Form 10-K. Results of Operations Overview The Company's net income was $3.6 million or $0.08 per diluted share and $6.4 million or $0.14 per diluted share for the three- and six-month periods ended June 30, 2014, respectively, compared to $2.6 million or $0.06 per diluted share and $5.2 million or $0.11 per diluted share during the same periods in 2013, respectively. Net income during the three- and six-month periods ended June 30, 2014, represented a return on assets ("ROA") of 0.61% and 0.55%, respectively, compared to 0.45% and 0.44% in the same periods of 2013, respectively. Net income in these same periods of 2014 also represented a return on equity ("ROE") of 5.03% and 4.53%, respectively, compared to 3.86% and 3.80% in the same periods of 2013, respectively. The improvement in net income between these periods was due primarily to higher net interest income, lower provision for loan losses, and lower compensation-related expenses. These developments were partially offset by lower net mortgage banking revenue and, for the year-to-date period, a non-recurring charge in the first quarter of 2014 related to state income taxes. The following paragraphs describe these changes in greater detail, along with other matters affecting the Company's results of operations during the three and six months ended June 30, 2014 and 2013. 33 Net Interest Income The Company's net interest income increased by $1.2 million or 7.5% and by $2.2 million or 6.7% during the three and six months ended June 30, 2014, respectively, compared to the same periods in 2013. These increases were primarily attributable to a 28 basis point improvement in the Company's net interest margin, from 3.01% during the first half of 2013 to 3.29% during the same period in the current year. In the quarter just ended, the Company's net interest margin improved to 3.32% compared to 3.02% in the second quarter of last year. These improvements in net interest margin were due principally to an improved earning asset mix and an improved funding mix between these periods. Specifically, the Company's average loans receivable increased by $91.0 million or 6.4% during the first six months of 2014 compared to the same period in 2013 and its average mortgage-related securities, investment securities, and overnight investments declined by $141.3 million or 19.2% in the aggregate between these same periods. Loans receivable generally have a higher yield than securities and overnight investments. With respect to the Company's funding mix, its average checking and savings deposits increased by $35.6 million or 3.9% in the aggregate during the first half of 2014 compared to the same period in 2013 and its average certificates of deposit declined by $164.2 million or 21.5% between these periods. Checking and savings deposits generally have a lower interest cost (or no interest cost) than certificates of deposits. Also contributing to the improvement in funding mix during the first six months of 2014 was $37.5 million in average overnight borrowings from the FHLB of Chicago compared to no such borrowings in the 2013 year-to-date period. These borrowings, which were drawn to fund loan growth and net deposit outflows in recent months, had an average interest cost of only 0.13% during the first half of 2014, which is also a lower cost than certificates of deposit. Also contributing to the improvement in net interest margin during the six months ended June 30, 2014, compared to the same period in 2013 was a 46 basis point decline in the average cost of the Company's certificates of deposit. Management anticipates that the Company's cost of certificates of deposit will decline only modestly (if at all) during the remainder of 2014, although there can be no assurances. The favorable impact of the aforementioned developments on net interest income was partially offset by a $50.3 million or 2.3% decrease in average earning assets during the six months ended June 30, 2014, compared to the same period in 2013. The Company's earning assets have declined in recent periods as it has used available cash flow to fund a net decrease in its liabilities, particularly its certificates of deposit, as previously noted (refer to "Financial Condition-Deposit Liabilities," below, for additional discussion). 34 The following table presents 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 2014 2013 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) $ 1,515,464$ 16,518 4.36 % $ 1,415,619$ 15,974 4.51 % Mortgage-related securities 556,043 3,243 2.33 610,196 3,538 2.32 Investment securities (2) 13,242 33 1.00 11,663 10 0.34 Interest-earning deposits 13,973 4 0.11 103,270 38 0.15 Total interest-earning assets 2,098,722 19,798 3.77 2,140,748 19,560 3.65 Non-interest-earning assets 227,966 231,726 Total average assets $ 2,326,688$ 2,372,474 Liabilities and equity: Interest-bearing liabilities: Regular savings deposits $ 225,385 14 0.02 $ 231,136 17 0.03 Money market accounts 506,520 182 0.14 471,429 168 0.14 Interest-bearing demand accounts 231,983 7 0.01 224,309 9 0.02 Certificates of deposit 579,582 1,023 0.71 730,334 1,979 1.08 Total deposit liabilities 1,543,470 1,226 0.32 1,657,208 2,173 0.52 Advance payments by borrowers for taxes and insurance 17,895 - 0.00 19,723 1 0.02 Borrowings 245,057 1,170 1.91 207,566 1,197 2.31 Total interest-bearing liabilities 1,806,422 2,396 0.53 1,884,497 3,371 0.72 Non-interest-bearing liabilities: Non-interest-bearing deposits 178,041 160,246 Other non-interest-bearing liabilities 59,909 53,381 Total non-interest-bearing liabilities 237,950 213,627 Total liabilities 2,044,372 2,098,124 Total equity 282,316 274,350 Total average liabilities and equity $ 2,326,688$ 2,372,474 Net interest income and net interest rate spread $ 17,402 3.24 % $ 16,189 2.93 % Net interest margin 3.32 % 3.02 % Average interest-earning assets to average interest-bearing liabilities 1.16 X 1.14 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. 35 Six Months Ended June 30 2014 2013 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) $ 1,505,213$ 32,810 4.36 % $ 1,414,256$ 32,182 4.55 % Mortgage-related securities 569,066 6,598 2.32 637,885 7,465 2.34 Investment securities (2) 13,147 56 0.85 12,678 23 0.36 Interest-earning deposits 11,843 7 0.12 84,748 65 0.15 Total interest-earning assets 2,099,269 39,471 3.76 2,149,567 39,735 3.70 Non-interest-earning assets 227,419 231,066 Total average assets $ 2,326,688$ 2,380,633 Liabilities and equity: Interest-bearing liabilities: Regular savings deposits $ 223,012 27 0.02 $ 225,551 32 0.03 Money market accounts 499,670 361 0.14 469,241 345 0.15 Interest-bearing demand accounts 232,230 14 0.01 224,552 17 0.02 Certificates of deposit 598,391 2,186 0.73 762,633 4,544 1.19 Total deposit liabilities 1,553,303 2,588 0.33 1,681,977 4,938 0.59 Advance payments by borrowers for taxes and insurance 13,347 - 0.00 14,912 1 0.01 Borrowings 242,464 2,333 1.92 208,928 2,422 2.32 Total interest-bearing liabilities 1,809,114 4,921 0.54 1,905,817 7,361 0.77 Non-interest-bearing liabilities: Non-interest-bearing deposits 169,404 138,780 Other non-interest-bearing liabilities 65,854 62,405 Total non-interest-bearing liabilities 235,258 201,185 Total liabilities 2,044,372 2,107,002 Total equity 282,316 273,631 Total average liabilities and equity $ 2,326,688$ 2,380,633 Net interest income and net interest rate spread $ 34,550 3.22 % $ 32,374 2.93 % Net interest margin 3.29 % 3.01 % Average interest-earning assets to average interest-bearing liabilities 1.16 X 1.13 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.

