Baylake (BYLK) 10-K 2013 FY Annual report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

(Mark One)

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the fiscal year endedDecember 31, 2013

or

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the transition period from _________________ to _________________

Commission file number001-16339

BAYLAKE CORP.
(Exact name of registrant as specified in its charter)

Wisconsin	39-1268055
(State or other jurisdiction of	(I.R.S. Employer
incorporation or organization)	Identification No.)
217 North Fourth Avenue, Sturgeon Bay, WI	54235
(Address of principal executive offices)	(Zip Code)
Registrant’s telephone number, including area code:(920) 743-5551
Securities registered pursuant to Section 12(b) of the Act:None
Securities registered pursuant to Section 12(g) of the Act:Common Stock $5.00 Par Value Per Share

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yeso Nox

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
Yeso Nox

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 x Noo

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-Ko.

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

Large accelerated filero	Accelerated filero	Non-accelerated filero	Smaller reporting companyx
(Do not check if a smaller reporting company)

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

As of June 30, 2013, (the last business day of the Registrant’s most recently completed second fiscal quarter), the aggregate market value of the Common Stock (based upon the $9.78 per share average reported bid and asked price on that date) held by non-affiliates was approximately $68.34 million. This market value calculation excludes a total of 972,799 shares of common stock reported as beneficially owned by directors and executive officers. For purposes of this market value calculation, the Registrant assumed that all executive officers and directors (and no other person) qualified as “affiliates”; provided, however, nothing herein shall constitute an admission or any evidence whatsoever, as to affiliate status. As of February 28, 2014, 7,728,497 shares of Common Stock were outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

	Part of Form 10-K Into Which
Document	Portions of Documents are Incorporated
Definitive Proxy Statement for 2014 Annual Meeting of Shareholders to be filed within 120 days of the fiscal year ended December 31, 2013	Part III

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2013 FORM 10-K
TABLE OF CONTENTS

		DESCRIPTION	PAGE NO.
PART I
	ITEM 1.	Business	4
	ITEM 1A.	Risk Factors	15
	ITEM 1B.	Unresolved Staff Comments	27
	ITEM 2.	Properties	27
	ITEM 3.	Legal Proceedings	27
	ITEM 4.	Mine Safety Disclosures	27
PART II
	ITEM 5.	Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	28
	ITEM 6.	Selected Financial Data	31
	ITEM 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	33
	ITEM 7A.	Quantitative and Qualitative Disclosures about Market Risk	62
	ITEM 8.	Financial Statements and Supplementary Data	63
	ITEM 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	117
	ITEM 9A	Controls and Procedures	117
	ITEM 9B	Other Information	117
PART III
	ITEM 10.	Directors, Executive Officers and Corporate Governance	118
	ITEM 11.	Executive Compensation	118
	ITEM 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	119
	ITEM 13.	Certain Relationships and Related Transactions, and Director Independence	119
	ITEM 14.	Principal Accountant Fees and Services	119
PART IV
	ITEM 15.	Exhibits and Financial Statement Schedules	120
		Signatures	121

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PART I

ITEM 1.BUSINESS

General

Baylake Corp. (“we,” “us,” “our” or the “Company”) is a Wisconsin corporation organized in 1976 and is registered as a bank holding company under the Bank Holding Company Act of 1956, as amended (the “BHCA”). Our primary activities consist of holding the stock of our wholly-owned subsidiary bank, Baylake Bank (the “Bank”), and providing a wide range of banking and related business activities through the Bank and our other subsidiaries. At December 31, 2013, we had total assets of approximately $1.0 billion. For additional financial information, see our Consolidated Financial Statements at Part II, Item 8 of this Form 10-K.

Baylake Bank

Baylake Bank is a Wisconsin state bank originally chartered in 1876. The Bank is an independent community bank offering a full range of financial services primarily to small businesses and individuals located in our market area. We conduct our community banking business through 20 full-service financial centers located throughout Northeast Wisconsin, in Brown, Door, Kewaunee and Outagamie Counties. On September 7, 2012, we sold four branches located in the central part of Wisconsin. During the second quarter of 2013, we closed one branch, consolidating the related loans and deposits into our remaining branches. In the second half of 2013, we sold the deposits of two additional branches and moved these facilities to the Bank’s other real estate owned. These transactions reduced our number of branches from 27 to 20. We have eight financial centers in Door County, which is known for its tourism-related services. We have seven financial centers in Brown County, which includes the City of Green Bay. We serve a broader range of service, manufacturing and retail job segments in the Brown County market. The rest of our financial centers are located in smaller cities and smaller communities. Other principal industries in our market area include tourism/recreation, manufacturing, agriculture and food-related products. Services are provided in person at our financial centers discussed above or at other locations, as well as through the mail, over the telephone, electronically by using the Bank’s internet banking services, and mobile banking through customer mobile phones. In early February, 2014, we consummated the purchase of an additional branch facility in Outagamie County and $13.7 million of related deposits from Community Bank & Trust, a wholly owned subsidiary of Community Banc-Corp. of Sheboygan, Inc., Sheboygan, Wisconsin.

Non-Bank Subsidiaries

In addition to our banking operations, the Bank owns one non-bank subsidiary: Baylake Investments, Inc., located in Las Vegas, Nevada, which holds and manages a portion of the Bank’s investment portfolio. During the third quarter of 2012, the Bank discontinued operations of our insurance subsidiary, Baylake Insurance Agency, Inc., and sold the book of business to an unrelated third party. The Bank also owns a minority interest (49.8% of the outstanding common stock) in United Financial Services, Inc. (“UFS”), a data processing services company located in Grafton, Wisconsin that provides data processing services to other banks. During 2013, UFS expanded its operations by purchasing a data processing company located in Missouri. In the fourth quarter of 2013, we capitalized a wholly-owned registered investment advisor subsidiary, Admiral Asset Management, LLC, to provide investment advisory services to customers beyond those provided by the Bank.

Corporate Governance Matters

We maintain a website atwww.baylake.com. We make available through that website, free of charge, copies of our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports, as soon as reasonably practicable after we electronically file those materials with, or furnish them to, the Securities and Exchange Commission (“SEC”). Our SEC reports can be accessed through the Investor Relations link on our website. The SEC also maintains a website atwww.sec.gov that contains reports, proxy statements and other information regarding SEC registrants.

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Lending

We offer short-term and long-term loans on a secured and unsecured basis for business and personal purposes. We make real estate, commercial/industrial, agricultural, consumer and tax exempt loans in accordance with the basic lending policies established by our Board of Directors. We focus lending activities on individuals and small businesses in our market area. Our lending activity has been historically concentrated primarily within the State of Wisconsin. We do not conduct any substantial business with foreign obligors. We serve a wide variety of industries including, on a limited basis, a concentration on businesses directly and indirectly related to the tourism/recreation industries. Loans to customers in the tourism/recreation industry, including restaurants and lodging businesses, totaled approximately $78.8 million at December 31, 2013, or 12.8% of our aggregate loans outstanding at that date. Although competitive and economic pressures exist in this market segment, business remains relatively steady in the markets we serve. However, any deterioration in the economy of Northeastern Wisconsin (as a result, for example, of a decline in its manufacturing or tourism/recreation industries or otherwise) could have a material adverse effect on our business and operations. In particular, a decline in the Door County tourism business would not only affect our customers in the restaurant and lodging business, and therefore loans to such entities as described above, but could also affect loans and other business relationships with persons employed in that industry, as well as real estate values (including collateral values) in the area. Our expansion into other market areas has reduced our concentration level in tourism/recreation related businesses, but these types of businesses still remain an important element of the customer base that we serve.

In addition to originating loans, we buy and sell loan participations with other banks located in markets we serve. These loans are underwritten to the same lending standards as the loans we originate. Additionally, we purchase syndicated loans in the national market which represent small portions of large national credits. These credits are also subject to our normal underwriting guidelines and represented approximately $45.6 million in loans outstanding at December 31, 2013.

Our total outstanding loans as of December 31, 2013 were approximately $618.0 million, consisting of 46.5% commercial real estate loans, 23.0% residential real estate loans, 20.3% commercial and industrial loans, 6.0% construction and land development real estate loans, 3.1% tax exempt loans and 1.1% consumer loans. In September 2012, we sold approximately $36.8 million of loans in our branch sales.

Investments

We maintain a portfolio of investments, primarily consisting of U.S. government agency securities, U.S. government sponsored agency securities, mortgage-backed securities, obligations of states and their political subdivisions, and private placement and corporate bonds. We attempt to balance our portfolio to manage interest rate risks, maximize tax advantages, and meet liquidity needs while endeavoring to optimize investment income.

Deposits

We offer a broad range of depository products, including noninterest-bearing demand deposits, interest-bearing demand deposits, various savings and money market accounts and certificates of deposit. Deposits are insured by the Deposit Insurance Fund of the Federal Deposit Insurance Corporation (“FDIC”) up to statutory limits. At December 31, 2013, our total deposits were approximately $744.2 million, including interest-bearing deposits of $616.3 million and noninterest bearing deposits of $127.9 million. In September 2012, we sold approximately $65.2 million of deposits in our branch sales. In November 2013, we sold approximately $15.6 million of deposits in conjunction with closing two additional branches.

Other Customer Services and Products

Other services and products we offer include safe deposit box services, personal and corporate trust services, brokerage services, cash management, private banking, financial planning and electronic banking services, including mobile banking, and eBanc, an internet banking product for our customers.

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Seasonality

The tourism/recreation industry, particularly in the Door County market, substantially affects our business with our customers, particularly those customers in the restaurant and lodging businesses. The tourist business of Door County is largely seasonal, with the vast majority of tourist vacationing beginning in early spring and continuing until late fall. Although businesses and customers involved in the delivery of tourism-related services have financial needs throughout the entire year, the seasonal nature of the tourism business tends to result in increased demands for loans shortly before and during the tourist season and causes reduced deposits shortly before and during the early part of the tourist season. Although more pronounced in the past, this seasonality has become lessened by the continued growth of other industries throughout our markets in the past few years.

Competition

The financial services industry is highly competitive. We compete with other financial institutions and businesses in both attracting and retaining deposits and making loans in all of our principal markets. The primary factors in competing for deposits are interest rates, personalized services, the quality and range of financial services including electronic and mobile banking options, and convenience of office locations and office hours. Competition for deposit products comes primarily from other commercial banks, savings banks, credit unions and non-bank competitors, including insurance companies, money market and mutual funds, and other investment alternatives. The primary factors in competing for loans are interest rates, loan origination fees, terms and conditions, the quality and range of lending services and personalized services. Competition for loans comes primarily from other commercial banks, savings banks, mortgage banking firms, credit unions, finance companies, leasing companies and other financial intermediaries. Some of our competitors are not subject to the same degree of regulation as that imposed on bank holding companies or federally insured state-chartered banks, and may be able to price loans and deposits more aggressively. We also face direct competition from other banks and bank holding companies that have greater assets and resources than us.

Supervision and Regulation

We must comply with state and federal banking laws and regulations that control virtually all aspects of our operations. These laws and regulations generally aim to protect our depositors, not necessarily our shareholders or our creditors. Any changes in applicable laws or regulations may materially affect our business and prospects. Proposed legislative or regulatory changes may also affect our operations. The following description summarizes some of the laws and regulations to which we are subject. References to applicable statutes and regulations are brief summaries, do not purport to be complete and are qualified in their entirety by reference to such statutes and regulations.

Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010

On July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”). The Dodd-Frank Act resulted in sweeping changes in the regulation of financial institutions aimed at strengthening safety and soundness for the financial services sector. A summary of certain provisions of the Dodd-Frank Act is set forth below:

• Increased Capital Standards and Enhanced Supervision. The federal banking agencies are required to establish minimum leverage and risk-based capital requirements for banks and bank holding companies. These new standards will be no lower than current regulatory capital and leverage standards applicable to insured depository institutions and may, in fact, be higher when established by the agencies. The Dodd-Frank Act also increased regulatory oversight, supervision and examination of banks, bank holding companies and their respective subsidiaries by the appropriate regulatory agency.

• Federal Deposit Insurance. The Dodd-Frank Act made permanent the $250,000 deposit insurance limit for insured deposits and provided unlimited federal deposit insurance on noninterest bearing transaction accounts at all insured depository institutions through December 31, 2012. Subsequent to 2012, these amounts reverted from unlimited insurance to $250,000 coverage per separately insured depositor. The Dodd-Frank Act also changed the assessment base for federal deposit insurance from the amount of insured deposits to consolidated assets less tangible equity, eliminated the ceiling on the size of the Deposit Insurance Fund (the “DIF”) and increased the floor on the size of the DIF.

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• The Consumer Financial Protection Bureau (“CFPB”). The Dodd-Frank Act centralized responsibility for consumer financial protection by creating a new agency, the CFPB, responsible for implementing, examining and, for large financial institutions of $10 billion or more in total assets, enforcing compliance with federal consumer financial laws. Because we have under $10 billion in total assets, however, the Federal Reserve Bank of Chicago (“Reserve Bank”) will still continue to examine us at the federal level for compliance with such laws.

• Interest on Demand Deposit Accounts. The Dodd-Frank Act repealed the prohibition on the payment of interest on demand deposit accounts effective July 21, 2011, thereby permitting depository institutions to now pay interest on business checking and other accounts.

• Mortgage Reform. The Dodd-Frank Act provided for mortgage reform addressing a customer’s ability to repay, restricted variable-rate lending by requiring the ability to repay to be determined for variable rate loans by using the maximum rate that will apply during the first five years of a variable-rate loan term, and made more loans subject to requirement for higher-cost loans, new disclosures and certain other restrictions.

• Interstate Branching. The Dodd-Frank Act allows banks to engage in de novo interstate branching, a practice that was previously significantly limited.

• Interchange Fee Limitations. The Dodd-Frank Act gave the Board of Governors of the Federal Reserve (the “FRB”) the authority to establish rules regarding interchange fees charged for electronic debit transactions by a payment card issuer that, together with its affiliates, has assets of $10 billion or more and to enforce a new statutory requirement that such fees be reasonable and proportional to the actual cost of a transaction to the issuer. The FRB has rules under this provision that limit the swipe fees that a debit card issuer can charge a merchant for a transaction to the sum of 21 cents and five basis points times the value of the transaction, plus up to one cent for fraud prevention costs. While we are not directly subject to such regulations since our total assets do not exceed $10 billion, these regulations may impact our ability to compete with larger institutions who are subject to the restrictions.

See Part I, Item 1A, “Risk Factors” for further discussion of many of the foregoing items. We expect that many of the requirements called for in the Dodd-Frank Act will be implemented over time, and most will be subject to implementing regulations over the course of several years. Given the uncertainty associated with the manner in which the provisions of the Dodd-Frank Act will be implemented by the various regulatory agencies and through regulations, the full extent of the impact such requirements will have on financial institutions’ operations is unclear. The changes resulting from the Dodd-Frank Act may impact the profitability of our business activities, require changes to certain of our business practices, impose upon us more stringent capital, liquidity and leverage ratio requirements or otherwise adversely affect our business. These changes may also require us to invest significant management attention and resources to evaluate and make necessary changes in order to comply with new statutory and regulatory requirements.

Capital Requirements and Basel III

We and the Bank are subject to various regulatory capital requirements administered by the FRB. Failure to meet minimum capital requirements could result in certain mandatory and possible additional discretionary actions by regulators that, if undertaken, could have a material adverse effect on our financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action (described below), we must meet specific capital guidelines that involve quantitative measures of our assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting policies. Our capital amounts and classification are also subject to judgments by the regulators regarding qualitative components, risk weightings and other factors.

In July 2013, our and the Bank’s primary federal regulator, the FRB, published the Basel III Capital Rules establishing a new comprehensive capital framework for U.S. banking organizations. The rules implement the December 2010 framework of the Basel Committee on Banking Supervision (the “Basel Committee”), known as “Basel III,” for strengthening international capital standards as well as certain provisions of the Dodd-Frank Act. The Basel III Capital Rules substantially revise the risk-based capital requirements applicable to bank holding companies and depository institutions, including us and the Bank, compared to the current U.S. risk-based capital rules.

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The Basel III Capital Rules define the components of capital and address other issues affecting the numerator in banking institutions’ regulatory capital ratios. The Basel III Capital Rules also address risk weights and other issues affecting the denominator in banking institutions’ regulatory capital ratios and replace the existing risk-weighting approach, which was derived from the Basel I capital accords of the Basel Committee, with a more risk-sensitive approach based, in part, on the standardized approach in the Basel Committee’s 2004 Basel II capital accords. The Basel III Capital Rules also implement the requirements of Section 939A of the Dodd-Frank Act to remove references to credit ratings from the federal banking rules. The Basel III Capital Rules are effective for us and the Bank on January 1, 2015, subject to a phase-in period.

The Basel III Capital Rules, among other things: (i) revise minimum capital requirements and adjust prompt corrective action thresholds; (ii) revise the components of regulatory capital and create a new capital measure called “Tier 1 Common Equity” (“T1CE”), which must constitute at least 4.5% of risk-weighted assets; (iii) specify that Tier 1 capital consist only of T1CE and certain “Additional Tier 1 Capital” instruments meeting specified requirements; (iv) increase the minimum Tier 1 capital ratio requirement from 4% to 6%; (v) retain the existing risk-based capital treatment for 1-4 family residential mortgage exposures; (vi) permit most banking organizations, including us, to retain, through a one-time permanent election, the existing capital treatment for accumulated other comprehensive income; (vii) implement a new capital conservation buffer of common equity Tier 1 capital equal to 2.5% of risk-weighted assets, which will be in addition to the 4.5% T1CE ratio and be phased in over a three-year period beginning January 1, 2016, which buffer is generally required in order for an institution to make capital distributions and pay executive bonuses; (viii) increase capital requirements for past-due loans, high volatility commercial real estate exposures and certain short-term loan commitments; (ix) require the deduction of mortgage servicing assets and deferred tax assets that exceed 10% of T1CE in each category and 15% of T1CE in the aggregate; and (x) remove references to credit ratings consistent with the Dodd-Frank Act and establish due diligence requirements for securitization exposures.

Compliance with the Basel III Capital Rules is required for most banking organizations beginning January 1, 2015, including us and the Bank, subject to a transition period for several aspects of the final rules, including the new minimum capital ratio requirements, the capital conservation buffer and the regulatory capital adjustments and deductions. We are still in the process of assessing the impact that these complex new rules will have on us and the Bank, however, we believe that we will continue to exceed all estimated well-capitalized regulatory requirements on a fully phased-in basis.

Liquidity

Historically, regulation and monitoring of bank and bank holding company liquidity has been addressed as a supervisory matter, without required formulaic measures. However, the Basel III liquidity framework requires banks and bank holding companies to measure their liquidity against specific liquidity tests that, although similar in some respects to liquidity measures historically applied by banks and regulators for management and supervisory purposes, going forward would be required by regulation. One test, referred to as the liquidity coverage ratio (“LCR”), is designed to ensure that the banking entity maintains an adequate level of unencumbered high-quality liquid assets equal to the entity’s expected net cash outflow for a 30-day time horizon (or, if greater, 25% of its expected total cash outflow) under an acute liquidity stress scenario. The other, referred to as the net stable funding ratio (“NSFR”), is designed to promote more medium- and long-term funding of the assets and activities of banking entities over a one-year time horizon. In October 2013, the federal banking agencies proposed rules implementing the LCR for advanced approaches banking organizations and a modified version of the LCR for banking holding companies with at least $50 billion in total consolidated assets that are not advanced approach banking organizations, neither of which would apply to us or the Bank. The federal banking agencies have not yet proposed rules implementing the NSFR.

Baylake Corp.

As a bank holding company, we are subject to regulation by the FRB and examination by the Reserve Bank under the BHCA and are required to file reports of our operations and such additional information as the FRB may require under FRB policy.

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     Permitted Activities

     In 1999, Congress enacted the Gramm-Leach-Bliley Act (the “GLB Act”), which modernized the U.S. banking system by: (i) allowing bank holding companies that qualify as “financial holding companies” to engage in a broad range of financial and related activities; (ii) allowing insurers and other financial services companies to acquire banks; (iii) removing restrictions that applied to bank holding company ownership of securities firms and mutual fund advisory companies; and (iv) establishing the overall regulatory scheme applicable to bank holding companies that also engage in insurance and securities operations. The general effect of the law was to establish a comprehensive framework to permit affiliations among commercial banks, insurance companies, securities firms and other financial service providers. Activities that are financial in nature are broadly defined to include not only banking, insurance and securities activities, but also merchant banking and additional activities that the FRB, in consultation with the Secretary of the Treasury, determines to be financial in nature, incidental to such financial activities or “complementary” activities that do not pose a substantial risk to the safety and soundness of depository institutions or the financial system generally.

     In contrast to financial holding companies, bank holding companies are limited to managing or controlling banks, furnishing services to or performing services for its subsidiaries and engaging in other activities that the FRB determines by regulation or order to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. We have not elected to be certified as a financial holding company, so these limitations apply to us.

     Changes in Control

     Subject to certain exceptions, the BHCA and the Change in Bank Control Act, together with the applicable regulations, require FRB approval (or, depending upon the circumstances, no notice of disapproval) prior to any person or company acquiring a “controlling interest” in a bank or bank holding company, which is presumed to exist where an individual or company acquires the power, directly or indirectly to direct the management or policies of an insured depository institution or to vote 25% or more of any class of voting securities of any insured depository institution. A rebuttable presumption of control exists if a person or company acquires 10% or more but less than 25% of any class of voting securities of an insured depository institution and either the institution has registered securities under Section 12 of the Securities Exchange Act of 1934, or no other person will own a greater percentage of that class of voting securities immediately after the acquisition.

     As a bank holding company, we are required to obtain prior approval from the FRB before (i) acquiring all or substantially all of the assets of a bank or bank holding company, (ii) acquiring direct or indirect ownership or control of more than 5% of the outstanding voting stock of any bank or bank holding company (unless we own a majority of such bank’s voting shares), or (iii) merging or consolidating with any other bank or bank holding company.

     Dividends; Source of Strength

     The FRB has issued a policy statement on the payment of cash dividends by bank holding companies, which expresses the FRB’s view that a bank holding company should pay cash dividends only to the extent that its net income for the past year is sufficient to cover both the cash dividend and a rate of retention consistent with its needs. The FRB policy statement also indicates that it would be inappropriate for a bank holding company experiencing serious financial problems to borrow money to pay dividends. In addition, compliance with capital adequacy guidelines at both a bank subsidiary and a bank holding company could affect such entity’s ability to pay dividends, if its capital levels were to decrease.

     Under FRB policy, we are expected to act as a source of financial strength to the Bank and to commit resources to support the Bank in circumstances where we might not deem it appropriate to do so, absent such policy.

Baylake Bank

The Bank is a banking institution that is chartered by and headquartered in the State of Wisconsin, and it is subject to supervision and regulation by the Wisconsin Department of Financial Institutions, Division of Banking (“WDFI”). The WDFI supervises and regulates all areas of the Bank’s operations including, without limitation, the making of loans, the issuance of securities, the conduct of the Bank’s corporate affairs, the satisfaction of capital adequacy requirements, the payment of dividends and the establishment or closing of banking centers. The Bank is also a member of the FRB, which makes the Bank’s operations subject to broad federal regulation and oversight by the FRB. In addition, the Bank’s deposit accounts are insured by the FDIC to the maximum extent permitted by law, and the FDIC has certain enforcement powers over the Bank.

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     Reserves

     The FRB requires all depository institutions to maintain reserves against specified transaction accounts. Reserves are required to be maintained against aggregate transaction accounts as follows: a 3% reserve ratio is assessed on net transaction accounts over $12.4 million up to and including $79.5 million; a 10% reserve ratio is applied above $79.5 million. The first $12.4 million of otherwise reservable balances (subject to adjustments by the FRB) are exempted from reserve requirements. The Bank complies with the foregoing requirements. In October 2008, the FRB began paying interest on certain reserve balances. In addition, the reserve balances imposed by the FRB may be used by the Bank to satisfy liquidity requirements. An institution may borrow from the Reserve Bank “discount window” as a secondary source of funds, provided that the institution meets the Reserve Bank’s credit standards. The 2013 limits as stated above are reviewed annually and any changes are applicable to the following calendar year.

     Dividends

     The Bank is subject to legal limitations on the frequency and amount of dividends that can be paid to us. The FRB may restrict the ability of the Bank to pay dividends if such payments would constitute an unsafe or unsound banking practice. These regulations and restrictions may limit our ability to obtain funds from the Bank for our cash needs, including funds for acquisitions, payment of interest on our subordinated debentures and other debt obligations, payment of dividends and operating expenses. In addition, Wisconsin law requires that dividends of Wisconsin banks be paid out of current earnings or, no more than once within the immediate preceding two years, out of undivided profits. Any other dividends require the prior written consent of the WDFI.

     Deposit Insurance

     The Bank is a member of the DIF, which is administered by the FDIC. The Bank’s deposit accounts are insured by the FDIC, generally up to a maximum of $250,000. The FDIC imposes an assessment against all depository institutions. An institution’s assessment rate depends upon the category to which it is assigned and certain adjustments specified by the FDIC regulations, with less risky institutions paying lower rates. Assessment rates (inclusive of possible adjustments) currently range from 2.5 to 45 basis points of each institution’s total assets less tangible capital. The FDIC may increase or decrease the range of assessments uniformly, except that no adjustment can deviate more than two basis points from the base assessment rate without notice and comment rulemaking. The FDIC’s current assessment system represents a change, required by the Dodd-Frank Act, from its prior practice of basing the assessment on an institution’s aggregate deposits.

     On November 12, 2009, the FDIC adopted a rule requiring all institutions, with limited exceptions, to prepay on December 30, 2009, estimated quarterly risk-based assessments for the fourth quarter of 2009 and for all of 2010, 2011 and 2012. The Bank was required to prepay approximately $6.7 million in assessments in December 2009, although such premiums were not taken as a charge against operations until the period for which they applied. If a prepayment balance still remained after the 2012 fourth quarter assessment was paid in March 2013, it was to be refunded in the second quarter of 2013. The Bank received such a refund, in the amount of $0.4 million, in the second quarter of 2013.

     The FDIC has the authority to increase insurance assessments. A significant increase in insurance assessments would likely have an adverse effect on the operating expenses and results of operations of the Bank. We cannot predict what insurance assessment rates will be in the future.

     Insurance of deposits may be terminated by the FDIC upon a finding that an institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC. We do not know of any practice, condition or violation that might lead to termination of our deposit insurance.

     In addition to the FDIC assessments, the Financing Corporation (“FICO”) is authorized to impose and collect, with the approval of the FDIC, assessments for anticipated payments, issuance costs and custodial fees on bonds issued by the FICO in the 1980s to recapitalize the former Federal Savings and Loan Insurance Corporation. The bonds issued by the FICO are due to mature in 2017 through 2019. For the quarter ended December 31, 2013, the annualized FICO assessment was equal to 0.66 basis points of total assets less tangible capital.

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     Transactions with Affiliates

     Federal law limits the Bank’s authority to engage in transactions with “affiliates” (e.g., any entity that controls or is under common control with the Bank, including us and our other subsidiaries). The aggregate amount of covered transactions with any individual affiliate is limited to 10% of the capital and surplus of the Bank. The aggregate amount of covered transactions with all affiliates is limited to 20% of the Bank’s capital and surplus. Certain transactions with affiliates are required to be secured by collateral in an amount and of a type specified by federal law. The purchase of low quality assets from affiliates is generally prohibited. Transactions with affiliates must generally be on terms and under circumstances that are at least as favorable to the institution as those prevailing at the time for comparable transactions with non-affiliated companies.

The Sarbanes-Oxley Act of 2002 generally prohibits us from lending money to our executive officers and directors. However, the law contains a specific exception for loans by a depository institution to its executive officers and directors in compliance with federal banking laws. Under such laws, the Bank’s authority to extend credit to executive officers, directors and 10% shareholders (“insiders”), as well as entities such persons control, is limited. The laws limit both the individual and aggregate amount of loans that the Bank may make to insiders based, in part, on the Bank’s capital level and requires that certain board approval procedures be followed. Such loans are required to be made on terms substantially the same as those offered to non-insiders and not involve more than the normal risk of repayment. There is an exception for loans made pursuant to a benefit or compensation program that is widely available to all employees of the institution and does not give preference to insiders over other employees. Loans to executive officers are subject to additional limitations based on the type of loan involved.

     Community Reinvestment Act

     Under the Community Reinvestment Act (“CRA”) and the implementing regulations, the Bank has a continuing and affirmative obligation to help meet the credit needs of its local community, including low and moderate-income neighborhoods, consistent with the safe and sound operation of the Bank. The CRA requires the boards of directors of financial institutions, such as the Bank, to adopt a CRA statement for each assessment area that, among other things, describes its efforts to help meet community credit needs and the specific types of credit that the institution is willing to extend. The Bank’s service area is designated and comprises the six counties within the geographic area of Central and Northeast Wisconsin. The Bank’s board of directors is required to review the appropriateness of this delineation at least annually.

     Prompt Corrective Action

     The FRB has adopted risk-based capital adequacy guidelines for bank holding companies and their subsidiary state-chartered banks that are members of the FRB. The risk-based capital guidelines are designed to make regulatory capital requirements more sensitive to differences in risk profiles among banks and bank holding companies, to account for off-balance sheet exposure, to minimize disincentives for holding liquid assets, and to achieve greater consistency in evaluating the capital adequacy of major banks throughout the world. Under these guidelines, assets and off-balance sheet items are assigned to broad risk categories each with designated weights. The resulting capital ratios represent capital as a percentage of total risk-weighted assets and off-balance sheet items.

     The current guidelines require all bank holding companies and federally regulated banks to maintain a minimum risk-based total capital ratio equal to 8%, of which at least 4% must be Tier 1 Capital. Tier 1 Capital, which includes common shareholders’ equity, noncumulative perpetual preferred stock, and a limited amount of cumulative perpetual preferred stock and trust preferred securities, less certain goodwill items and other intangible assets, is required to equal at least 4% of risk-weighted assets. The remainder (“Tier 2 Capital”) may consist of (i) an allowance for loan losses of up to 1.25% of risk-weighted assets, (ii) excess of qualifying perpetual preferred stock, (iii) hybrid capital instruments, (iv) perpetual debt, (v) mandatory convertible securities, and (vi) subordinated debt and intermediate-term preferred stock up to 50% of Tier 1 Capital. Total capital is the sum of Tier 1 Capital and Tier 2 Capital, less reciprocal holdings of other banking organizations’ capital instruments, investments in unconsolidated subsidiaries and any other deductions as determined by the appropriate regulator.

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     The federal bank regulatory authorities have also adopted regulations that supplement the risk-based guidelines. These regulations generally require banks and bank holding companies to maintain a minimum level of Tier 1 Capital to total assets less goodwill of 4% (the “Leverage Ratio”). The FRB permits a bank to maintain a minimum 3% Leverage Ratio if the bank achieves a 1 rating under the CAMELS rating system in its most recent examination, as long as the bank is not experiencing or anticipating significant growth. The CAMELS rating is a non-public system used by bank regulators to rate the strengths and weaknesses of financial institutions. The CAMELS rating comprises six categories: capital adequacy, asset quality, management, earnings, liquidity and sensitivity to market risk. Banking organizations experiencing or anticipating significant growth, as well as those organizations which do not satisfy the criteria described above, will be required to maintain a minimum leverage ratio ranging generally from 4% to 5%.

     The Federal Deposit Insurance Act (“FDIA”) requires, among other things, the federal banking agencies to take “prompt corrective action” in respect of depository institutions that do not meet minimum capital requirements. The capital-based regulatory framework consists of five categories of compliance with regulatory capital guidelines, including “well-capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized” and “critically undercapitalized.” To qualify as a “well-capitalized” institution, a bank must have a Leverage Ratio of no less than 5%, a Tier 1 Capital ratio of no less than 6% and a total risk-based capital ratio of no less than 10%, and the bank must not be under any order or directive from the appropriate regulatory agency to meet and maintain a specific capital level. Generally, a financial institution must be “well-capitalized” before the FRB will approve an application by a bank holding company to acquire or merge with a bank or bank holding company. A bank’s capital category is determined solely for the purpose of applying prompt corrective action regulations, and the capital category may not constitute an accurate representation of the bank’s overall financial condition or prospects for other purposes.

     Under the regulations, the applicable agency can treat an institution as if it were in the next lower category if the agency determines that the institution is in an unsafe or unsound condition or is engaging in an unsafe or unsound practice. The degree of regulatory scrutiny of a financial institution will increase, and the permissible activities of the institution will decrease, as it moves downward through the capital categories. Institutions that fall into one of the three undercapitalized categories may be required to (i) submit a capital restoration plan; (ii) raise additional capital; (iii) restrict their growth, deposit interest rates, and other activities; (iv) improve their management; (v) eliminate management fees; or (vi) divest themselves of all or a part of their operations. Bank holding companies can be called upon to boost the institutions’ capital and to partially guarantee the institutions’ performance under their capital restoration plans.

     Immediately upon becoming undercapitalized, a depository institution becomes subject to the provisions of Section 38 of the FDIA, which (a) restricts payment of capital distributions and management fees; (b) requires that the appropriate federal banking agency monitor the condition of the institution and its efforts to restore its capital; (c) requires submission of a capital restoration plan; (d) restricts the growth of the institution’s assets; and (e) requires prior approval of certain expansion proposals. The appropriate federal banking agency for an undercapitalized institution also may take any number of discretionary supervisory actions if the agency determines that any of these actions is necessary to resolve the problems of the institution at the least possible long-term cost to the DIF. These discretionary supervisory actions include: (i) requiring the institution to raise additional capital; (ii) restricting transactions with affiliates; (iii) requiring divestiture of the institution or sale of the institution to a willing purchaser; and (iv) any other supervisory action that the agency deems appropriate. These and additional mandatory and permissive supervisory actions may be taken with respect to significantly undercapitalized and critically undercapitalized institutions.

     As of December 31, 2013, we and the Bank exceeded the guidelines contained in the applicable regulations, policies and directive pertaining to capital adequacy to be classified as “well-capitalized.”

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     The Basel III Capital Rules revise the current prompt corrective action requirements effective January 1, 2015 by: (i) introducing a T1CE ratio requirement at each level (other than critically undercapitalized), with the required T1CE ratio being 6.5% for “well-capitalized” status; (ii) increasing the minimum Tier 1 capital ratio requirement for each category (other than critically undercapitalized), with the minimum Tier 1 capital ratio for well-capitalized status being 8% (compared to the current 6%); and (iii) eliminating the current provision that provides that a bank with a composite supervisory rating of 1 may have a 3% leverage ratio and still be adequately capitalized. The Basel III Capital Rules do not change the total risk-based capital requirement for any prompt corrective action category.

     Interstate Banking and Branching

     The BHCA was amended by the Interstate Banking Act. The Interstate Banking Act provides that adequately capitalized and managed bank holding companies are permitted to acquire banks in any state.

     State laws prohibiting interstate banking or discriminating against out-of-state banks are preempted. States are not permitted to enact laws opting out of this provision; however, states are allowed to adopt minimum age restrictions requiring that target banks located within the state be in existence for a period of years, up to a maximum of five years, before a bank may be subject to the Interstate Banking Act. The Interstate Banking Act, as amended by the Dodd-Frank Act, establishes deposit caps which prohibit acquisitions that result in the acquiring company controlling 30% or more of the deposits of insured banks and thrift institutions held in the state in which the target maintains a branch of 10% or more of the deposits nationwide. States have the authority to waive the 30% deposit cap. State-level deposit caps are preempted as long as they do not discriminate against out-of-state companies, and the federal deposit caps apply only to initial entry acquisitions.

     Under the Dodd-Frank Act, national banks and state banks are able to establish branches in any state if that state would permit the establishment of the branch by a state bank chartered in that state. Wisconsin law permits a state bank to establish a branch of the bank anywhere in the state. Accordingly, under the Dodd-Frank Act, a bank with its headquarters outside the State of Wisconsin may establish branches anywhere in the State of Wisconsin.

     Bank Secrecy Act/Anti-money Laundering

     The Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (“USA PATRIOT Act”) provides the federal government with additional powers to address terrorist threats through enhanced domestic security measures, expanded surveillance powers, increased information sharing and broad anti-money laundering requirements. By way of amendments to the Bank Secrecy Act (“BSA”), the USA PATRIOT Act puts in place measures intended to encourage information sharing among bank regulatory and law enforcement agencies. In addition, certain provisions of the USA PATRIOT Act impose affirmative obligations on a broad range of financial institutions.

     Among other requirements, the USA PATRIOT Act and related regulations require banks to establish anti-money laundering programs. Additionally, the USA PATRIOT Act requires each financial institution to develop a customer identification program (“CIP”) as part of its anti-money laundering program. The key components of the CIP are identification, verification, government list comparison, notice and record retention. The purpose of the CIP is to enable the financial institution to determine the true identity and anticipated account activity of each customer. We and our affiliates have adopted policies, procedures and controls to comply with the BSA and the USA PATRIOT Act.

     Office of Foreign Assets Control Regulations

     The United States has imposed economic sanctions that affect transactions with designated foreign countries, nationals and others. These are typically known as the “OFAC” rules based on their administration by the U.S. Treasury Department Office of Foreign Assets Control (“OFAC”). The OFAC-administered sanctions targeting countries take many different forms. Generally, however, they contain one or more of the following elements: (i) restrictions on trade with or investment in a sanctioned country, including prohibitions against direct or indirect imports from and exports to a sanctioned country and prohibitions on “U.S. persons” engaging in financial transactions relating to making investments in, or providing investment-related advice or assistance to, a sanctioned country; and (ii) a blocking of assets in which the government or specially designated nationals of the sanctioned country have an interest, by prohibiting transfers of property subject to U.S. jurisdiction (including property in the possession or control of U.S. persons). Blocked assets (e.g. property and bank deposits) cannot be paid out, withdrawn, set off or transferred in any manner without a license from OFAC. Failure to comply with these sanctions could have serious legal and reputational consequences.

