UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
{X} QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2001
--------------------------------------------------
OR
{ } TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
-------------------- -----------------
Commission file number 0-8679
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BAYLAKE CORP.
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Wisconsin 39-1268055
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(State or other jurisdiction of incorporation (Identification No.)
or organization)
217 North Fourth Avenue, Sturgeon Bay, WI 54235
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(Address of principal executive offices) (Zip Code)
(920)-743-5551
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(Registrant's telephone number, including area code)
None
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(Former name, former address and former fiscal year, if
changed since last report)
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 No
------------ ---------------
Applicable Only to Corporate Issuers:
Number of outstanding shares of each of common stock, par value $5.00 per share,
as of November 8, 2001: 7,471,575 shares
BAYLAKE CORP. AND SUBSIDIARIES
INDEX
PART 1 - FINANCIAL INFORMATION PAGE NUMBER
Item 1. Financial Statements
Consolidated Balance Sheets as of September 30, 2001 3
and December 31, 2000
Consolidated Statements of Income for the three and 4
nine months ended September 30, 2001 and 2000
Consolidated Statements of Comprehensive Income for the three 5
and nine months ended September 30, 2001 and 2000
Consolidated Statements of Cash Flows for the nine months ended 6 - 7
September 30, 2001 and 2000
Notes to Consolidated Condensed Financial Statements 8
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 9 - 33
Item 3. Quantitative and Qualitative Disclosures About Market Risk 33
PART II - OTHER INFORMATION 33 - 34
Item 1. Legal Proceedings
Item 2. Changes in Securities and Use of Proceeds
Item 3. Defaults Upon Senior Securities
Item 4. Submission of Matter to a Vote of Security Holders
Item 5. Other Information
Item 6. Exhibits and Reports on Form 8-K
Signatures 35
EXHIBIT INDEX 34
Exhibit 11 Statement re: computation of per share earnings 36
Exhibit 15 Letter re: unaudited interim financial information 37
2
PART 1 - FINANCIAL INFORMATION
BAYLAKE CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(dollars in thousands)
SEPTEMBER 30, DECEMBER 31,
ASSETS 2001 2000
---- ----
Cash and due from banks $ 19,676 $ 21,695
Investment securities available for sale (at market) 142,168 135,089
Investment securities held to maturity (market
value $19,793 and $18,503, at September 30,
2001 and December 31, 2000, respectively) 19,412 18,422
Federal funds sold 11,501
Loans held for sale 82 724
Loans 595,733 555,107
Less: Allowance for loan losses 7,721 7,006
--------- ---------
Loan, net of allowance for loan losses 588,012 548,101
Bank premises and equipment 20,879 21,313
Federal Home Loan Bank stock (at cost) 6,279 5,955
Accrued interest receivable 5,750 5,733
Income taxes receivable 1,276 1,135
Deferred income taxes 737 2,256
Goodwill 5,091 5,455
Other Assets 8,763 6,390
--------- ---------
Total Assets $ 829,626 $ 772,268
========= =========
LIABILITIES
Domestic deposits
Non-interest bearing $ 73,071 $ 69,149
Interest bearing
NOW 43,816 49,582
Savings 206,622 183,369
Time, $100,000 and over 131,718 61,334
Other time 197,478 189,820
--------- ---------
Total interest bearing 579,634 484,105
Total deposits 652,705 553,254
Short-term borrowings
Federal funds purchased, repurchase 3,842 80,289
Agreements, borrowings from unaffiliated banks and
Federal Home Loan Bank advances
Accrued expenses and other liabilities 7,918 6,868
Dividends payable 0 819
Other borrowings 90,000 77,700
Long-term debt 158 211
Long-term debt-trust preferred securities 16,100 0
--------- ---------
Total liabilities 770,723 719,141
--------- ---------
SHAREHOLDERS' EQUITY
Common stock, $5 par value: authorized 10,000,000
Shares; issued 7,494,734 shares as of September 30,
2001, and 7,468,733 as of December 31, 2000: 37,474 37,344
outstanding 7,471,575 as of September 30, 2001 and
7,445,574 as of December 31, 2000
Additional paid-in capital 7,266 7,185
Retained earnings 11,468 8,670
Treasury Stock (625) (625)
Net unrealized gain (loss) on securities available
for sale, net of tax of $1,795 as of September 30,
2001 and $277 as of December 31, 2000 3,320 553
--------- ---------
Total shareholders' equity 58,903 53,127
--------- ---------
Total liabilities and shareholders' equity $ 829,626 $ 772,268
========= =========
3
BAYLAKE CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(dollars in thousands, except per share amounts)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2001 2000 2001 2000
-------- -------- -------- --------
Interest income
Interest and fees on loans $ 12,246 $ 12,375 $ 37,985 $ 34,062
Interest on investment securities
Taxable 1,648 1,729 5,064 5,070
Exempt from federal income taxes 657 617 1,959 1,885
Other interest income 141 -- 150 --
-------- -------- -------- --------
Total interest income 14,692 14,721 45,158 41,017
-------- -------- -------- --------
Interest expense
Interest on deposits 6,235 6,103 19,178 17,102
Interest on short-term borrowings 27 992 1,160 1,801
Interest on other borrowings 1,144 1,373 3,933 4,017
Interest on long-term debt 4 113 12 166
Interest on trust preferred securities 402 -- 997 --
-------- -------- -------- --------
Total interest expense 7,812 8,581 25,280 23,086
-------- -------- -------- --------
Net interest income 6,880 6,140 19,878 17,931
Provision for loan losses 425 120 1,075 330
-------- -------- -------- --------
Net interest income after provision for
loan losses 6,455 6,020 18,803 17,601
-------- -------- -------- --------
Other income
Fees from fiduciary activities 205 122 500 389
Fees from loan servicing 329 204 829 582
Fees for other services to customers 709 665 2,045 1,876
Gains from sales of loans 206 60 570 139
Other income 120 122 341 321
-------- -------- -------- --------
Total other income 1,569 1,173 4,285 3,307
-------- -------- -------- --------
Other expenses
Salaries and employee benefits 3,058 2,662 8,992 7,852
Occupancy expense 440 389 1,308 1,124
Equipment expense 353 360 1,059 1,074
Data processing and courier 247 231 726 686
Operation of other real estate 85 (13) 249 (70)
Other operating expenses 1,154 1,030 3,275 2,982
-------- -------- -------- --------
Total other expenses 5,337 4,659 15,609 13,648
-------- -------- -------- --------
Income before income taxes 2,687 2,534 7,479 7,260
Income tax expense 785 776 2,216 2,204
-------- -------- -------- --------
Net Income $ 1,902 $ 1,758 $ 5,263 $ 5,056
======== ======== ======== ========
Basic earnings per common share (1) $ 0.25 $ 0.24 $ 0.70 $ 0.68
Diluted earnings per common share (1) $ 0.25 $ 0.23 $ 0.69 $ 0.66
Cash dividends per share $ 0.11 $ 0.10 $ 0.33 $ 0.30
(1) Based on 7,466,776 average shares outstanding in 2001 and 7,443,036 in 2000.