36

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, 2014, Compared to June 30, 2013 Increase (Decrease) Volume Rate Net (Dollars in thousands) Interest-earning assets: Loans receivable $ 1,087$ (543 )$ 544 Mortgage-related securities (310 ) 15 (295 ) Investment securities 1 22 23 Interest-earning deposits (26 ) (8 ) (34 ) Total interest-earning assets 752 (514 ) 238 Interest-bearing liabilities: Savings accounts 3 (6 ) (3 ) Money market accounts 12 2 14

Interest-bearing demand accounts -

(2 ) (2 ) Certificates of deposit (355 ) (601 ) (956 ) Total deposit liabilities (340 ) (607 ) (947 ) Advance payments by borrowers for taxes and insurance - (1 ) (1 ) Borrowings 198 (225 ) (27 ) Total interest-bearing liabilities (142 ) (833 ) (975 ) Net change in net interest income $ 894 $

319 $ 1,213 Six Months Ended June 30, 2014, Compared to June 30, 2013 Increase (Decrease) Volume Rate Net (Dollars in thousands) Interest-earning assets: Loans receivable $ 2,006$ (1,378 )$ 628 Mortgage-related securities (804 ) (63 ) (867 ) Investment securities 1 32 33 Interest-earning deposits (46 ) (12 ) (58 ) Total interest-earning assets 1,157 (1,421 ) (264 ) Interest-bearing liabilities: Savings accounts 6 (11 ) (5 ) Money market accounts 22 (6 ) 16

Interest-bearing demand accounts 1

(4 ) (3 ) Certificates of deposit (842 ) (1,516 ) (2,358 ) Total deposit liabilities (813 ) (1,537 ) (2,350 ) Advance payments by borrowers for taxes and insurance - (1 ) (1 ) Borrowings 357 (446 ) (89 ) Total interest-bearing liabilities (456 ) (1,984 ) (2,440 ) Net change in net interest income $ 1,613 $