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     Regulatory Enforcement Authority

     Federal and state banking laws grant substantial regulatory enforcement powers to federal and state banking regulators. This enforcement authority includes, among other things, the ability to assess civil money penalties, to issue cease and desist or removal orders and to initiate injunctive actions against banking organizations and institution-affiliated parties. In general, these enforcement actions may be initiated for violations of laws and regulations and unsafe or unsound practices. Other actions or inactions may provide the basis for enforcement action, including misleading or untimely reports filed with regulatory agencies.

     Privacy

     Under the Gramm-Leach-Bliley Act, federal banking regulators adopted rules limiting the ability of banks and other financial institutions to disclose nonpublic information about consumers to nonaffiliated third parties. The rules require disclosure of privacy policies to consumers and, in some circumstances, allow consumers to prevent disclosure of certain personal information to nonaffiliated third parties.

     Incentive Compensation Policies and Restrictions

     The Dodd-Frank Act requires the federal bank regulatory agencies and the SEC to establish joint regulations or guidelines prohibiting incentive-based payment arrangements at specified regulated entities having at least $1 billion in total assets that encourage inappropriate risks by providing an executive officer, employee, director or principal shareholder with excessive compensation, fees or benefits or that could lead to material financial loss to the entity. In addition, these regulators must establish regulations or guidelines requiring enhanced disclosure to regulators of incentive-based compensation arrangements. The agencies proposed such regulations in April 2011, but the regulations have not been finalized. Our total assets are currently slightly below the $1 billion threshold where these rules would apply. If, however, our assets exceed $1 billion in the future and the regulations are adopted in the form initially proposed, they will impose limitations on the manner in which we may structure compensation for our executives.

     In July 2010, the federal banking agencies issued guidance that applies to all banking organizations supervised by the agencies (thereby including both us and the Bank). Pursuant to the guidance, to be consistent with safety and soundness principles, a banking organization’s incentive compensation arrangements should (i) provide employees with incentive that appropriately balance risk and reward; (ii) be compatible with effective controls and risk management; and (iii) be supported by strong corporate governance, including active and effective oversight by the banking organization’s board of directors. Monitoring methods and processes used by a banking organization should be commensurate with the size and complexity of the organization and its use of incentive compensation.

     The FRB will review, as part of the regular risk-focused examination process, the incentive compensation arrangements of banking organizations, such as us and the Bank, that are not “large, complex banking organizations.” These reviews will be tailored to each organization based on the scope and complexity of the organization’s activities and the prevalence of incentive compensation arrangements. The findings of the supervisory initiatives will be included in reports of examination. Deficiencies will be incorporated into the organization’s supervisory ratings, which can affect the organization’s ability to make acquisitions and take other actions. Enforcement actions may be taken against a banking organization if its incentive compensation arrangements, or related risk management control or governance processes, pose a risk to the organization’s safety and soundness and the organization is not taking prompt and effective measures to correct the deficiencies.

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     Ability-to-Repay and Qualified Mortgage Rule

     Pursuant to the Dodd-Frank Act, the Consumer Financial Protection Bureau (“CFPB”) issued a final rule on January 10, 2013 (effective on January 10, 2014) amending Regulation Z as implemented by the Truth in Lending Act, requiring mortgage lenders to make a reasonable and good faith determination based on verified and documented information that a consumer applying for a mortgage loan has a reasonable ability to repay the loan according to its terms. Mortgage lenders are required to determine consumers’ ability to repay in one of two ways. The first alternative requires the mortgage lender to consider the following eight underwriting factors when making the credit decision: (i) current or reasonably expected income or assets; (ii) current employment status; (iii) the monthly payment on the covered transaction; (iv) the monthly payment on any simultaneous loan; (v) the monthly payment for mortgage-related obligations; (vi) current debt obligations, alimony and child support; (vii) the monthly debt-to-income ratio or residual income; and (viii) credit history. Alternatively, the mortgage lender can originate “qualified mortgages,” which are entitled to a presumption that the creditor making the loan satisfied the ability-to-repay requirements. In general, a qualified mortgage is a mortgage loan without negative amortization, interest-only payments, balloon payments, or terms exceeding 30 years. In addition, to be a qualified mortgage the points and fees paid by a consumer cannot exceed 3% of the total loan amount. Qualified mortgages that are “higher priced” (e.g. subprime loans) are given a safe harbor of compliance. The Bank is predominantly an originator of compliant qualified mortgages.

     Consumer Laws and Regulations

     The Bank is also subject to other federal and state consumer laws and regulations that are designed to protect consumers in transactions with banks. While the list set forth below is not exhaustive, these laws and regulations include the Truth in Lending Act, the Truth in Savings Act, the Electronic Funds Transfer Act, the Expedited Funds Availability Act, the Check Clearing for the 21^st Century Act, the Fair Credit Reporting Act, the Equal Credit Opportunity Act, the Fair Housing Act, the Home Mortgage Disclosure Act, the Fair and Accurate Transactions Act, the Mortgage Disclosure Improvement Act and the Real Estate Settlement Procedures Act, among others. These laws and regulations mandate certain disclosure requirements and regulate the manner in which financial institutions must deal with customers when taking deposits or making loans to customers. The Bank must comply with the applicable provisions of these consumer protection laws and regulations as part of its ongoing customer relations.

     Legislative and Regulatory Initiatives

     From time to time, various legislative and regulatory initiatives are introduced in Congress and state legislatures, as well as by regulatory agencies. Such initiatives may include proposals to expand or contract the powers of bank holding companies and depository institutions or proposals to substantially change the financial institution regulatory system. Such legislation could change banking statues and our operating environment in substantial and unpredictable ways. If enacted, such legislation could increase or decrease the cost of doing business, limit or expand permissible activities or affect the competitive balance among banks, savings associations, credit unions and other financial institutions. We cannot predict whether any such legislation will be enacted and, if enacted, the effect that it or any implementing regulations would have on our financial condition or results of operations. A change in statues, regulations or regulatory policies applicable to us or any of our subsidiaries could have a material effect on our business, financial condition and results of operations.

     Employees

     At December 31, 2013, we had 267 total employees company-wide, 229 of which were full-time. We consider our relationship with our employees to be good. At December 31, 2012, we had 274 total employees, 236 of which were full-time. The primary reason for the reduction in employees in 2013 was the closure of two central Wisconsin branches in November 2013.

ITEM 1A.RISK FACTORS

Forward-Looking Statements

This report contains statements that may constitute forward-looking statements within the meaning of the safe-harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995, such as statements other than historical facts contained or incorporated by reference in this report. These forward-looking statements include statements with respect to our financial condition, results of operations, plans, objectives, future performance and business, including statements preceded by, followed by or that include the words “believes,” “expects,” or “anticipates,” references to estimates or similar expressions. Future filings by us with the SEC, and future statements other than historical facts contained in written material, press releases and oral statements issued by us, or on our behalf, may also constitute forward-looking statements.

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Forward-looking statements are subject to significant risks and uncertainties, and our actual results may differ materially from the results discussed in such forward-looking statements. Factors that might cause actual results to differ from the results discussed above include, but are not limited to, the Risk Factors set forth below and any other risks identified in this report or in other filings we may make with the SEC. All forward-looking statements contained in this report or which may be contained in future statements made for or on our behalf are based upon information available at the time the statement is made and we assume no obligation to update any forward-looking statements.

Risk Factors

An investment in our common stock contains a high degree of risk. In addition to the other information contained in, or incorporated by reference into, this Form 10-K, including the matters addressed under the caption “Forward Looking Statements” above, you should carefully consider the risks described below before deciding whether to invest in our common stock. If any of the events highlighted in the following risks actually occurs, or if additional risks and uncertainties not presently known to us or that we do not currently believe to be important to you, materialize, our business, results of operations or financial condition would likely suffer. In such an event, the trading price of our common stock could decline and you could lose all or part of your investment. In assessing these risks, you should also refer to the other information contained in our filings with the SEC, including our financial statements and related notes.

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Risks Related to Our Lending and Credit Activities

We are subject to lending concentration risks.

As of December 31, 2013, approximately 72.8% of our loan portfolio consisted of commercial and industrial, real estate construction and commercial real estate loans (collectively, “commercial loans”). Commercial loans are generally viewed as having more inherent risk of default than residential mortgage loans or retail loans. Also, the commercial loan balance per borrower is typically larger than that for residential mortgage loans and retail loans, inferring higher potential losses on an individual loan basis. Because the Bank’s loan portfolio contains a number of larger commercial loans, the deterioration of one or a few of these loans could cause a significant increase in nonaccrual loans, which could result in a loss of interest income from these loans, an increase in the provision for loan losses, and an increase in loan charge offs, all of which could have a material adverse effect on our financial condition and results of operations.

Our business may be adversely affected by conditions in the financial markets and economic conditions generally, as our borrowers’ ability to repay loans and the value of the collateral securing our loans decline.

From December 2007 to June 2009 the United States economy experienced the worst economic downturn since the Great Depression. This period was marked by reduced business activity across a wide range of industries and regions as well as significant increases in unemployment. Many businesses experienced serious financial difficulties due to the lack of consumer spending and liquidity in the credit markets. In addition, unemployment increased significantly and continues at elevated levels. The financial services industry and the securities markets generally were materially and adversely affected by significant declines in the values of nearly all asset classes and by a serious lack of liquidity. This was initially triggered by declines in home prices and the resulting impact on sub-prime mortgages but spread to all mortgage and real estate asset classes, and to equity securities as well.

Although the economy has been in the recovery phase since 2009, the recovery is less robust than anticipated and there can be no assurance that the economy will not enter into another recession, whether in the near term or long term. Because we have a significant amount of real estate loans, decreases in real estate values could adversely affect the value of property used as collateral. Adverse changes in the economy may also have a negative effect on the ability of our borrowers to make timely repayments of their loans, which could have an adverse impact on our earnings. Consequently, any decline in the economy in our market area could have a material adverse effect on our financial condition and results of operations.

Weakness in the markets for residential or commercial real estate, including the secondary residential mortgage loan markets, could reduce our net income and profitability.

During the severe recession that lasted from 2007 to 2009, softened residential housing markets, increased delinquency and default rates, and volatile and constrained secondary credit markets negatively impacted the mortgage industry. Our financial results were adversely affected by these changes in real estate values, primarily in Northeastern Wisconsin. Decreases in real estate values adversely affected the value of property used as collateral for loans as well as investments in our portfolio. Continued slow growth in the economy since 2009 has resulted in decreased demand for commercial real estate loans, which has negatively impacted loan growth opportunities and net income.

Real estate values and the demand for commercial real estate loans have not fully recovered from the recent recession. There can be no assurance that the economy will not enter into another recession, whether in the near term or long term. Significant declines in real estate values in Northeastern Wisconsin coupled with the impact of any future possible economic downturns and high unemployment levels, could drive losses beyond the levels provided for in our allowance for loan losses, in which case our future earnings would be adversely affected.

Additional declines in real estate values and home sales within Northeastern Wisconsin, and financial stress on borrowers as a result of job losses, or other factors, could have further adverse effects on borrowers that might result in higher delinquencies and greater charge-offs in future periods, which would adversely affect our financial condition and results of operations.

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Our allowance for loan losses may be insufficient.

To address risks inherent in our loan portfolio, we maintain an allowance for loan losses that represents management’s best estimate of probable losses that may occur within our existing loan portfolio. The level of the allowance reflects management’s continuing evaluation of various factors, including industry concentrations, specific credit risks, loan loss experience, current loan portfolio quality, present economic, political and regulatory conditions, and unidentified losses inherent in the current loan portfolio. Determining the appropriate level of the allowance for loan losses involves a high degree of subjectivity and requires us to make estimates of significant credit risks and future trends, all of which may undergo material changes. In evaluating our impaired loans, we assess repayment expectations and determine collateral values based on all information that is available to us. However, we must often make subjective decisions based on our assumptions about the creditworthiness of the borrowers and the value of the collateral.

Continuing deterioration in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans, and other factors, both within and outside of our control, may require an increase in our allowance for loan losses. In addition, bank regulatory agencies periodically examine our allowance for loan losses and may require an increase in the allowance or the recognition of further loan charge-offs, based on judgments different from those of management.

If charge-offs in future periods exceed our allowance for loan losses, we will need to take additional loan loss provisions to increase our allowance for loan losses. Any additional loan loss provisions will reduce our net income or increase our net loss, which would have a material adverse effect on our financial condition and results of operations.

We are subject to environmental liability risk associated with collateral securing our real estate lending.

Because a significant portion of our loan portfolio is secured by real property, from time to time we may find it necessary to foreclose on and take title to properties securing such loans. In doing so, there is a risk that hazardous or toxic substances could be found on those properties. If such substances are found, we may be liable for remediation costs, as well as for personal injury and property damage. We may also be required to incur substantial expenses that could materially reduce the affected property’s value or limit our ability to use or sell the affected property. In addition, future environmental laws or more stringent interpretations or enforcement policies with respect to existing laws may increase our exposure to environmental liability. Although we are careful to perform environmental reviews on properties prior to foreclosure, our reviews may not detect all environmental hazards.

We rely on the accuracy and completeness of information about customers or counterparties, and inaccurate or incomplete information could negatively impact our financial condition and results of operations.

In deciding whether to extend credit or enter into other transactions with customers and counterparties, we may rely on information provided to us by such customers and counterparties, including financial statements and other financial information. We may also rely on representations of customers and counterparties as to the accuracy and completeness of that information and, with respect to financial statements, on reports of independent auditors. Our financial condition and results of operations could be negatively impacted to the extent we rely on financial statements that do not comply with generally accepted accounting principles or that are inaccurate or misleading.

Risks Related to Our Operations

We are subject to interest rate risk.

Our earnings and cash flows are largely dependent upon our net interest income, which is the difference between interest income on interest-earning assets such as loans and securities and interest expense paid on interest-bearing liabilities such as deposits and borrowed funds. There are many factors which influence interest rates that are beyond our control, including but not limited to general economic conditions and governmental policy, in particular, the policies of the FRB. Any changes in such policies, including changes in interest rates, could influence the amount of interest we receive on loans and securities and the amount of interest we pay on deposits and borrowings.

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Such changes could also affect (i) our ability to originate loans and obtain deposits, (ii) the value of our financial assets and liabilities, and (iii) the average maturity of our securities portfolio. In addition, an increase in the general level of interest rates may also adversely affect the ability of certain of our borrowers to repay their obligations. If the interest rates paid on deposits and other borrowings increase at a faster rate than the interest rates received on loans and other investments, our net interest income, and therefore our earnings, would be adversely affected. Earnings would also be adversely affected if the interest rates received on loans and other investments fall more quickly than the interest rates paid on deposits and other borrowings.

Management uses various methods to monitor interest rate risk and believes it has implemented effective asset and liability strategies to reduce the potential effects of changes in interest rates on our results of operations. Management also periodically adjusts our mix of assets and liabilities to manage interest rate risk. However, any substantial, unexpected, prolonged change in market interest rates could have a material adverse effect on our financial condition and results of operations.

The mortgage-backed securities in which we invest are subject to several types of risk.

We invest in mortgage-backed securities that evidence interests in, or are secured by, a single mortgage loan or a pool of mortgage loans. Accordingly, these securities are subject to all of the risks of the underlying mortgage loans. In a rising interest rate environment, the value of mortgage-backed securities may be adversely affected when payments on underlying mortgages do not occur as anticipated, resulting in the extension of the security’s effective maturity and the related increase in interest rate sensitivity of a longer-term instrument. The value of mortgage-backed securities may also change due to shifts in the market’s perception of issuers and regulatory or tax changes adversely affecting the mortgage securities’ market as a whole. In addition, mortgage-backed securities are subject to the credit risk associated with performance of the underlying mortgage properties. Mortgage-backed securities are issued by investment banks, not financial institutions, and while the loans that are pooled to create the security carry government agency guarantees, the securities themselves are not insured or guaranteed by the United States government. Finally, mortgage-backed securities are also subject to geographic risk when the mortgages underlying the securities are concentrated in one or more geographic areas. This risk is managed by monitoring the geographic dispersion of the underlying loans in each security. As of December 31, 2013, the highest concentration of loans secured by 1-4 family homes issued in any state was issued in California and those loans represented approximately 21.4% of the total amount invested in mortgage-backed securities.

Although we generally invest in mortgage-backed securities collateralized by residential loans, the value of such securities can be negatively impacted by any dislocation in the mortgage-backed securities market in general. During the recent economic downturn, the mortgage-backed securities market suffered from a severe dislocation created by mortgage pools that included sub-prime mortgages secured by residential real estate.

Changes in our accounting policies or in accounting standards could materially affect how we report our financial results and condition.

Our accounting policies are fundamental to understanding our financial results and condition. Some of these policies require use of estimates and assumptions that may affect the value of our assets or liabilities and financial results. Some of our accounting policies are critical because they require management to make difficult, subjective and complex judgments about matters that are inherently uncertain and because it is likely that materially different amounts would be reported under different conditions or using different assumptions. If such estimates or assumptions underlying our financial statements are incorrect, we may experience material losses.

From time to time, the Financial Accounting Standards Board (“FASB”) changes the financial accounting and reporting standards or the interpretation of those standards that govern the preparation of our external financial statements. These changes are beyond our control, can be hard to predict and could materially impact how we report our results of operations and financial condition. We could be required to apply a new or revised standard retroactively, resulting in our restating prior period financial statements in material amounts.

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Our controls and procedures may fail or be circumvented.

Management regularly reviews and updates our internal controls, disclosure controls and procedures, and corporate governance policies and procedures. Any system of controls, however well-designed and operated, is based in part on certain assumptions and can provide only reasonable assurances that the objectives of the system are met. Any failure or circumvention of our controls and procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on our business, financial condition and results of operations.

Uncertainty in the financial markets could result in lower fair values for our investment securities, which fair values may not be realizable if we were to sell those securities today.

The upheaval in the financial markets during the recent recession has adversely impacted investor demand for all classes of securities and has resulted in volatility in the fair values of our investment securities. Significant prolonged reduction in investor demand could result in lower fair values for these securities and may result in recognition of an other-than-temporary impairment charge, which would have a direct adverse impact on our consolidated results of operations. In assessing whether any impairment of investment securities is other-than-temporary, management considers the length of time and extent to which the fair value has been less than cost, the financial condition and near-term prospects of the issuer, and the intent and ability to retain our investment in the security for a period of time sufficient to allow for any anticipated recovery in fair value in the near term.

Impairment of deferred income tax assets could require charges to earnings, which could result in an adverse impact on our results of operations.

In assessing the realizability of deferred income tax assets, management considers whether it is more likely than not that some portion or all of the deferred income tax assets will not be realized. Assessing the need for, or the sufficiency of, a valuation allowance requires management to evaluate all available evidence, both negative and positive. Positive evidence necessary to overcome the negative evidence includes whether future taxable income in sufficient amounts and character within the carry back and carry forward periods is available under the tax law, including the use of tax planning strategies. When negative evidence (e.g. cumulative losses in recent years, history of operating loss or tax credit carry forwards expiring unused) exists, more positive evidence than negative evidence will be necessary. At December 31, 2013, net deferred tax assets are approximately $6.6 million. If a valuation allowance becomes necessary with respect to such balance, it could have a material adverse effect on our business, results of operations and financial condition.

We may not be able to attract and retain skilled personnel.

Our success depends, in large part, on our ability to attract and retain key personnel. Competition for the best people in most activities engaged in by us can be intense and we may not be able to hire people as needed or retain them. The unexpected loss of services of one or more of our key personnel could have a material adverse impact on our business because of their skills, knowledge of our local markets, years of industry experience and the difficulty of promptly finding qualified replacement personnel.

Our operations are geographically limited and are more at risk for downturns in those areas.

Our financial performance generally is highly dependent upon the business environment in Northeastern Wisconsin, particularly in Door and Brown Counties. As a result of this geographical concentration, we are more vulnerable to downturns or other factors that affect the local economy or decrease demand for our services than if our operations were conducted over a wider area. Other local factors, such as natural disasters and the local regulatory climate, could also significantly affect our results because of our lack of geographical diversity.

The overall economic environment evident during 2013 remained challenging for many households and businesses in Northeast Wisconsin and the business environment of the markets in which we operate have been adversely affected. In our market area, especially in Door County, a significant percentage of our customer base is in the tourism industry, particularly lodging and restaurants and many other of our customers depend indirectly on the tourism industry. With this concentration in a single industry, any downturn, deterioration of the economy or other issues affecting local tourism could reduce the demand for our services, increase problem loans and thus disproportionately have a materially adverse effect on our financial condition and results of operations.

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We continually encounter technological change.

The financial services industry is continually undergoing rapid technological change with frequent introductions of new technology driven by products and services. The effective use of technology increases efficiency and enables financial institutions to better serve customers and to reduce costs. Our future success depends, in part, upon our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands, as well as to create additional efficiencies in our operations. Many of our competitors have substantially greater resources to invest in technological improvements. We may not be able to effectively implement new technology driven products and services or be successful in marketing these products and services to our customers. Failure to successfully keep pace with technological change affecting the financial services industry could have a material adverse impact on our business and, in turn, our financial condition and results of operations.

We are dependent upon third parties for certain information system, data management and processing services and to provide key components of our business infrastructure.

We outsource certain information system and data management and processing functions to third party service providers. These third party service providers are also sources of operational and information system interruptions or breaches, and unauthorized disclosures of sensitive or confidential client or customer information. If third party service providers encounter any of these issues, or if we have difficulty communicating with them, we could be exposed to disruption of operations, loss of service or connectivity to customers, reputational damage, and litigation risk that could have a material adverse effect on our results of operations or our business.

Third party vendors provide key components of our business infrastructure such as internet connections, network access and core application processing. While we have selected these third party vendors carefully, we do not control their actions. Any problems caused by these third parties, including as a result of their not providing us their services for any reason or their performing their services poorly, could adversely affect our ability to deliver products and services to our customers and otherwise to conduct our business. Replacing these third party vendors could also entail significant delay and expense.

Our information systems may experience an interruption or breach in security.

We rely heavily on communications and information systems to conduct our business. Any failure, interruption or breach in security or operational integrity of these systems could result in failures or disruptions in our customer relationship management, general ledger, deposit, loan and other systems. While we have internal policies and procedures designed to prevent or limit the effect of a failure, interruption or security breach of our information systems, as well as contracts and service agreements with applicable outside vendors, we cannot be assured that any such failures, interruptions or security breaches will not occur or, if they do, that they will be addressed adequately. The occurrence of any failures, interruptions or security breaches of our information systems could damage our reputation, result in a loss of customer business, subject us to additional regulatory scrutiny, or expose us to civil litigation and possible financial liability, any of which could have a material adverse effect on our financial condition.

Risks Related to Legal and Regulatory Compliance

We operate in a highly regulated environment, which could increase our cost structure or have other negative impacts on our operations.

We are highly regulated by both federal and state regulatory authorities. Regulation includes, among other things, capital and reserve requirements, permissible investments and lines of business, dividend limitations, limitations on products and services offered, loan limits, geographical limits, consumer credit regulations, community reinvestment requirements and restrictions on transactions with affiliated parties. The system of supervision and regulation applicable to us establishes a comprehensive framework for our operations and is intended primarily for the protection of the DIF, our depositors and the public, rather than our stockholders. We are also subject to regulation by the SEC. Failure to comply with applicable laws, regulations or policies could result in sanction by regulatory agencies, civil monetary penalties, and/or damage to our reputation, which could have a material adverse effect on our business, consolidated financial condition and results of operations. While we have policies and procedures designed to prevent noncompliance with such laws, regulations and policies, there can be no assurance that such noncompliance will not occur. In addition, any change in government regulation could have a material adverse effect on our business.

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The full impact of the recently enacted Dodd-Frank Act is currently unknown given that many of the details and substance of the new laws will be implemented through agency rulemaking.

On July 21, 2010, President Obama signed the Dodd-Frank Act into law. This law significantly changed the bank regulatory structure and affected the lending, deposit, investment, trading and operating activities of financial institutions and their holding companies. The Dodd-Frank Act requires various federal agencies to adopt a broad range of new implementing rules and regulations, and to prepare numerous studies and reports for Congress. The federal agencies are given significant discretion in drafting the implementing rules and regulations, and consequently, many of the details and much of the impact of the Dodd-Frank Act may not be known for many months or years.

Among the many requirements of the Dodd-Frank Act for new banking regulations is a requirement for new capital regulations, which are discussed in detail under Part I, Item 1, “Business-Supervision and Regulation-Capital Requirements and Basel III”.

Certain provisions of the Dodd-Frank Act are expected to have a near-term impact on us. For example, effective July 21, 2011, the Dodd-Frank Act eliminated the federal prohibition on paying interest on demand deposits, thus allowing businesses to have interest-bearing checking accounts. As a result, some financial institutions have commenced offering interest on such demand deposits to compete for customers. Our interest expense will increase and our net interest margin will decrease if we offer interest on demand deposits to attract additional customers or maintain current customers, which could have a material adverse effect on our business, financial condition and results of operations.

The Dodd-Frank Act also broadens the base for FDIC insurance assessments. Assessments are now based on the average consolidated total assets less tangible equity capital. The Dodd-Frank Act also permanently increased the maximum amount of deposit insurance for banks, savings institutions and credit unions to $250,000 per depositor, retroactive to January 1, 2008. Noninterest-bearing transaction accounts and Interest on Lawyers Trust Accounts (“IOLTA”) accounts were previously entitled to unlimited deposit insurance through December 31, 2012. Effective January 1, 2013, however, unlimited deposit insurance on such noninterest bearing transaction accounts and IOLTA accounts expired and those accounts are now subject to the same $250,000 per depositor insurance limitation as all of our other deposit accounts.

The Dodd-Frank Act created the new CFPB, with broad powers to supervise and enforce consumer protection laws. The CFPB has broad rule-making authority for a wide range of consumer protection laws that apply to all banks, including the authority to prohibit “unfair, deceptive or abusive” acts and practices. Examination and enforcement authority with respect to such consumer protection laws for banks with assets of $10 billion or less, such as the Bank, will remain with their primary federal regulator.

Many aspects of the Dodd-Frank Act are subject to rulemaking and will take effect over several years, making it difficult to anticipate the overall financial impact on us. However, compliance with this relatively new law and its implementing regulations will result in additional operating costs that could have a material adverse effect on our financial condition and results of operations.

We are subject to examinations and challenges by taxing authorities.

In the normal course of business, we are routinely subjected to examinations and challenges from federal and state taxing authorities regarding the amount of taxes due in connection with our investments and the businesses in which we engage. Federal and state taxing authorities have recently become increasingly aggressive in challenging tax positions taken by financial institutions. These tax positions may relate to tax compliance, sales and use, franchise, gross receipts, payroll, property or income tax issues, including tax base, apportionment and tax planning. The challenges made by taxing authorities may result in adjustments to the timing or amount of taxable income or deductions or the allocations of income among tax jurisdictions. If any such challenges are not resolved in our favor, they could have a material adverse impact on our consolidated financial condition and results of operations.

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External Risks

We may be adversely affected by the soundness of other financial institutions.

Financial institutions are interrelated as a result of trading, clearing, counterparty or other relationships. We routinely execute transactions with counterparties in the financial services industry, including commercial banks, brokers and dealers, investment banks, and other institutional clients. Many of these transactions expose us to credit risk in the event of default by a counterparty. In addition, our credit risk may be heightened when the collateral we hold cannot be realized upon liquidation or is liquidated at prices not sufficient to recover the full amount of the credit or derivative exposure due to us. Any such losses could have a material adverse effect on our consolidated financial condition and results of operations.

Competition may affect our results.

We face strong competition in originating loans, in seeking deposits and in offering our other services. We must compete with commercial banks, savings associations, trust companies, mortgage banking firms, credit unions, finance companies, mutual funds, insurance companies, brokerage, interest-only institutions and investment banking firms. Our market area is also served by several commercial banks and savings associations that are substantially larger than us in terms of deposits and loans and have greater human and financial resources.

Our ability to compete successfully depends on a number of factors, including but not limited to: (i) our ability to develop, maintain and build upon long-term customer relationships; (ii) our ability to expand our market positions; (iii) the scope, relevance and pricing of our products and services offered to meet customer needs; (iv) the rate at which we introduce new products and services relative to our competitors; (v) customer satisfaction with our level of service; and (vi) industry and general economic trends.

Failure to perform in any of these areas could significantly weaken our competitive position, which could adversely affect our growth and profitability, which, in turn, could have a material adverse impact on our financial position and results of operation.

Customers may decide not to use banks to complete their financial transactions, which could result in a loss of income to us.

Technology and other changes are allowing customers to complete financial transactions using non-banks that historically have involved banks at one or both ends of the transaction. For example, customers can now pay bills and transfer funds directly without going through a bank. The process of eliminating banks as intermediaries, known as disintermediation, could result in the loss of fee income, as well as the loss of customer deposits.

Acts or threats of terrorism and political or military actions by the United States or other governments could adversely affect general economic industry conditions.

Geopolitical conditions may affect our earnings. Acts or threats of terrorism and political actions taken by the United States or other governments in response to terrorism, or similar activity, could adversely affect general economic or industry conditions and, as a result, our consolidated financial condition and results of operations.

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Strategic Risks

Maintaining or increasing our market share may depend on lowering prices and market acceptance of new products and services.

Our success depends, in part, on our ability to adapt our products and services to evolving industry standards. There is increasing pressure to provide products and services at lower prices. Lower prices can reduce our net interest margin and revenues from our fee-based products and services. In addition, the widespread adoption of new technologies, including internet services, could require us to make substantial expenditures to modify or adapt our existing products and services. Also, these and other capital investments in our business may not produce expected growth in earnings anticipated at the time of the expenditure. We may not be successful in introducing new products and services, achieving market acceptance of our products and services, or developing and maintaining loyal customers.

Future growth or operating results may require us to raise additional capital but that capital may not be available.

We are required by federal and state regulatory authorities to maintain adequate levels of capital to support our operations. To the extent our future operating results erode capital or we elect to expand through loan growth or acquisition, we may be required to raise capital.

Our ability to raise capital will depend on conditions in the capital markets, which are outside of our control, and on our financial performance. Accordingly, we cannot be assured of our ability to raise capital when needed or on favorable terms. If we cannot raise additional capital when needed, we will be subject to increased regulatory supervision and the imposition of restrictions on our growth and business. These could negatively impact our ability to operate or further expand our operations and may result in increases in operating expenses and reductions in revenues that could have a material effect on our consolidated financial condition and results of operations.

Reputation Risks

Unauthorized disclosure of sensitive or confidential client or customer information, whether through a breach of our computer system or otherwise, could severely harm our business.

As part of our financial and data processing products and services, we collect, process and retain sensitive and confidential client and customer information. Despite the security measures we have in place, our facilities and systems, and those of third party service providers, may be vulnerable to security breaches, acts of vandalism, computer viruses, misplaced or lost data, programming and/or human error, or other similar events. Any security breach involving the misappropriation, loss or other unauthorized disclosure of confidential information, whether by us or our vendors, could severely damage our reputation, expose us to the risks of litigation and liability, disrupt our operations and/or harm our business.

Ethics or conflict of interest issues could damage our reputation.

We have established a Code of Conduct and related policies and procedures to address the ethical conduct of business and to avoid potential conflicts of interest. Any system of controls, however well designed and operated, is based, in part, on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met. Any failure or circumvention of our related controls and procedures or failure to comply with the established Code of Conduct could have a material adverse effect on our reputation, business, results of operations and/or financial condition.

Liquidity Risks

We could experience an unexpected inability to obtain needed liquidity.

Liquidity measures the ability to meet current and future cash flow needs as they become due. The liquidity of a financial institution reflects its ability to meet loan requests, to accommodate possible outflows in deposits, and to take advantage of interest rate market opportunities. The ability of a financial institution to meet its current financial obligations is a function of its balance sheet structure, its ability to liquidate assets and its access to alternative sources of funds. We seek to ensure our funding needs are met by maintaining an appropriate level of liquidity through asset/liability management. If we become unable to obtain funds when needed, it could have a material adverse effect on our business and, in turn, our consolidated financial condition and results of operations.

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We rely on dividends from the Bank for most of our revenues.

We are a separate and distinct legal entity from our subsidiaries. Historically, we have received substantially all of our revenue in the form of dividends from the Bank. Federal and/or state laws and regulations limit the amount of dividends that the Bank may pay to us. Also, a holding company’s right to participate in a distribution of assets upon a subsidiary’s liquidation or reorganization is subject to the prior claims of the subsidiary’s creditors. In the event the Bank is unable to pay dividends to us when needed, we may not be able to service our debt or pay our obligations, including dividends on the Trust Preferred Stock and Convertible Promissory Notes. Any inability to receive dividends from the Bank could have a material adverse effect on our business, financial condition and/or results of operations.

Risks Related to an Investment in Our Common Stock

The price of our securities can be volatile.

Price volatility may make it more difficult for you to sell your securities when you want and at prices you find attractive. Our securities prices can fluctuate widely in response to a variety of factors including, among other things:

• actual or anticipated variations in quarterly results of operations or financial conditions

• operating results and stock price performance of other companies that investors deem comparable to us;

• news reports relating to trends, concerns and other issues in the financial services industry;

• perceptions in the marketplace regarding us and/or our competitors;

• significant acquisitions or business combinations, strategic partnerships, joint ventures or capital commitments by or involving us or our competitors;

• changes in government regulations; and

• geopolitical conditions such as acts or threats of terrorism or military conflicts.

General market fluctuations, industry factors and general economic and political conditions and events, such as economic slowdowns or recessions, interest rate changes, or credit loss trends could also cause our securities prices to decrease regardless of our operating results. In addition, while our common stock was recently listed on the NASDAQ Stock Market LLC (“NASDAQ”), there continues to be limited trading activity in the stock. As such, relatively small trades may have a significant impact on the price of our stock.

Our securities are not an insured deposit.

Securities issued by us are not a bank deposit and are not insured or guaranteed by the FDIC or any other government agency. Securities are subject to investment risk, and investors must be able to afford the loss of their entire investment.

You may not continue to receive dividends on your investment in our common stock.

Our ability to pay dividends is dependent upon our receipt of dividends from the Bank, which is subject to regulatory restrictions. Such restrictions, which govern state-chartered banks, generally limit the payment of dividends on bank stock to the bank’s undivided profits after all payments of all necessary expenses, provided that the bank’s surplus equals or exceeds its capital. In addition, under the terms of our junior subordinated debentures, we would be precluded from paying dividends on our common stock if we were in default under the debentures, if we exercised our right to defer payments of interest on the debentures, or if certain related defaults occurred. Beginning in February 2008, our Board of Directors, in consultation with our federal and state bank regulators, elected to forego the payment of cash dividends on our common stock. No cash dividends were declared beginning on that date or through 2011. In January 2012, our Board of Directors announced that it would be resuming the payment of dividends. There can be no assurance that we will be able to continue paying dividends to our shareholders and if we do, in what amounts. Total dividends declared and paid in 2012 were $0.08 per share. During 2013, total dividends of $0.22 per share were declared and paid.

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The holders of our junior subordinated debentures have rights that are senior to those of our shareholders.

On March 31, 2006, we issued $16.1 million of floating rate junior subordinated debentures in connection with a $16.1 million trust preferred securities issuance by our subsidiary, Baylake Capital Trust II. The 2006 junior subordinated debentures mature in June of 2036. The purpose of the transaction was to raise additional capital in order for us to redeem our trust preferred securities issued by our subsidiary Baylake Capital Trust I. Payments of the principal and interest on the trust preferred securities are conditionally guaranteed by us. The junior subordinated debentures are senior to our shares of common stock. As a result, we must make payments on the junior subordinated debentures (and the related trust preferred securities) before any dividends can be paid on our common stock and, in the event of our bankruptcy, dissolution or liquidation, the holders of the debentures must be satisfied before any distributions can be made to the holders of our common stock. We have the right to defer distributions on the junior subordinated debentures (and the related trust preferred securities) for up to five years, during which time no dividends may be paid to holders of our common stock.

There may be future sales or other dilution of our equity, which may adversely affect the market price of our securities.

We are not restricted from issuing additional securities, including common stock and securities that are convertible or exchangeable for, or that represent the right to receive common stock. The issuance of additional shares of common stock or the issuance of convertible securities would dilute the ownership interest of our existing common shareholders. The market price of our common stock could decline as a result of an equity offering, as well as other sales of a large block of shares of our common stock or similar securities in the market after an equity offering, or the perception that such sales could occur.

During 2009 and 2010, we issued $9.45 million of our 10% Convertible Notes due June 30, 2017 (the “Convertible Notes”) and, as of December 31, 2013, we had $9.40 million of Convertible Notes outstanding. The Convertible Notes are convertible into shares of our common stock at a rate of one share for every $5.00 in aggregate principal amount outstanding (the “Conversion Ratio”), or an aggregate 1,880,000 shares, at the holders’ discretion. In addition, on October 1, 2014, one-half of the original principal amount of the Convertible Notes are mandatorily convertible into common stock at the Conversion Ratio to the extent not previously converted by the holders. The issuance of common stock in conjunction with any such conversion of our Convertible Notes will further dilute the ownership interest of our existing common shareholders, and may adversely impact the market price of our shares.

The holders of our Convertible Notes will have rights that are senior to those of our shareholders.

The Convertible Notes are senior to our junior subordinated debentures issued in connection with trust preferred securities, as well as shares of our common stock. In the event of our bankruptcy, dissolution or liquidation, the holders of our Convertible Notes must be satisfied before any distributions can be made to the holders of our common stock or junior subordinated debentures.

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ITEM 1B.UNRESOLVEDSTAFF COMMENTS

None.

ITEM 2.PROPERTIES

The Bank owns its headquarters and nineteen other branches. The main office is located in Sturgeon Bay, Wisconsin and the branches are distributed by county as follows: seven in Brown County, seven in Door County, four in Kewaunee County, and one in Outagamie County. In September 2012, we sold four branches in central Wisconsin, and in 2013, we closed three additional branches, two of which were also in central Wisconsin and were in conjunction with a sale of the deposits of such branches. The three facilities related to the 2013 closures were transferred to other real estate.

