WAUW Wauwatosa Hldgs (MM)

 

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

Form 10-Q

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

For the quarterly period ended September 30, 2007

OR

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

Commission File Number 000-51507

WAUWATOSA HOLDINGS, INC.

(Exact name of registrant as specified in its charter)

Federal (State or other jurisdiction of incorporation or organization)		20-3598485 (IRS Employer Identification No.)

11200 W. Plank Ct.
Wauwatosa, WI 53226
(414) 761-1000
(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 (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes   þ      No o

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

Large accelerated filer   o		Accelerated filer   þ		Non-accelerated filer   o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).     Yes o      No þ

The number of shares outstanding of the issuer’s common stock, $0.01 par value per share, was 31,418,902 at October 31, 2007.

 

 

WAUWATOSA HOLDINGS, INC.

10-Q INDEX

		Page No.
PART I. FINANCIAL INFORMATION
Item l. Financial Statements
Consolidated Statements of Financial Condition as of September 30, 2007 (unaudited) and December 31, 2006			3
Consolidated Statements of Operations for the nine and three months ended September 30, 2007 and 2006 (unaudited)			4
Consolidated Statements of Changes in Shareholders’ Equity for the nine months ended September 30, 2007 and 2006 (unaudited)			5
Consolidated Statements of Cash Flows for the nine months ended September 30, 2007 and 2006 (unaudited)			6-7
Notes to Consolidated Financial Statements			8-20
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			20-44
Item 3. Quantitative and Qualitative Disclosures about Market Risk			45-46
Item 4. Controls and Procedures			46
PART II. OTHER INFORMATION			47
Item 1. Legal Proceedings			47
Item 1A. Risk Factors			47
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			47
Item 6. Exhibits			48
Signatures			49
Certification
Certification
Certification
Certification

PART I — FINANCIAL INFORMATION

See Accompanying Notes to Consolidated Financial Statements.

See Accompanying Notes to Consolidated Financial Statements.

See Accompanying Notes to Consolidated Financial Statements.

WAUWATOSA HOLDINGS, INC AND SUBSIDIARIES

At September 30, 2007, $14.0 million of the Company’s government sponsored entity bonds and $61.9 million of the Company’s mortgage backed securities were pledged as collateral to secure repurchase agreement obligations of the Company.

The amortized cost and fair values of investment securities by contractual maturity at September 30, 2007, are shown below. Actual maturities may differ from contractual maturities because issuers have the right to call or prepay obligations with or without call or prepayment penalties.

Gross unrealized losses on securities available-for-sale and the fair value of the related securities, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, were as follows:

There are three, seventeen, five and one individual securities at September 30, 2007 that comprise the mortgage backed securities, collateralized mortgage obligations, government sponsored entity bonds and municipal securities, respectively, which have been in an unrealized loss position for twelve months or longer. Because the decline in fair value of all aforementioned securities is attributable to changes in interest rates and not credit deterioration, and because the Company has the ability and intent to hold these securities until a market price recovery or maturity, these investments are not considered other-than-temporarily impaired.

Securities Held-to-Maturity

As of September 30, 2007, the Company held three securities that have been designated as held-to-maturity. The securities have a total amortized cost of $7.6 million and an estimated fair value $7.1 million. Each security is callable quarterly, one beginning in the first quarter of 2008 with a final maturity in 2019. The remaining two securities are callable beginning in the first quarter of 2009 with a final maturity in 2022.

Real estate collateralizing the Company’s first mortgage loans is primarily located in the Company’s general lending area of metropolitan Milwaukee.

Non-performing loans totaled $68.9 million at September 30, 2007 and $28.9 million at December 31, 2006.

Commercial, commercial real estate and multi-family loans with nonaccrual status or having restructured terms are considered to be impaired loans. The following table presents data on impaired loans at September 30, 2007 and December 31, 2006.

     A summary of the activity in the allowance for loan loss is as follows:

The $220 million in advances due in 2016 consist of eight callable advances. The call features are as follows: $70 million at a weighted average rate of 4.44% callable quarterly until maturity, two $25 million advances at a weighted average rate of 4.64% callable beginning in July 2008, and August 2008 and quarterly thereafter, and two $50 million advances at a weighted average rate of 4.13% callable beginning in January 2009 and March 2009 and quarterly thereafter.

The $69 million in repurchase agreements include quarterly call options beginning in 2009. The repurchase agreements are collateralized by securities available for sale with an estimated fair value of $75.9 million at September 30, 2007.

The Company selects loans that meet underwriting criteria established by the FHLB as collateral for outstanding advances. The Company’s FHLB borrowings are limited to 60% of the carrying value of unencumbered one- to four-family mortgage loans. In addition, these advances are collateralized by FHLB stock of $17.6 million at September 30, 2007 and $17.2 million at December 31, 2006.