4
BAYLAKE CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(dollars in thousands)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2001 2000 2001 2000
---- ---- ---- ----
Net Income $1,902 $1,758 $5,263 $5,056
------ ------ ------ ------
Other comprehensive income, net of tax:
Unrealized gains on securities:
Unrealized gains arising during period 1,146 1,222 2,767 1,193
------ ------ ------ ------
Comprehensive income $3,048 $2,980 $8,030 $6,249
====== ====== ====== ======
5
BAYLAKE CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(dollars in thousands)
NINE MONTHS ENDED
SEPTEMBER 30,
2001 2000
---- ----
Cash flows from operating activities:
Interest received from:
Loans $ 37,850 $ 32,838
Investments 7,191 6,715
Fees and service charges 3,958 2,942
Interest paid to depositors (18,465) (16,279)
Interest paid to others (6,413) (5,735)
Cash paid to suppliers and employees (14,326) (12,160)
Income taxes paid (2,358) (2,251)
-------- --------
Net cash provided by operating activities 7,437 6,070
Cash flows from investing activities:
Principal payments received on investments 20,189 9,202
Purchase of investments (35,825) (12,550)
Proceeds from sale of other real estate owned 1,112 990
Loans made to customers in excess of principal collected (42,469) (85,583)
Capital expenditures (740) (3,780)
-------- --------
Net cash used in investing activities (57,733) (91,721)
Cash flows from financing activities:
Net increase (decrease) in demand deposits, NOW accounts, and savings 21,409 39,262
Accounts
Net increase (decrease) in short term borrowing (76,447) 60,498
Net increase (decrease) in time deposits 78,041 (4,381)
Proceeds from other borrowings and long-term debt 35,000 23,000
Payments on other borrowings and long term debt (22,753) (25,253)
Proceeds from issuance of common stock 211 41
Proceeds from issuance of trust preferred securities 16,100 0
Dividends paid (3,284) (2,976)
-------- --------
Net cash provided by financing activities 48,277 90,191
-------- --------
Net increase (decrease) in cash and cash equivalents (2,019) 4,540
Cash and cash equivalents, beginning 21,695 19,475
-------- --------
Cash and cash equivalents, ending $ 19,676 $ 24,015
======== ========
6
SEPTEMBER 30,
2001 2000
----- ----
Reconciliation of net income to net cash provided by operating activities:
Net income $ 5,263 $ 5,056
Adjustments to reconcile net income to net cash provided by operating
Activities:
Depreciation 1,175 1,096
Provision for losses on loans and real estate owned 1,075 330
Amortization of premium on investments 139 109
Accretion of discount on investments (112) (131)
Cash surrender value increase (41) (66)
Gain from disposal of ORE (49) (231)
Gain on sale of loans (570) (138)
Proceeds from sale of loans held for sale 59,183 15,778
Originations of loans held for sale (58,613) (15,639)
Equity in income of service center (189) (160)
Amortization of goodwill 364 368
Amortization of mortgage servicing rights 108 73
Mortgage servicing rights booked (296) (182)
Deferred compensation 173 186
Changes in assets and liabilities:
Interest receivable 56 (1,365)
Prepaids and other assets (963) 26
Unearned income (2) (35)
Interest payable 402 1,072
Taxes payable (142) (47)
Other liabilities 476 (30)
-------- --------
Total adjustments 2,174 1,014
-------- --------
Net cash provided by operating activities $ 7,437 $ 6,070
======== ========
7
BAYLAKE CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2001
1. The accompanying unaudited consolidated financial statements should be
read in conjunction with Baylake Corp.'s 2000 annual report on Form
10-K. In the opinion of management, the unaudited financial information
included in this report reflects all adjustments, consisting only of
normal recurring accruals, which are necessary for a fair statement of
the financial position as of September 30, 2001 and December 31, 2000.
The results of operations for the three and nine months ended September
30, 2001 and 2000 are not necessarily indicative of results to be
expected for the entire year.
2. The market value of investment securities, by type, held by Baylake
Corp. are as follows:
SEPTEMBER 30, DECEMBER 31,
2001 2000
---- ----
(dollars in thousands)
Investment securities held to maturity:
Obligations of state and political subdivisions $ 19,793 $ 18,503
-------- --------
Investment securities held to maturity $ 19,793 $ 18,503
======== ========
Investment securities available for sale:
U.S. Treasury and other U.S. government agencies $ 28,027 $ 32,997
Obligations of states and political subdivisions 34,443 33,795
Mortgage-backed securities 76,928 66,986
Other 2,770 1,311
-------- --------
Investment securities available for sale $142,168 $135,089
======== ========
3. At September 30, 2001 and December 31, 2000, loans were as follows:
SEPTEMBER 30, DECEMBER 31,
2001 2000
---- ----
(dollars in thousands)
Commercial, financial and agricultural $ 362,299 $ 335,868
Real estate - construction 67,605 41,524
Real estate - mortgage 148,660 160,150
Installment 17,526 17,925
Less: Deferred loan origination fees, net of costs (357) (360)
--------- ---------
$ 595,733 $ 555,107
Less allowance for loan losses (7,721) (7,006)
--------- ---------
Net loans $ 588,012 $ 548,101
========= =========
4. Baylake Corp. declared a cash dividend of $0.11 per share payable on
September 17, 2001 to shareholders of record as of September 4, 2001.