The main office building located in Sturgeon Bay serves as our corporate headquarters and main banking office. The twenty offices owned by the Bank are in good condition and considered adequate for present and near term requirements. In addition, the Bank owns other real property that we do not consider in the aggregate to be material to our consolidated financial position. All of such other real property is reserved for future expansion and is located in the following Wisconsin municipalities: Neenah and Oshkosh.

ITEM 3.LEGAL PROCEEDINGS

We may be involved from time to time in various routine legal proceedings incidental to our business. Neither we nor any of our subsidiaries are currently engaged in any legal proceedings that are expected to have a material adverse effect on our consolidated financial statements.

ITEM 4.MINE SAFETY DISCLOSURES

Not applicable.

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PART II

ITEM 5.MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Historically, trading in shares of our common stock has been limited. Since mid-1993 through November 3, 2013, our common stock had been quoted on the Over-The-Counter Bulletin Board (“OTCBB”), an electronic interdealer quotation system providing real-time quotations on eligible securities. Beginning in November 2013, our stock began being quoted on the NASDAQ Stock Market LLC (the “NASDAQ”) (Trading symbol: BYLK.)

The following table summarizes high and low bid prices and cash dividends declared for our common stock for the periods indicated. Bid prices are as reported from the OTCBB through November 3, 2013 and from the NASDAQ beginning November 4, 2013. The reported high and low prices represent interdealer bid prices, without retail mark-up, mark-downs or commission, and may not necessarily represent actual transactions.

	Calendar Period		High		Low		Cash Dividends per share
2013		4th Quarter	$	14.00	$	10.13		$	0.07
		3rd Quarter	$	11.30	$	9.70		$	0.06
		2nd Quarter	$	10.00	$	9.01		$	0.05
		1st Quarter	$	10.00	$	7.50		$	0.04
2012		4th Quarter	$	7.95	$	7.50		$	0.04
		3rd Quarter	$	8.00	$	6.50		$	0.02
		2nd Quarter	$	6.75	$	6.00		$	0.01
		1st Quarter	$	6.65	$	4.15		$	0.01

We had approximately 1,700 shareholders of record at February 28, 2014. The number of shareholders does not separately reflect persons or entities that hold their stock in nominee or “street” name through various brokerage firms.

The holders of our common stock are entitled to receive such dividends when and as declared by our Board of Directors and if required, approved by our regulators. In determining the payment of cash dividends, our Board of Directors considers the earnings, capital and debt servicing requirements, financial ratio guidelines and restrictions issued by the FRB and other banking regulators, our financial condition, and other relevant factors.

Our ability to pay dividends is dependent upon our receipt of dividends from the Bank, which is subject to regulatory restrictions. Such restrictions, which govern state-chartered banks, generally limit the payment of dividends on bank stock to the bank’s undivided profits after all payments of all necessary expenses, provided that the bank’s surplus equals or exceeds its capital, as discussed further in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operation-Capital Resources. In addition, under the terms of our junior subordinated debentures due 2036, we would be precluded from paying dividends on our common stock if we were in default under the debentures, if we exercised our right to defer payments of interest on the debentures, or if certain related defaults occurred.

Beginning in February 2008, our Board of Directors, in consultation with our federal and state bank regulators, elected to forego the payment of cash dividends on our common stock. No cash dividends were declared beginning on that date or through 2011. In 2012, our Board of Directors declared a quarterly dividend each quarter totaling $0.08 per share for the year. Additional quarterly dividends of $0.04, $0.05, $0.06, and $0.07 were declared in each respective quarter in 2013. Nonetheless, there is no assurance that we will be able to continue to declare quarterly dividends going forward and, even if we do, in what amounts. We maintain a dividend reinvestment plan enabling participating shareholders to elect to purchase shares of our common stock in lieu of receiving cash dividends. Such shares may be newly issued or acquired by us in the open market. New shares issued under this plan are limited to one million over the life of the plan.

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In 2009 and 2010, we completed closings for a private placement of Convertible Notes. The Convertible Notes were offered and sold primarily to “accredited investors” as defined in the Securities Act of 1933 and up to 35 non-accredited investors in reliance on the exemption from registration under Section 4(2) of the Securities Act of 1933, as amended and Rule 506 thereunder. At the closings, we issued in aggregate $9.45 million of Convertible Notes. The proceeds of this financing were contributed, in part, as additional capital to the Bank and otherwise used for general purposes. As of December 31, 2013, $9.40 million of the Convertible Notes remain outstanding.

The Convertible Notes accrue interest at a fixed rate of 10% per annum upon issuance and until maturity or earlier conversion or redemption. Interest is payable quarterly, in arrears, on January 1, April 1, July 1 and October 1 of each year. The Convertible Notes are convertible into shares of our common stock at a conversion ratio of one share of common stock for each $5.00 in aggregate principal amount held on the record date of the conversion, subject to certain adjustments as described in the Convertible Notes. Beginning on July 1, 2014, we may redeem the notes in whole or in part. A notice of redemption supersedes and takes priority over any notice of conversion. Prior to October 1, 2014, each holder of the Convertible Notes may convert up to 100% (at the discretion of the holder) of the original principal amount into shares of our common stock at the conversion ratio. On October 1, 2014, one-half of the original principal amounts are mandatorily convertible at the conversion ratio if conversion has not occurred. The principal amount of any Convertible Note that has not been converted or redeemed will be payable at maturity on June 30, 2017. We are not obligated to register the common stock related to the conversion of the Convertible Notes. In the fourth quarter of 2012, debentures in the amount of $50,000 were converted to 10,000 shares of common stock at the investor’s option. Subsequent to December 31, 2013, $200,000 of debentures were converted to 40,000 shares of common stock at the investors’ option.

We did not sell any securities without registration during the fourth quarter of 2013.

We repurchased 10,000 shares of our common stock during the fourth quarter of 2013 for a total of 163,000 shares repurchased during 2013 under a stock repurchase program approved by our board of directors on May 23, 2013 (the “Repurchase Program”). This program authorized us to repurchase up to 400,000 shares of our stock through May 30, 2014.

	Total Number of Shares Purchased		Average Price Paid per Share		Total Number of Shares Purchased as Part of Publically Announced Plans or Programs(1)		Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs
October 1 – October 31, 2013		—		—		—		247,000
November 1 – November 30, 2013		10,000		11.31		10,000		237,000
December 1 – December 31, 2013		—		—		—		237,000
Three months ended December 31, 2013		10,000		11.31		10,000		237,000
Year Ended December 31, 2013		163,000	$	10.48		163,000		237,000

(1) On May 23, 2013, our Board of Directors approved the Repurchase Program, which authorized us to repurchase up to 400,000 shares of our stock through May 30, 2014.

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Performance Graph

The following graph shows the cumulative stockholder return on our common stock over the last five fiscal years compared to the returns of Standard & Poors 500 Stock Index and the NASDAQ Bank Index, prepared for NASDAQ by the Center for Research in Securities Prices at the University of Chicago.

     Baylake Corp.

	Period Ending
Index	12/31/09	12/31/10	12/31/11	12/31/12	12/31/13
Baylake Corp.	56.00	82.00	84.00	153.76	269.34
NASDAQ Bank	83.70	95.55	85.52	101.50	143.84
S&P 500	126.46	145.51	148.59	172.37	228.19

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ITEM 6.SELECTED FINANCIAL DATA

BAYLAKE CORP.
FIVE YEAR SELECTED CONSOLIDATED FINANCIAL DATA

	Year Ended December 31, (dollars in thousands, except per share data)
	2013			2012			2011			2010			2009
Results of operations:
Interest and dividend income	$	34,740		$	39,186		$	42,122		$	45,050		$	47,468
Interest expense		4,540			6,755			9,582			12,825			18,259
Net interest income before provision for loan losses		30,200			32,431			32,540			32,225			29,209
Provision for loan losses		1,400			5,425			5,050			7,350			6,500
Net interest income after provision for loan losses		28,800			27,006			27,490			24,875			22,709
Noninterest income		9,830			13,823			10,020			8,955			12,485
Noninterest expense		27,302			31,704			31,627			33,609			29,978
Income before provision (benefit) for income taxes		11,328			9,125			5,883			221			5,216
Income tax provision (benefit)		3,319			1,483			1,407			(916	)		887
Net income	$	8,009		$	7,642		$	4,476		$	1,137		$	4,329
Per Share Data:(1)
Net income per share (basic)(1)	$	1.01		$	0.96		$	0.57		$	0.14		$	0.55
Net income per share (diluted)(1)		0.87			0.84			0.57			0.14			0.55
Cash dividends per common share		0.22			0.08			—			—			—
Book value per share at end of year		12.02			11.73			10.67			9.74			9.43
Selected Financial Condition Data (at December 31):
Total assets	$	996,776		$	1,023,971		$	1,086,929		$	1,052,453		$	1,044,457
Securities		230,883			242,019			284,331			266,760			204,834
Gross loans		617,960			595,533			631,015			629,891			651,894
Total deposits		744,212			806,015			865,187			852,566			831,629
Short-term borrowings(2)		58,448			51,568			47,566			19,236			21,122
Other borrowings(3)		66,700			40,000			55,000			70,000			85,000
Subordinated debentures		16,100			16,100			16,100			16,100			16,100
Convertible promissory notes		9,400			9,400			9,450			9,450			5,350
Total stockholders’ equity		93,881			93,144			84,401			77,067			74,598
Performance Ratios:
Return on average assets		0.83	%		0.74	%		0.43	%		0.11	%		0.41	%
Return on average total stockholders’ equity		8.55			8.60			5.53			1.45			6.01
Dividend payout ratio		21.78			8.31			—			—			—
Equity to assets		9.42			9.10			7.77			7.32			7.14
Net interest margin(4)		3.58			3.53			3.55			3.55			3.18
Net interest spread(4)		3.48			3.43			3.44			3.44			3.04
Noninterest income to average assets		1.02			1.33			0.96			0.86			1.19
Noninterest expense to average assets		2.84			3.05			3.04			3.23			2.86
Net overhead ratio(5)		1.82			1.72			2.08			2.37			1.67
Average loan-to-average deposit ratio		79.28			74.29			74.87			77.39			83.34
Average interest-earning assets to average interest-bearing liabilities		119.10			114.58			110.70			107.75			107.07
Efficiency ratio(6)		67.57			72.52			73.60			82.11			77.46
Asset Quality Ratios:(7)
Nonperforming loans to total loans		1.08	%		2.42	%		3.09	%		2.59	%		4.38	%
Allowance for loan losses to:
Gross loans		1.24			1.54			1.68			1.81			1.47
Nonperforming loans		115.02			63.43			54.32			69.71			33.51
Net charge-offs to average loans		0.48			1.11			0.94			0.85			1.50

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	Year Ended December 31, (dollars in thousands, except per share data)
		2013		2012		2011		2010		2009
Nonperforming assets to total assets		1.30		2.43		2.92		3.08		4.18
Capital Ratios:(8)
Stockholders’ equity to assets		9.42	%	9.10	%	7.77	%	7.32	%	7.14	%
Tier 1 risk-based capital		14.26		13.34		11.03		10.25		10.22
Total risk-based capital		16.71		15.96		13.54		12.76		12.18
Leverage ratio		10.48		9.41		7.93		7.41		7.60

(1)	Basic earnings per share are based on the weighted average number of shares outstanding for the period. Diluted earnings per share are based on the weighted average number of shares outstanding during the period as well as shares that would be issued if outstanding stock options were exercised, stock awards were fully vested and promissory notes were converted.
(2)	Consists of federal funds purchased and repurchase agreements.
(3)	Consists of Federal Home Loan Bank term notes.
(4)	Net interest margin represents net interest income as a percentage of average interest-earning assets, and net interest spread represents the difference between the weighted average yield on interest-earning assets and the weighted average cost of interest-bearing liabilities.
(5)	Net overhead ratio represents the difference between noninterest expense and noninterest income, divided by average assets.
(6)	Efficiency ratio represents noninterest expense divided by the sum of tax equivalent interest income and noninterest income, excluding net investment security gains, net gains on sale of fixed assets and land held for sale, and net gains on sale of branches and deposits. A lower efficiency ratio indicates a more efficient operation.
(7)	Nonperforming loans consist of nonaccrual loans, loans 90 days or more past due, but still accruing interest and restructured loans on nonaccrual. Nonperforming assets include nonperforming loans and foreclosed assets.
(8)	The capital ratios are presented on a consolidated basis. For information on our regulatory capital requirements, see Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Capital Resources” and Item 1. “Business-Supervision and Regulation”.

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ITEM 7.MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION

General

The following sets forth management’s discussion and analysis of our consolidated financial condition and results of operations that should be read in conjunction with our consolidated financial statements, related notes, the selected financial data and the statistical information presented elsewhere in this report for a more complete understanding of the following discussion and analysis.

Critical Accounting Policies

In the course of our normal business activity, management must select and apply many accounting policies and methodologies that are the basis for the financial results presented in our consolidated financial statements. Some of these policies are more critical than others.

Allowance for Loan Losses (“ALL”): The ALL represents management’s estimate of probable and inherent credit losses in the loan portfolio. Estimating the amount of the ALL requires the exercise of significant judgment and the use of estimates related to the amount and timing of expected future cash flows on impaired loans, estimated losses on pools of homogeneous loans based on historical loss experience, and consideration of other qualitative factors such as current economic trends and conditions, all of which may be susceptible to significant change. The loan portfolio also represents the largest asset on the consolidated balance sheet. Loan losses are charged off against the ALL while recoveries of amounts previously charged off are credited to the ALL. A provision for loan losses (“PFLL”) is charged to operations based on management’s periodic evaluation of the factors previously mentioned, as well as other pertinent factors.

The ALL consists of specific reserves on certain impaired loans and general reserves for non-impaired loans. Specific reserves reflect estimated losses based on regular analyses of all impaired non-homogenous loans. These analyses involve a high degree of judgment in estimating the amount of loss associated with specific loans, including estimating the amount and timing of future cash flows and collateral values. The general reserve is based on our historical loss experience which is updated quarterly. The general reserve portion of the ALL also includes consideration of certain qualitative factors such as 1) changes in the nature, volume and terms of loans, 2) changes in lending personnel, 3) changes in the quality of the loan review function, 4) changes in nature and volume of past-due, nonaccrual and/or classified loans, 5) changes in concentration of credit risk, 6) changes in economic and industry conditions, 7) changes in legal and regulatory requirements, 8) unemployment and inflation statistics, and 9) changes in underlying collateral values.

There are many factors affecting the ALL, some are quantitative while others require qualitative judgment. The process for determining the ALL (which management believes adequately considers potential factors which might possibly result in credit losses) includes subjective elements and, therefore, may be susceptible to significant change. To the extent actual outcomes differ from management estimates, additional PFLLs may be required that could adversely affect our earnings or financial position in future periods. Allocations of the ALL may be made for specific loans but the entire ALL is available for any loan that, in management’s judgment, should be charged-off or for which an actual loss is realized.

As an integral part of their examination process, various regulatory agencies review the ALL as well. Such agencies may require that changes in the ALL be recognized when such regulatory credit evaluations differ from those of management based on information available to the regulators at the time of their examinations.

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Other Real Estate Properties: Other real estate properties acquired through or in lieu of loan foreclosure are initially recorded at the lower of carrying cost or fair value, less estimated costs to sell, establishing a new cost basis. Fair value is determined using a variety of market information including but not limited to appraisals, professional market assessments and real estate tax assessment information. If fair value declines subsequent to foreclosure, a valuation allowance is recorded through expense. Costs incurred after acquisition are expensed.

Income Tax Accounting: The assessment of income tax assets and liabilities involves the use of estimates, assumptions, interpretations, and judgments concerning certain accounting pronouncements and federal and state tax codes. There can be no assurance that future events, such as court decisions or positions of federal and state taxing authorities, will not differ from management’s current assessment, the impact of which could be significant to the consolidated results of our operations and reported earnings. We believe that the net deferred income tax asset on our December 31, 2013 consolidated balance sheet is recoverable, and the income tax liabilities are adequate and fairly stated in the consolidated financial statements. See Note 16-”Income Taxes” to our consolidated financial statements for further information.

Overview

We are a full-service financial services company, providing a wide variety of loan, deposit and other banking products and services to our business, individual or retail, and municipal customers, as well as a full range of trust, investment and cash management services. We are the bank holding company of the Bank, a Wisconsin state-chartered bank and a member of the Reserve Bank and Federal Home Loan Bank of Chicago.

Our profitability, like most financial institutions, is dependent to a large extent upon net interest income. Results of operations are also affected by PFLL, operating expenses, income taxes and noninterest income. Economic conditions, competition and the monetary and fiscal policies of the federal government in general significantly affect financial institutions, including us. Lending activities are also influenced by regional and local economic factors, including specifically the demand for and supply of housing, competition among lenders, interest rate conditions and prevailing market rates on competing investments, customer preferences and levels of personal income and savings in our market area.

Our regulatory capital ratios and those of the Bank are in excess of the levels established by regulatory agencies for “well capitalized” financial institutions.

Performance Summary

The following is a brief summary of some of the factors that affected our operating results in 2013. See the remainder of this section for a more thorough discussion.

We reported net income of $8.0 million for the year ended December 31, 2013, an increase of $0.4 million compared to net income of $7.6 million in 2012. Basic and diluted earnings per share were $1.01 and $0.87, respectively, for 2013. Basic and diluted earnings per share were $0.96 and $0.84, respectively, for 2012. Return on average assets for the year ended December 31, 2013 was 0.83% compared to 0.74% for the year ended December 31, 2012. The return on average equity was 8.55% for 2013 compared to 8.60% for 2012. Cash dividends of $0.22 and $0.08 per share were declared in 2013 and 2012, respectively.

Key factors behind these results were:

§	Net interest income was $30.2 million in 2013 compared to $32.4 million in 2012.
§	Tax-equivalent net interest income was $31.3 million for 2013, a decrease of $2.2 million or 6.6% from $33.5 million for 2012. Tax-equivalent interest income decreased $4.4 million, while interest expense decreased $2.2 million.
§	The net interest margin for 2013 was 3.58% compared to 3.53% for 2012.

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§	Net loan charge-offs decreased from a year ago. Net loan charge-offs were $2.9 million in 2013, a decrease of $4.0 million compared to $6.9 million for 2012. Net loan charge-offs for commercial real estate loans represented $1.9 million of the $2.9 million total in 2013. Net loan charge-offs represented 0.48% of average loans in 2013 compared to 1.1% in 2012. The PFLL decreased to $1.4 million for 2013 compared to $5.4 million for 2012.
§	Noninterest income was $9.8 million for 2013, a decrease of $4.0 million or 28.9% from $13.8 million in 2012 resulting from a $1.0 million decrease in net gains from sales of loans, a $1.6 million decrease in gains from sale of securities, a $0.7 million decrease on net gain from sale of branches and deposits, and a $0.6 million decrease in gain from the sale of premises and equipment, including held for sale.
§	Noninterest expense was $27.3 million for 2013, a decrease of $4.4 million or 13.9% over 2012. This was primarily the result of a $2.9 million decrease in the operation of other real estate properties and a $0.7 million decrease in FDIC insurance expense.
§	Provision for income taxes resulted in tax expense of $3.3 million for 2013 versus a tax expense of $1.5 million for 2012. This was due to an increase of $2.2 million in taxable income in 2013. In addition, the previous write-off of a deferred tax asset of $0.7 million was reversed in 2012, reducing tax expense and increasing net earnings for that year.
§	In the second quarter of 2013, we closed a branch in Northeast Wisconsin and consolidated the associated loans and deposits in our remaining branches. In the fourth quarter of 2013, we closed our remaining two branches in central Wisconsin, selling $15.6 million of the deposits to another institution and retaining the loan assets. Subsequently in November 2013, those two branch facilities were adjusted to fair market value, resulting in a $0.3 million write-down, and transferred to our other real estate owned. Prior to 2013, in September 2012, we sold four branches also located in the central part of Wisconsin. Included in the sale was $65.2 million of deposit balances, $36.8 million of loan balances, $1.2 million of repurchase agreement balances, and $2.0 million of fixed assets. A net gain of $0.8 million was recognized from the sale.

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STATEMENT OF OPERATIONS ANALYSIS

Table 1: Average Balances and Interest Rates (interest and rates on a tax-equivalent basis)

	Year ended December 31, (dollars in thousands)
	2013							2012							2011
	Average Balance		Interest		Average Rate			Average Balance		Interest		Average Rate			Average Balance		Interest		Average Rate
ASSETS:
Interest-Earning Assets
Loans, net 1,2	$	601,228	$	28,539		4.75	%	$	623,685	$	31,412		5.04	%	$	629,759	$	33,668		5.35	%
U.S. Treasuries		—		—		—			—		—		—			—		—		—
U.S. government sponsored agencies		166,792		3,744		2.24			189,254		4,845		2.56			180,664		5,302		2.93
State and municipal obligations1		59,205		2,817		4.76			58,559		2,810		4.80			54,731		2,826		5.16
Other securities		15,243		619		4.06			21,413		1,045		4.88			25,979		1,247		4.80
Federal funds sold		2,254		6		0.27			3,342		8		0.24			2,009		5		0.25
Other money market instruments		28,900		82		0.28			51,391		123		0.24			52,955		131		0.25
Total earning assets		873,622		35,807		4.10	%		947,644		40,243		4.25	%		946,097		43,179		4.56	%
Noninterest-earning assets		87,055							91,214							94,858
Total assets	$	960,677						$	1,038,858						$	1,040,955
LIABILITIES AND STOCKHOLDERS’ EQUITY
Interest-Bearing Liabilities
NOW accounts	$	133,452	$	138		0.10	%	$	139,011	$	212		0.15	%	$	131,509	$	366		0.28	%
Savings accounts		298,933		418		0.14			310,298		638		0.21			288,432		1,400		0.49
Time deposits>$100M		51,039		533		1.04			84,599		1,123		1.33			89,975		1,643		1.83
Time deposits<$100M		127,850		1,079		0.84			147,559		1,788		1.21			184,155		2,871		1.56
Brokered deposits		21,544		324		1.50			43,238		708		1.64			50,671		877		1.73
Total interest-bearing deposits		632,818		2,492		0.39			724,705		4,469		0.62			744,742		7,157		0.96
Federal funds purchased		—		—		—			26		—		—			—		—		—
Repurchase agreements		34,728		79		0.23			27,578		61		0.22			26,013		79		0.30
FHLB advances		40,461		729		1.80			49,221		949		1.93			58,356		1,094		1.87
Subordinated debentures		16,100		266		1.65			16,100		297		1.85			16,100		272		1.69
Convertible promissory notes		9,400		975		10.37			9,440		979		10.37			9,450		980		10.37
Total interest-bearing liabilities		733,507		4,541		0.62	%		827,070		6,755		0.82	%		854,661		9,582		1.12	%
Demand deposits		125,498							114,787							96,386
Accrued expenses and other liabilities		7,958							8,191							9,022
Stockholders’ equity		93,714							88,810							80,886
Total liabilities and stockholders’ equity	$	960,677						$	1,038,858						$	1,040,955
Net interest income and rate spread3			$	31,266		3.48	%			$	33,488		3.43	%			$	33,597		3.44	%
Net interest margin4						3.58	%						3.53	%						3.55	%

1	The interest income on tax exempt securities and loans is computed on a tax-equivalent basis using a tax rate of 34% for all periods presented.
2	The average loan balances and rates include nonaccrual loans.
3	Interest rate spread is the difference between the annualized average yield earned on average interest-earning assets for the period and the annualized average rate of interest accrued on average interest-bearing liabilities for the period.
4	Net interest margin is the annualized effect of net interest income for a period divided by average interest-earning assets for the period.

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Table 2: Rate/Volume Analysis (1)

	2013 compared to 2012									2012 compared to 2011
	Increase (Decrease) due to									Increase (Decrease) due to
	(dollars in thousands)									(dollars in thousands)
	Volume			Rate			Net			Volume			Rate			Net
Interest income:
Loans(2)	$	(1,106	)	$	(1,767	)	$	(2,873	)	$	(308	)	$	(1,948	)	$	(2,256	)
U.S. government-sponsored agencies		(540	)		(560	)		(1,100	)		228			(685	)		(457	)
State and municipal obligations(2)		31			(24	)		7			190			(206	)		(16	)
Other securities		(269	)		(157	)		(426	)		(220	)		18			(202	)
Federal funds sold		(3	)		—			(3	)		3			—			3
Other money market instruments		(61	)		20			(41	)		(4	)		(4	)		(8	)
Total interest-earning assets		(1,948	)		(2,488	)		(4,436	)		(111	)		(2,825	)		(2,936	)
Interest expense:
NOW accounts		(8	)		(66	)		(74	)		12			(166	)		(154	)
Savings accounts		(23	)		(197	)		(220	)		48			(810	)		(762	)
Time deposits		(601	)		(698	)		(1,299	)		(577	)		(1,026	)		(1,603	)
Brokered deposits		(452	)		68			(384	)		(127	)		(42	)		(169	)
Repurchase agreements		16			2			18			4			(22	)		(18	)
FHLB advances		(160	)		(60	)		(220	)		(172	)		27			(145	)
Subordinated debentures		—			(31	)		(31	)		—			25			25
Convertible promissory notes		(4	)		—			(4	)		(1	)		—			(1	)
Total interest-bearing liabilities		(1,232	)		(982	)		(2,214	)		(813	)		(2,014	)		(2,827	)
Net interest income	$	(716	)	$	(1,506	)	$	(2,222	)	$	702		$	(811	)	$	(109	)

(1)	The change in interest due to both rate and volume has been allocated proportionally to the relationship to the dollar amounts of the change in each.
(2)	The yield on tax-exempt loans and securities is computed on a tax-equivalent basis using a tax rate of 34% for all periods presented.

2013 compared to 2012

Net Interest Income

Net interest income represents the difference between the dollar amount of interest earned on interest-earning assets and the dollar amount of interest paid on interest-bearing liabilities. The interest income and interest expense of financial institutions are significantly affected by general economic conditions, competition, policies of regulatory authorities and other factors.

Interest rate spread and net interest margin are used to measure and explain changes in net interest income. Interest rate spread is the difference between the yield on interest-earning assets and the rate paid for interest-bearing liabilities that fund those assets. Net interest margin is expressed as the percentage of net interest income to average interest-earning assets. Net interest margin exceeds interest rate spread because noninterest-bearing sources of funds (“net free funds”), principally demand deposits and stockholders’ equity, also support interest-earning assets. To compare tax-exempt asset yields to taxable yields, the yield on tax-exempt loans and securities is computed on a tax-equivalent basis. The narrative below discusses net interest income, interest rate spread and net interest margin on a tax-equivalent basis.

Table 1 above provides average balances of interest-earning assets and interest-bearing liabilities, tax-equivalent interest income and expense, and the corresponding interest rates earned, as well as net interest income, interest spread, and net interest margin on a tax-equivalent basis for the years ended December 31, 2013, 2012 and 2011. Results for 2013 and 2012 were impacted by the sale of four branches in September 2012. Included in the sale was $65.2 million of deposit balances, $36.8 million of loan balances, and $1.2 million of repurchase agreement balances. Results for 2013 were further impacted by the sale of $15.6 million of deposits associated with closure of two branches in November as well as by the closure of one other branch in the second quarter of 2013.

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Net interest income in the consolidated statements of operations (which excludes the tax-equivalent adjustment) was $30.2 million for 2013, compared to $32.4 million for 2012. The tax equivalent adjustments (adjustments needed to bring tax-exempt interest to a level that would yield the same after-tax income had that income been subject to taxation using a 34% tax rate) of $1.1 million for both 2013 and 2012 resulted in a tax-equivalent net interest income of $31.3 million and $33.5 million, respectively. The net interest margin for 2013 was 3.58% compared to 3.53% in 2012 and the interest rate spread for 2013 was 3.48% compared to 3.43% in 2012. The return on interest-earning assets declined 15 bp while the cost of interest-bearing liabilities declined 20 bp in 2013.

During 2013, we were liability sensitive (which means that liabilities will re-price faster than assets) but continued to re-position the balance sheet to be more asset sensitive (which means that assets will re-price faster than liabilities); thus, future rate increases would impact net interest income positively. We expect that in a gradually increasing rate environment, our statement of operations would benefit from asset sensitivity over the long term, although changes in the portfolio or the pace of interest rate increases could affect that trend.

As shown in the rate/volume analysis in Table 2 above, volume changes resulted in a $0.7 million decrease to tax-equivalent net interest income in 2013. The changes in the composition of earning assets resulted in a $1.9 million decrease to tax equivalent interest income in 2013 offset by a $1.2 million decrease in interest expense due to the composition change in interest-bearing liabilities. Rate changes on earning assets decreased interest income by $2.5 million but were partially offset by rate changes on interest-bearing liabilities, which decreased interest expense by $1.0 million, for a net decrease in net interest income of $1.5 million due to changes in interest rates.

For 2013, the yield on earning assets declined to 4.10% from 4.25% in 2012, which was the combined effect of a decrease of 29 bps in the loan yield, a 4 bp decline in the yield on tax-exempt securities, an 82 bp decrease in the yield on other securities, and a 32 bp decline in yields on U.S. government sponsored agencies offset in part by a 5 bp increase in yield on federal funds sold and a 4 bp increase in yield on other money market instruments. The average loan yield was 4.75% in 2013 and 5.04% in 2012. The decline in loan yields reflected lower yields received on new loan originations.

For 2013, the cost of interest-bearing liabilities decreased by 20 bps from 0.82% in 2012, to 0.62%. The combined average cost of interest-bearing deposits was 0.39%, down 23 bps from 2012, primarily resulting from the continued low short-term interest rate environment during 2013. Also contributing to the decrease was the cost of funding, comprising FHLB advances (down 13 bp to 1.80%) and subordinated debentures (down 20 bp to 1.65%). The cost of the Convertible Notes and repurchase agreements remained relatively constant. During 2013, $15.0 million of FHLB borrowings with a weighted average rate of 1.62% matured and $26.7 million of FHLB borrowings were advanced, resulting in a reduction in cost for the year as the new borrowings carried lower rates.

Average earning assets were $873.6 million in 2013, compared to $947.6 million in 2012. Average loans outstanding declined 3.6% to $601.2 million in 2013 from $623.7 million in 2012. Average loans to average total assets increased to 62.6% in 2013 from 60.0% in 2012. For 2013, tax-equivalent interest income on loans decreased $2.9 million, of which $1.2 million related to the decline in average outstanding balances and $1.7 million was due to the lower loan yields. Average balances of securities and short-term investments decreased $51.6 million in 2013 versus 2012. Tax-equivalent interest income on securities and short-term investments increased $0.8 million from volume changes, and decreased $0.7 million from the impact of the rate environment, for a net decrease of $1.5 million in tax-equivalent interest income on securities in our investment portfolio.

Average interest-bearing liabilities decreased $93.6 million in 2013 from 2012 levels, while net free funds (the total of demand deposits, accrued expenses, other liabilities and stockholders’ equity less noninterest earning assets) increased $15.4 million during the same period. The increase in net free funds is primarily attributable to an increase in demand deposits. Average demand deposits increased by $10.7 million, or 9.3%. Average interest-bearing deposits declined $91.9 million, or 12.7% during 2013 to $632.8 million. This decline resulted from a decrease in all categories of deposits, most significantly time deposits of $53.3 million. The decrease included $15.6 million of deposits sold in conjunction with the sale of two branches in November 2013. Additionally, brokered deposits of $19.6 million and deposits of $2.6 million obtained in prior years by utilizing a national listing service that matured in 2013 were not renewed. Interest expense on interest-bearing deposits decreased $1.0 million from the volume and mix changes and $1.0 million from impact of lower rates during 2013, resulting in an aggregate decrease of $2.0 million in interest expense on interest-bearing deposits for the year. Average wholesale-funding sources decreased by $1.7 million during 2013. For 2013, interest expense on wholesale funding sources decreased by $0.2 million from 2012 due to declining interest rates and reductions in average outstanding balances.

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Provision for Loan Losses

The PFLL is the periodic cost of providing an allowance for probable and inherent losses in our loan portfolio. The ALL consists of specific and general components. Our internal risk system is used to identify loans that meet the criteria for being “impaired” as defined in the accounting guidance. The specific component relates to loans that are individually classified as impaired and where expected cash flows are less than carrying value. The general component covers non-impaired loans and is based on historical loss experience adjusted for qualitative factors. These qualitative factors include: 1) changes in the nature, volume and terms of loans, 2) changes in lending personnel, 3) changes in the quality of the loan review function, 4) changes in nature and volume of past-due, nonaccrual and/or classified loans, 5) changes in concentration of credit risk, 6) changes in economic and industry conditions, 7) changes in legal and regulatory requirements, 8) unemployment and inflation statistics, and 9) changes in underlying collateral values.

Net loan charge-offs for the year ended December 31, 2013 were $2.9 million compared to net charge-offs of $6.9 million for 2012. Net charge-offs to average loans were 0.48% for 2013 compared to 1.11% in 2012. Nonperforming loans decreased by $7.7 million (53.9%), to $6.7 million at December 31, 2013, from $14.4 million at December 31, 2012, an indication of improvement in the quality of the loan portfolio. Refer to the “Balance Sheet Analysis - Risk Management and the Allowance for Loan Losses” and “Balance Sheet Analysis - Nonperforming Loans and Other Real Estate Owned” sections below for more information related to nonperforming loans.

PFLL for the year ended December 31, 2013 was $1.4 million compared to $5.4 million for the same period in 2012. Our management believes that the ALL as of December 31, 2013 is appropriate in view of the present condition of the loan portfolio and the amount and quality of the collateral supporting nonperforming loans. We are continually monitoring nonperforming loan relationships and will make provisions, as necessary, if the facts and circumstances change. In addition, a decline in the quality of our loan portfolio as a result of general economic conditions, factors affecting particular borrowers or our market area, could affect the adequacy of the ALL. If there are significant charge-offs against the ALL or we otherwise determine that the ALL is inadequate, we will need to make additional PFLLs in the future. See the “Balance Sheet Analysis - Risk Management and the Allowance for Loan Losses” below for more information related to nonperforming loans.

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Noninterest Income

Table 3: Noninterest Income

	Non-interest Income Years Ended December 31,
	2013			2012			% Change
Fees from fiduciary services	$	1,062		$	1,007		$	5.5	%
Fees from loan servicing		591			598			(1.2	)%
Service charges on deposit accounts		2,774			3,043			(8.8	)%
Other fee income		630			682			(7.6	)%
Financial services income		1,220			897			36.0	%
Gains from sales of loans		1,414			2,386			(40.7	)%
Gains from sale of branches and deposits		122			826			(85.2	)%
Net change in valuation of MSR		(96	)		(193	)		50.3	%
Net gains from sale of securities		574			2,188			(73.8	)%
Net gain (loss) from sale of premise and equipment		(3	)		582			(100.5	)%
Increase in CSV		340			366			(7.1	)%
Income in equity of UFS		936			675			38.7	%
Other income		266			766			(65.3	)%
Total Noninterest Income	$	9,830		$	13,823			(28.9	)%

Fees from fiduciary services, service charges on deposit accounts, financial services income, gains from the sales of loans, and income from our UFS subsidiary were the primary components of noninterest income in 2013. Total noninterest income for 2013 was $9.8 million, a $4.0 million or 28.9% decrease from $13.8 million in 2012. This decrease was due primarily to a $1.0 million decrease in gains from the sale of loans, a $1.6 million decrease in net gains from the sale of securities, a $0.7 million decrease in net gain on the sale of branches, and a $0.6 million decrease in net gains on sale of premises and equipment, including premises and equipment held for sale. The noninterest income to average assets ratio was 1.02% for the year ended December 31, 2013 compared to 1.33% for the same period in 2012.

Gains of $0.6 million from the sale of securities in our investment portfolio were realized in 2013 compared to $2.2 million of such gains in 2012. These gains were available due to the low interest rate environment and the sales allowed us to reposition our investment portfolio to take advantage of increased credit related spreads and to provide additional cash for potential business opportunities that were considered. Our securities portfolio at December 31, 2013 has net unrealized gains of $1.8 million.

Gains on loans sold in the secondary market decreased from $2.4 million in 2012 to $1.4 million in 2013, a decrease of $1.0 million, or 40.7%. These gains were primarily from residential mortgage loans sold in the secondary market and are included in gains from sales of loans in noninterest income. Although the low interest rate environment continued to generate strong refinance business in the first half of 2013, movement upwards in the interest rate yield curve during the last two quarters of 2013 reduced origination and refinance activity. Additionally, we chose to hold more mortgage loans on our balance sheet rather than sell them into the secondary market in 2013, thus not recording a gain on sale.

Noninterest income in 2012 was positively impacted by a $0.6 million net gain on the sale of vacant land located adjacent to one of our branches in the Green Bay region, a $0.8 million net gain from the sale of four of our branches in central Wisconsin, and an increase of $0.5 million in life insurance death benefit, events that were not recurring in 2013.

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Noninterest Expense

Table 4: Noninterest Expense

	Noninterest Expense Years Ended December 31,
	2013		2012		% Change
Salaries and employee benefits	$	16,551	$	17,016		(2.7	)%
Occupancy		1,938		2,259		(14.2	)%
Equipment		1,190		1,137		4.7	%
Data processing and courier		854		904		(5.5	)%
Operation of other real estate properties		969		3,846		(74.8	)%
Business development and advertising		592		620		(4.5	)%
Charitable contributions		153		49		212.2	%
Stationary and supplies		424		516		(17.8	)%
Director fees		364		401		(9.2	)%
FDIC		699		1,396		(49.9	)%
Legal and professional		708		546		29.7	%
Loan and collection		224		519		(56.8	)%
Other outside services		878		817		7.5	%
Other operating		1,758		1,678		4.8	%
Total non-interest expense	$	27,302	$	31,704		(13.9	)%

Noninterest expense in 2013 decreased to $27.3 million from $31.7 million in 2012, primarily as a result of a decrease of $2.9 million in expenses related to the operation of other real estate properties (74.8%), a decrease of $0.7 million in FDIC insurance expense (49.9%), and a decrease of $0.3 million in loan and collection costs (56.8%).