563 $ 2,176 37 Provision for Loan LossesThe Company's provision for loan losses was $321,000 in the second quarter of 2014 compared to $1.7 million in the same quarter last year. The provision for the six months ended June 30, 2014, was $334,000 compared to $2.6 million in the same period last year. The decline in the provision for loan loss during the six month period was due principally to an improvement in the general credit quality of the Company's loan portfolio, as evidenced by a decrease in the overall level of the Company's classified loans, as described later in this release. This improvement resulted in a decline in the portion of the Company's allowance for loan loss that is determined primarily by internal risk ratings and the level of loans within each rating. General economic, employment, and real estate conditions continue to improve in the Company's markets, although at a relatively slow pace. However, current conditions continue to be challenging for some borrowers. As such, there can be no assurances that classified loans and/or non-performing loans will continue to trend lower in future periods or that the Company's provision for loan losses will not vary considerably from period to period. For additional discussion related to the Company's non-performing loans, non-performing assets, classified assets, and allowance for loan losses, refer to "Financial Condition-Asset Quality," below. Non-Interest Income Total non-interest income decreased by $1.4 million or 19.3% and $3.9 million or 26.9% during the three and six months ended June 30, 2014, respectively, compared to the same periods in 2013, respectively. Significant reasons for the changes in the components of non-interest income are discussed in the following paragraphs. Deposit-related fees and charges decreased modestly during each of the three- and six-month periods ended June 30, 2014, respectively, compared to the same periods in the previous year. Deposit-related fees and charges consist of overdraft fees, ATM and debit card fees, merchant processing fees, account services charges, and other revenue items related to services performed by the Company for its retail and commercial deposit customers. In previous periods, the Company had reported ATM and debit card fees, merchant processing fees, and certain other items as a component of other income (for additional discussion refer to "Note 1. Basis of Presentation" in the Company's Unaudited Condensed Consolidated Financial Statements included in "Item 1. Financial Statements"). Management attributes the decrease in deposit-related fees and charges during the 2014 periods to changes in deposit customer spending behavior in recent periods which has resulted in lower revenue from overdraft charges and from check printing commissions. These developments were partially offset by increased revenue from treasury management and merchant card processing services that the Company offers to commercial depositors. Also contributing was increased revenue from a debit card reward program that the Company implemented in 2013.

Brokerage and insurance commissions were $691,000 during the second quarter of 2014, which was $287,000 or 29.3% lower than the same period in the previous year. On a year-to-date basis, this source of revenue was $1.4 million in 2014, which was a $292,000 or 17.5% decline from the same period in 2013. This revenue item consists of commissions earned on sales of tax-deferred annuities, mutual funds, and certain other securities, as well as personal and business insurance products. These decreases were primarily due to a decline in customer demand for tax-deferred annuities in the most recent quarter. In addition, commission revenue in the 2013 periods benefited from higher commissions from sales of

equity-related investments. 38 Mortgage banking revenue, net, was $792,000 and $1.4 million during the three and six-month periods ended June 30, 2014, respectively. This compared to $2.4 million and $5.1 million during the same periods in 2013, respectively. The following table presents the components of mortgage banking revenue, net, for the periods indicated (in prior periods these components had been presented as separate line items in the consolidated statements of income): Three Months Ended Six Months Ended June 30 June 30 2014 2013 2014 2013 (Dollars in thousands) Gross servicing fees $ 702$ 722$ 1,418$ 1,437 Mortgage servicing rights amortization (456 ) (785 ) (878 ) (1,793 ) Mortgage servicing rights valuation recovery 1 1,115 1 2,229 Loan servicing revenue, net 247 1,052 541 1,873 Gain on sale of loan activity, net 545 1,382