Note 7 — Stock-Based Compensation

Stock-Based Compensation Plan

In 2005, the Company’s shareholders approved the 2006 Equity Incentive Plan. During the quarter ended March 31, 2007, the Company granted 782,500 stock options in tandem with stock appreciation rights and 251,500 shares of restricted stock. The restricted shares were issued from previously unissued shares. All stock awards granted under these plans vest over a period of five years and are required to be settled in shares of the Company’s common stock. The exercise price for all stock options granted is equal to the quoted NASDAQ market close price on the date that the awards were granted and expire ten years after the grant date, if not exercised.

Accounting for Stock-Based Compensation Plan

The fair value of stock options granted is estimated on the grant date using a Black-Scholes pricing model. The fair value of restricted shares is equal to the quoted NASDAQ market close price on the date of grant. The fair value of stock grants is recognized as compensation expense on a straight-line basis

over the vesting period of the grants. Compensation expense is included in compensation, payroll taxes and other employee benefits in the consolidated statements of income.

Assumptions are used in estimating the fair value of stock options granted. The weighted average expected life of the stock options represent the period of time that the options are expected to be outstanding and is based on the SEC simplified approach to calculating expected term. The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant. The expected volatility is based on the historical volatility for a group of selected peers. The following assumptions were used in estimating the fair value of options granted in the nine month period ended September 30, 2007.

In accordance with Statement on Financial Standards No. 123R, Share-Based Payment, the Company is required to estimate potential forfeitures of stock grants and adjust compensation expense recorded accordingly. The estimate of forfeitures will be adjusted over the requisite service period to the extent that actual forfeitures differ, or are expected to differ, from such estimates. Changes in estimated forfeitures will be recognized in the period of change and will also impact the amount of stock compensation expense to be recognized in future periods.

A summary of the Company’s stock option activity for the nine months ended September 30, 2007, is presented below.

The following table summarizes information about the Company’s nonvested stock option activity for the nine months ended September 30, 2007:

The Company amortizes the expense related to stock options as compensation expense over the vesting period. During the nine months ended September 30, 2007, 782,500 options were granted, of which 15,000 have been forfeited. Expense for the stock options granted of approximately $632,000 and $211,000 was recognized during the nine and three month periods ended September 30, 2007. At September 30, 2007, the Company had $4.0 million in estimated unrecognized compensation costs related to outstanding stock options that is expected to be recognized over the next 51 months.

The following table summarizes information about the Company’s restricted stock shares activity for the nine months ended September 30, 2007:

The Company amortizes the expense related to restricted stock awards as compensation expense over the vesting period. During the nine months ended September 30, 2007, 251,500 shares of restricted stock were awarded, of which no shares have been forfeited. Expense for the restricted stock awards of approximately $667,000 and $222,000 was recorded for the nine and three month periods ended September 30, 2007. At September 30, 2007, the Company had $3.8 million of unrecognized compensation expense related to restricted stock shares that is expected to be recognized over a period of 51 months.

operations. In determining the fair value of its derivative loan commitments for economic purposes, the Company considers the value that would be generated when the loan arising from exercise of the loan commitment is sold in the secondary mortgage market. That value includes the price that the loan is expected to be sold for in the secondary mortgage market.

Note 11 – Charter Conversion

On September 28, 2007, the Company completed its charter conversion to change the Company’s charter from a Wisconsin corporation to that of a federal corporation regulated exclusively by the Office of Thrift Supervision (the “OTS”). Similarly, the Company’s mutual holding company parent, Lamplighter Financial, MHC (the “MHC”) also completed its charter conversion to change the MHC’s charter from a Wisconsin chartered mutual holding company to a federally chartered mutual holding company exclusively regulated by the OTS. The charter conversions were approved by the OTS and the Company’s charter conversion was approved by its shareholders at a special meeting held on June 12, 2007. Wauwatosa Savings continues to be a Wisconsin chartered savings bank.

Pursuant to the plan of charter conversion, the outstanding shares of common stock, par value $.01 per share of the Company as a Wisconsin corporation, became by operation of law, on a one-for-one basis, common stock, par value $.01 per share of the Company as a federal corporation.

Note 12 – Recent Accounting Developments

The Company adopted Financial Accounting Standards Board Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” in the quarter ended March 31, 2007. Total unrecognized tax benefits as of January 1, 2007 totaled $4.1 million. This unrecognized benefit is primarily Wisconsin tax on a portion of the income generated by the Company’s subsidiary located in the state of Nevada for the period July 1, 2002 through December 31, 2006. If recognized, the Company’s effective tax rate would be impacted by the $4.1 million in unrecognized tax benefits, plus $811,000 in interest, less the federal tax effect of $1.7 million for a net benefit of $3.2 million.

A State of Wisconsin closing agreement regarding this matter was executed on March 30, 2007. The Wisconsin settlement had an effect of reclassifying $4.0 million in unrecognized benefits as of January 1, 2007 as accrued state tax liability at March 31, 2007. Under the terms of the closing agreement, the Company paid $1.2 million, including interest, on the settlement date with the remaining $3.7 million, including interest, to be paid over the next three years. It is Company policy to recognize interest and penalties as income tax expense. As of January 1, 2007, $811,000 in interest payable had been accrued.