Salaries and employee benefits expense is the largest component of noninterest expense, totaling $16.6 million in 2013, a decrease of $0.5 million or 2.7% from 2012. Commissioned salespersons, including financial advisors and mortgage loan originators, are paid a base salary plus commissions. Mortgage commission expense decreased $0.2 million in 2013 due to decreased mortgage origination and refinancing activity and the related decreased mortgage volumes partially offset by financial advisor commissions which increased $0.1 million in 2013. The number of full-time equivalent employees decreased from 266 in 2012 to 258 in 2013 primarily due to the closure of three branches in 2013. In 2013 our financial results met our targeted performance levels and management cash incentive bonuses of $0.5 million were earned. This reflected a modest increase compared to management cash incentive bonuses of $0.4 million earned in 2012.

Costs associated the Bank’s Supplemental Executive Retirement Plan (“SERP Plan”), which is intended to provide deferred compensation in excess of that available under our other retirement programs to certain management and highly-compensated employees who have contributed and are expected to continue to contribute to our success, were $0.2 million for 2013, consistent with 2012. No Bank contributions were made to the SERP Plan in 2013 or 2012.

Accrued benefit costs, principally for health insurance, pension costs and bonus expense, represent the remaining portion of personnel-related costs. Health insurance costs are expected to increase in 2014 due to increases in health insurance premiums. Benefit expense was consistent with 2012 and included incentive compensation costs for 2013 of $0.9 million, which includes $0.3 million related to the Equity Incentive Plan. In March 2013 and April 2012, grants of restricted stock units and stock options were made under the plan. 401K safe harbor contributions of $0.3 million were made in 2013 and $0.4 million in 2012. In addition, a 401K 1% matching contribution of $0.1 million was made in 2013. There were no end-of-year 401K contributions made in 2013 or 2012.

Net occupancy expense decreased to $1.9 million in 2013 compared to $2.3 million in 2012. Positively impacting net occupancy expense in 2013 was the sale of four branches in September 2012, which will continue to reduce operating expenses as we will no longer be responsible for the costs of maintaining those branches, and the closure of the three other branches in 2013.

Data processing and courier expense was consistent at $0.9 million in 2013 and 2012. Management estimates that data processing expense should decrease in the future as a result of volume-related decreases in both the number of transactions and the number of loan/deposit accounts resulting from the sale of four branches in September 2012 and sale of deposits in 2013.

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Income from other real estate is netted against related expenses in the determination of operation of other real estate properties. These properties reflected a net expense from the operation of such real estate of $1.0 million in 2013 compared to $3.8 million in 2012, a decrease of $2.8 million, or 74.8%. Provision for valuation reductions of foreclosed properties obtained by us in collection efforts were charged to 2013 operations in the amount of $0.9 million, reflecting a decline in estimated market values of properties based on appraisals and other evaluation means. This compared to a $3.3 million provision for such valuations in 2012. Significant efforts were made to further reduce the balances of our foreclosed properties. A net gain of $0.2 million was recognized on the sale of foreclosed properties in 2013 compared to a net gain of $0.1 million in 2012.

FDIC insurance premiums decreased to $0.7 million for 2013 from $1.4 million for the same period a year ago, a decrease of $0.7 million, or 49.9%.The decrease in FDIC insurance premiums in 2013 compared to 2012 was primarily related to a decrease in the assessment rate.

Loan and collection expenses were $0.2 million in 2013 compared to $0.5 million in 2012. This is primarily related to costs on loans that are in the collection process that have not been transferred to foreclosed properties and includes costs incurred for property management fees, real estate taxes, insurance and operating expenses. We continue to outsource a portion of our legal services deemed appropriate in resolving nonperforming loans, as well as utilizing our internal legal staff. These external legal costs totaled $0.1 million in 2013 compared to $0.2 million in 2012 as the volume of nonperforming loans declined further in 2013.

Provision for Income Taxes

Income tax expense totaled $3.3 million in 2013 on pre-tax income of $11.3 million (for an effective tax rate of 29.3%), compared to income tax expense of $1.5 million in 2012 on pre-tax income of $9.1 million (for an effective tax rate of 16.3%). The lower effective tax rate in 2012 compared to 2013 reflected a tax valuation reserve reversal of $0.7 million related to deferred tax assets in 2012.

See Note 1, “Nature of Business and Summary of Significant Accounting Policies” and Note 16, “Income Taxes” of the Notes to Consolidated Financial Statements for a further discussion of income tax accounting. Income tax expense recorded in the consolidated statements of operations involves interpretation and application of certain accounting pronouncements and federal and state tax codes and is, therefore, considered a critical accounting policy. We undergo examination by various taxing authorities. Such taxing authorities may require that changes in the amount of tax expense or valuation allowance be recognized when their interpretations differ from those of management, based on their judgments about information available to them at the time of their examinations.

2012 compared to 2011

Net Interest Income

Net interest income in the consolidated statements of operations (which excludes the tax-equivalent adjustment) was $32.4 million for 2012, compared to $32.5 million for 2011. Net interest income in both 2012 and 2011 was negatively impacted by the high level of nonperforming loans for which interest income is not recognized. Nonperforming loans decreased $5.1 million (26.2%) from the end of 2011 to the end of 2012. The tax equivalent adjustments (adjustments needed to bring tax-exempt interest to a level that would yield the same after-tax income had that income been subject to taxation using a 34% tax rate) of $1.1 million for both 2012 and 2011 resulted in a tax-equivalent net interest income of $33.5 million and $33.6 million, respectively. The net interest margin for 2012 was 3.53% compared to 3.55% in 2011 and the interest rate spread for 2012 was 3.43% compared to 3.44% in 2011. The return on interest-earning assets declined 31 bp while the cost of interest-bearing liabilities declined 30 bp in 2012.

As shown in the rate/volume analysis in Table 2 above, volume changes resulted in a $0.7 million increase to tax-equivalent net interest income in 2012. The changes in the composition of earning assets resulted in a $0.1 million decrease to tax equivalent interest income in 2012 offset by a $0.8 million decrease in interest expense due to the composition change in interest-bearing liabilities. Rate changes on earning assets decreased interest income by $2.8 million but were partially offset by rate changes on interest-bearing liabilities that decreased interest expense by $2.0 million, for a net decrease of $0.8 million in net interest income due to changes in interest rates.

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For 2012, the yield on earning assets declined to 4.25% from 4.56% in 2011, which was the combined effect of a decrease of 31 bps in the loan yield, a 36 bp decline in the yield on tax-exempt securities, a 1 bp decrease in the yield on money market instruments, and a 37 bp decline in yields on U.S. government sponsored agencies. The average loan yield was 5.04% in 2012 and 5.35% in 2011. The decline in loan yields reflected lower yields received on new loan originations.

For 2012, the cost of interest-bearing liabilities decreased by 30 bps from 1.12% in 2011, to 0.82%. The combined average cost of interest-bearing deposits was 0.62%, down 34 bps from 2011, primarily resulting from the continued low short-term interest rate environment during 2012. Also contributing to the decrease was the cost of wholesale funding, comprising repurchase agreements (down 8 bps to 0.22%). Partially offsetting the decrease were increases in costs of FHLB advances (up 6 bps to 1.93%) and subordinated debentures (up 16 bps to 1.85%). The cost of Convertible Notes remained constant at 10.37%. During 2012, $15.0 million of FHLB borrowings with a weighted average rate of 1.63% matured and were paid off, thus resulting in an increase in cost of FHLB advances for the year as the remaining advances outstanding carried higher rates.

Average earning assets were $947.6 million in 2012, compared to $946.1 million in 2011. Average loans outstanding declined 1.0% to $623.7 million in 2012 from $629.8 million in 2011. Average loans to average total assets decreased to 60.0% in 2012 from 60.5% in 2011. For 2012, tax-equivalent interest income on loans decreased $2.3 million, of which $0.3 million related to the decline in average outstanding balances and $2.0 million was due to the lower loan yields. Average balances of securities and short-term investments increased $7.6 million (2.4%) in 2012 versus 2011. Tax-equivalent interest income on securities and short-term investments increased $0.2 million from volume changes, and decreased $0.9 million from the impact of the rate environment, for a net decrease of $0.7 million in tax-equivalent interest income on securities in our investment portfolio and our short-term investments.

Average interest-bearing liabilities decreased $27.6 million in 2012 from 2011 levels, while net free funds (the total of demand deposits, accrued expenses, other liabilities and stockholders’ equity less noninterest earning assets) increased $25.5 million during the same period. The increase in net free funds is primarily attributable to an increase in demand deposits. Average demand deposits increased by $18.4 million, or 19.1%. Average interest-bearing deposits declined $20.0 million, or 2.7% during 2012 to $724.7 million. This decline resulted from a decrease in time deposits partially offset by increases in savings deposits and interest-bearing demand deposits. Interest expense on interest-bearing deposits decreased $0.7 million from the volume and mix changes and $2.0 million from impact of lower rate during 2012, resulting in an aggregate decrease of $2.7 million in interest expense on interest-bearing deposits for the year. Average wholesale-funding sources decreased by $7.6 million during 2012 primarily due to the reduction in FHLB borrowings. For 2012, interest expense on wholesale funding sources decreased by $0.1 million from 2011 due to declining interest rates and reductions in average outstanding balances.

Provision for Loan Losses

Net loan charge-offs for the year ended December 31, 2012 were $6.9 million compared to net charge-offs of $5.9 million for 2011. Net charge-offs to average loans were 1.11% for 2012 compared to 0.94% in 2011. Although net charge-offs increased, nonperforming loans decreased by $5.1 million (26.2%), to $14.4 million at December 31, 2012, from $19.5 million at December 31, 2011. Refer to the “Balance Sheet Analysis - Risk Management and the Allowance for Loan Losses” and “Balance Sheet Analysis - Nonperforming Loans and Other Real Estate Owned” sections below for more information related to nonperforming loans.

PFLL for the year ended December 31, 2012 was $5.4 million compared to $5.1 million for the same period in 2011.

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Noninterest Income

Fees for fiduciary services, service charges on deposit accounts, finance services income, gains from the sales of loans, gains from the sale of branches and deposits, and gains from the sale of securities, were the primary components of noninterest income in 2012. Total noninterest income for 2012 was $13.8 million, a $3.8 million or 38.0% increase from $10.0 million in 2011. This increase was due primarily to a $0.9 million increase in gains from the sale of loans, a $1.5 million increase in net gains from the sale of securities, a $0.8 million net gain on the sale of branches, and a $0.6 million increase in net gains on sale of premises and equipment, including premises and equipment held for sale. The noninterest income to average assets ratio was 1.33% for the year ended December 31, 2012 compared to 0.96% for the same period in 2011.

Gains of $2.2 million from the sale of securities in our investment portfolio were realized in 2012 compared to $0.7 million of such gains in 2011. These gains were available due to the low interest rate environment and the sales allowed us to reposition our investment portfolio to take advantage of increased credit-related spreads and to provide additional cash for potential business opportunities that were considered. Our securities portfolio at December 31, 2012 had net unrealized gains of $8.7 million.

Gains on loans sold in the secondary market increased from $1.5 million in 2011 to $2.4 million in 2012, an increase of $0.9 million, or 61.3%. These gains were primarily from residential mortgage loans sold in the secondary market and are included in gains from sales of loans in noninterest income. Also, positively impacting the gain on sale of loans was an increase of $0.2 million in new mortgage servicing rights on loans sold in the secondary market with servicing rights retained.

Noninterest income in 2012 was further positively impacted by a $0.1 million (9.6%) increase in fees from fiduciary services, from $0.9 million in 2011 to $1.0 million in 2012, a $0.6 million net gain on the sale of vacant land located adjacent to one of our branches in the Green Bay region, a $0.8 million net gain from the sale of four of our branches in central Wisconsin, and an increase of $0.2 million in life insurance death benefit.

Noninterest Expense

Noninterest expense in 2012 increased to $31.7 million from $31.6 million in 2011, for an increase of $0.1 million (0.2%), primarily as a result of an increase in expenses related to the operation of foreclosed properties partially offset by a decrease in FDIC insurance expense.

Salaries and employee benefits expense is the largest component of noninterest expense, totaling $17.0 million in 2012, a decrease of $0.2 million or 1.0% from 2011. Commissioned salespersons, including financial advisors and mortgage loan originators, are paid a base salary plus commissions. Mortgage commission expense increased $0.1 million in 2012 due to increased mortgage refinancing activity and the related increased mortgage volumes. Financial advisor commissions in 2012 were consistent with 2011 levels. The number of full-time equivalent employees decreased from 298 in 2011 to 266 in 2012 primarily due to the sale of four branches in Waupaca County. In 2012 our financial results met our targeted performance levels and management cash incentive bonuses of $0.4 million were earned. This is consistent with management cash incentive bonuses earned in 2011.

Also contributing to the change in salary and employee benefits were lower expenses related to the Bank’s SERP Plan. Net costs associated with the Plan were $0.2 million for 2012 compared to less than $0.1 million for 2011, due to an increase in the earnings on investment balances. No Bank contributions to the Plan were made in 2012 and 2011.

Accrued benefit costs, principally for health insurance, pension costs and bonus expense, represent the remaining portion of personnel-related costs. Benefit expense was up $0.2 million from 2011 due, in part, to an increase of $0.1 million in group health insurance costs. Also impacting the increase was a $0.1 million increase in incentive compensation costs. Total incentive compensation costs for 2012 were $0.8 million, which includes $0.2 million related to the Equity Incentive Plan. In April 2012 and March of 2011, grants of restricted stock units and stock options were made under that plan. In addition, 401K safe harbor contributions of $0.4 million were made in 2012 and 2011. There were no matching or end-of-year 401K contributions made in 2012 or 2011.

Net occupancy expense was unchanged at $2.3 million in 2012 and 2011. The full impact of the sale of four branches in September 2012 was not realized until 2013, but is expected to reduce operating expenses as we will no longer be responsible for the costs of maintaining those branches.

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Data processing and courier expense was $0.9 million in 2012 compared to $0.8 million in 2011. The data processing and courier expense savings resulting from the sale of the four branches in September 2012 did not begin to be realized until 2013.

Income from foreclosed properties is netted against foreclosed property expenses in the determination of operations of other real estate. Foreclosed properties reflected a net expense from the operation of such real estate of $3.8 million in 2012 compared to $2.1 million in 2011, an increase of $1.7 million, or 79.7%. Provision for valuation reductions of foreclosed properties were charged to 2012 operations in the amount of $3.3 million, reflecting a decline in perceived market values of properties obtained by us in collection efforts. This compared to a $1.7 million provision for such valuations in 2011. Significant efforts were made to further reduce the balances of our foreclosed properties, which resulted in additional write-downs of the carrying values of those properties to reflect updated property valuations. A net gain of $0.1 million was recognized on the sale of foreclosed properties in 2012 compared to a net gain of $0.2 million in 2011. Net operating expenses of foreclosed properties was $0.8 million in 2012 compared to $0.6 million in 2011.

A $0.1 million provision for impairment loss on letters of credit, related to a liability for our exposure on a specific standby letter of credit that supported secondary market financing on behalf of the borrower, was recognized in 2011. During the second quarter of 2012, collateral securing the impaired letter of credit was sold and the related valuation reserve was reduced to zero.

FDIC insurance premiums decreased to $1.4 million for 2012 from $2.4 million for the same period a year ago, a decrease of $1.0 million, or 42.6%, primarily resulting from a change in the method by which the assessment rate is determined, which became effective on April 1, 2011, as well as an improvement in the regulatory standing of the Bank.

Loan and collection expenses were $0.5 million in 2012 compared to $0.8 million in 2011. This primarily related to costs on loans that were in the collection process that have not been transferred to foreclosed properties and includes costs incurred for property management fees, real estate taxes, insurance and operating expenses. External legal costs associated with such collection efforts totaled $0.2 million in 2012 compared to $0.1 million in 2011.

Costs related to other outside services totaled $0.8 million in 2012, $0.1 million more than in 2011. The primary reason for the increase of $0.1 million was increased outsourcing expenses related to various activities, including trust processing services and executive compensation consulting.

Provision for Income Taxes

Income tax expense totaled $1.5 million in 2012 on pre-tax income of $9.1 million (for an effective tax rate of 16.3%), compared to income tax expense of $1.4 million in 2011 on pre-tax income of $6.0 million (for an effective tax rate of 23.6%). The lower effective tax rate in 2012 compared to 2011 reflected a tax valuation reserve reversal of $0.7 million related to deferred tax assets.

See Note 1, “Nature of Business and Summary of Significant Accounting Policies” and Note 16, “Income Taxes” of the Notes to Consolidated Financial Statements for a further discussion of income tax accounting.

BALANCE SHEET ANALYSIS

Loans

Gross loans outstanding increased from $595.5 million at December 31, 2012 to $618.0 million at December 31, 2013, a 3.8% increase year over year. This follows a 5.6% decrease between December 31, 2011 and December 31, 2012.

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Table 5 summarizes the composition (mix) of the loan portfolio at December 31 for the most recent five fiscal years:

Table 5: Loan Composition

	As of December 31, (dollars in thousands)
	2013						2012						2011						2010						2009
	Amount			% of Total			Amount			% of Total			Amount			% of Total			Amount			% of Total			Amount			% of Total
Amount of loans by type
Real estate-mortgage
Commercial	$	287,815			46.6	%	$	291,992			49.0	%	$	317,198			50.3	%	$	344,263			54.7	%	$	353,110			54.2	%
1-4 Family residential		142,398			23.0			127,315			21.4			143,456			22.7			129,449			20.6			124,830			19.2
Construction		36,948			6.0			40,901			6.9			53,606			8.5			55,467			8.8			62,827			9.6
Commercial, financial and agricultural		125,290			20.3			108,890			18.3			91,750			14.6			73,928			11.7			83,674			12.8
Consumer installment		6,495			1.1			7,882			1.3			8,809			1.4			10,225			1.6			11,804			1.8
Tax exempt loans		19,435			3.1			18,970			3.2			16,577			2.6			16,892			2.7			16,009			2.5
Less: deferred fees, net of costs		(421	)		(0.1	)		(417	)		(0.1	)		(381	)		(0.1	)		(333	)		(0.1	)		(360	)		(0.1	)
Total loans (net of unearned income)	$	617,960			100.0	%	$	595,533			100.0	%	$	631,015			100.0	%	$	629,891			100.0	%	$	651,894			100.0	%

Commercial real estate loans secured by farmland, multifamily property, and nonfarm/non-residential real estate property totaled $287.8 million at year-end 2013 comprising 46.6% of the loan portfolio. Loans of this type are mainly for business property, multifamily property and community purpose property. The credit risk related to these types of loans is greatly influenced by general economic conditions, especially those applicable to the Northeast Wisconsin market area, and the resulting impact on our borrowers’ operations. Many times, we will take additional real estate collateral to further secure the overall lending relationship. A decline in the tourism industry, or other economic effects, such as increased interest rates affecting demand for real estate, could affect both our lending opportunities in this area and the value of our collateral for these loans.

Commercial, financial and agricultural loans not secured by real estate totaled $125.3 million at year-end 2013, an increase of $16.4 million or 15.1% since year-end 2012 due to increased loan originations, primarily purchased loan participations with other financial institutions and in the syndicated loan market. This category of loans has been an area of emphasis as we attempt to attain loan growth and look to further reduce our exposure in commercial real estate loans. The commercial, financial and agricultural loan classification primarily consists of commercial loans to small businesses. Loans of this type are in a broad range of industries and include service, retail, wholesale and manufacturing concerns. Agricultural loans are made principally to farmers engaged in dairy, cherry and apple production. Borrowers are primarily concentrated in Door, Brown, Outagamie and Kewaunee Counties of Wisconsin. The origination of new commercial and commercial real estate loans was primarily from our market area in Brown County. Growth in tourism-related business in Door County improved in 2013 and 2012 compared to the previous five years, however not at the higher growth levels experienced in years prior to 2006. The credit risk related to these loans is largely influenced by general economic conditions, especially those applicable to the Northeast Wisconsin market area, and the resulting impact on borrowers’ operations.

Management uses an active credit risk management process for commercial loans to ensure that sound and consistent credit decisions are made. Management attempts to control credit risk by adhering to detailed underwriting procedures, performing comprehensive loan administration, and undertaking periodic review of borrowers’ outstanding loans and commitments. Borrower relationships are formally reviewed periodically during the life of the loan. Further analyses by customer, industry, and location are performed to monitor trends, financial performance and concentrations.

Real estate construction loans declined $4.0 million or 9.7% to $36.9 million at December 31, 2013 from $40.9 million at December 31, 2012. Loans in this classification are primarily short-term interim loans that provide financing for the acquisition or development of commercial real estate, such as multifamily or other commercial development projects. Real estate construction loans are generally made to developers who are well known to us, have prior experience with us and are well capitalized. Construction projects undertaken by these developers are carefully reviewed by us to assess their economic feasibility. The credit risk related to real estate construction loans is generally limited to specific geographic areas, but it is also influenced by general economic conditions. We attempt to control the credit risk on these types of loans by making loans to developers in familiar markets, reviewing the merits of the individual project, controlling loan structure and monitoring project progress and advances of construction proceeds.

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Our loan portfolio is diversified by types of borrowers and industry groups within the market areas that we serve. Significant loan concentrations are considered to exist for a financial entity when such amounts are loans to multiple borrowers engaged in similar activities that cause them to be similarly impacted by economic or other conditions. We have identified certain industry groups within our market area, including lodging, restaurants, retail shops, small manufacturing, real estate rental properties and real estate development that represent concentrations in our portfolio. At December 31, 2013, one industry group concentration existed in our loans that exceeded 10% of total loans; loans on non-residential real estate rental properties located throughout our market area totaled $75.5 million or 12.2% of total loans at December 31, 2013. This compares to $70.9 million or 11.9% at December 31, 2012.

At the end of 2013, residential real estate mortgage loans totaled $142.4 million and comprised 23.0% of the loan portfolio. These loans increased $15.1 million or 11.9% during 2013 due to our strategy to hold more of the first mortgages originated on our balance sheet rather than sell them into the secondary market as in prior years. The largest increase occurred in our first lien residential mortgage loans, which increased $14.7 million. Home equity loans accounted for an increase of $1.1 million. Our product offerings include mortgages that will be recorded on our balance sheet rather than sold in the secondary market. Residential real estate loans consist of conventional fixed-rate home mortgages, adjustable indexed variable rate mortgage loans, home equity loans, and secondary home mortgages. Loans are primarily for properties within the market areas we serve. Residential real estate loans generally contain a limit for the maximum loan to collateral value of 75% to 80% of fair market value. Private mortgage insurance may be required when the loan-to-value ratio exceeds these limits.

We offer indexed adjustable-rate mortgage loans based upon market demands. At year-end 2013, those loans totaled $39.1 million, an increase of $13.4 million over 2012. Adjustable rate mortgage loans contain an interest rate adjustment provision tied to the weekly average yield on U.S. Treasury securities adjusted to a constant maturity of one year (the “index”), plus an additional spread of up to 2.75%. Interest rates on indexed mortgage loans are adjusted, up or down, on predetermined dates fixed by contract, in relation to and based on the index or market interest rates as of a predetermined time prior to the adjustment date. Adjustable rate mortgage loans have an initial rate-lock period, ranging from one to five years, during which time the interest rate is fixed, with adjustments permitted thereafter, subject to annual and lifetime interest rate caps that vary by product type. Annual limits on interest rate changes are 2% while aggregate lifetime interest rate increases over the term of the loan are currently capped at 6% above the original mortgage loan interest rate. We do not originate sub-prime loans.

We also offer loans that are not retained on our balance sheet. We participate in a fixed rate mortgage program under the Federal Home Loan Mortgage Corporation (“FHLMC”) guidelines. These loans are sold in the secondary market without recourse and we retain servicing rights. During 2013, sales of these loans totaled $30.1 million compared to $60.5 million during 2012. In addition, we also offer fixed rate mortgages through participation in fixed rate mortgage programs with private investors. These loans also are sold in the secondary market without recourse with servicing rights released to the buyer. In 2013, we sold $64.5 million in mortgage loans through the secondary market programs, including FHLMC compared to $115.7 million in 2012. When we sell mortgage loans in the secondary market, we make representations and warranties to the purchasers about various characteristics of each loan, including the underwriting standards applied and the documentation being provided. Failure to comply with the requirements established by the purchaser of the loan may result in us having to repurchase the loan. There have not been any material instances where we were required to repurchase loans.

Installment loans to individuals totaled $6.5 million, or 1.1%, of the total loan portfolio at December 31, 2013, compared to $7.9 million, or 1.3%, at December 31, 2012. Installment loans include short-term installment loans, direct and indirect automobile loans, recreational vehicle loans, credit card loans, and other personal loans. Individual borrowers may be required to provide collateral or a satisfactory endorsement or guaranty from another party, depending upon the specific type of loan and the creditworthiness of the borrower. Loans are made to individual borrowers located in the market areas we serve. Credit risks for loans of this type are generally influenced by general economic conditions (especially in the market areas served), the characteristics of individual borrowers and the nature of the loan collateral. Reviewing the creditworthiness of the borrowers, as well as taking the appropriate collateral and guaranty positions on such loans, primarily controls credit risk.

Tax exempt loans totaled $19.4 million at December 31, 2013 compared to $19.0 million at year-end 2012. Tax exempt loans are short or long-term loans to municipalities and other tax exempt entities. The proceeds of these loans are collateralized by the backing of the corresponding taxing authority and can be used for general municipal purposes or revenue producing projects.

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Table 6 details expected maturities by loan purpose as of December 31, 2013. Those loans with expected maturities over one year are further scheduled by fixed rate or variable rate interest sensitivity.

Table 6: Loan Maturity and Interest Rate Sensitivity

	Maturity
December 31, 2013	Within 1 Year		1-5 Years		After 5 Years		Total
	(dollars in thousands)
Loans secured primarily by real estate:
Residential	$	35,341	$	28,265	$	78,792	$	142,398
Construction		24,244		11,774		930		36,948
Commercial(1)		73,846		166,759		46,789		287,394
Commercial, financial and agricultural		31,528		60,616		33,146		125,290
Tax-exempt		2,532		3,911		12,992		19,435
Consumer		3,101		2,677		717		6,495
Total	$	170,592	$	274,002	$	173,366	$	617,960

	Interest sensitivity
		Fixed rate		Variable rate
Due after one year		$	284,645	$	162,723

⁽¹⁾ Commercial loans have been adjusted for deferred fees, net of costs.

Critical factors in the overall management of credit quality are sound loan underwriting and administration, systematic monitoring of existing loans and commitments, effective loan review on an ongoing basis, allowance to provide for anticipated loan losses, and nonaccrual and charge-off policies.

Risk Management and the Allowance for Loan Losses

The loan portfolio is our primary asset subject to credit risk. To address this credit risk, we set aside an allowance for probable and inherent credit losses through periodic charges to our earnings. These charges are shown in our consolidated statements of operations as PFLL. See “Statement of Operations Analysis - Provision For Loan Losses” above. We attempt to control, monitor and minimize credit risk through the use of prudent lending standards, a thorough review of potential borrowers prior to lending, and ongoing and timely review of payment performance. Asset quality administration, including early identification of loans performing in a substandard manner as well as timely and active resolution of problems, further enhances management of credit risk and minimization of loan losses. Any losses that occur and are charged off against the ALL are periodically reviewed with specific efforts focused on achieving maximum recovery of both principal and interest.

In general, our loan policy establishes underwriting guidelines for each of our major loan categories. In addition to requiring financial statements, applications, credit histories and credit analyses for underwriting our loans, some of the more significant guidelines for specific types of loans are:

• For commercial real estate loans, maximum loan-to-value ratios range from 50% to 80% upon origination, depending on the collateral securing the loan. Loan terms have a maximum amortization period of 20 years. Hazard insurance is required on collateral securitizing the loan and appropriate legal work is performed to verify our lien position.

• For first mortgage 1-4 family residential real estate loans, maximum loan-to-value ratios do not generally exceed 80% upon origination, unless private mortgage insurance is purchased by the borrower. Loan terms have a maximum amortization period of 30 years. Hazard insurance is required on collateral securing the loan and appropriate title work is performed to verify our lien position.

• For commercial and industrial loans, loan-to-value ratios and loan terms will vary, reflecting varied collateral securitizing the loan. Documentation required for the loan transaction may include income tax returns, financial statements, profit and loss budgets and cash flow projections. Loans included in this type are short-term loans, lines of credit, term loans and floor plans.

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• For home equity loans and second mortgages, maximum loan-to-value ratios do not generally exceed 85%. Hazard insurance is required on collateral securing the loan and appropriate title work is performed to verify our lien position.

On a quarterly basis, management reviews the adequacy of the ALL. The analysis of the ALL consists of three components: (i) specific credit reserve established for expected losses relating to specific individual loans for which the recorded investment in the loans exceeds its fair value; (ii) general portfolio reserve based on historical loan loss experience for significant loan categories; and (iii) general portfolio reserve based on economic conditions as well as specific factors in the markets in which we operate.

The specific credit reserve for the ALL is based on a regular analysis by the loan officers of all commercial credits. The loan officers grade commercial credits and the loan review function validates the grades assigned. In the event that the loan review function downgrades the loan, it is included in the ALL analysis process at the lower grade. This grading system is in compliance with regulatory classifications. At least quarterly, all commercial loans that have been deemed impaired are evaluated. The fair value of the loan is determined based on either the present value of expected future cash flows discounted at the loan’s effective interest rate, the market price of the loan or, if the loan is collateral dependent, the fair value of the underlying collateral less the cost of sale. This evaluation may include obtaining supplemental market data and/or routine site visits to offer support to the evaluation process. If the carrying value of the loan exceeds the fair value less estimated costs to sell, a specific reserve is established. Such reserves are reviewed by the Delinquent Account Review Team.

We have two other major components of the ALL that do not pertain to specific loans: “General Reserves – Historical” and “General Reserves – Other.” We determine General Reserves – Historical based on our historical recorded charge-offs of loans in particular categories, analyzed as a group. As it relates to the historical loss component, we use the historical loss look-back period of the average eight and twelve quarters. We believe using the average of the eight and twelve quarters for historical charge-off factors enables the model to provide a reflection of the recent economic times. We determine General Reserves – Other by taking into account other factors, such as 1) changes in the nature, volume and terms of loans, 2) changes in lending personnel, 3) changes in the quality of the loan review function, 4) changes in nature and volume of past-due, nonaccrual and/or classified loans, 5) changes in concentration of credit risk, 6) changes in economic and industry conditions, 7) changes in legal and regulatory requirements, 8) unemployment and inflation statistics, and 9) changes in underlying collateral values. By nature, our general reserve changes with our fluid lending environment and the overall economic environment in which we lend. As such, we are continually attempting to enhance this portion of the allocation process to reflect anticipated losses in our portfolio driven by these changing factors. Economic statistics, specifically unemployment and inflation rates for national, state and local markets are monitored and factored into the allocation to address repayment risk. Further identification and management of portfolio concentration risks, both by loan category and by specific markets, is reflected in the general allocation component.

All of the factors we take into account in determining the ALL in the general categories are subject to change; thus, the reserves are not necessarily indicative of the loan categories in which future loan losses will occur. As loan balances and estimated losses in a particular loan type decrease or increase and as the factors and resulting allocations are monitored by management, changes in the risk profile of the various parts of the loan portfolio may be reflected in the allowance.

Table 7: Quarterly Allowance for Loan Loss Components

	12/31/13		09/30/13		6/30/13		3/31/13		12/31/12
	(dollars in thousands)
Component 1 – Specific credit reserve	$	642	$	669	$	1,492	$	290	$	1,340
Component 2 – General reserves		6,261		7,151		7,316		7,597		7,537
Unallocated		755		75		15		426		288
Allowance for Loan Losses	$	7,658	$	7,895	$	8,823	$	8,313	$	9,165

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Management believes the ALL is at an appropriate level to absorb probable and inherent losses in the loan portfolio at December 31, 2013 and while the model determines the ALL in components, the entire ALL is available to cover any loss within the loan portfolio. The unallocated portion of the ALL of $0.8 million at December 31, 2013 is due to the subjective nature of the model. Management believes the total ALL at December 31, 2013 is appropriate based on the risk profile of the related loan portfolio. Management continues to monitor our model results and will make necessary changes in the future when deemed necessary.

Proactive efforts to collect on all nonperforming loans, including use of the legal process when deemed appropriate to minimize the risk of further deterioration of such loans, will be ongoing. In the event that the facts and circumstances relating to these nonperforming loans change, additions to the ALL may become necessary. With respect to the remainder of the loan portfolio, while management uses available information to recognize losses on loans, future adjustments to the ALL may become necessary based on changes in economic conditions and the impact of such changes on our borrowers. Management remains watchful of credit quality issues and believes that issues within the portfolio are reflective of the challenging economic environment experienced over the past few years. Should the economic climate deteriorate further, the level of nonperforming loans, charge-offs and delinquencies could rise, warranting an increase in the provision.

As an integral part of their examination process, various regulatory agencies review the ALL as well. Such agencies may require that changes in the ALL be recognized when their credit evaluations differ from those of management, based on their judgments regarding information available to them at the time of their examinations.

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As Table 8 indicates, the ALL at December 31, 2013 was $7.7 million compared to $9.2 million at December 31, 2012. Loans increased 3.8% in 2013, while the allowance as a percent of gross loans decreased to 1.24% from 1.54% at year-end 2012. Net loan charge-offs decreased in 2013 to $2.9 million from $6.9 million in 2012. Net commercial real estate loan charge-offs represented 64.1% of the total net charge-offs for 2013 versus 65.5% for 2012, while commercial, financial and agriculture loan net charge-offs represented 16.7% of the total net charge-offs for 2013 versus 5.9% for 2012. Net residential real estate charge-offs represented 15.6% of total net charge-offs for 2013 versus 16.6% for 2012. Loans charged-off are subject to periodic review and specific efforts are taken to achieve maximum recovery of principal, accrued interest and related expenses.

Table 8: Loan Loss Experience

	Years Ended December 31, (Dollars in thousands)
	2013			2012			2011			2010			2009
Daily average amount of loans	$	601,228		$	623,685		$	629,759		$	642,312		$	699,091
Loans, end of period	$	617,960		$	595,533		$	631,015		$	629,891		$	651,894
ALL, at beginning of year	$	9,165		$	10,638		$	11,502		$	9,600		$	13,561
Loans charged off:
Real estate, residential		552			1,216			1,903			156			2,297
Real estate, construction		93			781			373			1,837			647
Real estate, commercial		2,132			5,075			3,499			5,443			3,766
Commercial, financial and agricultural		758			492			625			1,030			4,135
Consumer installment		55			108			223			123			413
Total loans charged off		3,590			7,672			6,623			8,589			11,258
Recoveries of loans previously charged off:
Real estate, residential		100			74			12			207			24
Real estate, construction		15			25			59			4			238
Real estate, commercial		269			557			103			1,316			149
Commercial, financial and agricultural		272			87			482			1,553			355
Consumer installment		27			31			53			61			31
Total loans recovered		683			774			709			3,141			797
Net loans charged off (“NCOs”)		2,907			6,898			5,914			5,448			10,461
Additions to ALL charged to operations		1,400			5,425			5,050			7,350			6,500
ALL, at end of year	$	7,658		$	9,165		$	10,638		$	11,502		$	9,600
Ratio of NCOs during period to average loans outstanding		0.48	%		1.11	%		0.94	%		0.85	%		1.50	%
Ratio of ALL to NCOs		2.63	X		1.33	X		1.80	X		2.11	X		0.92	X
Ratio of ALL to total loans end of period		1.24	%		1.54	%		1.69	%		1.83	%		1.47	%

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Table 9 shows the amount of the ALL by loan class on the dates indicated. It also shows the percentage of balances for each loan type to total loans. In general, it would be expected that those types of loans which have historically more risk of loss associated with them will have a proportionally larger amount of the ALL allocated to them than do loans that have historically less risk of loss.

Table 9: Allowance for Loan Losses by Loan Class

	As of December 31, (dollars in thousands)
	2013					2012					2011					2010					2009
	Amount		% of loans in each category to total loans			Amount		% of loans in each category to total loans			Amount		% of loans in each category to total loans			Amount		% of loans in each category to total loans			Amount		% of loans in each category to total loans
Commercial, financial & agricultural	$	663		20.3	%	$	678		18.3	%	$	770		14.6	%	$	1,189		11.7	%	$	1,496		12.8	%
Commercial real estate		4,431		46.5			5,787		18.9			5,467		50.2			6,355		54.6			4,558		54.2
Real estate
Construction		372		6.0			628		6.9			1,231		8.5			1,424		8.8			1,184		9.6
Residential		1,373		23.0			1,682		21.4			1,995		22.7			2,103		20.6			1,453		19.1
Consumer installment		64		1.1			102		1.3			161		1.4			391		1.6			375		1.8
Tax exempt		—		3.1			—		3.2			—		2.6			—		2.7			—		2.5
Not specifically allocated		755					288					1,014					40					534
Total allowance	$	7,658		100.0	%	$	9,165		100.0	%	$	10,638		100.0	%	$	11,502		100.0	%	$	9,600		100.0	%

Nonperforming Loans and Other Real Estate Owned

Management encourages early identification of nonaccrual and problem loans in order to minimize the risk of loss.

Nonperforming loans are defined as nonaccrual loans, loans 90 days or more past due but still accruing, and restructured loans non-accruing. Additionally, whenever management becomes aware of facts or circumstances that may adversely impact the collection of principal or interest on loans, it is the practice of management to place such loans on nonaccrual status immediately rather than waiting until the loans become 90 days past due. The accrual of interest income is discontinued when a loan becomes 90 days past due as to principal or interest, or earlier if the loan is moved to nonaccrual status before 90 days. When interest accruals are discontinued, unpaid interest credited to income is reversed. If collection is in doubt, cash receipts on nonaccrual loans are used to reduce principal rather than recorded as interest income.