881 3,242 Mortgage banking, net $ 792$ 2,434$ 1,422$ 5,115

In prior periods the above components of mortgage banking revenue, net, had been presented as separate line items in the consolidated statement of income (for additional discussion refer to "Note 1. Basis of Presentation" in the Company's Unaudited Condensed Consolidated Financial Statements included in "Item 1. Financial Statements"). Loan servicing revenue, net, was $247,000 in the second quarter of 2014 compared to $1.1 million in the same period in 2013. On a year-to-date basis, this revenue item was $541,000 in 2014 compared to $1.9 million in 2013. The change in the valuation allowance that the Company maintains against its mortgage servicing rights ("MSRs") is recorded as a recovery or loss, as the case may be, in the period in which the change occurs. Higher market interest rates for residential loans beginning in early 2013 and continuing into 2014 resulted in lower future prepayment expectations on the loans underlying the Company's MSRs, which resulted in a recovery of substantially all of the related valuation allowance in 2013. Higher rates also resulted in substantially lower MSR amortization in the 2014 periods compared to the same periods in 2013 due to a lower level of actual loan prepayments. As of June 30, 2014, the Company's MSRs had a net book value of $8.2 million. As of the same date the Company serviced $1.1 billion in loans for third-party investors compared to $1.2 billion one year ago. The valuation of MSRs, as well as the periodic amortization of MSRs, is significantly influenced by the level of market interest rates and loan prepayments. In periods prior to 2014 the amortization of MSRs exceeded the fee revenue that was collected from servicing the related mortgage loans. Amortization of MSRs was elevated in those periods because of a low interest rate environment, which resulted in increased loan prepayment activity and faster amortization of the related MSRs. Market interest rates for residential mortgage loans have increased and prepayment expectations decreased in recent periods. As such, the Company could record reduced levels of MSR amortization expense and has recovered all or a portion of previously established allowance on MSRs. In contrast, if market interest rates decrease and/or actual or expected loan prepayment expectations increase in future periods, amortization expense is likely to increase because of higher levels of loan prepayment activity. In addition, the Company could potentially record charges to earnings related to increases in the valuation allowance on its MSRs. Gain on loan sales activities, net, was $545,000 and $881,000 during the three- and six-month periods ended June 30, 2014, respectively, compared to $1.4 million and $3.2 million in the same periods last year, 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 2014 sales of these loans were $156.8 million or 84.5% lower than they were during the same period in 2013. Increases in market interest rates for mortgage loans during 2013 and continuing into 2014 have resulted in lower originations and sales of fixed-rate, one- to four-family loans in recent periods. If market interest rates remain at their current level or trend higher, management anticipates that the Company's gains on sales of loans will continue to be substantially lower during the remainder of 2014 than they were in 2013. 39 Income from bank-owned life insurance ("BOLI") was $582,000 during the three months ended June 30, 2014, compared to $426,000 during the same period in 2013. On a year-to-date basis, income from BOLI was $1.1 million in 2014 compared to $1.2 million in the same period of 2013. Results in the second quarter of 2014 included a payout of excess death benefits under the terms of the insurance contracts. Results in the second quarter of 2014 included a payout of excess death benefits under the terms of the insurance contracts. The second quarter of 2013 does not include any payouts related to excess death benefits. On a year-to-date basis, however, payouts of excess death benefits in 2014 were lower than they were during the same six-month period in 2013. Other non-interest income was $636,000 during the second quarter of 2014 compared to $182,000 during the same quarter in 2013. During the six-month period, other non-interest income was $888,000 in 2014 compared to $598,000 in the same period last year. These changes were due primarily to increased fee income from interest rate swaps related to certain commercial lending relationships. In late 2013 the Company began to mitigate the interest rate risk associated with these types of lending relationships by executing interest rate swaps related to the relationships, the accounting for which resulted in the recognition of a certain amount of fee income at the time the swap contracts were executed. Management expects that this source of revenue will vary from period to period depending on borrower preference for the types of lending relationships that generate the need for the interest rate swaps. Non-Interest Expense Total non-interest expense decreased by $191,000 or 11.0% and $2.4 million or 6.7% during the three and six months ended June 30, 2014, respectively, compared to the same periods in 2013, respectively. Significant reasons for the changes in the components of non-interest expense are discussed in the following paragraphs. Compensation-related expenses decreased by $855,000 or 7.8% and $2.0 million or 9.3% during the three- and six-month periods ended June 30, 2014, respectively, compared to the same period in 2013, respectively. These decreases were due primarily to lower costs related to the Company's defined benefit pension plan, the benefits of which were frozen for most participants effective December 31, 2013. Also contributing to the decrease in this plan's costs was an increase in the discount rate used to determine the present value of the pension obligation. Compensation-related expenses was also lower in the 2014 periods because of a change in the manner in which employees earn vacation and other paid time off benefits beginning in 2014. Management anticipates that this change, which is non-recurring, will reduce full-year compensation expense in 2014 by approximately $1.3 million compared to 2013. The favorable developments described in the preceding paragraph were partially offset by an increase in employer contributions to the Company's defined contribution savings plan. This increase was intended to partially offset the effects of the changes that were made to the defined benefit pension plan, as previously described. Also offsetting the favorable developments described in the preceding paragraph was the impact of normal annual merit increases granted to most employees in the first quarter of 2014. Occupancy and equipment expenses increased by $153,000 or 5.3% during the three months ended June 30, 2014, compared to the same period in the prior year. Year-to-date, occupancy and equipment expenses increased by $424,000 or 7.1% in 2014 compared to the same six month period in 2013. Most of these increases were caused by increased snow removal costs and utility expenses earlier in 2014 due to harsh winter conditions compared to the prior year. Also contributing were increased maintenance and repair costs in the 2014 periods relative to the