The IRS completed its examination of the Company’s consolidated federal income tax returns for 2003 and 2004. As such, only 2005 and 2006 remain as open years for federal purposes. The Company’s Wisconsin tax returns are open to further audit for the years ended December 31, 2004 through 2006.

In September 2006, the FASB issued SFAS 157, Fair Value Measurements , which upon adoption will replace various definitions of fair value in existing accounting literature with a single definition, will establish a framework for measuring fair value, and will require additional disclosures about fair value measurements. The statement clarifies that fair value is the price that would be received to sell an asset or the price paid to transfer a liability in the most advantageous

market available to the entity and emphasizes that fair value is a market-based measurement and should be based on the assumptions market participants would use. The statement also creates a three-level hierarchy under which individual fair value estimates are to be ranked based on the relative reliability of the inputs used in the valuation. This hierarchy is the basis for the disclosure requirements, with fair value estimates based on the least reliable inputs requiring more extensive disclosures about the valuation method used and the gains and losses associated with those estimates. SFAS 157 is required to be applied whenever another financial accounting standard requires or permits an asset or liability to be measured at fair value. The statement does not expand the use of fair value to any new circumstances. The Company will be required to apply the new guidance beginning January 1, 2008, and is in the process of assessing the impact on its results of operations, financial position, and liquidity.

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, Including an Amendment of FASB Statement No. 115 (“SFAS 159”). SFAS 159 permits entities to choose to measure many financial instruments and certain other items generally on an instrument-by-instrument basis at fair value that are not currently required to be measured at fair value. SFAS 159 is intended to provide entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. SFAS 159 does not change requirements for recognizing and measuring dividend income, interest income, or interest expense. The Company will be required to apply the new guidance beginning January 1, 2008, and is in the process of assessing the impact on its results of operations, financial position, and liquidity.

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

Cautionary Statements Regarding Forward-Looking Information

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 also be made by the Company from time to time in other reports and documents as well as in oral presentations. When used in written documents or oral statements, the words “anticipate,” “believe,” “estimate,” “expect,” “objective” and similar expressions and verbs in the future tense, are intended to identify 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 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:

	•		inflation and changes in the interest rate environment that reduce our margins or reduce the fair value of financial instruments;
	•		legislative or regulatory changes that adversely affect our business;

	•		our ability to enter new markets successfully and take advantage of growth opportunities;
	•		general economic conditions, either nationally or in our market areas, that are worse than expected;
	•		significantly increased competition among depository and other financial institutions;
	•		adverse changes in the securities markets;
	•		adverse changes in the real estate markets;
	•		changes in accounting policies and practices, as may be adopted by the bank regulatory agencies and the Financial Accounting Standards Board; and
	•		changes in consumer spending, borrowing and savings habits.

See also the factors referred to in reports filed by the Company with the Securities and Exchange Commission (particularly those under the caption “Risk Factors” in Item 1A of the Company’s 2006 Annual Report on Form 10-K).

Overview

Generally, our results of operations depend on our net interest income. Net interest income is the difference between the interest income we earn on loans receivable, investment securities and cash and cash equivalents and the interest we pay on deposits and other borrowings. The Company’s banking subsidiary, Wauwatosa Savings Bank (“Wauwatosa Savings”), is primarily a mortgage lender with such loans comprising 93.9% of total loans receivable on September 30, 2007. Further, 79.0% of loans receivable are residential mortgage loans with over four-family loans comprising 33.4% of all loans on September 30, 2007. Wauwatosa Savings funds loan production primarily with retail deposits and Federal Home Loan Bank advances. On September 30, 2007, deposits comprised 69.3% of total liabilities. Time deposits, also known as certificates of deposit, accounted for 83.8% of total deposits at September 30, 2007. Federal Home Loan Bank advances outstanding on September 30, 2007 totaled $341.4 million, or 23.1% of total liabilities.

Our results of operations also are affected by our provision for loan losses, noninterest income and noninterest expense. Noninterest income consists primarily of service charges and mortgage banking fee income. Noninterest expense consists primarily of compensation and employee benefits and occupancy expenses. Our results of operations also may be affected significantly by general and local economic and competitive conditions, governmental policies and actions of regulatory authorities. During the nine months ended September 30, 2007, our results of operation were adversely affected by a significant increase in loan charge-offs and subsequent need to make additional provisions for loan losses. As discussed below, during the three and nine months ended September 30, 2007, the Company significantly increased its provision for loan losses to $2.8 million and $8.9 million, respectively, from $1.2 million and $1.8 million for the three and nine months ended September 30, 2006. Additional information regarding loan quality and its impact on our financial condition and results of operations can be found in the Asset Quality discussion beginning on page 36.