5. Baylake Capital Trust I, a Delaware business trust and subsidiary of
Baylake Corp., declared its interest payment on the outstanding shares
of the Trust's 10.00% Cumulative Preferred Securities on October 1,
2001. This distribution covers the period from July 1, 2001 through
September 30, 2001 and payment was made to shareholders of record on
the close of business on September 28, 2001 at a rate of $0.25 per
security.
8
PART 1 - FINANCIAL INFORMATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
GENERAL
The following sets forth management's discussion and analysis of the
consolidated financial condition and results of operations of Baylake Corp.
("Baylake" or the "Company") for the three and nine months ended September 30,
2001 and 2000 which may not be otherwise apparent from the consolidated
financial statements included in this report. Unless otherwise stated, the
"Company" or "Baylake" refers to this entity and to its subsidiaries on a
consolidated basis when the context indicates. For a more complete
understanding, this discussion and analysis should be read in conjunction with
the financial statements, related notes, the selected financial data and the
statistical information presented elsewhere in this report.
On October 1, 1998, the Company acquired Evergreen Bank, N.A. ("Evergreen") and
changed its name to Baylake Bank, N.A. ("BLBNA"). Prior to the acquisition,
Evergreen was under the active supervision of the Office of the Comptroller of
the Currency ("OCC") due to its designation of Evergreen as a "troubled
institution" and "critically under capitalized". As part of the acquisition, the
Company was required to contribute $7 million of capital to Evergreen. As of the
date of this report, no payments to the seller of Evergreen have been made by
the Company and no payments are presently due. However, the Company may become
obligated for certain contingent payments that may become payable in the future,
based on a formula set forth in the stock purchase agreement, not to exceed $2
million. Such contingent payments are not accrued at September 30, 2001, since
that amount, if any, is not estimable.
Forward-Looking Information
This discussion and analysis of financial condition and results of operations,
and other sections of this report, may contain forward-looking statements that
are based on the current expectations of management. Such expressions of
expectations are not historical in nature and are forward-looking statements
within the meaning of the Private Securities Litigation Reform Act of 1995.
Words such as "anticipates," "believes," "estimates," "expects," "forecasts,"
"intends," "is likely," "plans," "projects," and other such words are intended
to identify in such forward-looking statements. The statements contained herein
and in such forward-looking statements involve or may involve certain
assumptions, risks and uncertainties, many of which are beyond the control of
the Company, that may cause actual future results to differ materially from what
may be expressed or forecasted in such forward-looking statements. Readers
should not place undue expectations on any forward-looking statements. In
addition to the assumptions and other factors referenced specifically in
connection with such statements, the following factors could impact the business
and financial prospects of the relationships; demand for
9
financial products and financial services; the degree of competition by
traditional and non-traditional financial services competitors; changes in
banking legislation or regulations; changes in tax laws; changes in interest
rates; changes in prices; the impact of technological advances; governmental and
regulatory policy changes; trends in customer behavior as well as their ability
to repay loans; and changes in the general economic conditions, nationally or in
the State of Wisconsin.
RESULTS OF OPERATIONS
For the three months ended September 30, 2001, earnings increased $144,000, or
8.2%, to $1.90 million from $1.76 million for the third quarter of 2000. Basic
operating and fully diluted earnings per share increased to $0.25 per share in
the third quarter of 2001 compared with $0.24 in 2000, an increase of 4.2%.
The annualized return on average assets and return on average equity for the
three months ended September 30, 2001 were 0.92% and 13.17%, respectively,
compared to 0.96% and 14.26%, respectively, for the same period a year ago.
The increase in net income for the period is primarily due to improved net
interest income after provision for loan losses and an increase in other income
offset to a lesser extent by increased other expenses.
For the nine months ended September 30, 2001, net income increased $207,000, or
4.1%, to $5.26 million from $5.06 million for the first nine months of 2000. The
change in net income is due for the same reasons as listed above. Basic
operating earnings per share increased to $0.70 for the first nine months of
2001 compared to $0.68 for the nine months ended September 30, 2000, an increase
of 2.9%. On a fully diluted basis, the Company recorded $0.69 per share for the
first nine months of 2001 and $0.66 for the same period in 2000.
The annualized return on average assets and return on average equity for the
first nine months ended September 30, 2001 were 0.88% and 12.63%, respectively
compared to 0.97% and 14.10%, respectively for the same period a year ago.
Cash dividends declared in the first nine months of 2001 increased 10.0% to
$0.33 per share compared with $0.30 for the same period in 2000.
NET INTEREST INCOME
Net interest income is the largest component of the Company's operating income
(net interest income plus other non-interest income) accounting for 83.0% of
total operating income for the first nine months of 2001, as compared to 85.1%
for the first nine months of 2000. Net interest income represents the difference
between interest earned on loans, investments and other interest earning assets
offset by the interest expense attributable to the deposits and the borrowings
that fund such assets. Interest fluctuations together with changes in the volume
and types of earning assets and interest-bearing liabilities combine to affect
total net interest income. This analysis discusses net interest income on a
tax-equivalent basis in order to provide comparability
10
among the various types of earned interest income. Tax-exempt interest income is
adjusted to a level that reflects such income as if it were fully taxable.
Net interest income on a tax equivalent basis for the three months ended
September 30, 2001 increased $760,000, or 11.8%, to $7.2 million from $6.5
million for the same period a year ago. Total interest income for the third
quarter of 2001 was $15.0 million, approximately the same when compared to the
same period last year. Interest expense in the third quarter of 2001 decreased
$769,000, or 9.0%, to $7.8 million when compared to $8.6 million in the third
quarter of 2000. The increase in net interest income between these two quarterly
periods occurred primarily as a result of growth in the average volume of
interest earning assets and non-interest bearing deposits and a decrease in the
cost of average interest paying liabilities offset to a lesser extent by an
increase in interest paying liabilities and a decrease in the yield of average
earning assets.