2013 periods. 40

Federal deposit insurance premiums were $372,000 during the second quarter of 2014, which was $136,000 or 57.6% higher than the same period in 2013. On a year-to-date basis, these premiums were $746,000 in 2014, which was $297,000 or 28.5% lower than the same period in 2013. The year-to-date decrease was caused by continued improvement in the Company's financial condition and operating results which, under the FDIC's risk-based premium assessment system, has resulted in a lower insurance assessment rate. Also contributing to the decrease was a lower level of average total assets in the first half of 2014 compared to 2013. The FDIC uses average total assets as the assessment base for determining the insurance premium. The quarterly increase in deposit insurance premiums was caused by a $250,000 retroactive credit the Company received in the second quarter of 2013 that was also related to its improved condition and results, but which related to premiums that had been paid in earlier periods. Advertising and marketing-related expenses declined by $30,000 or 5.6% during the second quarter of 2014 compared to the same quarter in the previous year. Year-to-date, advertising and marketing expenses declined by $93,000 or 8.8% in 2014 compared to the same six month period in the prior year. At this time management expects advertising and marketing-related expenses for the full year of 2014 to be about 5% higher than they were in 2013. However, this will depend on future management decisions and there can be no assurances. Net losses and expenses on foreclosed real estate were $607,000 and $967,000 during the three and six months ended June 30, 2014, respectively compared to $443,000 and $1.5 million during the same period of last year. In general, the Company has experienced lower losses and expenses on foreclosed real estate in recent periods due to lower levels of foreclosed properties. Management does not consider the increase in the second quarter of 2014 to be indicative of a reversal in this general trend, although there can be no assurances. Income Tax Expense Income tax expense was $2.0 million and $1.5 million during the three months ended June 30, 2014 and 2013, respectively, and was $4.4 million and $2.7 million during the six months ended as of the same dates, respectively. The Company's effective tax rates ("ETRs") during the second quarters of 2014 and 2013 were 35.7% and 35.9%, respectively. The 2014 year-to-date period includes a non-recurring charge of $518,000 (net of federal income tax benefit) that was related to a payment by the Company to the Wisconsin Department of Revenue (the "Department") to settle a tax matter that has been previously disclosed. Excluding this non-recurring charge, as well as the related federal tax benefit, the Company's effective tax rates ("ETRs") during the first six months of 2014 and 2013 were 36.1% and 34.1%, respectively. The Company's ETR will vary from period to period depending primarily on the impact of non-taxable revenue items, such as tax-exempt interest income and earnings from BOLI. The Company's ETR will generally be higher in periods in which these non-taxable revenue items comprise a smaller portion of pre-tax

income. Financial Condition Overview The Company's total assets decreased by $9.5 million or 0.4% during the six months ended June 30, 2014. During this period the Company's mortgage-related securities available-for-sale declined by $50.5 million. In addition, overnight borrowings from the FHLB of Chicago, which are a component of borrowings, increased by $25.0 million during the period and advance payments from borrowers for taxes and insurance increased by $18.2 million. Cash flows from these sources funded a $47.5 million increase in the Company's loans receivable and a $46.6 million decrease in its deposit liabilities. The Company's total shareholders' equity increased from $281.0 million at December 31, 2013, to $285.8 million at June 30, 2014. The following paragraphs describe these changes in greater detail, as well as other changes in the Company's financial condition during the three and six months ended June 30, 2014. Mortgage-Related Securities Available-for-Sale The Company's portfolio of mortgage-related securities available-for-sale declined by $50.5 million or 11.3% during the six months ended June 30, 2014. This decrease was principally caused by periodic principal repayments on the securities. The Company did not purchase any available-for-sale securities during the six months ended June