Restructuring loans involves the granting of some concession to the borrower involving a loan modification, such as payment schedule changes, interest rate reductions, or principal charge-offs. A troubled debt restructuring (“TDR”) includes a loan modification where a borrower is experiencing financial difficulty and we grant a concession to that borrower that we would not otherwise consider except for the borrower’s financial difficulties. A TDR may be either accrual or nonaccrual status based upon the performance of the borrower and management’s assessment of collectability. A loan that is modified at a market rate of interest may no longer be classified as a TDR in the calendar year subsequent to the restructuring if it is in compliance with the modified terms. If a TDR is placed on nonaccrual status, it remains there until a sufficient period of performance under the restructured terms has occurred at which time it is returned to accrual status, generally six months.

Also included in our restructured notes are modifications where a note is separated into two notes (A/B notes). The A note is considered an impaired loan, either accruing or nonaccruing while the B note is charged-off. The A note will be considered a TDR through the current calendar year in which it was restructured, but may no longer be classified as a TDR in the calendar year subsequent to the restructuring if it is in compliance with the modified terms.

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Table 10: Nonperforming Loans and Other Real Estate Owned

	December 31, (dollars in thousands)
	2013			2012			2011			2010			2009
Nonaccrual loans	$	6,403		$	10,724		$	15,242		$	15,877		$	23,247
Accruing loans past due 90 days or more		—			—			—			—			—
Restructured loans, non-accruing		255			3,724			4,341			623			3,343
Total nonperforming loans (“NPLs”)		6,658			14,448			19,583			16,500			26,590
Other real estate owned, net		6,298			10,476			12,119			15,952			14,995
Total nonperforming assets (“NPAs”)	$	12,956		$	24,924		$	31,702		$	32,452		$	41,585
Ratios:
NPLs to total loans		1.08	%		2.42	%		3.10	%		2.62	%		4.08	%
NPAs to total assets		1.30	%		2.44	%		2.92	%		3.08	%		3.98	%
ALL to NPLs		115.02	%		63.44	%		54.32	%		69.71	%		36.10	%

Nonperforming loans at December 31, 2013 were $6.7 million compared to $14.4 million at December 31, 2012. Nonperforming loans decreased $7.7 million, or 53.9% from December 31, 2012. Management believes collateral is currently sufficient to recover the net carrying value of those loans in the event of foreclosure or repossession, and has aggressively charged off collateral deficiencies. Our assessment is based on recent appraisals, professional market valuations and/or sales agreements with respect to each of the properties. Management is continually monitoring these relationships and in the event facts and circumstances change, additional PFLLs may be necessary.

Table 11: Quarterly Nonaccrual and Restructured Loans

	Quarters Ended (dollars in thousands)
	12/31/13		09/30/13		06/30/13		03/31/13		12/31/12
Nonaccrual loans	$	6,403	$	6,215	$	8,231	$	8,499	$	10,724
Restructured loans, non-accruing		255		299		114		140		3,724
Total nonperforming loans	$	6,658	$	6,514	$	8,345	$	8,639	$	14,448
Restructured loans, accruing interest	$	9,009	$	9,020	$	3,959	$	3,267	$	3,931

As of December 31, 2013, loans in the restructured loans accruing category were $9.0 million, an increase of $5.1 million, or 129.2%, from December 31, 2012. During 2013, $6.9 million in loans were transferred to TDR status, $0.3 million in loans were transferred out of TDR accruing status to nonaccrual, $1.4 million in loans were transferred out of TDR accruing status due to compliance with restructured terms, and $0.1 million in principal payments were received on TDR accruing loans.

Loans in the restructured non-accrual category decreased $3.4 million, or 93.2%, from $3.7 million at December 31, 2012 to $0.3 million at December 31, 2013. The major reasons for the changes were decreases due to principal payments ($3.1 million) and charge-offs ($0.6 million), partially offset by transfers from TDR accruing ($0.3million).

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Table 12: 30-89 Days Past Due Loans

The following table presents an analysis of our past due loans excluding nonaccrual loans:

PAST DUE LOANS (EXCLUDING NONACCRUALS)
30-89 DAYS PAST DUE
(Dollar amounts in thousands)

	12/31/13			09/30/13			06/30/13			03/31/13			12/31/12
Total secured by real estate	$	1,039		$	2,621		$	3,346		$	4,290		$	2,333
Commercial and industrial loans		15			707			700			699			903
Loans to individuals		26			16			24			39			29
All other loans		—			—			—			—			—
Total	$	1,080		$	3,344		$	4,070		$	5,028		$	3,265
Percent of total loans		0.17	%		0.55	%		0.68	%		0.85	%		0.55	%

As indicated above, loan balances 30 to 89 days past due have decreased by $2.2 million since December 31, 2012.

Table 13: Foregone Loan Interest

The following table shows, for those loans accounted for on a nonaccrual basis for the years ended as indicated, the gross interest that would have been recorded if the loans had been current in accordance with their original terms and the amount of interest income that was included in interest income for the period.

	Years ended December 31, (dollars in thousands)
	2013		2012			2011
Interest income in accordance with original terms	$	276	$	573		$	1,250
Interest income recognized		—		(110	)		(98	)
Reduction in interest income	$	276	$	463		$	1,152

Table 14: Other Real Estate Properties Summary

Other real estate properties, which represent properties that we acquired through foreclosure or in satisfaction of debt or bank facilities no longer in use, totaled $6.3 million at December 31, 2013. This compared to $10.5 million at year-end 2012. Management actively seeks to ensure that properties held are administered to minimize any risk of loss.

Activity for other real estate properties for 2013, 2012 and 2011, including costs of operation are shown below:

	Years ended December 31, (dollars in thousands)
	2013			2012			2011
Income from operation of other real estate properties	$	—		$	329		$	391
Expense from operation of other real estate properties		(1,395	)		(4,369	)		(2,736	)
Net gains from sale of other real estate properties		426			194			205
Cost of operation and sale of other real estate properties	$	(969	)	$	(3,846	)	$	(2,140	)

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Investment Portfolio

Our investment portfolio is intended to provide us with adequate liquidity, flexibility in asset/liability management and earning potential.

Table 15: Investment Portfolio

	December 31, (dollars in thousands)
	2013		2012		2011
Securities Available for Sale (“AFS”):
U.S. Treasury and U.S. government sponsored agency securities	$	3,014	$	2,008	$	14,089
Obligations of states and political subdivisions		56,630		54,833		53,638
Mortgage-backed securities		149,985		164,792		191,343
Asset-backed securities		3,782		4,406		5,288
Private placement and corporate bonds		3,520		5,629		12,070
Other equity securities		1,905		1,654		1,654
Total AFS amortized cost	$	218,836	$	233,322	$	278,082
Total AFS fair value and carrying value	$	220,608	$	242,019	$	284,331
Securities Held to Maturity (“HTM”):
Obligations of states and political subdivisions	$	10,275	$	—	$	—
Total HTM amortized cost and carrying value		10,275		—		—
Total HTM fair value		10,275		—		—

Securities classified as available for sale are those securities which we have determined might be sold to manage interest rates, reposition holdings to increase returns or modify durations, or in response to changes in interest rates or other economic factors. They may or may not be held until maturity. Securities available for sale are carried at fair value. We evaluate securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. As part of such monitoring, the credit quality of individual securities and their issuers is assessed. Adjustments to market value that are considered temporary are recorded as a separate component of other comprehensive income, net of tax. If an impairment of a security is identified as other-than-temporary based on information available, such as the decline in the creditworthiness of the issuer, external market ratings or the anticipated or realized elimination of associated dividends, such impairments are further analyzed to determine if a credit loss exists. If there is a credit loss, it will be recorded in the consolidated statement of operations. Unrealized losses other than credit losses will continue to be recognized in other comprehensive income, net of tax. Unrealized losses have not been included in the results of operations because the unrealized losses were not deemed other-than-temporary. We do not have the intent to sell the securities and have determined that it is not more likely than not that we will be required to sell the debt securities before their anticipated recovery and therefore, there is no other-than-temporary impairment. The losses on these securities are expected to dissipate as they approach their maturity dates and/or if interest rates decline.

During 2013, securities with a fair value of $6.4 million were sold and $53.8 million of other securities were purchased. Gains of $0.6 million were realized on the sale of securities in 2013.

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Table 16: Securities Portfolio Maturity Distribution(dollars in thousands, rates on a tax-equivalent basis)

	Securities AFS – maturity distribution and weighted average yield at December 31, 2013
	Within one year					After one year but Within five years					After five years but Within ten years					After ten years					Total
	Amount		Yield			Amount		Yield			Amount		Yield			Amount		Yield			Amount		Yield
U.S. government-sponsored agency securities	$	—		—	%	$	—		—	%	$	2,964		2.38	%	$	—		—	%	$	2,964		2.38	%
Mortgage-backed securities		9,775		5.04			102,097		2.83			32,348		2.47			5,665		2.05			149,885		2.87
Asset-backed securities		—		—			2,793		1.26			—		—			957		1.71			3,750		1.37
Obligations of states and political subdivisions		920		2.18			19,850		3.43			36,711		3.78			1,188		4.21			58,669		3.64
Private placement and corporate bonds		—		—			—		—			—		—			3,435		5.90			3,435		5.90
Other securities		1,905		5.32			—		—			—		—			—		—			1,905		5.32
Total carrying value	$	12,600		4.88	%	$	124,740		2.80	%	$	72,023		3.13	%	$	11,245		3.43	%	$	220,608		3.06	%

	Securities HTM – maturity distribution and weighted average yield at December 31, 2013
Mortgage-backed securities	$	—	—	%	$	—	—	%	$	10,275	2.67	%	$	—	—	%	$	10,275	2.67	%

Average securities balances totaled $241.2 million in 2013 compared with $269.2 million in 2012. In 2013, average taxable securities comprised approximately 75.5% of the total average investments compared to 78.2% in 2012.

Goodwill

Goodwill is not amortized but is subject to impairment tests on an annual basis or more frequently if deemed appropriate.

During 2013, we hired a third party valuation firm to determine an estimated cash fair value of our common stock. Consideration was given to our nature and history, the competitive and economic outlook for our trade area and for the banking industry in general, our book value and financial condition, our future earnings and dividend paying capacity, the size of the block valued, and the prevailing market prices of bank stocks. The following valuation methodologies were considered: 1) net asset value – defined as our net worth, 2) market value – defined as the price at which knowledgeable buyers and sellers would agree to buy and sell our common stock, and 3) investment value – defined as an estimate of the present value of the future benefits, usually earnings, cash flow, or dividends, that will accrue to our common stock. When consideration was given to the three valuation methodologies, as well as all other relevant valuation variables and factors, the fully-diluted cash fair value range of our common shares was considered to be in excess of the book value. Since the valuation ranges obtained from that firm exceeded the carrying value including goodwill, step one of the impairment test established under generally accepted accounting principles was met and, therefore, no goodwill impairment was recognized. If the carrying amount would have exceeded fair value, we would have performed the second step to measure the amount of impairment loss. Based on the valuation obtained as of September 30, 2013, the valuation exceeded the carrying value by a range of 41% to 52%. As of December 31, 2013, there are no conditions that would require goodwill impairment to be reevaluated.

Deposits

Deposits are our largest source of funds. Average total deposits for 2013 were $758.3 million, a decrease of 9.7% from 2012. At December 31, 2013, deposits totaled $744.2 million, a decrease of $61.8 million (7.7%) from $806.0 million at December 31, 2012. In November 2013, $15.6 million in deposits were sold in conjunction with the closure of two branches. Additionally, brokered deposits of $19.6 million and $2.6 million of deposits obtained in previous years by utilizing a national deposit listing service that matured in 2013 were not renewed. We also saw a customer preference towards money market deposits as customers moved out of time deposits. Average brokered certificates of deposit decreased $21.7 million (50.2%) between 2012 and 2013 and total brokered deposits decreased $24.7 million to $11.5 million at year-end 2013 from $36.2 million at December 31, 2012. The reliance on brokered certificates of deposit as a noncore source of funding decreased as loan demand declined and less expensive sources of wholesale funds became available during 2013. From a liquidity standpoint, those funds were not necessary as our cash position was sufficient to pay time deposits as they matured and otherwise provided us with liquidity for our operations. Management views brokered certificates of deposits as a stable source of funds. If liquidity concerns arise, we believe (but cannot be assured) that we have alternative sources of funds, such as lines with correspondent banks and borrowing arrangements with the FHLB. Typically, overall deposit balances for the first six months of the year tend to decline slightly as a result of the seasonality of our customer base, as customers draw down deposits during the first half of the year in anticipation of the summer tourist season.

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Table 17: Average Deposits Distribution

	For the year ended December 31, (dollars in thousands)
	2013								2012								2011
	Amount		% of Total			Average Rate			Amount		% of Total			Average Rate			Amount		% of Total			Average Rate
Noninterest-bearing demand deposits	$	125,498		16.6	%		0.0	%	$	114,787		13.7	%		0.0	%	$	96,385		11.5	%		0.0	%
Interest-bearing demand deposits		133,452		17.6			0.1			139,011		16.6			0.2			131,509		15.6			0.3
Savings deposits (excluding brokered deposits)		298,933		39.4			0.1			310,298		37.0			0.2			291,132		34.6			0.5
Other time deposits (excluding brokered deposits)		127,850		16.9			0.8			147,559		17.5			1.8			184,156		21.9			1.57
Time deposits $100,000 and over (excluding brokered deposits)		51,039		6.7			1.0			84,599		10.1			1.3			89,988		10.7			1.57
Brokered deposits		21,544		2.8			1.8			43,238		5.1			2.1			47,957		5.7			1.78
Total deposits	$	758,316		100.0	%				$	839,492		100.0	%				$	841,127		100.0	%

Table 18: Maturity Distribution-Certificates of Deposit and Other Time Deposits of $100,000 or More

	December 31, 2013 (dollars in thousands)
	Certificates of Deposit		Other Time Deposits		Total
Three months or less	$	8,205	$	2,192	$	10,397
Over three months through six months		3,356		416		3,772
Over six months through twelve months		15,015		1,284		16,299
Over twelve months		13,264		1,195		14,459
Total	$	39,840	$	5,087	$	44,927

As shown in Table 17, noninterest bearing demand deposits in 2013 averaged $125.5 million, up 9.3% from $114.8 million in 2012. This $10.7 million increase reflects the shift from time deposits to transactional accounts due to the continued low interest rate environment. As of December 31, 2013, noninterest-bearing demand deposits totaled $127.9 million compared to $132.5 million at year-end 2012.

Interest-bearing deposits generally consist of interest-bearing checking accounts, savings accounts, money market accounts, individual retirement accounts (“IRAs”) and certificates of deposit (“CDs”). In 2013, interest-bearing deposits averaged $632.8 million, a decrease of 12.7% from 2012. Average balances of NOW accounts, savings deposits and money market accounts decreased $16.9 million (3.8%) as a result of customer preference in a low interest rate environment. During the same period, time deposits, including CDs and IRAs (other than brokered time deposits and time deposits over $100,000) decreased on average by $19.7 million (13.4%), primarily in response to customer reaction to aggressive rate declines in national markets. Average time deposits over $100,000, other than brokered time deposits, decreased by $33.6 million (39.7%). These deposits were priced within the framework of our rate structure and did not materially affect the average rates on deposit liabilities. Increased competition for consumer deposits and customer awareness of interest rates continue to limit our core deposit growth in these types of deposits. Because of decreased loan demand, we were able to reduce our average brokered deposits by $21.7 million, (50.2%) in 2013 compared to 2012.

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In 2014, we will continue to focus on attracting and retaining core deposit accounts and expanding customer deposit relationships by emphasizing customer service and convenience and new product offerings, and competitive pricing. In the event that core deposit growth goals are not accomplished, we will continue to look at other wholesale sources of funds.

Other funding sources

Total other funding sources, including short-term borrowings, Federal Home Loan Bank (“FHLB”) advances, convertible promissory notes and subordinated debentures, were $150.6 million at December 31, 2013, an increase of $33.5 million, (28.7%), from $117.1 million at December 31, 2012. Borrowings from the FHLB are secured by our portfolio of one-to-four family residential first mortgages, home equity loans and lines of credit and eligible investment securities allowing us to use FHLB borrowings for additional funding purposes.

Table 19: Short-term Borrowings

	December 31, (dollars in thousands)
	2013			2012			2011
Securities sold under agreements to repurchase:
Balance end of year	$	58,448		$	51,568		$	47,566
Average amounts outstanding during year		34,728			27,578			26,013
Maximum month-end amounts outstanding		69,902			51,568			47,566
Average interest rates on amounts outstanding at end of year		0.11	%		0.35	%		0.41	%
Average interest rates on amounts outstanding during year		0.23	%		0.22	%		0.30	%

Securities are sold to Bank customers under repurchase agreements at prevailing market rates.

Long-term Debt

On March 31, 2006, we issued $16.1 million of trust preferred securities and $0.5 million of trust common securities issued under the name Baylake Capital Trust II (“the Trust”) that adjust quarterly at a rate equal to 1.35% over the three month LIBOR (1.60% at December 31, 2013). The Trust’s ability to pay amounts due on the trust preferred securities is solely dependent upon our making payment on the related subordinated debentures to the Trust. Our obligations under the subordinated debentures include a conditional guarantee by us of the Trust’s obligations under the trust securities issued by the Trust. In addition, under the terms of the Debentures, we would be precluded from paying dividends on our common stock if we were in default under the Debentures, if we exercised our right to defer payments of interest on the Debentures or if certain related defaults occurred. At December 31, 2013 we are current on our interest payments on the Debentures.

During 2009 and 2010, we completed closings of a private placement of our 10% Convertible Notes due June 30, 2017. The Convertible Notes were offered and sold in reliance on the exemption from registration under Section 4(2) of the Securities Act of 1933 and Rule 506 thereunder. Through December 31, 2010 we issued $9.45 million principal amount of the Convertible Notes, at par, and received gross proceeds in the same amount.

The Convertible Notes accrue interest at a fixed rate of 10% per annum upon issuance and until maturity or earlier conversion or redemption. Interest is payable quarterly, in arrears, on January 1, April 1, July 1, and October 1, of each year. The Convertible Notes are convertible into shares of our common stock at a conversion ratio of one share of common stock for each $5.00 in aggregate principal amount held on the record date of the conversion subject to certain adjustments as described in the Convertible Notes. Beginning on July 1, 2014, we may redeem the Convertible Notes in whole or in part. A notice of redemption supersedes and takes priority over any notice of conversion. Prior to October 1, 2014, each holder of the Convertible Notes may convert up to 100% (at the discretion of the holder) of the original principal amount into shares of our common stock at the conversion ratio. On October 1, 2014, one-half of the original principal amounts are mandatorily convertible at the conversion ratio if conversion has not already occurred. The principal amount of any Convertible Note that has not been converted or redeemed is payable at maturity on June 30, 2017. We are not obligated to register the common stock related to the conversion of the Convertible Notes. In the fourth quarter of 2012, Convertible Notes in the amount of $50,000 were converted to 10,000 shares of common stock at the investor’s option. Subsequent to December 31, 2013, Convertible Notes in the amount of $0.2 million were converted to 40,000 shares of common stock at the investor’s option.

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We incurred debt offering issuance costs of $0.2 million in conjunction with the issuance of the Convertible Notes. These costs were capitalized and are being amortized to interest expense using the effective interest method over the initial conversion term, which runs through September 30, 2014.

Off-Balance Sheet Arrangements

We do not currently use interest rate contracts (e.g. swaps), forward loan sales or other derivatives to manage interest rate risk and do not have any of these instruments outstanding. The Bank does have, through its normal operations, loan commitments and standby letters of credit outstanding as of December 31, 2013 and 2012 in the amount of $228.2 million and $245.9 million, respectively. These are further explained in Note 14 of the Notes to Consolidated Financial Statements in Item 8 below.

Contractual Obligations

As of December 31, 2013, we were contractually obligated under long-term agreements as follows:

Table 20: Contractual Obligations

	Payments due by period (dollars in thousands)
	Total		Less than 1 year		1 to 3 years		3 to 5 years		More than 5 years
Certificates of deposit and other time deposit obligations	$	155,169	$	102,464	$	50,132	$	2,573	$	—
Repurchase agreements		58,448		58,448		—		—		—
Subordinated debentures		16,100		—		—		—		16,100
Convertible promissory notes(1)		9,400		4,700		—		4,700		—
FHLB advances		66,700		41,000		17,000		5,200		3,500
Totals	$	305,817	$	206,612	$	67,132	$	12,473	$	19,600

(1) One-half of the Convertible Notes are mandatorily convertible to shares of common stock by October 1, 2014. The principal amount of any Convertible Note that has not been converted or redeemed is payable at maturity on June 30, 2017. We expect all notes to convert by September 30, 2014.

For a discussion of these contractual obligations, see Note 11, “Subordinated Debentures,” and Note 12, “Convertible Promissory Notes,” to the Consolidated Financial Statements included in Item 8 below.

Liquidity

Liquidity management refers to our ability to ensure that cash is available in a timely manner to meet loan demand and depositors’ needs, and to service other liabilities as they become due, without undue cost or risk, or causing a disruption to normal operating activities. We believe we have sufficient cash on hand to meet our current obligations. We and the Bank have different liquidity considerations.

Our primary sources of funds are dividends from the Bank and net proceeds from borrowings and the offerings of subordinated debentures and convertible promissory notes. We may also undertake offerings of debt and issue our common stock if and when we deem it prudent to do so, subject to regulatory approval if required. We generally manage our liquidity position in order to provide funds necessary to meet interest obligations of our trust preferred securities and convertible notes, pay dividends to our shareholders, and repurchase shares. Prior to 2008, dividends received from the Bank were our main source of liquidity. Beginning in the first quarter of 2008, we and the Bank were required to get regulatory approval prior to the declaration or payment of any dividends. During the period from 2008 through 2011, our liquidity was supported by cash balances available at the time of the written agreement and the proceeds from the issuance of the promissory notes in 2009 and 2010. Effective December 2012, the requirement for us and the Bank to obtain approval prior to declaring or paying a dividend is no longer in place.

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The Bank meets its cash flow needs by having funding sources available to it to satisfy the credit needs of customers as well as having available funds to satisfy deposit withdrawal requests. Liquidity at the Bank is derived from deposit growth, payments on and maturities of loans, payments on and maturities of the investment portfolio, access to other funding sources, marketability of certain assets, the ability to use its loan and investment portfolios as collateral for secured borrowings and a strong capital position.

Maturing investments and investment sales have been a primary source of liquidity at the Bank. Principal payments on investments totaling $48.0 million were received in 2013 and $6.4 million of proceeds were received from investment sales. Offsetting these amounts, $52.0 million in investments were purchased in 2013. At December 31, 2013, the carrying value of investment securities maturing within one year was $12.6 million, or 5.5% of the total investment securities portfolio. This compares to 3.3% of our investment securities with one year or less maturities as of December 31, 2012. At December 31, 2013 and 2012 the mortgage-backed securities portfolio was $160.2 million and $169.1 million, respectively, representing 69.4% and 69.9% of the investment portfolio, respectively. Approximately 8.8%, or $14.1 million, of the mortgage-backed securities outstanding at December 31, 2013 were issued and guaranteed by the Government National Mortgage Associate (“GNMA”), Small Business Administration (“SBA”) or the United States Department of Veterans Affairs (“VA”); agencies of the United States government. An additional 76.4%, or $122.4 million, of the mortgage-backed securities outstanding at December 31, 2013 were issued by either the Federal National Mortgage Association (“FNMA”), the Federal Home Loan Mortgage Corporation (“FHLMC”), or FHLB; United States government-sponsored agencies. Non-agency mortgage-backed securities present a level of credit risk that does not exist with agency-backed securities, but only comprised approximately 14.8%, or $23.7 million, of the outstanding mortgage-backed securities at December 31, 2013. We evaluate these non-agency mortgage-backed securities at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation.

During February 2012, proceeds of $2.1 million were received from the FHLB under their excess FHLB stock repurchase program that was implemented in 2011. Additional proceeds of $0.6 million and $0.5 million were received in May 2012 and August 2012, respectively, from the stock repurchase program.

During 2013 and 2012, we maintained large balances at the Reserve Bank for liquidity purposes. On average, those balances were $28.6 million in 2013 and $51.2 million in 2012. At year-end 2013, the balance was $53.2 million. We anticipate reducing those balances in 2014.

Deposit growth is another potential source of liquidity for the Bank. As a financing activity reflected in the 2013 Consolidated Statements of Cash Flows, deposit decreases were $61.7 million in 2013. The Bank’s overall average deposit base decreased $61.8 million or 7.7% during 2013. Deposit growth is potentially the most stable source of liquidity for the Bank, although brokered deposits are inherently less stable than locally generated core deposits. Affecting liquidity are core deposit growth levels, certificate of deposit maturity structure and retention, and characteristics and diversification of wholesale funding sources affecting the channels by which brokered deposits are acquired. Conversely, deposit outflow would require the Bank to develop alternative sources of funds which may not be as liquid and may be potentially a more costly alternative.

Federal funds sold averaged $2.3 million in 2013 compared to $3.3 million in 2012. Funds provided from the maturity of these assets typically are used as funding sources for seasonal loan growth, which typically has higher yields. Short-term and liquid by nature, federal funds sold generally provide a yield lower than other earning assets. The Bank has a strategy of maintaining a sufficient level of liquidity to accommodate fluctuations in funding sources and will at times take advantage of specific opportunities to temporarily invest excess funds at narrower than normal rate spreads while still generating additional interest revenue. At December 31, 2013, the Bank had $0.1 million federal funds sold.

The scheduled maturity of loans can provide a source of additional liquidity. At December 31, 2013, the Bank had $170.6 million, or 27.6% of total loans maturing within one year. Factors affecting liquidity relative to loans are loan origination volumes, loan prepayment rates and the maturity structure of existing loans. The Bank’s liquidity position is influenced by changes in interest rates, economic conditions and competition. Conversely, loan demand as a need for liquidity will cause us to acquire other sources of funding which could be harder to find and, therefore, more costly to acquire.

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Within the classification of short-term borrowings at year-end 2013, securities sold under agreements to repurchase totaled $58.4 million. At December 31, 2013, the Bank had no federal funds purchased. Generally, federal funds are purchased from various upstream correspondent banks while securities sold under agreements to repurchase are obtained from a base of business customers. At December 31, 2013, the Bank had $60.0 million available in the form of federal funds lines. Short-term and long-term FHLB advances are another source of funds, with $66.7 million outstanding at year-end 2013. At December 31, 2013, the Bank had an additional $22.1 million of available FHLB credit.

The Bank’s liquidity resources were sufficient in 2013 to fund the deposit run-off from the sale of the branches, and meet other cash needs as they arose.

We continue to focus on expanding customer deposit relationships and attracting core deposit accounts by emphasizing customer service while maintaining competitive pricing. In the event that core deposit growth goals are not accomplished, we will continue to look at other wholesale sources of funds. In addition, we may acquire additional brokered deposits as funding for short-term liquidity needs. Short-term liquidity needs will also be addressed by growth in short-term borrowings, maturing federal funds sold and portfolio investments, and loan maturities and prepayments.

In assessing liquidity, historical information such as seasonality (the effect on liquidity of loan demand starts before and during the tourist season and deposit draw down which affects liquidity shortly before and during the early part of the tourist season), local economic cycles and the economy in general are considered along with our current financial position and projections. Management believes that, in the current economic environment, our liquidity position is adequate. To our knowledge, there are no known trends nor any known demands, commitments, events or uncertainties that will result or are reasonably likely to result in material increases or decreases in our liquidity.

Capital Resources

Stockholders’ equity at December 31, 2013 increased $0.8 million or 0.8% to $93.9 million, compared to $93.1 million at the end of 2012. Accumulated other comprehensive income decreased to $1.1 million at year-end 2013 versus accumulated other comprehensive income of $5.3 million at year-end 2012. The ratio of stockholders’ equity to assets at December 31, 2013 was 9.42%, compared to 9.10% at year-end 2012.

Under applicable regulatory guidelines, the Trust Preferred Securities qualify as Tier 1 capital up to a maximum of 25% of Tier 1 capital. Any additional portion of Trust Preferred Securities qualify as Tier 2 capital. As of December 31, 2013, all $16.1 million of the Trust Preferred Securities qualify as Tier 1 capital. Our convertible promissory notes, which qualify as Tier 2 capital, totaled $9.4 million at the end of 2013.

Cash dividends of $0.22 and $0.08 per share were declared and paid in 2013 and 2012, respectively. In January 2014, we declared a $0.07 per share dividend payable in March 2014.

On May 23, 2013, after review of our capital position, our board of directors approved the Repurchase Program, authorizing us to repurchase up to 400,000 shares of our stock through May 30, 2014. During the second quarter of 2013, 10,000 shares were repurchased under this program. 143,000 shares and 10,000 shares were repurchased under this program during the third and fourth quarters of 2013, respectively. The total shares repurchased during 2013 was 163,000 shares. 237,000 shares may yet be repurchased.

The adequacy of our capital is regularly reviewed to ensure that sufficient capital is available for current and future needs and is in compliance with regulatory guidelines. The assessment of overall capital adequacy depends upon a variety of factors, including asset quality, liquidity, stability of earnings, changing competitive forces, economic conditions in markets served and strength of management.

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The FRB has established capital adequacy rules which take into account risks attributable to balance sheet assets and off-balance sheet activities. All banks and bank holding companies must meet a minimum total risk-based capital ratio of 8%. Of the 8% required, at least half must consist of core capital elements defined as Tier 1 capital. The federal banking agencies also have adopted leverage capital guidelines which banking organizations must meet. Under these guidelines, the most highly rated banking organizations must meet a leverage ratio of at least 3% Tier 1 capital to assets, while lower rated banking organizations must maintain a ratio of at least 4% to 5%. Failure to meet minimum capital requirements can initiate certain mandatory and possible additional discretionary actions by regulators that, if undertaken, could have a material adverse effect on the consolidated financial statements.

Effective December 29, 2010, we and the Bank entered into a written agreement with the Reserve Bank and the WDFI (the “Written Agreement”). Under the terms of the Written Agreement, both we and the Bank agreed, among other things, to: (a) submit for approval plans to maintain sufficient capital; (b) comply with applicable notice provisions with respect to the appointment of new directors and senior executive officers and legal and regulatory limitations on indemnification payments and severance payments; (c) refrain from declaring or paying dividends absent prior regulatory approval. Failure to comply with the provisions of the Written Agreement could have resulted in the imposition of additional restrictions and/or sanctions by the FRB and WDFI and could have had a material adverse effect on our consolidated financial condition and results of operation. Effective June 4, 2012, the FRB and WDFI terminated the Written Agreement in favor of an informal agreement that was entered into June 19, 2012 between us and the FRB and WDFI. This informal agreement required both us and the Bank to (i) refrain from declaring or paying dividends absent prior regulatory approval, (ii) submit capital plans as evidence of sufficient capital and (iii) submit an annual business plan and budget at least 30 days prior to the beginning of the year. The informal agreement was subsequently terminated effective December 14, 2012.

To be “well capitalized” under the regulatory framework, the Tier 1 capital ratio must meet or exceed 6%, the total capital ratio must meet or exceed 10% and the leverage ratio must meet or exceed 5%. As of December 31, 2013, our Tier 1 capital ratio was 14.26%, our total capital ratio was 16.71%, and our leverage ratio was 10.48%.

Management believes that a strong capital position is necessary to take advantage of opportunities for profitable expansion of product and market share and to provide depositor and investor confidence. Our capital level must be maintained at an appropriate level to provide the opportunity for an adequate return on the capital employed. Management actively reviews our capital strategies to ensure that capital levels are appropriate based on the perceived business risks, further growth opportunities, industry standards, and regulatory requirements.

Recent Accounting Pronouncements

See Note 1 to the Notes to Consolidated Financial Statements titled “Recent Accounting Pronouncements.”

ITEM 7A.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

Interest Rate Sensitivity Management

Our business and the composition of our consolidated balance sheet consist of investments in interest-earning assets (including loans and securities) which are primarily funded by interest-bearing liabilities (deposits and borrowings). We maintain all of our financial instruments for non-trading purposes. Such financial instruments have varying levels of sensitivity to changes in market rates of interest. Our operating income and net income depends, to a substantial extent, on “rate spread” (i.e., the differences between the income we receive from loans, securities, and other earning assets and the interest expense we pay to obtain deposits and other liabilities). These rates are highly sensitive to many factors that are beyond our control, including general economic conditions and the policies of various governmental and regulatory authorities.

We measure our overall interest rate sensitivity through a net interest income analysis. The net interest income analysis measures the changes in net interest income in the event of hypothetical changes in interest rates. This analysis assesses the risk of changes in net interest income in the event of an immediate and sustained 100 bp and 200 bp increase in market interest rates or a 100 bp and 200 bp decrease in market rates. The interest rate scenarios are used for analytical purposes and do not necessarily represent management’s view of future market interest rate movements. The table below presents our projected changes in net interest income for 2014 based on financial data at December 31, 2013, for the various rate shock levels indicated.

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Table 21: Net Interest Income Sensitivity Analysis

Potential impact on 2014 consolidated net interest income	Net Interest Income (Dollars in thousands)
	Potential Change in Net Interest Income ($)			Potential Change in Net Interest Income (%)
+ 200 bps	$	(1,623	)		(5.22	)%
+ 100 bps	$	(1,262	)		(4.06	)%
Base
- 100 bps	$	(1,013	)		(3.26	)%
- 200 bps	$	(1,812	)		(5.83	)%

Note: The table above may not be indicative of future results.

In order to limit exposure to interest rate risk, we have developed strategies to manage our liquidity, shorten the effective maturities of certain interest-earning assets, and increase the effective maturities of certain interest-bearing liabilities including the FHLB borrowings. The origination of floating rate loans such as business, construction and other prime or London Interbank Offered Rate (“LIBOR”)-based loans is emphasized. The majority of fixed rate loans have re-pricing periods less than five years. The mix of floating and fixed rate assets is designed to mitigate the impact of rate changes on our net interest income.

There can be no assurance that the results of operations would be impacted as indicated in the above table if interest rates did move by the amounts discussed above. Management continually reviews its interest risk position through its Asset/Liability Management Committee. Management’s philosophy is to maintain relatively matched rate sensitive asset and liability positions within the range described above in order to provide earnings stability in the event of significant interest rate changes.

ITEM 8.FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Our Consolidated Financial Statements are included on the pages that follow.

REPORT BY BAYLAKE CORP.’S MANAGEMENT
ON INTERNAL CONTROL OVER FINANCIAL REPORTING

Our management is responsible for establishing and maintaining an effective system of internal control over financial reporting, as such term is defined in Section 13a-15(f) of the Securities Exchange Act of 1934. The Company’s system of internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. There are inherent limitations in the effectiveness of any system of internal control over financial reporting, including the possibility of human error and circumvention or overriding of controls. Accordingly, even an effective system of internal control over financial reporting can provide only reasonable assurance with respect to financial statement preparation. Projections of any evaluation of effectiveness to future periods are subject to the risks that controls may become inadequate because of changes in conditions or that the degree of compliance with the policies or procedures may deteriorate.

Management maintains a comprehensive system of internal controls intended to ensure that transactions are executed in accordance with management’s authorization, assets are safeguarded and financial records are reliable. Management also takes steps to see that information and communication flows are effective and to monitor performance, including performance of internal control procedures.

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Management assessed the Company’s systems of internal control over financial reporting as of December 31, 2013. This assessment was based on criteria for effective internal control over financial reporting described inInternal Control – Integrated Frameworkissued by the CommitteeofSponsoring Organizations of the Treadway Commission. Based on this assessment, management believes that as of December 31, 2013, the Company maintained effective internal control over financial reporting based on those criteria.

The Company’s independent registered public accountants have issued an audit report on the effectiveness of the Company’s internal control over financial reporting.

	/s/ Robert J. Cera		/s/ Kevin L. LaLuzerne
Robert J. Cera President and Chief Executive Officer		Kevin L. LaLuzerne Senior Vice President and Chief Financial Officer

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Shareholders, Audit Committee and Board of Directors
Baylake Corp.
Sturgeon Bay, WI

We have audited the accompanying consolidated balance sheets of Baylake Corp. (the “Company”) as of December 31, 2013 and 2012, and the related consolidated statements of operations, comprehensive income, changes in stockholders’ equity and cash flows for the years ended December 31, 2013, 2012, and 2011. We also have audited Baylake Corp.’s internal control over financial reporting as of December 31, 2013, based on criteria established inInternal Control – Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management as well as evaluating the overall consolidated financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of consolidated financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of consolidated financial statements in accordance with accounting principles generally accepted in the United States of America, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the consolidated financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Baylake Corp. as of December 31, 2013 and 2012, and the results of its operations and cash flows for the years ended December 31, 2013, 2012 and 2011, in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, Baylake Corp. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2013, based on criteria established inInternal Control – Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commissions (COSO).