For the three months ended September 30, 2001, average earning assets increased
$88.5 million, or 13.2%, when compared to the same period last year. The Company
recorded an increase in average loans of $64.3 million, or 12.2%, for the third
quarter of 2001 compared to the same period a year ago. Loans have typically
resulted in higher rates of interest income to the Company than have investment
securities.
Interest rate spread is the difference between the tax-equivalent rate earned on
average earning assets and the rate paid on average interest-bearing
liabilities. As a result of a lower interest rate environment, the interest rate
spread remained compressed for the quarter ended September 30, 2001 when
compared to the same period a year ago. The interest rate spread decreased 3
basis points to 3.25% at September 30, 2001 from 3.28% in the same quarter in
2000. While the average yield on earning assets decreased 106 basis points
during the period, the average rate paid on interest-bearing liabilities
decreased 103 basis points over the same period as a result of a lower cost of
funding from deposits and other wholesale funding such as federal funds
purchased and loans from the Federal Home Loan Bank.
Net interest margin is tax-equivalent net interest income expressed as a
percentage of average earning assets. The net interest margin exceeds the
interest rate spread because of the use of non-interest bearing sources of funds
to fund a portion of earning assets. As a result, the level of funds available
without interest cost (demand deposits and equity capital) is an important
component increasing net interest margin.
Net interest margin (on a federal tax-equivalent basis) for the three months
ended September 30, 2001 decreased from 3.82% to 3.76% compared to the same
period a year ago. The average yield on interest earning assets amounted to
7.84% for the third quarter of 2001, representing a decrease of 106 basis points
from the same period last year. Total loan yields decreased 112 basis points to
8.36%, while total investment yields decreased 46 basis points to 6.46%, as
compared to the same period a year ago. The Company's average cost on
interest-bearing deposit liabilities decreased 85 basis points to 4.37% for the
third quarter of 2001 when compared to the third quarter of 2000, while
short-term borrowing costs decreased 317 basis points to 3.66%
11
comparing the two periods. Other borrowing costs decreased 179 basis points to
5.04% during the same time period. These factors contributed to a decrease in
the Company's interest margin for the three months ended September 30, 2001
compared to the same period a year ago.
The ratio of average earning assets to average total assets measures
management's ability to employ overall assets for the production of interest
income. This ratio was 92.5% for the third quarter of 2001 compared with 92.0%
for the same period in 2000. The ratio increased slightly in 2001, primarily as
a result of growth in earning assets offset to a lesser degree by an increase in
non-accrual loans.
Net interest income on a tax equivalent basis for the nine months ended
September 30, 2001 increased $2.0 million, or 10.5%, to $20.9 million from $18.9
million for the same period a year ago. Total interest income for the nine
months ended September 30, 2001 increased $4.2 million, or 10.0%, to $46.2
million from $42.0 million for the nine months ended September 30, 2000, while
interest expense increased $2.2 million, or 9.5%, to $25.3 million when compared
to $23.1 million for the nine months ended September 30, 2000. The increase in
net interest income between these two periods occurred primarily as a result of
growth in the average volume of interest earning assets and non-interest bearing
deposits and a decrease in the cost of interest paying liabilities offset to a
lesser extent by an increase in interest paying liabilities and a decrease in
the yield of average earning assets.
For the nine months ended September 30, 2001, average earning assets increased
$103.7 million, or 16.3%, when compared to the same period last year. The
Company recorded an increase in average loans of $89.0 million, or 18.0%, for
the first nine months of 2001 compared to the same period a year ago. Loans have
typically resulted in higher rates of interest income to the Company than have
investment securities.
The interest rate spread remained compressed for the nine months ended September
30, 2001 when compared to the same period a year ago. The interest rate spread
decreased 16 basis points to 3.31% at September 30, 2001 from 3.47% over the
same period in 2000. While the average yield on earning assets decreased 47
basis points during the period, the average rate paid on interest-bearing
liabilities decreased 32 basis points over the same period as a result of a
lower cost of funding from deposits and a lower cost of funding from other
wholesale funding such as federal funds purchased and loans from the Federal
Home Loan Bank due to a lower interest rate environment.
Net interest margin (on a federal tax-equivalent basis) for the nine months
ended September 30, 2001 decreased from 3.96% to 3.77% compared to the same
period a year ago. The average yield on interest earning assets amounted to
8.33% for the nine months ended September 30, 2001, representing a decrease of
47 basis points from the same period last year. Total loan yields decreased 50
basis points to 8.86%, while total investment yields decreased 35 basis points
to 6.63%, as compared to the same period a year ago. The Company's average cost
on interest-bearing deposit liabilities decreased 22 basis points to 4.78% for
the first nine months of 2001 when compared to the same period in 2000, while
short-term borrowing costs decreased 119 basis points to 5.51% comparing the two
periods. Other borrowing costs decreased 101 basis points to 5.43% during the
same time period. These factors contributed
12
to a decrease in the Company's interest margin for the nine months ended
September 30, 2001 compared to the same period a year ago.
The ratio of average earning assets to average total assets was 92.6% for the
first nine months of 2001 compared with 92.0% for the same period in 2000. The
ratio increased slightly in 2001, primarily as a result of growth in earning
assets offset to a lesser degree by an increase in non-accrual loans.
Provision for Loan Losses
The provision for loan losses is the periodic cost (not less than quarterly) of
providing an allowance for future loan losses. In any accounting period, the
amount of provision is based on management's evaluation of the loan portfolio,
especially nonperforming and other potential problem loans, taking into
consideration many factors, including loan growth, net charge-offs, changes in
the composition of the loan portfolio, delinquencies, management's assessment of
loan quality, general economic factors and collateral values.