The following discussion and analysis is presented to assist the reader in the understanding and evaluation of the Company’s financial condition and results of operations. It is intended to complement the unaudited consolidated financial statements, footnotes, and supplemental financial data appearing elsewhere in this Form 10-Q and should be read in conjunction therewith. The detailed discussion focuses on the results of operations for the three and nine month periods ended September 30, 2007 and 2006 and the financial condition as of September 30, 2007 compared to the financial condition as of December 31, 2006.

Critical Accounting Policies

Critical accounting policies are those that involve significant judgments and assumptions by management and that have, or could have, a material impact on our income or the carrying value of our assets.

Allowance for Loan Losses. Wauwatosa Savings establishes valuation allowances on loans considered impaired. A loan is considered impaired when, based on current information and events, it is probable that Wauwatosa Savings will not be able to collect all amounts due according to the contractual terms of the loan agreement. A valuation allowance is established for an amount equal to the impairment when the carrying amount of the loan exceeds the net realizable value of the underlying collateral.

Wauwatosa Savings also establishes valuation allowances based on an evaluation of the various risk components that are inherent in the credit portfolio. The risk components that are evaluated include past loan loss experience; the level of nonperforming and classified assets; current economic conditions; volume, growth, and composition of the loan portfolio; adverse situations that may affect the borrower’s ability to repay; the estimated value of any underlying collateral; regulatory guidance; and other relevant factors. The allowance is increased by provisions charged to earnings and recoveries of previously charged-off loans and reduced by charge-offs. The adequacy of the allowance for loan losses is reviewed and approved at least quarterly by the Wauwatosa Savings board of directors. The allowance reflects management’s best estimate of the amount needed to provide for the probable loss on impaired loans and other inherent losses in the loan portfolio, and is based on a risk model developed and implemented by management and approved by the Wauwatosa Savings board of directors.

Actual results could differ from this estimate and future additions to the allowance may be necessary based on unforeseen changes in loan quality and economic conditions. In addition, state and federal regulators periodically review the Wauwatosa Savings allowance for loan losses. Such regulators have the authority to require Wauwatosa Savings to recognize additions to the allowance at the time of their examination.

Income Taxes. We recognize income taxes under the asset and liability method. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the

enactment date. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that all or some portion of the deferred tax assets will not be realized.

If our estimated current and deferred tax assets, liabilities or any related estimated valuation allowance are too high or too low, it will affect our future net income in the period that the new information resulting in a better estimate of income tax assets and liabilities becomes available.

During the first quarter of 2007, the Company settled a dispute with the state of Wisconsin regarding the operations of the Company’s investment subsidiary located in the state of Nevada. The settlement covered the Nevada operations through the March 30, 2007 settlement date. The settlement had no material effect on net income for the period as the full liability of $4.9 million, including interest, net of deferred Federal tax benefit of $1.7 million, was accrued in prior periods. The settlement had the effect of reducing the estimated effective tax rate for the year ended December 31, 2007 from the year ended December 31, 2006 as statutory interest will no longer accrue as the liability has been settled.

Comparison of Operating Results for the Nine Months Ended September 30, 2007 and 2006

General — Net income for the nine months ended September 30, 2007 totaled $1.3 million, or $0.04 for both basic and diluted earnings per share compared to net income of $5.8 million, or $0.17 for both basic and diluted earnings per share for the nine months ended September 30, 2006. Year-to-date 2007 results generated an annualized return on average assets of 0.10% and an annualized return on average equity of 0.75%, compared to 0.49% and 3.27%, respectively, for the comparable period in 2006. The decrease in net income was a result of a $7.0 million increase in the provision for loan losses and a $2.6 million decrease in net interest income, partially offset by a $1.3 million increase in non-interest income and a $724,000 decrease in other noninterest expense. The increase in the provision for loan losses was the direct result of an increase in loan charge-offs and an increase in specific loan losses attributable to classified loans. Loan charge-off activity and specific loan reserves will be discussed in additional detail in the Asset Quality section beginning on page 36. The net interest margin for the first nine months of 2007 was 2.22% compared to 2.56% for the first nine months of 2006.

Total Interest Income — Total interest income increased $4.8 million, or 7.1%, to $72.3 million during the nine months ended September 30, 2007 compared to $67.5 million for the nine months ended September 30, 2006. Interest income on loans increased $2.8 million, or 4.4%, to $65.1 million for the nine months ended September 30, 2007 compared to $62.3 million for the comparable period in 2006. The increase resulted primarily from an increase of $36.7 million, or 2.7%, in the average loan balance to $1.4 billion during the nine-month period ended September 30, 2007 from $1.3 billion during the comparable period in 2006. The increase in average loans was compounded by a 10 basis point increase in the average yield on loans to 6.28% for the nine-month period ended September 30, 2007 from 6.18% for the comparable period in 2006. In addition, interest income from mortgage-related securities increased $1.0 million, or 33.3%, to $4.1 million for the nine months ended September 30, 2007 compared to $3.1 million for the comparable period in 2006. This was primarily due to the increase of $19.0 million, or 22.2%, in the average balance to $104.6 million during the nine-month period ended September 30, 2007