/s/ Baker Tilly Virchow Krause, LLP
Milwaukee, Wisconsin

March 3, 2014

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BAYLAKE CORP.
CONSOLIDATED BALANCE SHEETS
December 31, 2013 and 2012
(Dollar amounts in thousands)

		December 31, 2013			December 31, 2012
ASSETS
Cash and due from financial institutions	$	76,179		$	109,621
Federal funds sold		63			1,018
Securities held to maturity, at amortized cost		10,275			—
Securities available for sale, at fair value		220,608			242,019
Loans held for sale		1,360			894
Loans, net of allowance of $7,658 and $9,165 at December 31, 2013 and 2012, respectively		610,302			586,368
Cash surrender value of life insurance		23,401			23,061
Premises and equipment, net		19,714			20,818
Premises and equipment held for sale		844			1,068
Federal Home Loan Bank stock		3,598			3,598
Other real estate owned, net		6,298			10,476
Goodwill		6,641			6,641
Deferred income taxes, net		6,636			6,358
Accrued interest receivable		2,506			2,752
Other assets		8,351			9,279
Total Assets	$	996,776		$	1,023,971
LIABILITIES AND STOCKHOLDERS’ EQUITY
Deposits
Noninterest-bearing	$	127,940		$	132,477
Interest-bearing		616,272			673,538
Total Deposits		744,212			806,015
Federal Home Loan Bank advances		66,700			40,000
Repurchase agreements		58,448			51,568
Subordinated debentures		16,100			16,100
Convertible promissory notes		9,400			9,400
Accrued expenses and other liabilities		8,035			7,744
Total Liabilities		902,895			930,827
Commitments and Contingencies - Note 14
Common stock, $5 par value, authorized 50,000,000 shares; Issued- 8,194,010 shares and 8,158,360 shares at December 31, 2013 and 2012 respectively; outstanding- 7,809,997 shares and 7,937,347 at December 31, 2013 and 2012 respectively		40,970			40,792
Additional paid-in capital		12,371			12,192
Retained earnings		44,719			38,448
Treasury stock (384,013 shares and 221,013 shares at December 31, 2013 and 2012 respectively)		(5,256	)		(3,549	)
Accumulated other comprehensive income		1,077			5,261
Total Stockholders’ Equity		93,881			93,144
Total Liabilities and Stockholders’ Equity	$	996,776		$	1,023,971

See accompanying Notes to Consolidated Financial Statements

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BAYLAKE CORP.
CONSOLIDATED STATEMENTS OF OPERATIONS
Years ended December 31, 2013, 2012 and 2011
(Dollar amounts in thousands, except per share data)

		2013			2012			2011
INTEREST AND DIVIDEND INCOME
Loans, including fees	$	28,236		$	31,123		$	33,384
Taxable securities		4,928			6,442			7,101
Tax exempt securities		1,488			1,490			1,501
Federal funds sold		88			131			136
Total Interest and Dividend Income		34,740			39,186			42,122
INTEREST EXPENSE
Deposits		2,492			4,469			7,158
Repurchase agreements		78			61			79
Federal Home Loan Bank advances and other debt		728			949			1,093
Subordinated debentures		266			297			272
Convertible promissory notes		976			979			980
Total Interest Expense		4,540			6,755			9,582
Net interest income before provision for loan losses		30,200			32,431			32,540
Provision for loan losses		1,400			5,425			5,050
Net interest income after provision for loan losses		28,800			27,006			27,490
NONINTEREST INCOME
Fees from fiduciary activities		1,062			1,007			919
Fees from loan servicing		591			598			709
Fees for other services to customers		4,624			4,622			4,985
Net gain on sale of loans		1,414			2,386			1,479
Net change in valuation of mortgage servicing rights		(96	)		(193	)		(292	)
Net realized gain on sale of securities		574			2,188			651
Net (losses) gains on sale of premises and equipment		(3	)		582			(5	)
Net gain on sale of branches and deposits		122			826			—
Increase in cash surrender value of life insurance		340			366			451
Income in equity of UFS subsidiary		936			675			815
Other income		266			766			308
Total Noninterest Income		9,830			13,823			10,020
NONINTEREST EXPENSE
Salaries and employee benefits		16,551			17,016			17,182
Occupancy expense		1,938			2,259			2,273
Equipment expense		1,190			1,137			1,199
Data processing and courier expense		854			904			842
FDIC insurance expense		699			1,396			2,431
Provision for impairment of standby letters of credit		—			—			68
Operation of other real estate		969			3,846			2,140
Loan and collection expense		224			519			771
Other outside services		878			817			689
Other operating expenses		3,999			3,810			4,032
Total Noninterest Expense		27,302			31,704			31,627
Income before provision for income taxes		11,328			9,125			5,883
Provision for income taxes		3,319			1,483			1,407
Net Income	$	8,009		$	7,642		$	4,476
Basic earnings per share	$	1.01		$	0.96		$	0.57
Diluted earnings per share	$	0.87		$	0.84		$	0.57
Cash dividends paid per share	$	0.22		$	0.08		$	0.04

See accompanying Notes to Consolidated Financial Statements

67

BAYLAKE CORP.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Years ended December 31, 2013, 2012 and 2011
(Dollar amounts in thousands)

	2013			2012			2011
Net Income	$	8,009		$	7,642		$	4,476
Other comprehensive income (losses), net of tax
Unrealized gains (losses) on securities
Net unrealized holding (losses) gains arising during the period		(6,351	)		4,636			5,233
Less: reclassification adjustment for gains included in net income		(574	)		(2,188	)		(651	)
Tax effect		2,741			(968	)		(1,810	)
Other comprehensive (loss) income		(4,184	)		1,480			2,772
Comprehensive income	$	3,825		$	9,122		$	7,248

See accompanying Notes to Consolidated Financial Statements

68

BAYLAKE CORP.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
Years ended December 31, 2013, 2012 and 2011
(Dollar amounts in thousands)

															Accumulated
						Additional									Other
	Common Stock					Paid-In			Retained			Treasury			Comprehensive			Stockholders’
	Shares			Amount		Capital			Earnings			Stock			Income			Equity
Balance, January 1, 2011		7,911,539		$	40,662	$	11,980		$	26,965		$	(3,549	)	$	1,009		$	77,067
Net income		—			—		—			4,476			—			—			4,476
Net changes in unrealized gains on securities available for sale		—			—		—			—			—			5,233			5,233
Reclassification adjustment for net gains realized in income		—			—		—			—			—			(651	)		(651	)
Tax effect		—			—		—			—			—			(1,810	)		(1,810	)
Total comprehensive income																			7,248
Stock-based compensation expense recognized, net		—			—		86			—			—			—			86
Balance, December 31, 2011		7,911,539			40,662		12,066			31,441			(3,549	)		3,781			84,401
Net income		—			—		—			7,642			—			—			7,642
Net changes in unrealized gains on securities available for sale		—			—		—			—			—			4,636			4,636
Reclassification adjustment for net gains realized in income		—			—		—			—			—			(2,188	)		(2,188	)
Tax effect		—			—		—			—			—			(968	)		(968	)
Total comprehensive income																			9,122
Stock-based compensation expense recognized, net		—			—		193			—			—			—			193
Vesting of Restricted Stock Units (“RSUs”)		14,919			75		(75	)											—
Tax benefit from vesting of RSUs		—			—		13			—			—			—			13
Exercise of stock options		889			5		(1	)		—			—			—			4
Expiration/forfeiture of unexercised stock options/RSUs		—			—		(4	)		—			—			—			(4	)
Conversion of debentures		10,000			50		—			—			—			—			50
Cash dividends - ($0.08 per share)		—			—		—			(635	)		—			—			(635	)
Balance, December 31, 2012		7,937,347		$	40,792		12,192			38,448			(3,549	)		5,261			93,144
Net income		—			—		—			8,009			—			—			8,009
Net changes in unrealized gains on securities available for sale		—			—		—			—			—			(6,351	)		(6,351	)
Reclassification adjustment for net gains realized in income		—			—		—			—			—			(574	)		(574	)
Tax effect		—			—		—			—			—			2,741			2,741
Total comprehensive income																			3,825
Purchase of treasury stock		(163,000	)		—		—			—			(1,707	)		—			(1,707	)
Stock-based compensation expense recognized, net		—			—		292			—			—			—			292
Vesting of RSUs		28,679			143		(143	)		—			—			—			—
Tax benefit from vesting of RSUs		—			—		47			—			—			—			47
Exercise of stock options		6,971			35		(4	)		—			—			—			31
Tax benefit from exercise of stock options/RSUs		—			—		8			—			—			—			8
Forfeiture of stock options/RSUs not forfeited		—			—		(13	)		—			—			—			(13	)
Tax expense from forfeiture of unexercised stock options/RSUs		—			—		(8	)		—			—			—			(8	)
Cash dividends - ($0.22 per share)		—			—		—			(1,738	)		—			—			(1,738	)
Balance, December 31, 2013		7,809,997		$	40,970	$	12,371		$	44,719		$	(5,256	)	$	1,077		$	93,881

See accompanying Notes to Consolidated Financial Statements

69

BAYLAKE CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended December 31, 2013, 2012 and 2011
(Dollar amounts in thousands)

	2013			2012			2011
CASH FLOWS FROM OPERATING ACTIVITIES
Reconciliation of net income to net cash provided by operating activities:
Net Income	$	8,009		$	7,642		$	4,476
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		1,297			1,295			1,338
Amortization of debt issuance costs		36			36			35
Provision for loan losses		1,400			5,425			5,050
Provision for impairment of letters of credit		—			—			68
Loss on transfer of bank facilities to other real estate		268			—			—
Net amortization of premium/discount on securities		2,402			2,721			2,364
Increase in cash surrender value of life insurance		(340	)		(366	)		(451	)
Net gain on life insurance death benefit		—			(501	)		(297	)
Net realized gain on sale of securities		(574	)		(2,188	)		(651	)
Net gain on sale of loans		(1,414	)		(2,386	)		(1,479	)
Net gain on sale of branches		(122	)		(826	)		—
Proceeds from sale of loans held for sale		69,364			118,988			89,595
Origination of loans held for sale		(68,641	)		(116,025	)		(83,765	)
Change in valuation of mortgage servicing rights, net of payments and payoffs		96			193			292
Recovery of deferred tax asset previously written off		—			(658	)		—
Provision for valuation allowance on other real estate owned		946			3,284			1,746
Net (gains) losses on sale of premises and equipment		3			(582	)		5
Net gain on disposals of other real estate owned		(202	)		(194	)		(205	)
Provision for deferred income tax expense		2,463			477			247
Stock-based compensation expense		292			193			86
Forfeiture of stock options not exercised and RSUs not vested		(13	)		—			—
Income in equity of UFS subsidiary		(936	)		(675	)		(815	)
Changes in assets and liabilities:
Return of prepaid FDIC assessment		358			—			—
Accrued income taxes		1,441			1,332			2,319
Accrued interest receivable and other assets		287			(1,425	)		1,739
Income tax refund		(316	)		—			3,046
Payment to reduce LOC valuation allowance		—			(1,995	)		(232	)
Accrued expenses and other liabilities		291			602			1,356
Net cash provided by operating activities		16,395			14,367			25,867
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from sale of securities available for sale		6,406			51,431			32,119
Principal payments on securities available for sale		48,034			64,188			63,922
Purchase of securities held to maturity		(10,275	)		—			—
Purchase of securities available for sale		(41,782	)		(71,393	)		(110,743	)
Proceeds from FHLB stock redemption		—			3,194			—
Proceeds from sale of other real estate owned		5,040			8,040			7,419
Proceeds from sale of premises and equipment		7			855			321
Loan originations and payments, net		(26,371	)		(17,656	)		(12,165	)
Additions to premises and equipment		(816	)		(1,278	)		(695	)
Proceeds from life insurance surrender		—			—			1,698
Proceeds from life insurance death benefit		—			870			457
Rabbi Trust initial funding		—			—			(1,626	)
Net change in federal funds sold		955			(505	)		(512	)
Dividend from UFS subsidiary		433			1,659			413
Net cash used in sale of branches		—			(26,674	)		—
Net cash (used in) provided by investing activities		(18,369	)		12,731			(19,392	)

See accompanying Notes to Consolidated Financial Statements

70

BAYLAKE CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended December 31, 2013, 2012 and 2011
(Dollar amounts in thousands)

	2013			2012			2011
CASH FLOWS FROM FINANCING ACTIVITIES
Net change in deposits	$	(61,681	)	$	6,008		$	12,620
Net change in federal funds purchased and repurchase agreements		6,880			5,153			28,330
Repayments on Federal Home Loan Bank advances		(15,000	)		(15,000	)		(15,000	)
Proceeds from Federal Home Loan Bank advances		41,700			—			—
Tax benefit from vesting of restricted stock units		47			13			—
Proceeds from exercise of stock options		31			4			—
Purchase of treasury stock		(1,707	)		—			—
Cash dividends paid		(1,738	)		(635	)		—
Net cash (used in) provided by financing activities		(31,468	)		(4,457	)		25,950
Net change in cash		(33,442	)		22,641			32,425
Beginning cash		109,621			86,980			54,555
Ending cash	$	76,179		$	109,621		$	86,980
Supplemental cash flow information:
Interest paid	$	4,758		$	7,125		$	9,923
Income taxes (refunded) paid, net		(316	)		(2,400	)		2,682
Supplemental noncash disclosure:
Transfers from loans to other real estate owned	$	1,037		$	9,487		$	5,127
Mortgage servicing rights resulting from sale of loans		225			398			180
Conversion of debentures to equity		—			(50	)		—
Transfers from real estate held for sale to other real estate owned		60			—			—
Transfers from premises and equipment to other real estate owned		509			—			—

See accompanying Notes to Consolidated Financial Statements

71

BAYLAKE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2013, 2012 and 2011
(Dollar amounts in thousands, except per share data)

NOTE 1 - NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The consolidated financial statements of Baylake Corp. (the “Company”) include the accounts of the Company, its wholly owned subsidiaries Baylake Bank (the “Bank”) and Admiral Asset Management, LLC (“Admiral”), and the Bank’s wholly owned subsidiaries: Baylake Investments, Inc. and Baylake Insurance Agency, Inc.,. During the third quarter of 2012, operations of Baylake Insurance Agency were discontinued and the book of business was sold to a third party. No cash proceeds were received in the transaction; however the Bank will receive future commissions for a three-year period based on insurance renewals on the sold book of business. In the fourth quarter of 2013. The Company capitalized Admiral, a wholly-owned registered investment advisor subsidiary to provide investment advisory services in addition to those offered by the Bank. All significant intercompany items and transactions have been eliminated. Management has evaluated the impact of all subsequent events and determined that all subsequent events have been appropriately recognized and disclosed in the accompanying consolidated financial statements through the date of this report.

The Bank owns a 49.8% interest (500 shares) in United Financial Services, Inc. (“UFS”), a data processing service. In addition to the ownership interest, UFS and the Company have a common member on each of their respective Boards of Directors. The investment in this entity is carried under the equity method of accounting and the Company’s pro rata share of UFS’s income is included in noninterest income. On June 27, 2006, UFS amended an earlier agreement for employment with a key employee of UFS allowing that individual the option to purchase up to 20%, or 240 shares, of the authorized shares of UFS. The option price was $1,000 per share less dividends or distributions to owners. During 2007, options for 120 shares were exercised by the key employee. The remaining options were exercised in 2010. Income in equity of UFS recognized by the Company was $936, $675, and $815 for the years ended 2013, 2012, and 2011, respectively. Amounts paid to UFS for data processing services by the Bank were $937, $1,014, and $1,022 in 2013, 2012, and 2011, respectively. The carrying value of the Company’s investment in UFS was $3,849 and 3,345 at December 31, 2013 and December 31, 2012, respectively. The current book value of UFS is approximately $7,697 per share as of December 31, 2013.

The Bank makes commercial, mortgage, and installment loans to customers substantially all of whom are located in Door, Brown, Kewaunee and Outagamie Counties of Wisconsin. Although the Bank has a diversified portfolio, a substantial portion of its debtors’ ability to honor their contracts is dependent upon the economic condition of the local tourism/recreation businesses, as well as the industrial, commercial and agricultural industries.

On June 13, 2012, the Bank entered into a branch sale agreement to sell the Bank’s branch operations in Waupaca, Manawa, Fremont and King, Wisconsin. On September 7, 2012, the transaction, which included total deposits of $65,180, and total loans of $36,752 was consummated, resulting in a gain on sale of $826. In November of 2013, the Bank consummated the sale of deposits in the amount of $15,616 relating to its branch operations in Berlin and Poy Sippi, Wisconsin, resulting in a premium on the sale of $122.

Use of Estimates: To prepare financial statements in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”), management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the consolidated financial statements and the disclosures provided, and actual results could differ. The allowance for loan losses, value of foreclosed properties, other than temporary impairment of securities, income tax expense, and fair values of financial instruments are particularly subject to change.

Cash Flows: Cash and cash equivalents include cash and deposits with other financial institutions. Balances over $250 in those institutions are not insured by the FDIC and therefore pose a potential risk in the event the institution were to fail. As of December 31, 2013, uninsured deposits totaled $2,912.

72

BAYLAKE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2013, 2012 and 2011
(Dollar amounts in thousands)

NOTE 1 – NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES(Continued)

Securities: Securities are classified as held to maturity or available for sale at the time of purchase. Investment securities classified as held to maturity, which management has the intent and ability to hold to maturity, are reported at amortized cost, adjusted for amortization of premiums and accretion of discounts, using a method that approximates level yield. Investment securities classified as available for sale, which management has the intent and ability to hold for an indefinite period of time, but not necessarily to maturity, are carried at fair value, with unrealized gains and losses, net of related deferred income taxes, included in stockholders’ equity as a separate component of other comprehensive income. Premiums and discounts are amortized or accreted into interest income over the estimated life (earlier of call date, maturity, or estimated life) of the related security, using a prospective method that approximates level yield. Any decision to sell investment securities available for sale would be based on various factors, including, but not limited to, asset/liability management strategies, changes in interest rates or prepayment risks, liquidity needs, or regulatory capital considerations. Gains and losses on sales are recorded on the trade date and determined using the specific identification method.

Declines in the fair value of securities below their cost that are other-than-temporary due to credit issues are reflected as “Other than temporary impairment of securities” in the consolidated statement of operations. In estimating other-than-temporary losses, management considers: (1) the length of time and extent that fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the Company’s ability and intent to hold the security for a period sufficient to allow for any anticipated recovery in fair value. The difference between the present values of the cash flows expected to be collected and the amortized cost basis is the credit loss. The credit loss is the portion of the other-than-temporary impairment that is recognized in earnings and is a reduction to the cost basis of the security. The portion of other-than-temporary impairment related to all other factors is included in other comprehensive income (loss).

Federal Home Loan Bank (“FHLB”) stock: The Bank is a member of the FHLB system. Members are required to own a certain amount of stock based on the level of borrowings and other factors, and may invest in additional amounts. FHLB stock is carried at cost, classified as a restricted security, and periodically evaluated for impairment based on expected ultimate recovery of par value. The determination of whether a decline affects the ultimate recovery is influenced by criteria such as: 1) the significance of the decline in net assets of the FHLB as compared to the capital stock amount and length of time a decline has persisted; 2) impact of legislative and regulatory changes on the FHLB and 3) the liquidity position of the FHLB. Both cash and stock dividends are reported as income.

During 2011, the FHLB resumed the payment of cash dividends. In the latter part of 2011, the FHLB announced their intentions to repurchase excess stock from member banks beginning in 2012. During 2012, the Company participated in the stock repurchase program in which FHLB redeemed 31,935 of excess shares held by the Company at its aggregate par value of $3,194. Based on the payment of cash dividends and the repurchase of excess stock, the Company has determined that no impairment needs to be recorded on these securities.

Loans Held for Sale: Mortgage loans originated and intended for sale in the secondary market are carried at the lower of aggregate cost or market, as determined by outstanding commitments from investors. Net unrealized losses, if any, are recorded as a valuation allowance and charged to earnings.

Mortgage loans held for sale may be sold with servicing rights retained. The carrying value of mortgage loans sold with servicing rights retained is reduced by the amount allocated to the servicing right at the time of sale. Gains and losses on sales of mortgage loans are based on the difference between the selling price and the carrying value of the related loan sold.

Loans: Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at the principal balance outstanding, net of deferred loan fees and costs, and an allowance for loan losses. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized in interest income using the level-yield method without anticipating prepayments.

73

BAYLAKE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2013, 2012 and 2011
(Dollar amounts in thousands)

NOTE 1 – NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES(Continued)

Interest income on loans is discontinued at the time the loan is 90 days delinquent. Past due status is based on the contractual terms of the loan. In all cases, loans are placed on nonaccrual or charged off at an earlier date if collection of principal or interest is considered doubtful. All interest accrued but not received for loans placed on nonaccrual is reversed against interest income. Interest received on such loans is accounted for on the cash-basis or cost-recovery method until qualifying for return to accrual status. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

Restructured Loans: Restructured loans involve the granting of some concession to the borrower involving a loan modification, such as payment schedule changes, interest rate reductions, or principal charge-offs. A troubled debt restructuring (“TDR”) includes a loan modification where a borrower is experiencing financial difficulty and a concession is granted to that borrower that would not otherwise be considered but for the borrower’s financial difficulties. A TDR may be accrual or nonaccrual status based upon the performance of the borrower and management’s assessment of collectability. A TDR on nonaccrual is returned to accrual after performing in accordance with the modified terms for a sufficient period, generally six months. A loan that is modified at a market rate of interest may no longer be classified as a TDR in the calendar year subsequent to the restructuring if it is in compliance with the modified terms.

Allowance for Loan Losses: The allowance for loan losses (“ALL”) represents management’s estimate of probable and inherent credit losses in the loan portfolio. Estimating the amount of the ALL requires the exercise of significant judgment and the use of estimates related to the amount and timing of expected future cash flows on impaired loans, estimated losses on pools of homogeneous loans based on historical loss experience, and consideration of other qualitative factors such as current economic trends and conditions, all of which may be susceptible to significant change. Loan losses are charged off against the ALL, while recoveries of amounts previously charged off are credited to the ALL. A provision for loan losses (“PFLL”) is charged to operations based on management’s periodic evaluation of the factors previously mentioned, as well as other pertinent factors.

The ALL consists of specific reserves on certain impaired loans and general reserves for non-impaired loans. Specific reserves reflect estimated losses based on regular analyses of all impaired non-homogenous loans. These analyses involve a high degree of judgment in estimating the amount of loss associated with specific loans, including estimating the amount and timing of future cash flows and collateral values. The general reserve is based on the Bank’s historical loss experience which is updated quarterly. The general reserve portion of the ALL also includes consideration of certain qualitative factors such as 1) changes in the nature, volume and terms of loans, 2) changes in lending personnel, 3) changes in the quality of the loan review function, 4) changes in nature and volume of past-due, nonaccrual and/or classified loans, 5) changes in concentration of credit risk, 6) changes in economic and industry conditions, 7) changes in legal and regulatory requirements, 8) unemployment and inflation statistics, and 9) changes in underlying collateral values.

There are many factors affecting the ALL; some are quantitative while others require qualitative judgment. The process for determining the ALL (which management believes adequately considers potential factors which might possibly result in credit losses) includes subjective elements and, therefore, may be susceptible to significant change. To the extent actual outcomes differ from management estimates, additional PFLL could be required that could adversely affect the earnings or financial position in future periods. Allocations of the ALL may be made for specific loans but the entire ALL is available for any loan that, in management’s judgment, should be charged-off or for which an actual loss is realized. As an integral part of their examination process, various regulatory agencies review the ALL as well. Such agencies may require that changes in the ALL be recognized when such regulators’ credit evaluations differ from those of management based on information available to the regulators at the time of their examinations.

74

BAYLAKE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2013, 2012 and 2011
(Dollar amounts in thousands)

NOTE 1 – NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES(Continued)

Mortgage Servicing Rights: Mortgage servicing rights are recognized separately when they arise through sales of loans with servicing retained. Mortgage servicing rights are initially recorded at fair value with the offsetting effect recorded as a reduction to gain/loss on sale of loans. Changes in fair value are included in “net change in valuation of mortgage servicing rights” in the consolidated statements of operations. Subsequent to origination, under the fair value measurement method, the Company measures fair value based on market prices for comparable servicing contracts, when available, or alternatively, based on a valuation model that calculates the present value of estimated future net servicing income. The valuation model incorporates assumptions that market participants would use in estimating future net servicing income, such as the cost to service, the discount rate, prepayment speeds and default rates and losses. The Company compares the valuation model inputs and results to published industry data in order to validate the model results and assumptions. The fair values of mortgage servicing rights are subject to significant fluctuations as a result of changes in estimated and actual prepayment speeds and default rates and losses. Mortgage servicing rights are included in “other assets” on the consolidated balance sheets.

Loan servicing fee income earned for servicing loans is based on a contractual percentage of the outstanding principal or a fixed amount per loan and are recorded as income when earned. Loan servicing fees totaled $591, $598, and $709 for the years ended December 31, 2013, 2012, and 2011, respectively. Late fees and ancillary fees related to loan servicing are not material.

Bank Owned Life Insurance: The Company has purchased life insurance policies on certain key executives. Bank owned life insurance is recorded at the amount that can be realized under the insurance contract at the balance sheet date, which is the net cash surrender value.

Transfers of Financial Assets: Transfers of financial assets are accounted for as sales when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.

Other Real Estate Properties: Assets acquired through or instead of loan foreclosure and bank facilities no longer in use are initially recorded at the lower of carrying cost or fair value, less estimated costs to sell, establishing a new cost basis. If the fair value declines subsequent to foreclosure, a valuation allowance is recorded through expense. Costs incurred after acquisition are expensed. These costs include management fees, operating expenses, and valuation write-downs.

Premises and Equipment: Land is carried at cost. Premises and equipment are stated at cost less accumulated depreciation. Buildings and related components are depreciated using the straight-line method with useful lives ranging from 5 to 40 years. Furniture, fixtures, and equipment are depreciated using the straight-line (or accelerated) method with useful lives ranging from 3 to 12 years.

Rabbi Trust: During 2011, the Company established a Rabbi Trust to hold proceeds from the surrender of life insurance policies. The assets of the Rabbi trust are invested in investment choices identical to the investments selected by eligible participants in the Company’s Supplemental Executive Retirement Plan (“SERP”). This provides an economic hedge to the Company’s liability under the SERP. The Rabbi Trust remains in effect at December 31, 2013 and is included with other assets in the consolidated balance sheet.

Goodwill: Goodwill results from business acquisitions and represents the excess of the purchase price over the fair value of acquired tangible assets. The goodwill recorded represents the excess of market value over book value.

75

BAYLAKE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2013, 2012 and 2011
(Dollar amounts in thousands)

NOTE 1 – NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES(Continued)

During 2013 and 2012, the Company, with the assistance of a third party valuation firm, determined an estimated cash fair value of the Company’s common stock. Consideration was given to the nature and history of the Company, the competitive and economic outlook for the trade area and for the banking industry in general, the book value and financial condition of the Company, the future earnings and dividend paying capacity, the size of the block valued, and the prevailing market prices of bank stocks. The following valuation methodologies were considered: 1) net asset value – defined as the net worth of the Company, 2) market value – defined as the price at which knowledgeable buyers and sellers would agree to buy and sell the Company’s common stock, and 3) investment value – defined as an estimate of the present value of the future benefits, usually earnings, cash flow, or dividends, that will accrue to the Company’s common stock. When consideration was given to the three valuation methodologies, as well as all other relevant valuation variables and factors, the fully-diluted cash fair value range of the Company’s common shares was considered to be in excess of the book value. Since the valuation ranges obtained from that firm exceeded the carrying value including goodwill, step one of the impairment test established under U.S. GAAP was met and, therefore, no goodwill impairment was recognized. If the carrying amount would have exceeded fair value, the Company would have performed the second step to measure the amount of impairment loss. Based on the valuation obtained as of September 30, 2013, the valuation exceeded the carrying value by a range of 41% to 52%. As of December 31, 2013, there are no conditions that would require goodwill impairment to be reevaluated.

Long-Term Assets: Premises and equipment, and other long-term assets are reviewed for impairment when events indicate that their carrying amount may not be recoverable from future undiscounted cash flows. If impaired, the assets are recorded at fair value. Management has determined that such assets have not been impaired as of December 31, 2013 and 2012.

Loan Commitments and Related Financial Instruments: Financial instruments include off-balance-sheet credit instruments, such as commitments to make loans and commercial letters of credit, issued to meet customer financing needs. The face amount for these items represents the exposure to loss, before considering customer collateral or ability to repay. Such financial instruments are recorded when they are funded. Instruments, such as standby letters of credit, that are considered financial guarantees in accordance with accounting guidance are recorded at fair value.

Trust Fee Income: The Company provides trust services to customers and in return charges fees using terms customary in its industry, including charging fees based on the agreed-upon percentages of assets managed or as otherwise specified in the underlying agreements. Income from trust services is recognized when the services are provided and included as “fees from fiduciary activities” in the consolidated statements of operations.

Advertising Expense: The Company expenses all advertising costs as they are incurred. Total advertising costs for the years ended December 31, 2013, 2012 and 2011 were $221, $264 and $226, respectively and are included in “other operating expenses” in the consolidated statements of operations.

Earnings Per Common Share: Basic earnings per common share is net income or loss divided by the weighted average number of common shares outstanding during the period. Diluted earnings per common share include the dilutive effect of additional potential common shares issuable under stock options, stock awards, and convertible promissory notes.

Loss Contingencies: Loss contingencies, including claims and legal actions arising in the ordinary course of business, are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated.

Restrictions on Cash: Cash on hand or on deposit with the Federal Reserve Bank of Chicago (“Reserve Bank”) of $1,412 and $1,413 was required to meet regulatory reserve requirements on specific deposit liabilities as of December 31, 2013 and 2012, respectively. These balances earn interest. During 2012, the Reserve Bank eliminated balances previously required to be maintained to meet clearing requirements.

76

BAYLAKE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2013, 2012 and 2011
(Dollar amounts in thousands, except per share data)

NOTE 1 – NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES(Continued)

Dividend Reinvestment Plan: The Company administers a dividend reinvestment plan (“DRIP”), whereby the Company allocates applicable dividends to acquire, on the participant’s behalf, shares of the Company’s common stock. During 2013, total cash dividends of $1,738 were declared and paid by the Company. Of this amount, $261 was allocated to the DRIP and was used to purchase 24,398 shares in the open market at a weighted average price of $10.69 per share, to fulfill the DRIP plan requirements. No shares were issued by the Company during 2013 in administration of the DRIP.

During 2012, 14,261 shares were purchased in the open market at a weighted average price of $7.21 per share to fulfill the DRIP plan requirements, for a total of $103 in dividends.

Operating Segments: While the chief decision makers monitor the revenue streams of the various products and services, the identifiable segments are not material and operations are managed and financial performance is evaluated on a Company-wide basis. Accordingly, all of the financial service operations are considered by management to be aggregated in one reportable operating segment.

Stock-based Compensation: The Company accounts for equity awards by recognizing compensation expense related to the stock-based equity awards over the vesting period. See Note 18 for information on stock-based compensation.

Income Taxes: Deferred income taxes 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 that will apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred income tax assets and liabilities of a change in tax rates is recognized as income or expense in the period that includes the enactment date. See Note 16 for details on the Company’s income taxes.

A tax position is recognized as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a tax estimation presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely to be realized on examination. For tax positions not meeting the “more likely than not” test, no tax benefit is recorded.

The Company regularly reviews the carrying amount of its deferred income tax assets to determine if the establishment of a valuation allowance is necessary. If based on the available evidence it is more likely than not that all or a portion of the Company’s deferred income tax assets will not be realized in future periods, a deferred income tax valuation allowance would be established. Consideration is given to various positive and negative factors that could affect the realization of the deferred income tax assets. In evaluating this available evidence, management considers, among other things, historical financial performance, expectation of future earnings, the ability to carry back losses to recoup taxes previously paid, length of statutory carry forward periods, experience with operating loss and tax credit carry forwards not expiring unused, tax planning strategies and timing of reversals of temporary differences. Significant judgment is required in assessing future earning trends and the timing of reversals of temporary differences. The Company’s evaluation is based on current tax laws as well as management’s expectations of future performance. During the fourth quarter of 2012, it was determined that a valuation allowance of $658 previously established against a deferred tax receivable relating to the Company was no longer necessary. The valuation allowance was reversed through 2012 net income as a reduction of income tax expense.

77

BAYLAKE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2013, 2012 and 2011
(Dollar amounts in thousands)

NOTE 1 – NATURE OF BUSINESS AND SUMMAR OF SIGNIFICANT ACCOUNTING POLICIES(Continued)

The Company is subject to the income tax laws of the U.S., its states and municipalities. These tax laws are complex and subject to different interpretations by the taxpayer and the relevant governmental taxing authorities. The accounting guidance for income taxes prescribes a comprehensive model for how companies should recognize, measure, present, and disclose in their financial statements uncertain tax positions taken or expected to be taken on a tax return. Under the guidance, tax positions shall initially be recognized in the financial statements when it is more likely than not the position will be sustained upon the examination by the tax authorities. Such tax positions shall initially and subsequently be measured as the largest amount of tax benefit that is greater than 50% likely to be realized upon ultimate settlement with the tax authority assuming full knowledge of the position and all relevant facts. Interest and penalties related to income tax expense are recorded as income tax expense, net of federal and state tax benefit, when the amounts can reasonably be determined.

Reclassifications: Certain items previously reported were reclassified to conform to the current presentation.

Recent Accounting Pronouncements: In February 2013 the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2013-02,Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income,to improve the transparency of reporting these reclassifications. Other comprehensive income includes gains and losses that are initially excluded from net income for an accounting period. Those gains and losses are later reclassified out of accumulated other comprehensive income into net income. The amendments in this ASU do not change the current requirements for reporting net income or other comprehensive income in financial statements. All of the information that this ASU requires is already required to be disclosed elsewhere in the financial statements under U.S. GAAP. The amendments apply to all public and private companies that report items of other comprehensive income. Public companies are required to comply with these amendments for all reporting periods (interim and annual). The amendments are effective for reporting periods beginning after December 15, 2012, for public companies. The provisions of this guidance did not have a significant impact on the consolidated financial condition, results of operation or liquidity of the Company.

In July 2013 the FASB issued ASU No. 2013-11,Income Taxes (Topic740): Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists(a consensus of the Emerging Issues Task Force). ASU 2013-11 requires that an unrecognized tax benefit be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward except as follows: To the extent a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date under the tax law of the applicable jurisdiction to settle any additional income taxes that would result from the disallowance of a tax position or the tax law of the applicable jurisdiction does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets. The assessment of whether a deferred tax asset is available is based on the unrecognized tax benefit and deferred tax asset that exist at the reporting date and should be made presuming disallowance of the tax position at the reporting date. The amendments in this ASU are effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. Early adoption is permitted. The amendments should be applied prospectively to all unrecognized tax benefits that exist at the effective date. Retrospective application is permitted. The provisions of this guidance are not expected to have a significant impact on the consolidated financial condition, results of operation or liquidity of the Company.

78

BAYLAKE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2013, 2012 and 2011
(Dollar amounts in thousands)

NOTE 1 – NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES(Continued)

In January 2014, the FASB issued ASU No. 2014-04,Receivables – Troubled Debt Restructurings by Creditors (Subtopic 310-40) Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure (a consensus of the FASB Emerging Issues Task Force).The amendments in the ASU clarify when an in-substance repossession or foreclosure occurs — that is, when a creditor should be considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan such that the loan receivable should be derecognized and the real estate property recognized. The new ASU requires a creditor to reclassify a collateralized consumer mortgage loan to real estate property upon obtaining legal title to the real estate collateral, or the borrower voluntarily conveying all interest in the real estate property to the lender to satisfy the loan through a deed in lieu of foreclosure or similar legal agreement. The ASU is effective for the Company beginning January 1, 2015. The provisions of this guidance are not expected to have a significant impact on the consolidated financial condition, results of operation or liquidity of the Company.

NOTE 2 – FAIR VALUE INFORMATION

Accounting guidance establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The guidance describes three levels of inputs that may be used to measure fair value:

Level 1:	Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.
Level 2:	Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.
Level 3:	Significant unobservable inputs that reflect a reporting entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability. A financial instrument’s categorization within the valuation hierarchy is based upon the lowest level of input within the valuation hierarchy that is significant to the fair value measurement.

The methods and assumptions used to estimate fair value are described below.

Carrying amount is the estimated fair value for cash and cash equivalents, accrued interest receivable and payable, demand deposits, variable rate subordinated debt, short-term borrowings and variable rate loans and deposits that reprice frequently and fully.

If market prices or dealer quotes information is not available, fair values are determined based on the rate and term of the security and information about the issuer.

The fair value of securities available for sale is determined by obtaining quoted prices on nationally recognized securities exchanges (Level 1 inputs) or matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities (Level 2 inputs). For other securities not able to be priced on matrix pricing, outside third parties are relied upon (Level 3 inputs). One of the Company’s securities available for sale at December 31, 2012 was measured using Level 1 inputs but was sold prior to December 31, 2013.

The fair value of fixed rate non-impaired loans and deposits and non-impaired variable rate loans and deposits with infrequent repricing or repricing limits, is based on discounted cash flows using current market rates applied to the estimated life and credit risk. Fair values for impaired loans are estimated using discounted cash flow analysis or underlying collateral values. Fair value of loans held for sale is based on market quotes.

79

BAYLAKE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2013, 2012 and 2011
(Dollar amounts in thousands)

NOTE 2 – FAIR VALUE INFORMATION (Continued)

The fair value of fixed rate non-impaired loans and deposits and non-impaired variable rate loans and deposits with infrequent repricing or repricing limits, is based on discounted cash flows using current market rates applied to the estimated life and credit risk. Fair values for impaired loans are estimated using discounted cash flow analysis or underlying collateral values. Fair value of loans held for sale is based on market quotes.

The fair value of foreclosed properties is determined using a variety of market information including, but not limited to, appraisals, professional market assessments and real estate tax assessment information. Other real estate properties are adjusted to fair value less estimated costs to sell upon transfer to foreclosed properties, establishing a new cost basis when fair value is lower than the carrying cost on date of transfer. Subsequently, foreclosed properties are carried at lower of cost or fair value less estimated costs to sell (Level 3 inputs).

The fair value of impaired loans is based on review of comparable collateral in the similar marketplaces (Level 3 inputs) or an analysis of expected cash flows of the loan in relationship to the contractual terms of the loan (Level 3 inputs). Impaired loans are carried at the lower of amortized cost or fair value less estimated costs to sell. Impaired loans are not carried at fair value if there is sufficient collateral or expected repayments exceed the recorded investments of such loans.