30, 2014. 41 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 $8.8 million at June 30, 2014, compared to a net unrealized gain of $7.1 million at December 31, 2013. The Company maintains an investment in private-label CMOs that were purchased from 2004 to 2006 and are secured by prime residential mortgage loans. The securities were all rated "triple-A" by various credit rating agencies at the time of their purchase. However, all of the securities in the portfolio have been downgraded since their purchase. As of June 30, 2014, and December 31, 2013, the carrying value of the Company's investment in private-label CMOs was $34.1 million and $38.7 million, respectively. The net unrealized gain on the securities as of such dates was $866,000 and $580,000, respectively. As of June 30, 2014, $26.8 million of the Company's private-label CMOs were rated less than investment grade by at least one credit rating agency. These securities had a net unrealized gain of $779,000. As of December 31, 2013, $28.8 million of the Company's private-label CMOs were rated less than investment grade and had

a net unrealized gain of $502,000. As of June 30, 2014, management has determined that none of the Company's private-label CMOs were other-than-temporarily impaired. The Company does not intend to sell these securities and it is unlikely it would be required to sell them before the recovery of their amortized cost. However, collection is subject to numerous factors outside of the Company's control and a future determination of OTTI could result in significant losses being recorded through earnings

in future periods. 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 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 did not purchase any held-to-maturity securities during the six months ended June 30, 2014. 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 $3.0 million and $1.8 million at June 30, 2014, and December 31, 2013, respectively. For reasons noted previously in this report, management believes that sales of one- to four-family mortgage loans during the remainder of 2014 will continue to be substantially lower than they were in 2013.

Loans Receivable The Company's loans receivable increased by $47.5 million or 3.1% during the six months ended June 30, 2014. During the first half of 2014 commercial and industrial loans increased by $39.4 million or 23.6% on increased originations and credit line utilization by borrowers. In addition, multi-family real estate loans increased by $20.3 million or 7.6% on increased originations and construction disbursements on existing loans. Finally, one- to four-family loans increased by $10.2 million or 2.1% despite a lower level of originations in the first half of 2014 compared to the same period in 2013. This development was caused by higher market interest rates, as previously noted, which has significantly reduced the amount of prepayment activity in the one- to four-family loan portfolio in recent trends. In contrast, the Company's portfolio of commercial real estate loans declined by $27.4 million or 9.9% during the first half of 2014 due to low borrower demand and aggressive competition for these types of loans in recent periods. The Company's portfolios of home equity and consumer loans have declined modestly in recent periods for similar reasons. Growth in total loans 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 in 2014 or that total loans will not decrease during the period. 42



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 2014 2013 (Dollars in thousands) Commercial loans: Commercial and industrial $ 43,570$ 22,444 Commercial real estate 14,297 10,205 Multi-family real estate 57,472 29,499 Construction and development 32,552 45,024 Total commercial loans 147,891 107,172 Retail loans: One- to four-family first mortgages (1) 30,316 45,375 Home equity 16,705 23,794 Other consumer 730 1,861 Total retail loans 47,751 71,030 Total loan originations $ 195,642$ 178,202



(1) Excludes $32.2 million and $188.7 million in loans originated for sale during

the six months ended June 30, 2014 and 2013, respectively.

Mortgage Servicing RightsThe carrying value of the Company's MSRs was $8.2 million at June 30, 2014, and $8.7 million at December 31, 2013, net of valuation allowances of zero and $1,400 as of such dates, respectively. As of June 30, 2014, the Company serviced $1.1 billion in loans for third-party investors compared to $1.2 billion at December 31, 2013. Refer to "Results of Operations-Non-Interest Income," above, for additional discussion related to the Company's MSRs.