The provision for loan losses for the three months ended September 30, 2001
increased $305,000 to $425,000 compared with $120,000 for the third quarter of
2000. For the nine months ended September 30, 2001, the provision for loan
losses increased $745,000 to $1.1 million compared with $330,000 for the same
period last year. Management believes that the current allowance (giving effect
to the increased provision) conforms with the Company's loan loss reserve policy
and is adequate in view of the present condition of the Company's loan
portfolio. See "Risk Management and the Allowance for Possible Loan Losses"
below.
Non-Interest Income
Total non-interest income increased $396,000, or 33.8%, to $1.6 million for the
third quarter of 2001 when compared to the third quarter of 2000. This increase
occurred as a result of increased trust income, increased fees from loan
servicing, increased fees on other customer services, increased fees from loan
servicing, and increased gains from sales of loans.
Trust fees increased $83,000, or 68.0%, in the third quarter of 2001 compared to
the same quarter in 2000, primarily as a result of timing differences related to
billing and collection of fees and an increase in trust estate business.
Loan servicing fees increased $125,000, or 61.3%, to $329,000 in the third
quarter of 2001, when compared to the same quarter in 2000. The increase in 2001
resulted from an increase in commercial loan servicing income and mortgage
servicing rights income.
Gains on sales of loans in the secondary market increased $146,000 to $206,000
in the third quarter of 2001, when compared to the same quarter in 2000,
primarily as a result of increased gains from sales of mortgage and commercial
loans. Recent declines in interest rates have
13
stimulated mortgage production, including an increase in refinancing activity.
Sales of loans for the three months ended September 30, 2001 increased to $19.7
million, compared to $7.0 million for the same period a year earlier.
Service charges on deposit accounts for the third quarter of 2001 showed an
increase of $82,000, or 21.4%, over 2000 results, accounting for much of the
improvement in fee income generated for other services to customers. Financial
services income decreased $63,000, or 43.8%.
For the first nine months of 2001, non-interest income increased $978,000, or
29.6%, to $4.3 million from $3.3 million for the same period a year ago.
Trust fee income increased $111,000, or 28.5%, to $500,000 for the first nine
months of 2001 compared to $389,000 for the same period in 2000 as a result of
increased trust business.
Loan servicing fees increased $247,000, or 42.4%, to $829,000 for the first nine
months in 2001, when compared to the same period in 2000. The increase in 2001
resulted from an increase in commercial loan servicing income.
Gains on sales of loans in the secondary market increased $431,000 for the first
nine months of 2001, when compared to the same period in 2000, primarily as a
result of increased gains from sales of mortgage loans taken in the secondary
market. Sales of total loans for the first nine months of 2001 increased to
$59.2 million, compared to $15.8 million a year ago.
Other fees for services to customers increased for the nine months ended
September 30, 2001 as a result of an increase of $234,000, or 21.1%, in service
charges on deposit accounts. This increase was offset to a lesser extent by a
decrease in financial services income amounting to $107,000 when compared to the
same period in 2000.
Non-Interest Expense
Non-interest expense increased $678,000, or 14.6%, for the three months ended
September 30, 2001 compared to the same period in 2000. Salaries and employee
benefits showed an increase of $396,000, or 14.9%, for the period as a result of
additional staffing to operate new facilities and regular salary and related
benefit increases. Full time equivalent staff increased to 283 persons from 272
a year earlier. Increases in occupancy (amounting to $51,000 or 13.1%) offset by
a decrease in equipment expenses (amounting to $7,000 or 1.9%) occurred as a
result of expansion in the Green Bay and Waupaca markets and costs related to
modernization of various facilities.
Other operating expenses increased $124,000, or 12.0%, for the three months
ended September 30, 2001 when compared to the same period a year ago. Included
in 2001 expenses were amortization of goodwill related to the Four Seasons
acquisition (a purchase of a one bank holding
14
company in July 1996) of $82,000 (the same as in 2000) and amortization of
$39,000 (the same as in 2000) related to the BLBNA acquisition.
Included in other operating expenses are expenses related to other outside
services such as correspondent bank expense and expense on services provided by
third parties. These expenses increased $56,000 for the three months ended
September 30, 2001 when compared to the same period a year ago.
Expenses related to the amortization of trust preferred expenses (such as legal
and underwriting expenses) and other legal expenses related to various
regulatory filings increased $25,000 for the three months ended September 30,
2001.
Other items (such as supplies, telephone, postage and director fees) comprising
other operating expense show an increase of $43,000 or 4.5% in the third quarter
of 2001 when compared to the same quarter in 2000. The overhead ratio, which is
computed by subtracting non-interest income from non-interest expense and
dividing by average total assets, was 1.82% for the three months ended September
30, 2001 compared to 1.90% for the same period in 2000.
Non-interest expense increased $2.0 million, or 14.4%, for the nine months ended
September 30, 2001 compared to the same period in 2000. Salaries and employee
benefits showed an increase of $1.1 million, or 14.5%, for the period as a
result of additional staffing to operate new facilities and regular salary and
related benefit increases. Increases in occupancy (amounting to $184,000 or
16.4%) offset by a decrease in equipment expenses (amounting to $15,000 or 1.4%)
occurred as a result of expansion in the Green Bay and Waupaca markets and costs
related to modernization of various facilities.
Operation of other real estate shows an increase of $319,000. This is related
primarily to net gains on other real estate taken in 2001 of $43,000 compared to
net gains of $231,000 taken in the first nine months of 2000. Other expenses
related to the operation of other real estate owned amounted to $308,000 for the
first nine months of 2001.
Other operating expenses increased $293,000, or 9.8%, for the nine months ended
September 30, 2001 when compared to the same period a year ago. Included in 2001
expenses were amortization of goodwill related to the Four Seasons acquisition
(a purchase of a one bank holding company in July 1996) of $247,000 (the same as
in 2000) and amortization of $117,000 (the same as in 2000) related to the BLBNA
acquisition.
Legal expense and loan collection expense increased $19,000 for the nine months
ended September 30, 2001 primarily as a result of legal issues relating to loan
collection efforts of three commercial real estate loans on which foreclosure
action occurred.