Fair value of convertible promissory notes is based on current rates for similar financing.

No secondary market exists for FHLB stock. The stock is bought and sold at par from/to the FHLB. Management believes the recorded value reflects the fair value.

The fair value of mortgage servicing rights is based on a valuation model that calculates the present value of estimated net servicing income. The valuation model incorporates assumptions that market participants would use in estimating future net servicing income. These assumptions include servicing costs, expected loan lives, discount rates, and the determination of whether the loan is likely to be refinanced. The Company compares the valuation model inputs and results to widely available published industry data for reasonableness (Level 2 inputs).

80

BAYLAKE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2013, 2012 and 2011
(Dollar amounts in thousands)

NOTE 2 – FAIR VALUE INFORMATION(Continued)

The fair value of off-balance sheet items is measured based on the present value of expected future cash flows for instruments where the Bank is obligated to fund such commitments. Assets measured at fair value on a recurring basis are summarized below:

ASSETS MEASURED ON A RECURRING BASIS

	December 31, 2013		Quoted Prices in Active Markets For Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
Securities available for sale:
U.S. government sponsored agency securities	$	2,964	$	—	$	2,964	$	—
Mortgage-backed securities		149,885		—		149,403		482
Asset-backed securities		3,750		—		3,750		—
Obligations of states and political subdivisions		58,669		—		58,669		—
Private placement and corporate bonds		3,435		—		3,435		—
Other securities		1,905		—		1,905		—
Total securities available for sale		220,608		—		220,126		482
Mortgage servicing rights		967		—		967		—
Total	$	221,575	$	—	$	221,093	$	482

	December 31, 2012		Quoted Prices in Active Markets For Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
Securities available for sale:
U.S. government sponsored agency securities	$	2,011	$	—	$	2,011	$	—
Mortgage backed securities		169,121		—		166,018		3,103
Asset-backed securities		4,290		—		4,290		—
Obligations of states and political subdivisions		58,871		—		58,871		—
Private placement and corporate bonds		6,072		2,502		3,570		—
Other securities		1,654		—		1,654		—
Total securities available for sale		242,019		2,502		236,414		3,103
Mortgage servicing rights		839		—		839		—
Total	$	242,858	$	2,502	$	237,253	$	3,103

One security outstanding at December 31, 2012 and reported in Level 2 at that time is indicated as Level 1 in the above table presented based on further information available.

81

BAYLAKE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2013, 2012 and 2011
(Dollar amounts in thousands)

NOTE 2 – FAIR VALUE INFORMATION(Continued)

The following table presents additional information about Level 3 assets measured at fair value on a recurring basis:

	December 31, 2013			December 31, 2012
Balance, beginning of period	$	3,103		$	16,262
Transfer into Level 3		—			—
Other comprehensive income (loss)		(78	)		542
Transfer out of Level 3		—			(10,593	)
Principal payments		(2,543	)		(3,108	)
Balance, end of period	$	482		$	3,103

During 2012, quoted market prices became available on three securities previously in the Level 3 category. These securities were moved to Level 2. The balance at December 31, 2013 represents one security.

Assets measured at fair value on a non-recurring basis are summarized below:

ASSETS MEASURED ON A NON-RECURRING BASIS

	December 31, 2013		Quoted Prices in Active Markets For Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
Impaired loans with allocated allowance	$	1,252	$	—	$	—	$	1,252
Other real estate properties, net		6,298		—		—		6,298
Total		7,550		—		—		7,550

	December 31, 2012		Quoted Prices in Active Markets For Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
Impaired loans with allocated allowance	$	4,097	$	—	$	—	$	4,097
Other real estate properties, net		10,476		—		—		10,476
Total		14,573		—		—		14,573

The accounting guidance for financial instruments requires disclosures of estimated fair value of certain financial instruments and the methods and significant assumptions used to estimate their fair values. Certain financial instruments and all nonfinancial instruments are excluded from the scope of this guidance. Accordingly, the fair value disclosures required by this guidance are only indicative of the value of individual financial instruments as of the dates indicated and should not be considered an indication of the Company’s fair value.

82

BAYLAKE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2013, 2012 and 2011
(Dollar amounts in thousands)

NOTE 2 – FAIR VALUE INFORMATION(Continued)

	December 31,
	2013				2012
	Carrying Amount		Fair Value		Carrying Amount		Fair Value
Financial assets
Cash and cash equivalents	$	76,179	$	76,179	$	109,621	$	109,621
Federal funds sold		63		63		1,018		1,018
Securities held to maturity		10,275		10,275		—		—
Securities available for sale		220,608		220,608		242,019		242,019
Loans held for sale		1,360		1,384		894		908
Loans, net		610,302		605,655		586,368		587,166
Federal Home Loan Bank stock		3,598		3,598		3,598		3,598
Mortgage servicing rights		967		967		839		839
Other real estate owned, net		6,298		6,298		10,476		10,476
Accrued interest receivable		2,506		2,506		2,752		2,752
Financial liabilities
Deposits	$	744,212	$	739,315	$	806,015	$	806,820
Federal funds purchased and repurchase agreements		58,448		58,448		51,568		51,568
Federal Home Loan Bank advances		66,700		66,304		40,000		40,404
Subordinated debentures		16,100		16,100		16,100		16,100
Convertible promissory notes		9,400		9,316		9,400		9,316
Accrued interest payable		548		548		766		766

83

BAYLAKE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2013, 2012 and 2011
(Dollar amounts in thousands)

NOTE 3 - SECURITIES

The fair value of securities available for sale, the fair value of securities held to maturity and the related unrealized gains and losses as of December 31, 2013 and 2012 are as follows:

	2013
	Fair Value		Gross Unrealized Gains		Gross Unrealized Losses
Securities Available for Sale:
U.S. government sponsored agency securities	$	2,964	$	—	$	(50	)
Obligations of states and political subdivisions		58,669		2,232		(193	)
Asset-backed securities		3,750		94		(126	)
Mortgage-backed securities		149,885		2,197		(2,297	)
Private placement and corporate bonds		3,435		—		(85	)
Other securities		1,905		—		—
Total Securities Available for Sale	$	220,608	$	4,523	$	(2,751	)
Securities Held to Maturity:
Mortgage-backed securities	$	10,275	$	—	$	—
Total Securities Held to Maturity	$	10,275	$	—	$	—
Total Investment Securities	$	230,883	$	4,523	$	(2,751	)

	2012
	Fair Value		Gross Unrealized Gains		Gross Unrealized Losses
Securities Available for Sale:
U.S. government sponsored agency securities	$	2,011	$	3	$	—
Obligations of states and political subdivisions		58,871		4,042		(4	)
Asset-backed securities		4,290		113		(229	)
Mortgage-backed securities		169,121		4,839		(510	)
Private placement and corporate bonds		6,072		443		—
Other securities		1,654		—		—
Total Securities Available for Sale	$	242,019	$	9,440	$	(743	)
Securities Held to Maturity:
Mortgage-backed securities	$	—	$	—	$	—
Total Securities Held to Maturity	$	—	$	—	$	—
Total Investment Securities	$	242,019	$	9,440	$	(743	)

84

BAYLAKE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2013, 2012 and 2011
(Dollar amounts in thousands)

NOTE 3 - SECURITIES(Continued)

Other securities consist of short-term money market mutual funds and equity securities in the Federal Reserve Bank and other nonmarketable equity securities, which are carried at cost.

A summary of sales of securities available for sale during the year ended December 31 is as follows:

	2013		2012		2011
Proceeds	$	6,406	$	51,431	$	32,119
Gross realized gains		574		2,195		669
Gross realized losses		—		7		18

The estimated fair value of securities at December 31, 2013, by contractual maturity, is shown below. Expected maturities will differ from contractual maturities on other equity securities, mortgage-backed securities and asset-backed securities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

	AFS Estimated Fair Value		HTM Estimated Fair Value
Due in one year or less	$	920	$	—
Due after one year through five years		19,850		—
Due after five years through ten years		39,675		—
Due after ten years		4,623		—
		65,068		—
Other equity securities		1,905		—
Mortgage-backed securities		149,885		10,275
Asset-backed securities		3,750		—
	$	220,608	$

Securities pledged to secure public deposits had a carrying value of $108,122 and $86,497 at December 31, 2013 and 2012, respectively. Securities pledged to secure FHLB borrowings at December 31, 2013 and 2012 were $10,275 and $9,187, respectively.

85

BAYLAKE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2013, 2012 and 2011
(Dollar amounts in thousands)

NOTE 3 - SECURITIES(Continued)

Securities with unrealized losses at December 31, 2013 and 2012, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, are as follows:

	Less than 12 Months					12 Months or More					Total
Description of Securities	Fair Value		Unrealized Loss			Fair Value		Unrealized Loss			Fair Value		Unrealized Loss
2013
U.S. government sponsored agency securities	$	2,964	$	(50	)	$	—	$	—		$	2,964	$	(50	)
Obligations of states and political subdivisions		5,290		(193	)		—		—			5,290		(193	)
Mortgage-backed securities		62,908		(1,625	)		15,164		(672	)		78,072		(2,297	)
Asset-backed securities		2,290		(15	)		503		(111	)		2,793		(126	)
Private placement and corporate bonds		3,435		(85	)		—		—			3,435		(85	)
Total temporarily impaired	$	76,887	$	(1,968	)	$	15,667	$	(783	)	$	92,554	$	(2,751	)

	Less than 12 Months					12 Months or More					Total
Description of Securities	Fair Value		Unrealized Loss			Fair Value		Unrealized Loss			Fair Value		Unrealized Loss
2012
U.S. government sponsored agency securities	$	—	$	—		$	—	$	—		$	—	$	—
Obligations of states and political subdivisions		529		(4	)		—		—			529		(4	)
Mortgage-backed securities		14,502		(100	)		6,456		(410	)		20,958		(510	)
Asset-backed securities		—		—			3,210		(229	)		3,210		(229	)
Private placement and corporate bonds		—		—			—		—			—		—
Total temporarily impaired	$	15,031	$	(104	)	$	9,666	$	(639	)	$	24,697	$	(743	)

At December 31, 2013, the mortgage-backed securities category with continuous unrealized losses for twelve months or more comprised two securities. The asset-backed securities category with continuous unrealized losses for twelve months or more comprised two securities.

At December 31, 2012, the mortgage-backed securities category with continuous unrealized losses for twelve months or more comprised two securities and the asset-backed securities category with continuous unrealized losses for twelve months or more comprised two securities.

Management evaluates securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. As part of such monitoring, the credit quality of individual securities and their issuers are assessed. Adjustments to market value that are considered temporary are recorded as a separate component of other comprehensive income, net of income tax. If an impairment of a security is identified as other-than-temporary based on information available, such as the decline in the creditworthiness of the issuer, external market ratings or the anticipated or realized elimination of associated dividends, such impairments are further analyzed to determine if a credit loss exists. If there is a credit loss, it will be recorded in the consolidated statement of operations. Unrealized losses other than credit issues will continue to be recognized in other comprehensive income, net of income tax. Unrealized losses reflected in the preceding tables have not been included in results of operations because the unrealized losses were not deemed other-than-temporary. Management does not have the intent to sell the securities and has determined that it is not more likely than not that the Company will be required to sell the debt securities before their anticipated recovery and therefore, there is no other-than-temporary impairment. The losses on these securities are expected to dissipate as they approach their maturity dates and/or if interest rates decline.

86

BAYLAKE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2013, 2012 and 2011
(Dollar amounts in thousands)

NOTE 3 - SECURITIES(Continued)

At December 31, 2013 and 2012 the mortgage-backed securities portfolio was $160,160 (69.4%) and $169,121 (69.9%), respectively, of the investment portfolio. Approximately 8.8% or $14,097, of the mortgage-backed securities outstanding at December 31, 2013 were issued and guaranteed by the Government National Mortgage Association (“GNMA”), the Small Business Administration (“SBA”) or the United States Department of Veterans Affair (“VA”); agencies of the United States government. An additional 76.4%, or $122,369, of the mortgage-backed securities outstanding were issued by the Federal National Mortgage Association (“FNMA”), the Federal Home Loan Mortgage Corporation (“FHLMC”), or the Federal Home Loan Bank (“FHLB”); United States government-sponsored agencies. Non-agency mortgage-backed securities present a level of credit risk that does not exist currently with United States government agency-backed securities, but only comprise approximately 14.8%, or $23,694, of the outstanding mortgage-backed securities at December 31, 2013. Management evaluates these non-agency mortgage-backed securities at least quarterly and more frequently when economic or market concerns warrant such evaluation.

NOTE 4 - LOANS

Major classifications of loans as of December 31, 2013 and 2012 are as follows:

	2013			2012
Commercial	$	125,290		$	108,890
Real estate:
Residential		142,398			127,315
Commercial		287,815			291,992
Construction		36,948			40,901
Consumer		6,495			7,882
Tax exempt		19,435			18,970
Total		618,381			595,950
Less:
Deferred loan origination fees, net of costs		(421	)		(417	)
Allowance for loan losses		(7,658	)		(9,165	)
Loans, net	$	610,302		$	586,368

Loans having a carrying value of $132,563 and $97,507 were pledged as collateral for borrowings from the FHLB at December 31, 2013 and 2012, respectively.

Certain directors and officers of the Company and the Bank, including their immediate families, companies in which they are principal owners, and trusts in which they are involved, are considered related parties and were loan customers of the Bank during 2013 and 2012.

87

BAYLAKE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2013, 2012 and 2011
(Dollar amounts in thousands)

NOTE 4 – LOANS(Continued)

A summary of the changes in related party loans is as follows:

	For the year ended December 31,
	2013			2012
Balance at beginning of year	$	7,149		$	7,115
New loans made		2,873			2,400
Repayments received		(3,312	)		(2,200	)
Reclassification for loans related to new/former officers and directors		(524	)		(166	)
Balance at end of year	$	6,186		$	7,149

The level of the allowance for loan losses (AFLL) represents management’s estimate of an amount appropriate to provide for probable credit losses in the loan portfolio at balance sheet date. The change in the AFLL, in general, is a function of a number of factors but not limited to changes in the related loan portfolio, net charge offs, trends in past due and impaired loans, and involves significant management judgment in assessing these factors.

Changes in the allowance for loan losses were as follows:

	For the year ended December 31,
	2013			2012			2011
Balance at beginning of year	$	9,165		$	10,638		$	11,502
Provision charge to operations		1,400			5,425			5,050
Recoveries		683			774			709
Loans charged off		(3,590	)		(7,672	)		(6,623	)
Balance at end of year	$	7,658		$	9,165		$	10,638

Information regarding impaired loans is as follows:

	December 31,
	2013		2012
Impaired loans with no allocated allowance for loan loss	$	13,773	$	12,943
Impaired loans with allocated allowance for loan loss		1,895		5,437
Allowance allocated to impaired loans		643		1,340

	For the year ended December 31,
	2013		2012		2011
Average impaired loans during the period	$	14,914	$	26,212	$	39,245
Interest income recognized during impairment		329		325		2,187
Cash-basis interest income recognized		—		110		98

88

BAYLAKE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2013, 2012 and 2011
(Dollar amounts in thousands)

NOTE 4 – LOANS(Continued)

Nonperforming and restructured loans were as follows:

	December 31,
	2013		2012
Loans past due over 90 days still on accrual	$	—	$	—
Loans restructured in a troubled debt restructuring non-accruing		255		3,724
Nonaccrual loans		6,403		10,724
Total nonperforming loans	$	6,658	$	14,448
Restructured loans, accruing interest	$	9,009	$	3,931

If these loans had been current throughout their terms, interest income for the nonaccrual period would have approximated $276, $573 and $1,250 for the years ended December 31, 2013, 2012 and 2011 respectively.

A breakdown of the ALL and recorded investments in loans at December 31, 2013 is as follows:

	Construction			Real Estate- Residential			Real Estate- Commercial			Commercial			Consumer			Tax Exempt		Not Specifically Allocated			Total
Allowance for Loan Losses:
Beginning balance	$	652		$	1,658		$	5,787		$	678		$	102		$	—	$	288		$	9,165
Charge-offs		(93	)		(552	)		(2,132	)		(758	)		(55	)		—		—			(3,590	)
Recoveries		15			100			269			272			27			—		—			683
Provision		(202	)		167			507			471			(10	)		—		467			1,400
Ending Balance	$	372		$	1,373		$	4,431		$	663		$	64		$	—	$	755		$	7,658
Loans:
Ending balance	$	36,948		$	142,398		$	287,394		$	125,290		$	6,495		$	19,435	$	—		$	617,960
ALL		(372	)		(1,373	)		(4,431	)		(663	)		(64	)		—		(755	)		(7,658	)
Recorded investment	$	36,576		$	141,025		$	282,963		$	124,627		$	6,431		$	19,435	$	(755	)	$	610,302
Ending balance:
Individually evaluated	$	660		$	540		$	14,181		$	266		$	21		$	—	$	—		$	15,668
Collectively evaluated		36,288			141,858			273,213			125,024			6,474			19,435		—			602,292
Total	$	36,948		$	142,398		$	287,394		$	125,290		$	6,495		$	19,435	$	—		$	617,960

89

BAYLAKE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2013, 2012 and 2011
(Dollar amounts in thousands)

NOTE 4 – LOANS(Continued)

A breakdown of the ALL and recorded investments in loans at December 31, 2012 is as follows:

	Construction			Real Estate- Residential			Real Estate- Commercial			Commercial			Consumer			Tax Exempt		Not Specifically Allocated			Total
Allowance for Loan Losses:
Beginning balance	$	1,231		$	1,995		$	5,467		$	770		$	161		$	—	$	1,014		$	10,638
Charge-offs		(781	)		(1,216	)		(5,075	)		(492	)		(108	)		—		—			(7,672	)
Recoveries		25			74			557			87			31			—		—			774
Provision		177			805			4,838			313			18			—		(726	)		5,425
Ending Balance	$	652		$	1,658		$	5,787		$	678		$	102		$	—	$	288		$	9,165
Loans:
Ending balance	$	40,901		$	127,315		$	291,575		$	108,890		$	7,882		$	18,970	$	—		$	595,533
ALL		(652	)		(1,658	)		(5,787	)		(678	)		(102	)		—		(288	)		(9,165	)
Recorded investment	$	40,249		$	125,657		$	285,788		$	108,212		$	7,780		$	18,970	$	(288	)	$	586,368
Ending balance:
Individually evaluated	$	1,042		$	1,442		$	14,886		$	984		$	26		$	—	$	—		$	18,380
Collectively evaluated		39,859			125,873			276,689			107,906			7,856			18,970		—			577,153
Total	$	40,901		$	127,315		$	291,575		$	108,890		$	7,882		$	18,970	$	—		$	595,533

Loans are individually evaluated for impairment once a weakness or adverse trend is identified that may jeopardize the repayment of the loan.

The Company’s recorded investment in loans as of December 31, 2013 and 2012 shown above is broken down by portfolio segment and impairment methodology.

Credit Quality: Management utilizes a risk grading matrix on each of the Company’s commercial loans. Loans are graded on a scale of 1 to 7. A description of the loan grades is as follows:

0001 Excellent Risk. Borrowers of highest quality and character. Almost no risk possibility. Balance sheets are very strong with superior liquidity, excellent debt capacity and low leverage. Cash flow trends are positive and stable. Excellent ratios.

0002 Very Good Risk. Good ratios in all areas. High quality borrower. Normally quite liquid. Differs slightly from a 0001 rated customer.

0003 Strong in most categories. Possible higher levels of debt or shorter track record. Minimal attention required. Good management.

0004 Better than Average Risk. Adequate ratios, fair liquidity, desirable customer. Proactive management. Performance trends are positive. Any deviations are limited and temporary.

90

BAYLAKE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2013, 2012 and 2011
(Dollar amounts in thousands)

NOTE 4 – LOANS(Continued)

0005 Satisfactory Risk. Some ratios slightly weak. Overall ability to repay is adequate. Capable and generally proactive management in all critical positions. Margins and cash flow may lack stability but trends are stable to positive. Company normally profitable year to year but may experience an occasional loss.

0006 A Weakness detected in either management, capacity to repay or balance sheet. Erratic profitability and financial performance. Loan demands more attention. Includes loans deemed to have weaknesses and less than 90 days past due.

0006 B Have weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or in the Bank’s collateral position at some future date. Loans rated 0006B are not adversely classified and do not expose the Bank to sufficient risk to warrant adverse classification. Includes loans deemed to have weaknesses and less than 90 days past due.

0007 Well defined weaknesses and trends that jeopardize the repayment of loans. Ranging from workout to legal. Includes loans that are nonaccrual and/or 90 days and over past due.

In addition to the risk grading on commercial loans, real estate mortgage, consumer, and tax exempt loans are included in the 0001-0005 category until such time as the loan becomes past due 90 days or more or is moved to nonaccrual status at which point the loan is rated 0007.

Below is a breakdown of loans by risk grading as of December 31, 2013:

	0001-0005			0006A			0006B			0007(1)			Total
Commercial	$	118,284		$	2,510		$	3,080		$	1,416		$	125,290
Commercial real estate		237,773			20,732			10,549			18,761			287,815
Construction		33,125			1,857			1,105			861			36,948
		389,182			25,099			14,734			21,038			450,053
Real estate residential		139,364			1,305			464			1,265			142,398
Consumer		6,473			—			—			22			6,495
Tax exempt		19,435			—			—			—			19,435
Total	$	554,454		$	26,404		$	15,198		$	22,325		$	618,381
Deferred loan origination fees														(421	)
Total loans													$	617,960
Percent of total loans		89.7	%		4.3	%		2.4	%		3.6	%		100.0	%

⁽¹⁾ Included in the 0007 rated loans are $6,657 of loans that are collectively evaluated and not considered impaired because, in the event of default, no loss is expected.

91

BAYLAKE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2013, 2012 and 2011
(Dollar amounts in thousands)

NOTE 4 – LOANS(Continued)

Below is a breakdown of loss by risk grading as of December 31, 2012:

	0001-0005			0006A			0006B			0007(2)			Total
Commercial	$	102,038		$	1,835		$	3,351		$	1,666		$	108,890
Commercial real estate		232,298			19,964			18,720			21,010			291,992
Construction		32,195			5,924			1,539			1,243			40,901
		366,531			27,723			23,610			23,919			441,783
Real estate residential		123,343			1,159			630			2,183			127,315
Consumer		7,856			—			—			26			7,882
Tax exempt		18,970			—			—			—			18,970
Total	$	516,700		$	28,882		$	24,240		$	26,128		$	595,950
Deferred loan origination fees														(417	)
Total loans													$	595,533
Percent of total loans		86.7	%		4.8	%		4.1	%		4.4	%		100.0	%

⁽²⁾ Included in the 0007 rated loans are $7,748 of loans that are collectively evaluated and not considered impaired because, in the event of default, no loss is expected.

A summary of past due loans at December 31 are as follows:

	2013
	30-89 Days Past Due (accruing)		90 Days & Over or on Nonaccrual		Total
Construction	$	—	$	660	$	660
Real estate – residential		363		540		903
Real estate – commercial		676		5,171		5,847
Commercial		15		266		281
Consumer		26		21		47
Tax exempt		—		—		—
Total	$	1,080	$	6,658	$	7,738

	2012
	30-89 Days Past Due (accruing)		90 Days & Over or on Nonaccrual		Total
Construction	$	—	$	1,042	$	1,042
Real estate – residential		618		988		1,606
Real estate – commercial		1,715		11,408		13,123
Commercial		903		984		1,887
Consumer		29		26		55
Tax exempt		—		—		—
Total	$	3,265	$	14,448	$	17,713

92

BAYLAKE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2013, 2012 and 2011
(Dollar amounts in thousands)

NOTE 4 – LOANS(Continued)

A summary of troubled debt restructurings at December 31 is as follows:

	2013				2012
	Number of Modifications		Recorded Investment		Number of Modifications		Recorded Investment
Construction		—	$	—		—	$	—
Real estate – residential		—		—		5		455
Real estate – commercial		8		9,264		12		7,186
Commercial		—		—		1		14
Consumer		—		—		—		—
Tax exempt		—		—		—		—
Total		8	$	9,264		18	$	7,655

93

BAYLAKE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2013, 2012 and 2011
(Dollar amounts in thousands)

NOTE 4 – LOANS(Continued)

A roll forward of troubled debt restructuring during the year ended December 31, 2013 is as follows:

							��
	Construction		Real Estate- Residential			Real Estate- Commercial			Commercial			Consumer		Tax Exempt		Total
Accruing
Beginning balance	$	—	$	455		$	3,476		$	—		$	—	$	—	$	3,931
Principal payments		—		—			(120	)		—			—		—		(120	)
Charge-offs		—		—			—			—			—		—		—
Advances		—		—			10			—			—		—		10
New restructureds		—		—			6,865			—			—		—		6,865
Transfers to other real estate properties		—		—			—			—			—		—		—
Transfers to nonaccrual		—		(69	)		(255	)		—			—		—		(324	)
Transfers out of TDRs		—		(386	)		(967	)		—			—		—		(1,353	)
Ending Balance	$	—	$	—		$	9,009		$	—		$	—	$	—	$	9,009
Nonaccrual
Beginning balance	$	—	$	—		$	3,710		$	14		$	—	$	—	$	3,724
Principal payments		—		(69	)		(3,023	)		(14	)		��		—		(3,106	)
Charge-offs		—		—			(687	)		—			—		—		(687	)
Advances		—		—			—			—			—		—		—
New restructureds		—		—			—			—			—		—		—
Transfers to other real estate properties		—		—			—			—			—		—		—
Transfers from accruing		—		69			255			—			—		—		324
Transfers out of TDRs		—		—			—			—			—		—		—
Ending Balance	$	—	$	—		$	255		$	—		$	—	$	—	$	255
Totals
Beginning balance	$	—	$	455		$	7,186		$	14		$	—	$	—	$	7,655
Principal payments		—		(69	)		(3,143	)		(14	)		—		—		(3,226	)
Charge-offs		—		—			(687	)		—			—		—		(687	)
Advances		—		—			10			—			—		—		10
New restructureds		—		—			6,865			—			—		—		6,865
Transfers to other real estate properties		—		—			—			—			—		—		—
Transfers out of TDRs		—		(386	)		(967	)		—			—		—		(1,353	)
Ending Balance	$	—	$	—		$	9,264		$	—		$	—	$	—	$	9,264

94

BAYLAKE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2013, 2012 and 2011
(Dollar amounts in thousands)

NOTE 4 – LOANS(Continued)

A roll forward of troubled debt restructuring during the year ended December 31, 2012 is as follows:

	Construction		Real Estate- Residential			Real Estate- Commercial			Commercial			Consumer		Tax Exempt		Total
Accruing
Beginning balance	$	—	$	1,432		$	20,203		$	374		$	—	$	—	$	22,009
Principal payments		—		(699	)		(379	)		(374	)		—		—		(1,452	)
Charge-offs		—		(195	)		—			—			—		—		(195	)
Advances		—		—			47			—			—		—		47
New restructureds		—		457			1,017			—			—		—		1,474
Transfers to other real estate properties		—		(500	)		(110	)		—			—		—		(610	)
Transfers to nonaccrual		—		—			(9,710	)		—			—		—		(9,710	)
Transfers out of TDRs				(40	)		(7,592	)		—			—		—		(7,632	)
Ending Balance	$	—	$	455		$	3,476		$	—		$	—	$	—	$	3,931
Nonaccrual
Beginning balance	$	—	$	—		$	4,325		$	16		$	—	$	—	$	4,341
Principal payments		—		—			(3,889	)		(2	)		—		—		(3,891	)
Charge-offs		—		—			(2,871	)		—			—		—		(2,871	)
Advances		—		—			195			—			—		—		195
New restructureds		—		—			—			—			—		—		—
Transfers to other real estate properties		—		—			(3,760	)		—			—		—		(3,760	)
Transfers from accruing		—		—			9,710			—			—		—		9,710
Transfers out of TDRs		—		—			—			—			—		—		—
Ending Balance	$	—	$	—		$	3,710		$	14		$	—	$	—	$	3,724
Totals
Beginning balance	$	—	$	1,432		$	24,528		$	390		$	—	$	—	$	26,350
Principal payments		—		(699	)		(4,268	)		(376	)		—		—		(5,343	)
Charge-offs		—		(195	)		(2,871	)		—			—		—		(3,066	)
Advances		—		—			242			—			—		—		242
New restructureds		—		457			1,017			—			—		—		1,474
Transfers to other real estate properties		—		(500	)		(3,870	)		—			—		—		(4,370	)
Transfers out of TDRs		—		(40	)		(7,592	)		—			—		—		(7,632	)
Ending Balance	$	—	$	455		$	7,186		$	14		$	—	$	—	$	7,655

95

BAYLAKE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2013, 2012 and 2011
(Dollar amounts in thousands)

NOTE 4 – LOANS(Continued)

At December 31, 2013, there were no outstanding unfunded commitments to customers whose terms have been modified in a troubled debt restructuring.

Restructured loans involves the granting of some concession to the borrower involving a loan modification, such as payment schedule changes, interest rate reductions, or principal charge-offs (“A/B Note Structure”). During the year ended December 31, 2013, restructured loan modifications primarily consisted of loans in the real estate-commercial category. Reasons for restructuring were principal charge-offs, interest rate concessions, and term extensions.

A summary of troubled debt restructurings as of December 31, 2013 by restructure type is as follows:

	Accruing		Nonaccruing		Total
A/B Note Structure	$	657	$	—	$	657
Payment schedule changes		6,380		255		6,635
Interest rate reduction		1,972		—		1,972
Total	$	9,009	$	255	$	9,264

A loan that is modified at a market rate of interest may no longer be classified as a TDR in the calendar year subsequent to restructuring if it is in compliance with its modified terms.

All loans transferred out of TDRs in 2013 and 2012 have continued to perform under their restructured terms.

96

BAYLAKE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2013, 2012 and 2011
(Dollar amounts in thousands)

NOTE 4 – LOANS(Continued)

Information regarding impaired loans is as follows:

IMPAIRED LOANS AND ALLOCATED ALLOWANCE

December 31, 2013	Construction		Real Estate- Residential		Real Estate- Commercial		Commercial		Consumer		Tax Exempt		Not Specifically Allocated		Totals
With an allowance recorded:
Recorded investment	$	—	$	201	$	1,032	$	19	$	—	$	—	$	—	$	1,252
Unpaid principal balance		—		277		1,569		49		—		—		—		1,895
Related allowance		—		76		537		30		—		—		—		643
With no related allowance recorded:
Recorded investment	$	660	$	263	$	12,611	$	218	$	21	$	—	$	—	$	13,773
Unpaid principal balance		660		263		12,611		218		21		—		—		13,773
Related allowance		—		—		—		—		—		—		—		—
Total:
Recorded investment	$	660	$	464	$	13,643	$	237	$	21	$	—	$	—	$	15,025
Unpaid principal balance		660		540		14,180		267		21		—		—		15,668
Related allowance		—		76		537		30		—		—		—		643
Average recorded investment during year	$	767	$	434	$	13,503	$	227	$	31	$	—	$	—	$	14,962
Interest income recognized while impaired	$	3	$	8	$	316	$	—	$	—	$	—	$	—	$	329
December 31, 2012	Construction		Real Estate-Residential		Real Estate-Commercial		Commercial		Consumer		Tax Exempt		Not Specifically Allocated		Totals
With an allowance recorded:
Recorded investment	$	130	$	703	$	3,261	$	—	$	3	$	—	$	—	$	4,097
Unpaid principal balance		153		897		4,370		13		4		—		—		5,437
Related allowance		23		194		1,109		13		1		—		—		1,340
With no related allowance recorded:
Recorded investment	$	889	$	547	$	10,516	$	971	$	20	$	—	$	—	$	12,943
Unpaid principal balance		889		547		10,516		971		20		—		—		12,943
Related allowance		—		—		—		—		—		—		—		—
Total:
Recorded investment	$	1,019	$	1,248	$	13,777	$	971	$	25	$	—	$	—	$	17,040
Unpaid principal balance		1,042		1,442		14,886		984		26		—		—		18,380
Related allowance		23		194		1,109		13		1		—		—		1,340
Average recorded investment during year	$	2,889	$	2,582	$	22,518	$	791	$	18	$	—	$	—	$	28,798
Interest income recognized while impaired	$	2	$	87	$	230	$	6	$	—	$	—	$	—	$	325

Management regularly monitors impaired loan relationships. In the event facts and circumstances change, an additional PFLL may be necessary.

97

BAYLAKE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2013, 2012 and 2011
(Dollar amounts in thousands)

NOTE 5 - PREMISES AND EQUIPMENT

	December 31,
	2013		2012
Land	$	5,026	$	5,114
Buildings and improvements		22,554		23,317
Equipment		12,126		12,137
		39,706		40,568
Less accumulated depreciation		19,992		19,750
Premises and equipment, net	$	19,714	$	20,818

Depreciation expense was $1,297, $1,295 and $1,338 for the years ended December 31, 2013, 2012 and 2011, respectively.

NOTE 6 – OTHER REAL ESTATE OWNED, NET

Other Real Estate Owned is summarized as follows:

	For the year ended December 31,
	2013			2012
Beginning balance	$	14,334		$	14,913
Transfer of loan collateral to other real estate owned		1,037			9,487
Transfer of bank facilities to other real estate owned		569			—
Sale proceeds, net		(5,040	)		(8,040	)
Net gain from disposal of other real estate owned		202			194
Valuation allowance related to properties disposed		(2,536	)		(2,220	)
Total other real estate owned		8,566			14,334
Valuation allowance for losses		(2,268	)		(3,858	)
Total other real estate owned, net	$	6,298		$	10,476

98

BAYLAKE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2013, 2012 and 2011
(Dollar amounts in thousands)

NOTE 6 – OTHER REAL ESTATE OWNED, NET (Continued)

Changes in the valuation allowance for losses on other real estate owned were as follows:

	For the year ended December 31,
	2013			2012
Beginning balance	$	3,858		$	2,794
Provision charged to operations		946			3,284
Amounts related to properties disposed		(2,536	)		(2,220	)
Balance at end of year	$	2,268		$	3,858

NOTE 7 – MORTGAGE SERVICING RIGHTS

The Bank has obligations to service residential first mortgage loans and commercial loans that have been sold in the secondary market with servicing retained. Mortgage servicing rights (“MSRs”) are recorded when loans are sold in the secondary market with servicing retained. On a monthly basis MSRs are valued based on available market information. The Bank does not hedge against the risk of changes in fair value.

Changes in the carrying value of MSRs are as follows:

	For the year ended December 31,
	2013			2012
Balance at beginning of period	$	839		$	634
Addition from loans sold with servicing retained		227			398
Loan payments and payoffs		(195	)		(212	)
Changes in valuation		96			19
Fair value of MSRs at the end of period	$	967		$	839
Unpaid principal balance of loans serviced at December 31	$	125,684		$	117,560

99

BAYLAKE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2013, 2012 and 2011
(Dollar amounts in thousands)

NOTE 8 - DEPOSITS

The following is a summary of deposits by type at December 31:

	2013		2012
Noninterest-bearing demand deposits	$	127,940	$	132,477
Interest-bearing demand deposits		132,407		150,168
Savings deposits		41,249		38,714
Money market deposits		287,447		256,987
Time deposits $100,000 and greater		44,927		88,213
Other time deposits		110,242		139,456
Total deposits	$	744,212	$	806,015
Brokered deposits included above	$	11,482	$	36,164

At December 31, 2013, the scheduled maturities of time deposits were as follows:

2014	$	102,463
2015		44,473
2016		5,660
2017		2,563
2018		10
	$	155,169

Deposits from the Company’s directors and officers held by the Bank at December 31, 2013 and 2012 amounted to $5,609 and $5,713, respectively.

NOTE 9 - FEDERAL HOME LOAN BANK ADVANCES

A summary of FHLB advances at December 31 is as follows:

	December 31, 2013															December 31, 2012
Year of Maturity	Fixed Rate		Weighted Average Fixed Rate			Variable Rate		Weighted Average Variable Rate			Total		Weighted Average Rate			Total (All Fixed Rate advances)		Weighted Average Rate
2013	$	—		—	%	$	—		—	%	$	—		—	%	$	15,000		1.62	%
2014		31,000		0.99	%		10,000		0.13	%		41,000		0.78	%		13,000		2.13	%
2015		16,000		1.92	%		—		—	%		16,000		1.92	%		12,000		2.39	%
2016		1,000		0.91	%		—		—	%		1,000		0.91	%		—		—	%
2017		1,200		1.17	%		—		—	%		1,200		1.17	%		—		—	%
2018		—		—	%		4,000		0.25	%		4,000		0.25	%		—		—	%
2019		—		—	%		—		—	%		—		—	%		—		—	%
2020		—		—	%		—		—	%		—		—	%		—		—	%
2021		—		—	%		3,500		0.30	%		3,500		0.30	%		—		—	%
	$	49,200		1.30	%	$	17,500		0.19	%	$	66,700		1.01	%	$	40,000		1.88	%

Maximum month-end amounts outstanding were $69,200 and $55,000 during the years ended December 31, 2013 and 2012, respectively.

100

BAYLAKE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2013, 2012 and 2011
(Dollar amounts in thousands)

NOTE 9 - FEDERAL HOME LOAN BANK ADVANCES(Continued)

Each advance is payable at its maturity date, with a prepayment penalty applicable for fixed rate advances if repaid prior to maturity. FHLB advances are secured by $91,874 of real estate first mortgages, $40,689 of home equity loans and lines and $10,275 of mortgage-backed and U.S. government sponsored agency securities. During the third quarter of 2013, $15,000 of borrowings placed in prior years matured. During the fourth quarter of 2013, $16,000 of borrowings advanced in the same quarter matured.