Other Assets As of June 30, 2014, and December 31, 2013, the Company's net deferred tax asset, which is included as a component of other assets, was $22.8 million and $27.4 million, respectively. Management evaluates this asset on an on-going basis to determine if a valuation allowance is required. Management determined that no valuation allowance was required as of these dates. The evaluation of the net deferred tax asset requires significant management judgment based on positive and negative evidence. Such evidence includes the Company's recent trends in earnings, expectations for the Company's future earnings, the duration of federal and state net operating loss carryforward periods, and other factors. There can be no assurance that future events, such as adverse operating results, court decisions, regulatory actions or interpretations, changes in tax rates and laws, or changes in positions of federal and state taxing authorities will not differ from management's current assessments. The impact of these matters could be significant to the consolidated financial conditions, results of operations, and capital of the Company. The Company's foreclosed properties and repossessed assets, which are included as a component of other assets, were $6.1 million and $6.7 million at June 30, 2014, and December 31, 2013, respectively. Management expects foreclosed properties and repossessed assets to trend modestly lower in the near term. However, there can be no assurances that foreclosed properties and repossessed assets will not fluctuate significantly from period to period. 43 Deposit Liabilities The Company's deposit liabilities decreased by $46.6 million or 2.6% during the six months ended June 30, 2014. Certificates of deposit declined by $76.3 million or 12.0% during the period while core deposits, consisting of checking, savings and money market accounts, increased by $29.7 million or 2.6%. The Company continues to closely manage the rates it offers on certificates of deposit to control its overall liquidity position, which has resulted in a decline in certificates of deposit in recent periods. Core deposits have increased in recent periods in response to management's efforts to increase sales of such products and related services to commercial businesses, as well as efforts to focus its retail sales efforts on such products and related services. Also contributing to the increase in core deposits in recent periods, however, was customer reaction to the low interest rate environment for deposit products. Management believes that this environment has encouraged some customers to switch to core deposits in an effort to retain flexibility in the event interest rates rise in the future. If interest rates increase in the future, customer preference may shift from core 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 could have an adverse impact on its net interest margin. Borrowings Borrowings, which consist of advances from the FHLB of Chicago, increased by $24.4 million or 10.0% during the six months ended June 30, 2014. This increase was primarily caused by an increase in overnight borrowings from the FHLB of Chicago, which partially funded growth in the Company's loans receivable during the period, as well as the decrease in its deposit liabilities. The Company's term advances from the FHLB of Chicago are subject to significant prepayment penalties if repaid by the Company prior to their stated maturity. 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 $21.7 million at June 30, 2014, compared to $3.4 million at December 31, 2013. 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 increased from $281.0 million at December 31, 2013, to $285.8 million at June 30, 2014. This increase was due primarily to net income during the period, partially offset by the payment of cash dividends of $0.03 and $0.04 per share to shareholders in the first and second quarters, respectively. The book value of the Company's common stock was $6.14 per share at June 30, 2014, compared to $6.05 per share at December 31, 2013. On August 4, 2014, the Company's board of directors declared a $0.04 per share dividend payable on August 29, 2014, to shareholders of record on July 15, 2014. For additional discussion relating to the Company's ability to pay dividends refer to "Liquidity and Capital Resources-Capital Resources," below. 44 Asset Quality The following table summarizes non-performing loans and assets as of the dates indicated: At June 30 At December 31 2014 2013 (Dollars in thousands) Non-accrual commercial loans: Commercial and industrial $ 209 $ 284 Commercial real estate 2,534 4,401 Multi-family real estate 1,423 1,783 Construction and development 639 728 Total commercial loans 4,805 7,196 Non-accrual retail loans:

One- to four-family first mortgages 4,256

4,556 Home equity 448 676 Other consumer 61 104

Total non-accrual retail loans 4,765



5,336

Total non-accrual loans 9,570



12,532

Accruing loans delinquent 90 days or more (1) 291 443 Total non-performing loans 9,861



12,975

Foreclosed real estate and repossessed assets 6,138



6,736

Total non-performing assets $ 15,999



$ 19,711

Non-performing loans to total loans 0.63 % 0.86 % Non-performing assets to total assets 0.68 0.84



Interest income that would have been recognized if non-accrual loans had been current (2)

$ 600 $ 1,265 Interest income on non-accrual loans included in interest income (2) $ 199 $ 658



(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, 2014, and the twelve

months ended December 31, 2013, respectively. The Company's non-performing loans were $9.9 million or 0.63% of loans receivable as of June 30, 2014, compared to $13.0 million or 0.86% of loans receivable as of December 31, 2013. Non-performing assets, which includes non-performing loans, were $16.0 million or 0.68% of total assets and $19.7 million or 0.84% of total assets as of these same dates, respectively. Non-performing assets are classified as "substandard" in accordance with the Company's internal risk rating policy. In addition to non-performing assets, at June 30, 2014, management was closely monitoring $36.6 million in additional loans that were classified as "special mention" and $41.6 million in additional loans that were classified as "substandard" in accordance with the Company's internal risk rating policy. These amounts compared to $52.7 million and $36.1 million, respectively, as of December 31, 2013. As of June 30, 2014, most of the additional loans that were classified as "special mention" or "substandard" were secured by commercial real estate, multi-family real estate, land, and certain commercial business assets. The decrease in loans classified as "special mention" was due primarily to the downgrade of certain loans to "substandard" during the period. However, this development was largely offset by a number of other "substandard" loans that paid-off during the period or were upgraded due to the improved financial condition and operating results of the borrowers. In a number of the instances in which loans were downgraded from "special mention" to "substandard," management believes the conditions that caused the downgrade could be temporary, and that such loans may be upgraded in the future, rather than experience additional deterioration. However, there can be no assurances. Management does not believe any of these particular loans were impaired as