from $85.6 million during the comparable period in 2006. The increase in average mortgage-related securities was compounded by a 44 basis point increase in the average yield on mortgage-related securities to 5.21% for the nine-month period ended September 30, 2007 from 4.77% for the comparable period in 2006. Finally, interest income from debt securities, federal funds sold and short-term investments increased $1.0 million, or 46.3%, to $3.2 million for the nine months ended September 30, 2007 compared to $2.2 million for the comparable period in 2006. This was primarily due to the increase of $20.6 million, or 28.7%, in the average balance to $92.2 million during the nine-month period ended September 30, 2007 from $71.6 million during the comparable period in 2006. The increase in average other earning assets was compounded by a 56 basis point increase in the average yield on other earning assets to 4.61% for the nine-month period ended September 30, 2007 from 4.05% for the comparable period in 2006.

Total Interest Expense - Total interest expense increased by $7.4 million, or 19.0%, to $46.1 million during the nine months ended September 30, 2007 from $38.7 million during the nine months ended September 30, 2006. This increase was the result of an increase in both the rate paid on deposits and borrowings and an increase in average borrowings outstanding.

Interest expense on deposits increased $2.9 million, or 9.4%, to $33.6 million during the nine months ended September 30, 2007 from $30.8 million during the comparable period in 2006. The increase resulted primarily from an increase in the average cost of deposits to 4.39% for the nine-month period ended September 30, 2007 compared to 3.87% for the comparable period in 2006. The increase in the cost of deposits was partially offset by a decrease of $36.8 million, or 3.5%, in the average balance of deposits to $1.0 billion at September 30, 2007 from $1.1 billion during the comparable period in 2006.

Interest expense on borrowings increased $4.4 million, or 56.2%, to $12.4 million during the nine months ended September 30, 2007 from $8.0 million during the comparable period in 2006. The increase resulted primarily from an increase in average borrowings outstanding of $125.1 million, or 51.7%, to $366.9 million during the nine-month period ended September 30, 2007 from $241.9 million during the comparable period in 2006. The increase in average borrowings was compounded by a 13 basis point increase in the average cost of borrowings to 4.41% during the nine-month period ended September 30, 2007 from 4.28% during the comparable period in 2006.

Net Interest Income — Net interest income decreased by $2.6 million or 9.0%, during the nine months ended September 30, 2007 as compared to the same period in 2006. The decrease resulted primarily from a 31 basis point decrease in our net interest rate spread to 1.75% for the nine-month period ended September 30, 2007 from 2.06% for the comparable period in 2006. The 31 basis point decrease in the net interest rate spread resulted from a 43 basis point increase in the cost of interest bearing liabilities, which was partially offset by a 12 basis point increase in the yield on interest earning assets. The Company has experienced net interest margin compression as the yield curve remains relatively flat. The decrease in net interest income resulting from a decrease in our net interest rate spread was compounded by a decrease in net average earning assets of $20.4 million, or 10.6%, to $171.9 million for the nine-month period ended September 30, 2007 from $192.3 million for the comparable period in 2006. The decrease in average net assets was primarily attributable to the repurchase of outstanding Company common stock.

Provision for Loan Losses — Provision for loan losses increased $7.0 million, to $8.8 million during the nine months ended September 30, 2007, from $1.8 million during the comparable period during 2006. The increased provision for the nine months ended September 30, 2007 was the result of $4.6 million in loan charge-offs, specific loss provisions and a continued increase in non-performing assets. See the Asset Quality section beginning on page 36 for an analysis of charge-offs, non-performing assets, specific reserves and additional provisions.

Noninterest Income — Total noninterest income increased $1.3 million, or 33.7%, to $5.2 million during the nine months ended September 30, 2007 from $3.9 million during the comparable period in 2006. The increase resulted primarily from a decrease in the loss on sale of securities and an increase in mortgage banking income generated by Waterstone Mortgage Corporation, the Bank’s mortgage banking subsidiary. In September 2006, $26.7 million of investment securities with unrealized losses approximating $784,000 were designated for sale. The related realized and unrealized losses were recognized as reductions to income in that quarter. There was no comparable activity during the nine months ended September 30, 2007. Mortgage banking income increased $386,000, or 22.0% to $2.1 million during the nine months ended September 30, 2007 from $1.8 million during the comparable period in 2006. The nine-month period ended September 30, 2007 includes a full nine months of mortgage banking income, while the comparable period of 2006 only includes mortgage banking income from the February 9, 2006 acquisition of Waterstone through September 30, 2006.

Noninterest Expense — Total noninterest expense decreased $724,000, or 3.3%, to $21.0 million during the nine months ended September 30, 2007 from $21.8 million during the comparable period in 2006. The decrease was primarily the result of decreases in compensation, payroll taxes and other employee benefits, data processing expense and other noninterest expense, partially offset by increases in occupancy, office furniture and equipment expenses and professional fees.