Data processing expense increased $40,000, or 5.8%, for the nine months ended
September 30, 2001 as compared to the same period a year ago. The increase
occurred as a result of additional transaction volume and growth in the number
of accounts.
15
Expenses related to the amortization of trust preferred expenses (such as legal
and underwriting expenses) and other legal expenses related to various
regulatory filings increased $78,000 for the nine months ended September 30,
2001.
Other items (such as supplies, telephone, postage and director fees) comprising
other operating expense show an increase of $112,000 or 5.3% for the first nine
months of 2001 when compared to the same period in 2000. The overhead ratio,
which is computed by subtracting non-interest income from non-interest expense
and dividing by average total assets, was 1.89% for the nine months ended
September 30, 2001 compared to 2.00% for the same period in 2000.
Income Taxes
Income tax expense for the Company for the three months ended September 30, 2001
was $785,000, an increase of $9,000, or 1.2%, compared to the same period in
2000. The increase in income tax provision for the period was due to increased
taxable income.
Income tax expense for the Company for the nine months ended September 30, 2001
and 2000 was approximately the same at $2.2 million. The slight increase in
income tax provision of $12,000 for the period was due to increased taxable
income.
The Company's effective tax rate (income tax expense divided by income before
taxes) was 29.6% for the nine months ended September 30, 2001 compared with
30.4% for the same period in 2000. The effective tax rate of 29.6% consisted of
a federal effective tax rate of 27.2% and Wisconsin State effective tax rate of
2.4%.
Balance Sheet Analysis
Loans
At September 30, 2001, total loans increased $40.6 million, or 7.3%, to $595.7
million from $555.1 million at December 31, 2000. Growth in the Company's loan
portfolio resulted primarily from an increase in real estate construction loans
to $67.6 million at September 30, 2001 compared to $41.5 million at December 31,
2000. In addition, commercial loans increased to $362.3 million at September 30,
2001, compared to $335.9 million at December 31, 2000. Real estate mortgage
loans decreased to $148.7 million at September 30, 2001, compared with $160.2
million at December 31, 2000. Consumer loans totaled $17.5 million at September
30, 2001 compared to $17.9 million at December 31, 2000.
Growth in commercial real estate mortgages and commercial loans occurred
principally as a result of the Company's expansion efforts (primarily in the
Green Bay market) and the strong economic growth existing in that market.
The following table reflects the composition (mix) of the loan portfolio
(dollars in thousands):
16
September 30, December 31,
2001 2000
Amount of loans by type (dollars in thousands)
Real estate-mortgage
Commercial $268,045 $251,971
1-4 family residential
First liens 99,539 109,173
Junior liens 25,638 26,513
Home equity 23,483 24,464
Commercial, financial and agricultural 94,254 83,897
Real estate-construction 67,605 41,524
Installment
Credit cards and related plans 2,300 2,140
Other 15,226 15,785
Less: deferred origination fees, net of costs 357 360
Total 595,733 555,107
Risk Management and the Allowance for Loan Losses
The loan portfolio is the Company's primary asset subject to credit risk. To
reflect this credit risk, the Company sets aside an allowance or reserve for
credit losses through periodic charges to earnings. These charges are shown in
the Company's consolidated income statement as provision for loan losses. See
"Provision for Loan Losses" above. Credit risk is managed and monitored through
the use of lending standards, a thorough review of potential borrowers, and an
on-going review of payment performance. Asset quality administration, including
early identification of problem loans and timely resolution of problems, further
enhances management of credit risk and minimization of loan losses. All
specifically identifiable and quantifiable losses are immediately charged off
against the allowance. Charged-off loans are subject to periodic review, and
specific efforts are taken to achieve maximum recovery of principal and
interest.
Management reviews the adequacy of the Allowance for Loan Losses ("ALL") on a
quarterly basis to determine whether the allowance is adequate to provide for
probable losses inherent in the loan portfolio as of the balance sheet date.
Valuation of the adequacy of the ALL is based primarily on management's periodic
assessment and grading of the loan portfolio as described below. Additional
factors considered by management include the consideration of past loan loss
experience, trends in past due and nonperforming loans, risk characteristics of
the various classifications of loans, current economic conditions, the fair
value of underlying collateral, and other regulatory or legal issues that could
affect credit losses.
Loans are initially graded when originated. They are re-graded as they are
renewed, when there is a loan to the same borrower, when identified facts
demonstrate heightened risk of nonpayment, or if they become delinquent. The
loan review, or grading, process attempts to identify and measure problem and
watch list loans. Problem loans are those loans with higher than average risk
with workout and/or legal action probable within one year. These loans are
reported at least quarterly to the directors' loan committee and reviewed at
least monthly at the officers' loan committee for action to be taken. Watch list
loans are those loans considered as having weakness detected in either
character, capacity to repay or balance sheet concerns and prompt management to
take corrective action at the earliest opportunity. Problem and watch
17
list loans generally exhibit one or more of the following characteristics:
1. Adverse financial trends and condition
2. Decline in the entire industry
3. Managerial problems
4. Customer's failure to provide financial information or other collateral
documentation
5. Repeated delinquency, overdrafts or renewals
Every significant problem credit is reviewed by the loan review process and
assessments are performed quarterly to confirm the risk rating to that credit,
proper accounting and the adequacy of loan loss reserve assigned.
After reviewing the gradings in the loan portfolio, management will allocate or
assign a portion of the ALL to groups of loans and individual loans to cover
management's estimate of probable loss. Allocation is related to the grade of
the loan and includes a component resulting from the application of the
measurement criteria of Statements of Financial Accounting Standards No. 114,
"Accounting by Creditors for Impairment of a Loan" ("SFAS 114") and No. 118,
"Accounting by Creditors for Impairment of a Loan-Income Recognition and
Disclosures" ("SFAS 118"). Allocations also are made for unrated loans, such as
credit card loans, based on historical loss experience adjusted for portfolio
activity. These allocated reserves are further supplemented by unallocated
reserves based on management's judgment regarding risk of error, local economic
conditions and any other relevant factors. Management then compares the amounts
allocated for probable losses to the current allowance. To the extent that the
current allowance is insufficient to cover management's best estimate of
probable losses, management records additional provision for credit loss. If the
allowance is greater than required at that point in time, provision expense is
adjusted accordingly.