of June 30, 2014. 45

Trends in the credit quality of the Company's loan portfolio are subject to many factors that are outside of the Company's control, such as economic and market conditions. As such, there can be no assurances that there will not be significant fluctuations in the Company's non-performing assets and/or classified loans in future periods or that there will not be significant variability in the Company's provision for loan losses from period to period. A summary of the Company's allowance for loan losses is shown below for the periods indicated: Six Months Ended June 30 2014 2013 (Dollars in thousands) Balance at beginning of period $ 23,565$ 21,577 Provision for loan losses 334 2,622 Charge-offs: Commercial and industrial - (199 ) Commercial real estate (557 ) (493 ) Multi-family real estate (241 ) - Construction and development - (6 ) One- to four-family first mortgages (429 ) (860 ) Home equity (72 ) (648 ) Other consumer (239 ) (190 ) Total charge-offs (1,538 ) (2,396 ) Recoveries: Commercial and industrial 1 3 Commercial real estate 129 414 Multi-family real estate - - Construction and development 142 - One- to four-family first mortgages 135 247 Home equity 11 52 Other consumer 15 23 Total recoveries 433 739 Net charge-offs (1,105 ) (1,657 ) Balance at end of period $ 22,794$ 22,542 June 30 December 31 2014 2013 Allowance for loan losses to total loans 1.46 % 1.56 % Allowance for loan losses to non-performing loans 231.15 % 181.62 % Net charge-offs to average loans (1) 0.15 % 0.18 %



(1) The rate for the six months ended June 30, 2014, is annualized.

The Company's allowance for loan losses was $22.8 million or 1.46% of total loans at June 30, 2014, compared to $23.6 million or 1.56% of total loans at December 31, 2013. As a percent of non-performing loans, the Company's allowance for loan losses was 231.2% at June 30, 2014, compared to 181.6% at December 31, 2013. Management believes the allowance for loan losses at June 30, 2014, 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. 46



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), and prepayments of loans and mortgage-related securities are strongly influenced by interest rates, general and local economic conditions, and 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 12.22% at June 30, 2014, compared to 11.97% at December 31, 2013. The increase in this ratio was due in part to the Company's net income, less the dividends it paid during the period. Also contributing was a decline in the Company's total assets during the period, as noted in earlier paragraphs. At June 30, 2014, the Bank exceeded each of the applicable regulatory capital requirements (refer to Note 8, "Shareholders' Equity," of the Unaudited Condensed Consolidated Financial Statements, above). In order to be classified as "well-capitalized" by the FDIC, the Bank is required to have Tier 1 (leverage) capital to total adjusted assets of at least 5.0% and total risk-based capital to risk-weighted assets of at least 10.0%. At June 30, 2014, the Bank had a Tier 1 capital ratio of 11.22% and a total risk-based capital ratio of 18.15%. 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. In 2013 the FRB and the OCC published final regulatory capital rules under Basel III. These new rules will become effective on January 1, 2015, although certain aspects of the new rules will phase in over the following four years. At this time management does not expect these new rules to have a significant impact on the regulatory capital of the Bank, its financial condition, or its results of operations, although there can be no assurances. In addition, the Dodd-Frank Act will eventually impose specific capital requirements on savings and loan holding companies such as the Company. These developments, as well as other requirements that could be imposed by regulators, may impact the ability of the Company and/or its Bank to pay dividends or, in the case of the Company, repurchase

its common stock. 47



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

Contractual Obligations The following table presents, as of June 30, 2014, 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 $ 1,158,494 - - - $ 1,158,494 Certificates of deposits 451,347 $ 81,067$ 25,198

- 557,612 Borrowed funds 88,450 61,230 59,388 $ 60,223 269,291 Operating leases 891 1,361 823 2,347 5,422

Purchase obligations 2,400 4,800 4,800 600 12,600 Deferred retirement plans and deferred compensation plans 1,091 1,544 1,604

5,620 9,859 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, 2014:

Payments Due In One to Three to Over One Year Three Five Five Or Less Years Years Years Total (Dollars in thousands) Commercial lines of credit $ 103,068 - - - $ 103,068 Commercial loans 108,389 - $ 216 - 108,605 Standby letters of credit 4,111 $ 314 - - 4,425 Multi-family and commercial real estate loans 108,462 - - - 108,462

Residential real estate loans 30,389 - -

- 30,389 Revolving home equity and credit card lines 169,077 - - - 169,077 Net commitments to sell mortgage loans 10,340 - - - 10,340 48 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, 2014, the Company had forward commitments to sell one- to four-family mortgage loans of $10.3 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, 2014.


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