Compensation, payroll taxes and other employee benefit expense decreased $713,000, or 5.7%, to $11.8 million during the nine months ended September 30, 2007 from $12.5 million during the comparable period in 2006. Expense related to the Company’s stock option and restricted stock plans totaled $1.3 million during the nine months ended September 30, 2007. There was no comparable expense in the prior year. Compensation expense related to the ESOP totaled $966,000 during the nine months ended September 30, 2007 compared to $838,000 during the comparable period of 2006. The increase in ESOP expense resulted from an increase in the average market price of the Company’s common stock during the nine months ended September 30, 2007 compared to the same period in 2006. These increases were offset by a decrease in salary expense. Salary expense decreased by $2.1 million, or 20.9% to $8.0 million during the nine months ended September 30, 2007 compared to $10.0 million during the comparable period in 2006. Salary expense decreased as a result of a 19% reduction in full-time equivalent staff combined with a shift from cash bonus compensation to equity incentives.

Occupancy, office furniture and equipment increased by $643,000, or 20.5%, to $3.8 million during the nine months ended September 30, 2007 from $3.1 million during the comparable

period in 2006. The increase relates primarily to the operation of three new branch offices located in Franklin, Germantown and West Allis, Wisconsin that opened in August 2006, November 2006 and March 2007, respectively.

Data processing expense decreased $353,000, or 23.5%, for the nine months ended September 30, 2007 to $1.1 million from $1.5 million during the comparable period in 2006. Contract termination costs of $333,000 were recognized during the nine months ended September 30, 2006 as a result of the conversion of Wauwatosa Savings’ core processor to Metavante as of February 19, 2007.

Professional fees increased by $118,000, or 14.9% for the nine months ended September 30, 2007 to $911,000 from $793,000 for the nine months ended September 30, 2006. The increase is comprised of legal fees related to the Company’s change from a state charter to a federal charter, legal fees related to the termination of a defined benefit pension plan and additional audit expenses related to non-recurring auditing and reporting issues.

Other noninterest expense decreased $429,000, or 17.8%, to $2.0 million for the nine months ended September 30, 2007 from $2.4 million during the comparable period in 2006. The decrease is the result of the reduction in amortization of Waterstone Mortgage Corporation intangibles and decreases in brokered deposit fees, employee related business expenses and insurance expense.

Income Taxes — The effective tax rate for the nine months ended September 30, 2007 was 22.5% as compared to 36.9% for the comparable period during 2006. Of the total 14.4% decrease in effective tax rate, 1.5% was the result of a decline in state tax expense and 12.9% was the result of an increase in net non-taxable income as a percentage of total pre-tax income. Net non-taxable income increased by $67,000, or 10.4%, even as total pre-tax income declined by $7.5 million, or 82.3%. Net non-taxable income is comprised of the increase in cash surrender value of life insurance and municipal bond income partially offset by non-deductible ESOP and stock option expenses.

Net Income - As a result of the foregoing factors, net income for the nine months ended September 30, 2007 decreased $4.5 million, or 78.3%, to $1.3 million, from $5.8 million during the comparable period in 2006.

Comparison of Operating Results for the Three Months Ended September 30, 2007 and 2006

General — Net income for the three months ended September 30, 2007 totaled $421,000, or $0.01 for both basic and diluted earnings per share compared to net income of $906,000, or $0.03 for both basic and diluted earnings per share for the three months ended September 30, 2006. The quarter ended September 30, 2007 generated an annualized return on average assets of 0.10% and an annualized return on average equity of 0.82%, compared to returns of 0.22% and 1.52%, respectively, for the comparable period in 2006. The decrease in net income was due to an $1.6 million increase in provisions for loan loss and a $669,000 decrease in net interest income, partially offset by an $661,000 increase in noninterest income, a $566,000 decrease in noninterest expense and a $592,000 decrease in income taxes. The increase in the provision for

loan losses was the direct result of an increase in loan charge-offs and an increase in specific loan losses attributable to classified loans. Loan charge-off activity and specific loan reserves are discussed in additional detail in the Asset Quality section beginning on page 36. The net interest margin for the three months ended September 30, 2007 was 2.12% compared to 2.36% for the three months ended September 30, 2006.