As the following table indicates, the ALL at September 30, 2001 was $7.7 million
compared with $7.0 million at the end of 2000. Loans increased 7.3% from
December 31, 2000 to September 30, 2001, while the allowance as a percent of
total loans increased due to the loan loss provision being higher in comparison
to loan growth for the first nine months of 2001. The September 30, 2001 ratio
of ALL to outstanding loans was 1.30% compared with 1.26% at December 31, 2000
and the ALL as a percentage of nonperforming loans was 47.3% at September 30,
2001 compared to 53.9% at end of year 2000. Based on management's analysis of
the loan portfolio risk at September 30, 2001, a provision expense of $1.1
million was recorded for the nine months ended September 30, 2001, an increase
of $745,000 compared to the same period in 2000. Net loan charge-offs of
$360,000 occurred in the first nine months of 2001, and the ratio of net
charge-offs to average loans for the period ended September 30, 2001 was 0.08%
compared to (0.05%) at September 30, 2000. Commercial, agricultural and other
loan net charge-offs represented 73.9% of the total net charge-offs for the
first nine months of 2001. Two commercial loans totaling $495,000 accounted for
the majority of the net charge-offs. Loans charged-off are subject to periodic
review and specific efforts are taken to achieve maximum recovery of principal
and accrued interest.
18
Allowance for Loan Losses and Nonperforming Assets
(dollars in thousands)
For the period ended For the period ended For the period ended
September 30, 2001 September 30, 2000 December 31, 2000
-------------------- -------------------- --------------------
Allowance for Loan Losses
("ALL")
Balance at beginning of $ 7,006 $ 7,611 $ 7,611
period
Provision for loan losses 1,075 330 545
Charge-offs 1,097 423 2,074
Recoveries 737 608 924
-------- -------- --------
Balance at end of period 7,721 8,126 7,006
Net charge-offs ("NCOs") 360 (185) 1,150
Nonperforming Assets:
Nonaccrual loans $ 11,411 8,336 8,479
Accruing loans past due 90 0 0 0
days or more
Restructured loans 4,914 4,074 4,510
-------- -------- --------
Total nonperforming loans 16,325 12,410 12,989
("NPLs")
Other real estate owned 1,868 563 877
-------- -------- --------
Total nonperforming assets $ 18,193 12,973 13,866
("NPAs")
Ratios:
ALL to NCO's (annualized) 16.05 (32.90) 6.09
NCO's to average loans 0.08% (0.05%) 0.23%
(annualized)
ALL to total loans 1.30% 1.53% 1.26%
NPL's to total loans 2.74% 2.33% 2.34%
NPA's to total assets 2.36% 1.74% 1.80%
ALL to NPL's 47.30% 65.48% 53.94%
While management uses available information to recognize losses on loans, future
adjustments to the ALL may be necessary based on changes
19
in economic conditions and the impact of such change on the Company's borrowers.
Consistent with generally accepted accounting principles ("GAAP") and with the
methodologies used in estimating the unidentified losses in the loss portfolio,
the ALL consists of several components.
First, the allowance includes a component resulting from the application of the
measurement criteria of SFAS 114 and SFAS 118. The amount of this component is
included in the various categories presented in the following table.
The second component is statistically based and is intended to provide for
losses that have occurred in large groups of smaller balance loans, the credit
quality of which is impracticable to re-grade at end of period. These loans
would include residential real estate, consumer loans and loans to small
businesses generally in principal amounts of $100,000 and less. The loss factors
are based primarily on the Company's historical loss experience tracked over a
three-year period and accordingly will change over time. Due to the fact that
historical loss experience varies for the different categories of loans, the
loss factors applied to each category also differ.
The final or "unallocated" component of the ALL is a component that is intended
to absorb losses that may not be provided for by the other components. There are
several primary reasons that the other components discussed above might not be
sufficient to absorb the losses present in portfolios, and the unallocated
portion of the ALL is used to provide for the losses that have occurred because
of these reasons.
The first is that there are limitations to any credit risk grading process. Even
for experienced loan reviewers, grading loans and estimating losses involves a
significant degree of judgment regarding the present situation with respect to
individual loans and the portfolio as a whole. The overall number of loans in
the portfolio also makes it impracticable to re-grade every loan each quarter.
Therefore, it is possible that some currently performing loans not recently
graded will not be as strong as their last grading and an insufficient portion
of the allowance will have been allocated to them. In addition, it is possible
that grading and loan review may be done without knowing whether all relevant
facts are at hand. For example, troubled borrowers may inadvertently or
deliberately omit important information from correspondence with lending
officers regarding their financial condition and the diminished strength of
repayment sources.
The second is that loss estimation factors are based on historical loss totals.
As such, the factors may not give sufficient weight to such considerations as
the current general economic and business conditions that affect the Company's
borrowers and specific industry conditions that affect borrowers in that
industry. For example, with respect to loans to borrowers who are influenced by
trends in the local tourist industry, management considers the effects of
weather conditions, market saturation, and the competition for borrowers from
other tourist destinations and attractions.
Third, the loss estimation factors do not give consideration to the seasoning of
the loan portfolio. Seasoning is relevant because losses
20
are less likely to occur in loans that have been performing satisfactorily for
several years than in loans that are more recent.
Finally, the loss estimation factors do not give consideration to the interest
rate environment. Most obviously, borrowers with variable rate loans may be less
able to manage their debt service if interest rates rise.
For these reasons, management regards it as both a more practical and prudent
practice to maintain the total allowance at an amount larger than the sum of the
amounts allocated as described above.
The following table shows the amount of the ALL allocated for the time periods
indicated to each loan type as described. 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 loss associated with them
will have a proportionally larger amount of the allowance allocated to them than
do loans which have less risk.