NOTE 10 - REPURCHASE AGREEMENTS

Short-term borrowings consisted of the following at December 31:

	2013			2012
Securities sold under agreements to repurchase	$	58,448		$	51,568
Average amounts outstanding during year	$	34,728		$	27,578
Maximum month-end amounts outstanding		69,902			51,568
Average interest rates on amounts outstanding at end of year		0.11	%		0.35	%
Average interest rates on amounts outstanding during year		0.23	%		0.22	%

NOTE 11 - SUBORDINATED DEBENTURES

On March 31, 2006, the Company issued $16,100 of trust preferred securities (“Debentures”) and $498 of trust common securities through its wholly-owned subsidiary, Baylake Capital Trust II (“the Trust”) that adjust quarterly at a rate equal to 1.35% over the three month LIBOR (1.60% at December 31, 2013). The Trust’s ability to pay amounts due on the debentures is solely dependent upon the Company making payment on the related subordinated debentures to the Trust. The Company’s obligations under the Debentures include a conditional guarantee by the Company of the Trust’s obligations under the trust securities issued by the trust. In addition, under the terms of the Debentures, the Company would be precluded from paying dividends on the Company’s common stock if the Company was in default under the Debentures, if the Company exercised its right to defer payments of interest on the Debentures or if certain related defaults occurred. During the first three quarters of 2011, the Company exercised its right to defer the interest payments owing under the agreements. In the fourth quarter of 2011, however, the Company made all payments due under the agreements, including the deferral payments. At December 31, 2013 and 2012, the Company is current on all required payments.

NOTE 12 – CONVERTIBLE PROMISSORY NOTES

During 2009 and 2010, the Company issued 10% Convertible Notes due June 30, 2017 (the “Convertible Notes”) totaling $9,450. The Convertible Notes offering was exempt from registration under Section 4(2) of the Securities Act of 1933 and Rule 506 promulgated there under.

101

BAYLAKE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2013, 2012 and 2011
(Dollar amounts in thousands, except per share data)

NOTE 12 – CONVERTIBLE PROMISSORY NOTES(Continued)

The Convertible Notes accrue interest at a fixed rate of 10% payable quarterly, in arrears, on January 1, April 1, July 1, and October 1, of each year. The Convertible Notes are convertible into shares of the Company’s common stock at a conversion ratio of one share of common stock for each $5.00 in aggregate principal amount held on the record date of the conversion subject to certain adjustments as described in the Convertible Notes. Beginning on July 1, 2014, the Company may redeem the notes in whole or in part. A notice of redemption supersedes and takes priority over any notice of conversion. Prior to October 1, 2014, each holder of the Convertible Notes may convert up to 100% (at the discretion of the holder) of the original principal amount into shares of the Company’s common stock at the conversion ratio. On October 1, 2014, one-half of the original principal amounts are mandatorily convertible into common stock at the conversion ratio if conversion has not yet otherwise occurred. The principal amount of any Convertible Note that has not been converted will be payable at maturity on June 30, 2017. The Company is not obligated to register the common stock issued on the conversion of the Convertible Notes. During the fourth quarter of 2012, $50 of Convertible Notes was converted to 10,000 common shares at the investor’s option. Subsequent to December 31, 2013, $200 of Convertible Notes was converted to 40,000 common shares at the investor’s option.

The Company incurred debt issuance costs of $179 in conjunction with the sale of the Convertible Notes. These costs were capitalized and are being amortized to interest expense using the effective interest method over the initial conversion term, which is through September 30, 2014.

NOTE 13 - CAPITAL MATTERS

Banks and bank holding companies are subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines and, additionally for banks, prompt corrective action regulations involve quantitative measures of assets, liabilities, and certain off-balance-sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators. Failure to meet capital requirements can initiate regulatory action.

Prompt corrective action regulations provide five capital classifications: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized, although these terms are not used to represent overall financial condition. If adequately capitalized, regulatory approval is required to accept brokered deposits. If undercapitalized, capital distributions are limited, as is asset growth and expansion, and capital restoration plans are required. At December 31, 2013, regulatory notifications categorized the Bank and the Company as well capitalized, under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed the Bank’s or the Company’s category.

Effective December 29, 2010, the Company and the Bank entered into a Written Agreement (“Written Agreement”) with the Reserve Bank and the State of Wisconsin Department of Financial Institutions (“WDFI”). Under the terms of the Written Agreement, both the Company and the Bank agreed to, among other things: (a) submit for approval plans to permit the Company to maintain sufficient consolidated capital and the Bank, to maintain sufficient stand-alone capital; (b) comply with applicable notice provisions with respect to the appointment of new directors and senior executive officers of the Company and the Bank and legal and regulatory limitations on indemnification payments and severance payments; and (c) refrain from declaring or paying dividends absent prior regulatory approval. Effective June 4, 2012, the FRB and WDFI terminated the Written Agreement. In place of the Written Agreement, an informal agreement was entered into June 19, 2012, between the Company and the FRB and WDFI. This informal agreement required the Company and Bank to (i) refrain from declaring or paying dividends absent prior regulatory approval, (ii) submit capital plans as evidence of sufficient capital and (iii) submit an annual business plan and budget at least 30 days prior to the beginning of the year. The informal agreement was terminated effective December 14, 2012.

102

BAYLAKE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2013, 2012 and 2011
(Dollar amounts in thousands)

NOTE 13 - CAPITAL MATTERS(Continued)

Regulatory restrictions, which govern all state chartered banks, preclude the payment of dividends without the prior written consent of the WDFI if dividends declared and paid by such bank in either of the two immediately preceding years exceeded that bank’s net income for those years. During 2011, no dividends were declared. During 2012, the Company sought and received approval to declare and pay dividends of $0.08 per share or $635. The restriction requiring approval prior to declaration of dividends was removed at the time the informal agreement was terminated in December 2012. During 2013, the Company declared and paid dividends of $0.22 per share or $1,738. On January 21, 2014, the Company declared a dividend of $0.07 per share to shareholders of record on February 10, 2014.

The Company’s and the Bank’s risk-based capital and leverage ratios at December 31, 2013 and 2012 are presented below.

	Actual					For Capital Adequacy Purposes					To Be Well Capitalized Under Prompt Corrective Action Provisions
	Amount		Ratio			Amount		Ratio			Amount		Ratio
2013
Total Capital to Risk-Weighted Assets
Consolidated	$	116,195		16.71	%	$	55,616		8.00	%		N/A		N/A
Bank		113,254		16.30	%		55,571		8.00	%	$	69,464		10.00	%
Tier 1 (Core) Capital to Risk-Weighted Assets
Consolidated		99,137		14.26	%		27,808		4.00	%		N/A		N/A
Bank		105,596		15.20	%		27,786		4.00	%		41,678		6.00	%
Tier 1 (Core) Capital to Average Assets
Consolidated		99,137		10.48	%		37,834		4.00	%		N/A		N/A
Bank		105,596		11.16	%		37,836		4.00	%		47,295		5.00	%
2012
Total Capital to Risk-Weighted Assets
Consolidated	$	109,932		15.96	%	$	55,111		8.00	%		N/A		N/A
Bank		109,358		15.89	%		55,047		8.00	%	$	68,809		10.00	%
Tier 1 (Core) Capital to Risk-Weighted Assets
Consolidated		91,914		13.34	%		27,556		4.00	%		N/A		N/A
Bank		100,750		14.64	%		27,524		4.00	%		41,286		6.00	%
Tier 1 (Core) Capital to Average Assets
Consolidated		91,914		9.41	%		39,056		4.00	%		N/A		N/A
Bank		100,750		10.31	%		39,101		4.00	%		48,876		5.00	%

NOTE 14 – COMMITMENTS AND CONTINGENCIES

The Company is party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of customers. These financial instruments include off balance-sheet credit instruments, such as commitments to make loans and commercial letters of credit, issued to meet customer financing needs. The face amount for these items represents the exposure to loss, before considering customer collateral or ability to repay. Such financial instruments are recorded when they are funded. Instruments, such as standby letters of credit, that are considered financial guarantees are recorded at fair value. The Company does not use forward loan sale commitments.

103

BAYLAKE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2013, 2012 and 2011
(Dollar amounts in thousands)

NOTE 14 – COMMITMENTS AND CONTINGENCIES(Continued)

The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contract or notional amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments.

	December 31,
	2013		2012
Financial instruments whose contract amounts represent credit risk:
Commitments to extend credit	$	228,208	$	230,351
Standby letters of credit		9,898		15,499

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management’s credit evaluation of the counter-party. Collateral held varies but may include accounts receivable; inventory; property, plant, and equipment; and income-producing commercial properties. Fixed rate commitments totaled $20,533 and $15,666 at December 31, 2013 and 2012, respectively, with rates ranging from 0.75% to 8.00% in 2013 and 2.00% to 8.75% in 2012.

Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of customers to a third party. These are primarily issued to support private borrowing arrangements. The commitments expire in decreasing amounts through 2023, with a majority expiring by December 31, 2018. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Company does not require collateral as support for the commitments. Collateral is secured as commitments are funded.

In 2013, 2012 and 2011, impairment charges of $0, $0 and $68 were taken, respectively, on standby letters of credit which were issued by the Company on behalf of customers to accommodate their borrowings with third parties. The provision for impairment charges related to the establishment of a liability for the Company’s expected losses on outstanding letters of credit. During the second quarter of 2012, the collateral securing the letter of credit was sold to an unrelated third party who assumed the letter of credit. The liability for the guarantees was reduced to zero and no further impairment charges were recognized. At December 31, 2013 and 2012, there was no carrying value recorded by the Company as a liability for those guarantees.

Loss contingencies, including claims and legal actions arising in the ordinary course of business, are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated.

The Company does not use interest rate contracts (e.g. swaps) or other derivatives to manage interest rate risk and does not have any of these instruments outstanding as of and for the years ended December 31, 2013, 2012 and 2011.

104

BAYLAKE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2013, 2012 and 2011
(Dollar amounts in thousands)

NOTE 15 - RETIREMENT PLANS

The Bank has a 401(k) profit sharing plan covering all employees who qualify as to age and length of service. The discretionary employer contributions paid and expensed under all plans totaled $449, $366 and $367 in 2013, 2012 and 2011, respectively. Certain officers and directors of the Company and its subsidiaries are covered by nonqualified deferred compensation plans. Payments to be made under these plans are accrued over the anticipated years of service of the individuals covered. Amounts charged to expense were $323, $324, and $140 in 2013, 2012, and 2011, respectively. The aggregate amount of deferred compensation included in other liabilities in the consolidated balance sheets is $3,262 and $3,230 in 2013 and 2012, respectively. The Company has established the Baylake Bank Supplemental Executive Retirement Plan (“SERP Plan”), which is intended to provide certain management and highly compensated employees of the Company who have contributed and are expected to continue to contribute to the Company’s success, deferred compensation in addition to that available under the Company’s other retirement programs. Costs amounting to $225, $222 and $33 are included in the amounts charged to expense for 2013, 2012 and 2011, respectively. The Company has ceased making contributions to the Plan at the present time and does not expect to resume making contributions to the Plan in the foreseeable future.

NOTE 16 - INCOME TAXES

Income tax expense consists of the following:

	For the year ended December 31,
	2013			2012			2011
Current income taxes
Federal	$	922		$	1,699		$	1,123
State		(66	)		(35	)		37
		856			1,664			1,160
Deferred income taxes
Federal		1,535			159			(145	)
State		928			(340	)		392
		2,463			(181	)		247
Income tax expense	$	3,319		$	1,483		$	1,407

The provision for income taxes differs from the amount of income tax determined by applying the statutory federal income tax rate to pretax income as a result of the following differences:

	For the year ended December 31,
	2013			2012			2011
Income tax expense based on statutory rate (34%)	$	3,851		$	3,103		$	2,000
State income tax expense (benefit) net of federal tax expense (benefit)		569			(905	)		284
Effect of tax-exempt interest income		(698	)		(687	)		(684	)
Life insurance death benefit and earnings		(119	)		(295	)		(254	)
Equity in income of UFS subsidiary		(254	)		(184	)		(222	)
State valuation allowance reversal		—			658			—
Other		(30	)		(207	)		283
Expense based on effective tax rates	$	3,319		$	1,483		$	1,407

For purposes of calculating its tax provision, the Company anticipates that the undistributed earnings in the UFS subsidiary will be distributed back to the Company in the form of dividends.

105

BAYLAKE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2013, 2012 and 2011
(Dollar amounts in thousands)

NOTE 16 - INCOME TAXES (Continued)

Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes.

The following is a summary of the significant components of the Company’s deferred income tax assets and liabilities as of December 31, 2013 and 2012:

	2013		2012
Deferred income tax assets
Allowance for loan losses	$	3,003	$	3,594
Deferred loan fees		165		163
Deferred compensation		1,530		1,532
Nonaccrual loans		114		246
Accrued vacation pay		584		570
OREO property valuation/expenses		1,633		2,960
Donations		39		—
Deferred tax credits-AMT		2,437		2,638
State net operating loss carry forwards (NOLs)		665		986
Other		288		151
Total deferred tax assets before valuation allowance		10,458		12,840
Deferred income tax liabilities
Depreciation		1,757		1,798
FHLB stock dividends		413		419
Mortgage loan servicing		212		165
Net unrealized gain on securities available for sale		696		3,437
Equity in UFS subsidiary		525		464
Prepaid expenditures		165		143
Other		54		56
Total deferred income tax liabilities		3,822		6,482
Net deferred income tax assets	$	6,636	$	6,358

The Company has state net operating loss carry forwards of $12,810 and $18,917 at December 31, 2013 and December 31, 2012, respectively. $200 of the state net operating losses expire annually beginning in 2024 with the remainder expiring in 2032.

Prior to the fourth quarter of 2012, the Company carried a valuation allowance to reduce deferred income tax assets related to state net operating loss carry forwards to an amount which the Company believed the benefit would more likely than not be realized. Based on an assessment by the Company in the fourth quarter of 2012, it was determined the valuation allowance was no longer required. The valuation allowance of $658 was reduced to zero, with an offsetting reduction to income tax expense.

106

BAYLAKE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2013, 2012 and 2011
(Dollar amounts in thousands, except per share data)

NOTE 16- INCOME TAXES (Continued)

Income tax expense recorded in the consolidated statement of operations involves the interpretation and application of certain accounting pronouncements and federal and state tax codes. The Company undergoes examination by various regulatory taxing agencies. Such agencies may require that changes in the amount of tax expense be recognized when their interpretations differ from those of management, based on their judgment about information available to them at the time of their examination.

A reconciliation of the beginning and ending amounts of unrecognized tax benefits is as follows:

	For the year ended December 31,
	2013		2012			2011
Balance	$	—	$	174		$	—
Additions for tax positions of prior years		—		—			174
Settlements		—		(174	)		—
Balance, end of year	$	—	$	—		$	174

As of December 31, 2011, the gross unrecognized tax benefits represented estimated tax and interest costs related to an IRS audit for the 2009 tax year. In January 2012, the Company and the IRS reached a tentative settlement agreement to finalize the audit and the Company paid interest of $34. The excess liability of $140 was reversed when the audit was finalized in the fourth quarter of 2012.

The Company and its subsidiaries are subject to U.S. federal and Wisconsin state income tax. The Company and its subsidiaries file a consolidated federal income tax return and a combined Wisconsin tax return. The Company is no longer subject to examination by U.S. Federal taxing authorities for years before 2010 and for Wisconsin state income taxes for years before 2009. During the third quarter of 2013, the IRS began an audit of the Company’s 2011 federal income tax return. The audit concluded in the fourth quarter of 2013. The Company received a minimal amount of interest related to the timing of deductions taken for income tax purposes. The Company does not expect the total amount of unrecognized tax benefits to significantly increase or decrease in the next twelve months.

The Company recognizes interest and/or penalties related to income tax matters in income tax expense.

107

BAYLAKE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2013, 2012 and 2011
(Dollar amounts in thousands, except per share data)

NOTE 17 - EARNINGS PER SHARE

Earnings per share is based on the weighted average number of shares outstanding for the year. A reconciliation of the basic and diluted earnings per share amounts is as follows:

	For the year ended December 31,
	2013		2012		2011
Basic
Net income	$	8,009	$	7,642	$	4,476
Weighted average common shares outstanding		7,902,732		7,926,424		7,911,539
Basic earnings per common share	$	1.01	$	0.96	$	0.57
Diluted
Net income		8,009		7,642		4,476
Earnings from assumed conversion of convertible debentures		593		593		—
Net income	$	8,602	$	8,235	$	4,476
Weighted average common shares outstanding for basic earnings per share		7,902,732		7,926,424		7,911,539
Add: Dilutive effects of assumed exercises of stock options and vesting of restricted stock units		68,910		29,116		4,842
Add: Dilutive effects of convertible promissory notes		1,880,000		1,880,000		—
Average shares and dilutive potential common shares		9,851,642		9,835,540		7,916,381
Diluted earnings per common share	$	0.87	$	0.84	$	0.57
Additional common stock option shares that have not been included due to their antidilutive effect		49,949		93,152		112,400
Additional common stock convertible debenture shares that have not been included due to their antidilutive effect		—		—		1,890,000

NOTE 18 - STOCK OPTION PLAN

The Company had a non-qualified stock option plan (the “Option Plan”) under which certain officers and key salaried employees were entitled to purchase shares of the Company’s stock at an established exercise price. Unless earlier terminated, these options expired ten years from the date of grant. The options vested over a five-year period becoming exercisable 20% per year, commencing one year from date of grant. This plan expired in 2003. Subsequent to expiration of the Option Plan, options to purchase 10,000 shares of Company common stock were granted on the same terms and conditions as applied to options granted under the Option Plan. There was no compensation expense recognized for the Option Plan in 2013 or 2012. At December 31, 2013 and 2012, there was no unrecognized compensation cost related to the Option Plan and all unexpired options issued were fully vested. On January 6, 2014, the 10,000 options granted subsequent to expiration of the Option Plan, which were outstanding and fully vested at December 31, 2013, expired unexercised.

In June 2010, the Company’s shareholders approved the Baylake Corp 2010 Equity Incentive Plan (“the 2010 Plan”), under which current and prospective employees, non-employee directors and consultants may be awarded incentive stock options, non-statutory stock options, shares of restricted stock or RSUs, or stock appreciation rights. The aggregate number of shares of the Company’s common stock issuable under the 2010 Plan is 750,000.

108

BAYLAKE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2013, 2012 and 2011
(Dollar amounts in thousands, except per share data)

NOTE 18 - STOCK OPTION PLAN(Continued)

Stock Options
On March 19, 2013, the Company granted 43,176 stock options to certain members of management at the market value of the stock on the grant date, which was $9.50 per share. The options granted expire 10 years from date of grant and vest ratably over a five-year period. The fair value of the stock options granted was $2.58 per option, determined under the Black-Scholes option pricing model. Compensation cost to be recognized over the five-year vesting period, net of income tax, is $67. As of December 31, 2013, none of the options were vested and 3,227 options had been forfeited. Unrecognized compensation expense, net of income tax, is $53.

Restricted Stock Units
On March 19, 2013, the Company granted 35,177 RSUs to certain members of management at the market value of the stock, which was $9.50 per share. The RSUs were awarded at no cost to the employee and vest ratably over a five-year period. Compensation cost to be recognized over the five-year vesting period, net of income tax, is $203. As of December 31, 2013, none of the RSUs were vested and 2,629 RSUs were forfeited during 2013. Unrecognized compensation expense, net of income tax, is $158.

Accounting for Stock Options
The fair value of each option grant was estimated as of the date of the grant using the Black-Scholes option pricing model. The risk-free interest rate is based on the U.S. Treasury rate for the expected option term. The expected volatility is based on the volatility of the Company’s stock over the 36-month period preceding the grant date. The expected term represents the period of time the options are expected to be outstanding. The grant date fair values and assumptions used to determine such values are as follows:

	2013			2012
Weighted average grant date fair value	$	2.58		$	2.51
Assumptions:
Risk-free interest rate		1.35	%		1.61	%
Expected volatility		30.47	%		43.72	%
Expected term (in years)		7	years		7	years
Expected dividend yield		1.68	%		1.29	%

109

BAYLAKE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2013, 2012 and 2011
(Dollar amounts in thousands, except per share data)

NOTE 18 - STOCK OPTION PLAN(Continued)

Activity in the stock option plans during 2013 follows:

	Shares			Weighted Average Exercise Price		Weighted Average Remaining Contractual Term		Aggregate Intrinsic Value
Outstanding at beginning of year		163,281		$	6.44		7.48	$	—
Granted		43,176			9.50		—		—
Exercised		(6,971	)		4.40		—		—
Forfeited or expired		(23,662	)		10.81		—		—
Outstanding at end of year		175,824		$	6.69		7.63	$	—
Exercisable at end of year		45,738		$	6.91		5.92	$	202
Fully vested and expected to vest		175,824		$	6.69		7.63	$	1,125

Activity in the stock option plans during 2012 follows:

	Shares			Weighted Average Exercise Price		Weighted Average Remaining Contractual Term		Aggregate Intrinsic Value
Outstanding at beginning of year		112,400		$	7.27		6.46	$	—
Granted		73,015			6.20		—		—
Exercised		(889	)		—		—		—
Forfeited or expired		(21,245	)		10.10		—		—
Outstanding at end of year		163,281		$	6.44		7.48	$	—
Exercisable at end of year		38,610		$	10.20		3.31	$	70
Fully vested and expected to vest		163,281		$	6.44		7.48	$	338

Activity in the stock option plan during 2011 follows:

	Shares			Weighted Average Exercise Price		Weighted Average Remaining Contractual Term		Aggregate Intrinsic Value
Outstanding at beginning of year		49,628		$	13.73		1.45	$	—
Granted		74,572			4.15		—		—
Exercised		—			—		—		—
Forfeited or expired		(11,800	)		14.72		—		—
Outstanding at end of year		112,400		$	7.27		6.46	$	—
Exercisable at end of year		37,828		$	13.42		1.06	$	—
Fully vested and expected to vest		112,400		$	7.27		6.46	$	4

110

BAYLAKE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2013, 2012 and 2011
(Dollar amounts in thousands, except per share data)

NOTE 18 - STOCK OPTION PLAN(Continued)

The following options were outstanding at December 31, 2013:

		Number of Shares				Weighted-Average Exercise Price				Weighted-Average Remaining Life (in Years)
Price Range		Outstanding		Exercisable		Outstanding		Exercisable
$	4.15		61,486		22,857	$	4.15	$	4.15		7.20
$	6.20		64,389		12,881		6.20		6.20		8.25
$	9.50		39,949		—		9.50		—		9.21
$	14.15		10,000		10,000		14.15		14.15		0.01
			175,824		45,738		6.69		6.91		7.63

Information related to the stock option plan during each year follows:

	2013		2012		2011
Intrinsic value of options exercised	$	42	$	2	$	—
Cash received from option exercises		31		4		—
Tax benefit realized from option exercises		8		1		—

The following table summarizes information about the Company’s RSU activity for 2013 and 2012.

Restricted Stock Units

Activity in the RSUs during 2013 were as follows:

	RSUs			Weighted Average Grant Price
Outstanding at beginning of year		124,671		$	5.28
Granted		35,177			9.50
Vested		(28,679	)		5.13
Forfeited or expired		(8,484	)		6.62
Outstanding at end of year		122,685		$	6.43

111

BAYLAKE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2013, 2012 and 2011
(Dollar amounts in thousands, except per share data)

NOTE 18 - STOCK OPTION PLAN(Continued)

Activity in the RSUs during 2012 were as follows:

	RSUs			Weighted Average Grant Price
Outstanding at beginning of year		74,572		$	4.15
Granted		73,015			6.20
Vested		(14,919	)		4.15
Forfeited or expired		(7,997	)		5.29
Outstanding at end of year		124,671		$	5.28

Activity in the RSUs during 2011 were as follows:

	RSUs		Weighted Average Grant Price
Outstanding at beginning of year		—	$	—
Granted		74,572		4.15
Vested		—		—
Forfeited or expired		—		—
Outstanding at end of year		74,572	$	4.15

112

BAYLAKE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2013, 2012 and 2011
(Dollar amounts in thousands)

NOTE 19 - CONDENSED FINANCIAL INFORMATION - PARENT COMPANY ONLY

CONDENSED BALANCE SHEETS
December 31

	2013		2012
ASSETS
Cash and cash equivalents	$	3,279	$	1,194
Receivable from subsidiary		115		715
Deferred income taxes		132		96
Unamortized debt offering costs		27		63
Income tax receivable		—		—
Investment in subsidiaries		116,042		116,810
Other assets		22		3
Total assets	$	119,617	$	118,881
LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities
Interest payable	$	236	$	237
Debentures		16,100		16,100
Convertible promissory notes		9,400		9,400
Total liabilities		25,736		25,737
Stockholders’ equity		93,881		93,144
Total liabilities and stockholders’ equity	$	119,617	$	118,881

113

BAYLAKE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2013, 2012 and 2011
(Dollar amounts in thousands)

NOTE 19 - CONDENSED FINANCIAL INFORMATION - PARENT COMPANY ONLY(Continued)

CONDENSED STATEMENTS OF OPERATIONS
Years ended December 31

	2013			2012			2011
Income
Dividends from subsidiaries	$	5,724		$	789		$	—
Interest income		5			2			11
Other		1			—			—
Total income		5,730			791			11
Expenses
Interest		1,242			1,277			1,252
Other		552			379			226
Total expenses		1,794			1,656			1,478
Income (loss) before equity in undistributed net income of subsidiaries		3,936			(865	)		(1,467	)
Equity in undistributed net income of subsidiaries (earnings in excess of dividends)		3,316			7,202			5,368
Income before income taxes		7,252			6,337			3,901
Income tax benefit		(757	)		(1,305	)		(575	)
Net income	$	8,009		$	7,642		$	4,476

114

BAYLAKE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2013, 2012 and 2011
(Dollar amounts in thousands)

NOTE 19 - CONDENSED FINANCIAL INFORMATION - PARENT COMPANY ONLY(Continued)

CONDENSED STATEMENT OF CASH FLOWS
Years ended December 31

	2013			2012			2011
Cash flows from operating activities:
Net income	$	8,009		$	7,642		$	4,476
Adjustments to reconcile net income to net cash (used in) provided by operating activities:
Undistributed earnings of subsidiary (earnings in excess of dividends)		(3,316	)		(7,202	)		(5,368	)
Recovery of deferred tax asset previously written off		—			(658	)		—
Amortization of debt issuance costs		36			35			35
Net change in intercompany receivable		600			(19	)		5
Other changes, net		301			267			265
Net cash flows (used in) provided by operating activities		5,630			65			(587	)
Cash flows from investing activities:
Capitalization of non-bank subsidiary		(100	)		—			—
Net cash used in investing activities		(100	)		—			—
Cash flows from financing activities:
Purchase of treasury stock		(1,707	)		—			—
Dividends paid		(1,738	)		(635	)		—
Net cash used in financing activities		(3,445	)		(635	)		—
Net change in cash and cash equivalents		2,085			(570	)		(587	)
Beginning cash and cash equivalents		1,194			1,764			2,351
Ending cash and cash equivalents	$	3,279		$	1,194		$	1,764

115

BAYLAKE CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2013, 2012 and 2011
(Dollar amounts in thousands, except per share data)

NOTE 20 – SELECTED QUARTERLY FINANCIAL DATA

The following is selected unaudited financial data summarizing the results of operations for each quarter in the years ended December 31, 2013 and 2012:

	2013 Quarter Ended (In thousands, except per share data)
	March 31		June 30		September 30		December 31
Interest income	$	8,653	$	8,564	$	8,615	$	8,908
Interest expense		1,293		1,218		1,076		953
Net interest income		7,360		7,346		7,539		7,955
Provision for loan losses		600		600		200		—
Net interest income after PLL		6,760		6,746		7,339		7,955
Noninterest income		2,499		2,359		2,326		2,646
Noninterest expense		6,808		6,679		6,474		7,341
Income before income tax expense		2,451		2,426		3,191		3,260
Provision for income tax		696		695		986		942
Net income	$	1,755	$	1,731	$	2,205	$	2,318
Basic earnings per share	$	0.22	$	0.22	$	0.28	$	0.30
Diluted earnings per share	$	0.19	$	0.19	$	0.24	$	0.25

	2012 Quarter Ended (In thousands, except per share data)
	March 31		June 30		September 30		December 31
Interest income	$	10,318	$	9,982	$	9,722	$	9,164
Interest expense		1,998		1,784		1,592		1,381
Net interest income		8,320		8,198		8,130		7,783
Provision for loan losses		1,750		2,275		1,100		300
Net interest income after PLL		6,570		5,923		7,030		7,483
Noninterest income		3,045		4,342		3,250		3,186
Noninterest expense		7,833		8,877		7,255		7,739
Income before income tax expense (benefit)		1,782		1,388		3,025		2,930
Provision (benefit) for income tax		450		94		940		(1	)
Net income	$	1,332	$	1,294	$	2,085	$	2,931
Basic earnings per share	$	0.17	$	0.16	$	0.26	$	0.37
Diluted earnings per share	$	0.15	$	0.15	$	0.23	$	0.31

116

ITEM 9.CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

ITEM 9A.CONTROLS AND PROCEDURES

Disclosures Controls and Procedures:Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of December 31, 2013. Based on such evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, our disclosure controls and procedures are effective in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by us in the reports that we file or submit under the Exchange Act.

There are inherent limitations in the effectiveness of any system of internal control over financial reporting, including the possibility of human error and circumvention or overriding of controls. Accordingly, even an effective system of internal control over financial reporting can provide only reasonable assurance with respect to financial statement preparation. Projections of any evaluation of effectiveness to future periods are subject to the risks that controls may become inadequate because of changes in conditions or that the degree of compliance with the policies or procedures may deteriorate.

Management’s Report on Internal Control over Financial Reporting: The report of our management on our internal control over financial reporting appears on page 70 of this Annual Report on Form 10-K.

Changes in Internal Control Over Financial Reporting:There have not been any changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that have occurred during the quarter ended December 31, 2013, that have materially affected or are reasonably likely to materially affect our internal control over financial reporting.

ITEM 9B.OTHER INFORMATION

None.

117

PART III

ITEM 10.DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

The information set forth under the sections titled “Proposal No. 1, Election of Directors,” “Information on Executive Officers” and “Compliance with Section 16(a) of the Exchange Act” contained in the definitive proxy statement for our 2014 Annual Meeting of Stockholders is incorporated herein by reference.

ITEM 11.EXECUTIVE COMPENSATION

The information set forth under the sections titled “Director Fees and Benefits”, “Compensation Discussion and Analysis”, “Board of Directors Compensation Committee Report on Management Compensation”, and “Compensation Committee Interlocks and Insider Participation” contained in the definitive proxy statement for our 2014 Annual Meeting of Stockholders is incorporated herein by reference.

118

ITEM 12.SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

The information set forth under the section titled “Ownership of Baylake Common” contained in the definitive proxy statement for our 2014 Annual Meeting of Stockholders is incorporated herein by reference.

Equity compensation plan information:

The following table sets forth information regarding options and shares reserved for future issuance under the equity compensation plans as of December 31, 2013.

	Number of securities to be issued upon exercise of outstanding options, warrants and rights		Weighted-average exercise price of outstanding options, warrants and rights		Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a))
Plan Category	(a)		(b)		(c)
Equity compensation plans approved by security holders		165,824	$	4.88		410,033
Equity compensation plans not approved by security holders**		10,000		14.15		—
Total		175,824	$	6.91		410,033

** These options represent options granted with the same terms and conditions as those granted under the 1993 Stock Option Plan, as amended, but after expiration of that Plan.

ITEM 13.CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

Information set forth in the section titled “Certain Transactions with Management” in the definitive proxy statement for our 2014 Annual Meeting of Stockholders is incorporated herein by reference.

ITEM 14.PRINCIPAL ACCOUNTANT FEES AND SERVICES

Information set forth in the section titled “Principal Accountant Fees and Services” in the definitive proxy statement for our 2014 Annual Meeting of Stockholders is incorporated herein by reference.

119

PART IV

ITEM 15.EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

(a) 1 and 2
The consolidated financial statements and supplementary data contained in Item 8 of this report are filed as part of this Form 10-K.

All schedules have been omitted as the required information is either inapplicable or included in the Notes to Consolidated Financial Statements contained in Part II, Item 8 of this Form 10-K.

Reference is made to the Exhibit Index following the signatures for exhibits filed as part of this Form 10-K.

120

SIGNATURES

Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

BAYLAKE CORP.
By:	/s/Robert J. Cera
	Robert J. Cera
	President and Chief Executive Officer and
	Director (Principal Executive Officer)
By:	/s/Kevin L. LaLuzerne
	Kevin L. LaLuzerne
	Chief Financial Officer and Treasurer
	(Principal Financial and Accounting Officer)

Date:March 3, 2014

POWER OF ATTORNEY

KNOW ALL MEN BY THESE PRESENTS, that each individual whose signature appears below hereby designates and appoints Robert J. Cera and Kevin L. LaLuzerne, and each of them, any one of whom may act without the joinder of the other, as such person’s true and lawful attorney-in-fact and agents (the “Attorneys-in-Fact”) with full power of substitution and resubstitution, for such person and in such person’s name, place and stead, in any and all capacities, to sign any and all amendments to this report, and to file the same, with all exhibits thereto, and other documents in connection therewith, the Securities and Exchange Commission and any state securities commission, granting unto said Attorneys-in-Fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and conforming all that said Attorneys-in-Fact and agents or any of them, or their or his substitutes, may lawfully do or cause to be done by virtue hereof.

121

Pursuant to the requirements of the Securities Exchange Act of 1934 this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

/s/Robert W. Agnew	/s/Louis J. “Rick” Jeanquart
Robert W. Agnew, Director	Louis J. “Rick” Jeanquart, Director
Co-Chairman of the Board
/s/Richard A. Braun	/s/Kevin L. LaLuzerne
Richard A. Braun, Director	Kevin L. LaLuzerne, Chief Financial Officer
Co-Chairman of the Board	and Treasurer ( Principal Financial and
	Accounting Officer)
/s/Robert J. Cera	/s/Elyse Mollner Stackhouse
Robert J. Cera, President and Chief Executive	Elyse Mollner Stackhouse, Director
Officer and Director (Principal Executive
Officer)
/s/Roger G. Ferris	/s/Joseph J. Morgan
Roger G. Ferris, Director	Joseph J. Morgan, Director
/s/Terrence R. Fulwiler	/s/Dean J. Nolden
Terrence R. Fulwiler, Director	Dean J. Nolden, Director
/s/Dee Geurts-Bengston	/s/William Parsons
Dee Geurts-Bengston, Director	William Parsons, Director
/s/Thomas L. Herlache	/s/Paul Jay Sturm
Thomas L. Herlache, Director	Paul Jay Sturm, Director

* Each of the above signatures is affixed as of March 3, 2014.

122

Exhibit No.	Description
3.1	Articles of Incorporation, as amended through July 3, 2001, incorporated by reference to Exhibit 4.1 from the Company’s Registration Statement on Form S-3 (File No. 333-118857) filed on September 8, 2004
3.2	Articles of Amendment to Articles of Incorporation, incorporated by reference to Exhibit 3.1 from the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2007
3.3	Composite Articles of Incorporation, incorporated by reference to Exhibit 3.2 from the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2007
3.4	Bylaws, as amended through February 21, 1996, incorporated by reference to Exhibit 4.2 from the Company’s Registration Statement on Form S-3 (File No. 333-118857) filed on September 8, 2004
4.1	Advances, Collateral Pledge, and Security Agreement dated as of August 8, 1997 between Baylake Bank and Federal Home Loan Bank of Chicago, incorporated by reference to Exhibit 4.1 from the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2006
10.1	Baylake Bank’s Deferred Compensation Program with Thomas L. Herlache*, incorporated by reference to Exhibit 10.3 from the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 1993
10.2	Baylake Bank’s Deferred Compensation and Salary Continuation Agreement with Richard A. Braun*, incorporated by reference to Exhibit 10.5 from the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 1993
10.3	Deferred Compensation Plan for Selected Directors of Baylake Bank (Money Purchase Compensation Plan) dated December 19, 1995*, incorporated by reference to Exhibit 10.3 from the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2006
10.4	Baylake Corp. Stock Purchase Plan*, incorporated by reference to Exhibit 4 from the Company’s Form S-8 filed on February 10, 1998
10.5	Baylake Corp. 1993 Stock Option Plan, as amended in 1998*, incorporated by reference to Exhibit 99.1 from the Company’s Form S-8 filed on September 21, 1998
10.6	Baylake Bank Supplemental Executive Retirement Plan*, incorporated by reference to Exhibit 10.8 from the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2004
10.7	Employment Agreement dated as of June 30, 2006 between Baylake Bank and Robert J. Cera*, incorporated by reference to Exhibit 10.7 from the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2006
10.8	Executive Employee Salary Continuation Agreement for Thomas L. Herlache dated October 1, 1999*, incorporated by reference to Exhibit 10.9 from the Company’s Annual Report on Form 10-K for the Fiscal year ended December 31, 2006
10.9	Preferred Compensation Agreement, incorporated by reference to Exhibit 10.1 from the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2007*
10.10	Non-Qualified Retirement Trust incorporated by reference from the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2007*
10.11	Amendments to Deferred Compensation Agreements with Thomas L. Herlache and Summary of Benefits for serving as Chairman, incorporated by reference from the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2007*

123

10.12	Baylake Corp. 2010 Equity Incentive Plan, incorporated by reference to Exhibit A to the Proxy Statement on Schedule 14A filed on April 28, 2010 in connection with the Company’s 2010 Annual Meeting*
21.1	List of Subsidiaries
23.1	Consent of Baker Tilly Virchow Krause, LLP
24.1	Power of Attorney (contained on the Signature Page)
31.1	Certification of the Chief Executive Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934, as amended
31.2	Certification of the Chief Financial Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934, as amended
32.1	Certification of the Chief Executive Officer pursuant to Rule 13a-14(b) under the Securities Exchange Act of 1934, as amended and 18 U.S.C. Section 1350
32.2	Certification of the Chief Financial Officer pursuant to Rule 13a-14(b) under the Securities Exchange Act of 1934, as amended and 18 U.S.C. Section 1350

          *Designates compensation plans or agreements

124