Total Interest Income — Total interest income increased $1.2 million, or 5.0%, to $24.4 million during the three months ended September 30, 2007 compared to $23.3 million for the three months ended September 30, 2006. Interest income on loans increased $456,000, or 2.1%, to $21.8 million for the three months ended September 30, 2007 compared to $21.3 million for the comparable period of 2006. The increase resulted primarily from an increase of $22.6 million, or 1.7%, in the average loan balance to $1.38 billion during the three-month period ended September 30, 2007 from $1.36 billion during the comparable period in 2006. The increase in average balance was compounded by a 3 basis point increase in the average yield on loans to 6.24% for the three-month period ended September 30, 2007 from 6.21% for the comparable period in 2006. In addition, interest income from mortgage-related securities increased $558,000, or 57.2%, to $1.5 million for the quarter ended September 30, 2007 compared to $975,000 for the comparable quarter in 2006. This was primarily due to the increase of $36.5 million, or 45.0%, in the average balance to $117.5 million for the three months ended September 30, 2007 from $81.0 million during the comparable period in 2006. The increase in average mortgage-related securities was compounded by a 41 basis point increase in the average yield on mortgage-related securities to 5.18% for the quarter ended September 30, 2007 from 4.77% for the comparable period in 2006. Finally, interest income from debt securities, federal funds sold and short-term investments increased $140,000, or 14.3%, to $1.1 million for the three months ended September 30, 2007 compared to $978,000 for the comparable period in 2006. This was due to an 86 basis point increase in the average yield on other earning assets to 4.73% for the three-month period ended September 30, 2007 from 3.87% for the comparable period in 2006. The increase in average yield was partially offset by a decrease of $6.5 million, or 6.5%, in the average balance of other earning assets to $93.8 million during the three-month period ended September 30, 2007 from $100.3 million during the comparable period in 2006.

Total Interest Expense - Total interest expense increased by $1.8 million, or 12.9%, to $15.9 million during the three months ended September 30, 2007 from $14.1 million during the three months ended September 30, 2006. This increase was the result of an increase in both the rate paid on deposits and borrowings and an increase in average borrowings outstanding.

Interest expense on deposits increased $408,000, or 3.7%, to $11.5 million during the three months ended September 30, 2007 from $11.1 million during the comparable period in 2006 primarily as a result of an increase in the cost of deposits. The cost of total average deposits increased by 29 basis points to 4.43% for the three-month period ended September 30, 2007 compared to 4.14% for the comparable period during 2006. The increase in average yield was partially offset by a decrease of $33.3 million, or 3.1%, in the average balance of other earning assets to $1.0 billion during the three-month period ended September 30, 2007 from $1.1 billion during the comparable period in 2006.

Interest expense on borrowings increased $1.4 million, or 46.8%, to $4.4 million during the three

months ended September 30, 2007 from $3.0 million during the comparable period in 2006. The increase resulted primarily from an increase in average borrowings outstanding of $113.5 million, or 41.2%, to $388.7 million during the three-month period ended September 30, 2007 from $275.2 million during the comparable period in 2006. The increase in average borrowings was compounded by a 7 basis point increase in the average cost of borrowings to 4.42% during the three-month period ended September 30, 2007 from 4.35% during the comparable period in 2006.

Net Interest Income — Net interest income decreased by $669,000 or 7.3%, during the three months ended September 30, 2007 as compared to the same period in 2006. The decrease resulted primarily from a 15 basis point decrease in our net interest rate spread to 1.70% for the three month period ended September 30, 2007 from 1.85% for the comparable period in 2006. The 14 basis point decrease in the net interest rate spread resulted from a 24 basis point increase in the cost of interest bearing liabilities, which was partially offset by a 9 basis point increase in the yield on interest earning assets. The Company has experienced net interest margin compression as the yield curve remains relatively flat. The decrease in net interest income resulting from a decrease in our net interest rate spread was compounded by a decrease in net average earning assets of $41.1 million, or 21.3%, to $152.3 million for the three-month period ended September 30, 2007 from $193.3 million from the comparable period in 2006. The decrease in average net assets was primarily attributable to the repurchase of outstanding Company common stock.

Provision for Loan Losses — Provision for loan losses increased $1.6 million to $2.8 million during the three months ended September 30, 2007, from $1.2 million during the comparable period during 2006. The increased provision for the three months ended September 30, 2007 was the result of $914,000 of net loan charge-offs, specific loss provisions and a continued increase in non-performing assets. See Asset Quality section beginning on page 36 for an analysis of charge-offs, non-performing assets specific reserves and additional provisions.

Noninterest Income — Total noninterest income increased $661,000, or 53.8%, to $1.9 million during the three months ended September 30, 2007 from $1.2 million during the comparable period in 2006. The increase resulted primarily from a decrease in the loss on sale of securities and an increase in mortgage banking income generated by Waterstone Mortgage Corporation. During the quarter ended September 30, 2006, $26.7 million of investment securities with unrealized losses approximating $784,000 were designated for sale. The related realized and unrealized losses were recognized as reductions to income in that quarter. There was no comparable activity during the quarter ended September 30, 2007.

Noninterest Expense — Total noninterest expense decreased $566,000, or 7.3%, to $7.2 million during the three months ended September 30, 2007 from $7.8 million during the comparable period in 2006. The decrease was primarily the result of decreases in compensation, payroll taxes and other employee benefits and data processing expenses, partially offset by increases in occupancy, office furniture and equipment expense and other noninterest expense.

Compensation, payroll taxes and other employee benefit expense decreased $530,000, or 12.1%, to $3.9 million during the three months ended September 30, 2007 from $4.4 million during the

comparable period in 2006. This decrease resulted primarily from a reduction in the overall level of staffing compared to the prior year. Expense related to the Company’s stock option and restricted stock plans totaled $433,000 during the three months ended September 30, 2007. There was no comparable expense in the prior year. This increase was partially offset by a decrease in salary expense. Salary expense decreased by $898,000, or 25.1% to $2.7 million during the three months ended September 30, 2007 compared to $3.6 million during the comparable period in 2006. Salary expense decreased as a result of a 19% decrease in the overall level of full-time equivalent staff members and a shift from cash to stock-based compensation.

Occupancy, office furniture and equipment increased by $143,000, or 12.5%, to $1.3 million during the three months ended September 30, 2007 from $1.1 million during the comparable period in 2006. The increase relates primarily to the operation of three new branch offices located in Franklin, Germantown and West Allis, Wisconsin that opened in August 2006, November 2006 and March 2007, respectively.

Data processing expense decreased $214,000, or 30.2%, for the three months ended September 30, 2007 to $494,000 from $708,000 during the comparable period in 2006. Contract termination costs of $312,000 were recognized during the three months ended September 30, 2006 as a result of the conversion of Wauwatosa Savings’ core processor to Metavante. There were no such expenses during the comparable period in 2007.

Other noninterest expense increased $125,000, or 18.3%, to $808,000 for the quarter ended September 30, 2007 from $683,000 during the comparable quarter in 2006. The increase is primarily the result of an increase in expenses related to real estate owned. Real estate owned expense increased $178,000 to $219,000 during the three months ended September 30, 2007 from $41,000 during the comparable period in 2006. The increase in expense related to real estate owned was partially offset by reductions in expenses related to brokered deposit fees and employee related business expenses.

Income Taxes — The effective tax rate for the three months ended September 30, 2007 provided a 14.9% benefit as compared to a 36.9% expense for the comparable period during 2006. The inverse relationship between third quarter 2007 pre-tax income and income tax benefit was the result of the decline of the estimated annual effective tax rate to 22.5% calculated as of September 30, 2007 from 33.5% calculated as of June 30, 2007. The effective tax rate declined in proportion to the relationship between declining total pre-tax book income compared to stable net non-taxable book income.

Net Income - As a result of the foregoing factors, net income for the three months ended September 30, 2007 decreased $485,000, or 53.5%, to $421,000, from $906,000 during the comparable period in 2006.

Comparison of Financial Condition at September 30, 2007 and December 31, 2006

Total Assets — Total assets increased by $31.2 million, or 1.9%, to $1.68 billion at September 30, 2007 from $1.65 billion at December 31, 2006. The increase in total assets resulted primarily

from increases in securities both available for sale and held to maturity of $61.6 million, an increase in loans held for sale of $5.1 million, an increase in net loans receivable of $3.9 million and an increase in prepaid expenses and other assets of $10.3 million, offset by decreases in cash and cash equivalents of $51.2 million.

Cash and Cash Equivalents – Cash and cash equivalents decreased by $51.2 million, or 69.3%, to $22.6 million at September 30, 2007 from $73.8 million at December 31, 2006. The decrease in cash was primarily attributable to the repurchase of Company shares at a cost of $42.9 million. In addition, cash was used to purchase investment securities and to fund loans receivable and loans held for sale.

Securities Available for Sale – Securities available for sale increased by $54.0 million, or 46.0%, to $171.3 million at September 30, 2007 from $117.3 million at December 31, 2006. The Company invested an additional $58.0 million in its Nevada investment subsidiary during the nine months ended September 30, 2007 for the purpose of obtaining the best rate of return in light of limited growth in the loan portfolio as a result of a downturn in the local real estate market. The investment subsidiary used the proceeds of the capital infusion to purchase additional mortgage-related securities.

Securities Held to Maturity – Three structured corporate notes valued at $7.6 million were added to the investment portfolio in the first quarter of 2007. The terms of these high yield securities result in a high potential for market value volatility. As the Company has the intent and ability to hold these securities until maturity, the structured corporate notes have been classified as held-to-maturity rather than as available-for-sale.

Loans Held for Sale – Loans held for sale increased by $5.1 million, or 94.2%, to $10.5 million at September 30, 2007, from $5.4 million at December 31, 2006. Fluctuations in the balance of loans held for sale result primarily from the timing of loan closings and sales to third parties.

Loans Receivable — Loans receivable increased $8.2 million, or 0.6%, to $1.38 billion at September 30, 2007 from $1.37 billion at December 31, 2006. Loans receivable increased by $48.2 million, or 3.7%, during the nine months ended September 30, 2006. The 2007 total increase in loans receivable was primarily attributable to a $14.6 million increase in commercial business loans and a $1.2 million increase in mortgage loans, offset by a $7.1 million decrease in consumer loans. During the nine-month period ended September 30, 2007, $8.3 million in loans were transferred to real estate owned during the nine-month period ended September 30, 2007. The slower growth in loans receivable in 2007 compared to 2006 is directly tied to the downturn in the local real estate market.

The following table shows loan origination, principal repayment and sales activity during the periods indicated.