Consideration for making such allocations is consistent with the factors
discussed above, and all of the factors are subject to change; thus, the
allocation is not necessarily indicative of the loan categories in which future
loan losses will occur. It would also be expected that the amount allocated for
any particular type of loan will increase or decrease proportionately to both
the changes in the loan balances and to increases or decreases in the estimated
loss in loans of that type. In other words, changes in the risk profile of the
various parts of the loan portfolio should be reflected in the allowance
allocated.
Allocation of the Allowance for Loan Losses
(dollars in thousands)
Sept 30, 2001 Sept 30, 2000 Dec 31, 2000
---------------------------- -------------------------- ---------------------------
Amount Percent of Amount Percent of Amount Percent of
------------- loans to ------------- loans to ------------ loans to
total loans total loans total loans
----------- ----------- -----------
Commercial, financial $ 1 760 15.82% 1,460 15.82% 1,073 15.09%
& agricultural
Commercial real estate 3,400 44.99% 2,980 45.68% 2,993 45.27%
Real Estate:
Construction 370 11.35% 160 6.45% 302 7.47%
Residential 1,400 20.95% 1,440 24.28% 1,395 24.54%
Home equity lines 142 3.94% 134 4.45% 148 4.40%
Consumer 140 2.56% 130 2.94% 140 2.84%
Credit card 60 0.39% 37 0.38% 68 0.39%
Loan commitments 149 120 135
21
Not specifically 300 1,665 752
allocated --- ----- ---
Total allowance $7,721 $8,126 $7,006
Allowance for credit 1.30% 1.53% 1.26%
loss as a percentage
of total loans
Period end loans $595,733 100.00% $531,862 100.00% $555,107 100.00%
While there exists probable asset quality problems in the loan portfolio,
including loans acquired in the BLBNA purchase, management believes sufficient
reserves have been provided in the ALL to absorb probable losses in the loan
portfolio at September 30, 2001. In the time period since the purchase of BLBNA,
management has undertaken extensive efforts to identify and evaluate problem
loans stemming from the BLBNA acquisition. Although no assurance can be given,
management feels that the majority of these problem loans associated with BLBNA
have been identified. Ongoing efforts are being made to collect these loans, and
the Company involves the legal process when necessary to minimize the risk of
further deterioration of these loans for full collectibility.
As an integral part of their examination process, various regulatory agencies
also review the Company's ALL. Such agencies may require that changes in the ALL
be recognized when their credit evaluations differ from those of management,
based on their judgments about information available to them at the time of
their examination.
Non-Performing Loans, Potential Problem Loans and Other Real Estate
Management encourages early identification of non-accrual and problem loans in
order to minimize the risk of loss. This is accomplished by monitoring and
reviewing credit policies and procedures on a regular basis.
The accrual of interest income is discontinued when a loan becomes 90 days past
due as to principal or interest. When interest accruals are discontinued,
interest credited to income is reversed. If collectibility is in doubt, cash
receipts on non-accrual loans are used to reduce principal rather than recorded
as interest income.
Non-performing assets at September 30, 2001 were $18.2 million compared to $13.9
million at December 31, 2000. Other real estate owned totaled $1.9 million and
consisted of six residential and eight commercial properties. Non-accrual loans
represented $11.4 million of the total of non-performing assets, of which $2.7
million was acquired by the Company with the BLBNA acquisition. Real estate
non-accrual loans accounted for $9.7 million of the total, of which $2.5 million
was residential real estate and $7.2 million was commercial real estate,
22
while commercial and industrial non-accruals accounted for $1.5 million and
consumer loans accounted for $200,000.
Management believes collateral is sufficient to offset losses in the event
additional legal action would be warranted to collect these loans, except for
one commercial credit totaling $2.9 million. This credit is currently in the
process of legal action and it is anticipated that the specific reserve applied
to this loan (approximately $750,000) will be sufficient to cover the entire
amount of potential loss. $4.9 million of troubled debt restructured loans
existed at September 30, 2001, compared with $4.5 million at December 31, 2000.
Approximately $3.5 million of troubled debt restructured loans at September 30
consists of two commercial real estate credits which were granted various
payment concessions and had experienced past cashflow problems. These credits
were current at September 30, 2001. Management believes that collateral is
sufficient in those loans classified as troubled debt in event of default. As a
result, the ratio of non performing loans to total loans at September 30, 2001
was 2.7% and at December 31, 2000 was 2.3%. The Company's ALL was 47.3% of total
non-performing loans at September 30, 2001 compared to 53.9% at end of year
2000.
Potential problem loans at September 30, 2001 are restricted to one commercial
borrower with credits aggregating approximately $5.2 million. Potential problem
loans totaled $8.7 million at December 31, 2000. The commercial loan customer,
with credits totaling $5.1 million underwent management changes and is in the
process of modernizing their facilities. This credit was non-current at
September 30, 2001 but became current after November 1, 2001. This credit will
be monitored for future performance as management change is now in place.
Management's evaluation of the borrower's existing collateral supports an
expectation of full recovery even in the event of liquidation, regardless of
future performance, consummation of a business combination transaction or
potential default.
Investment Portfolio
At September 30, 2001, the investment portfolio (which includes investment
securities available for sale and held to maturity) increased $8.1 million, or
5.3%, to $161.6 million from $153.5 million at December 31, 2000. At September
30, 2001, the investment portfolio represented 19.5% of total assets compared
with 19.9% at December 31, 2000.
Securities held to maturity and securities available for sale consist of the
following:
At September 30, 2001
(dollars in thousands)
Amortized Cost Gross Unrealized Gross Unrealized Estimated Market
Gains Losses Value
-------------- ---------------- ---------------- ----------------
Securities held to maturity
Obligations of states & $ 19,412 $ 381 $ 0 $ 19,793
political subdivisions
23
Securities available for sale
Obligations of U.S. Treasury & 26,293 1,734 0 28,027
other U.S. Agencies
Mortgage-backed securities 75,100 1,920 92 76,928
Obligations of states & 32,890 1,553 34,443
political subdivisions
Other securities 100 100
Equity securities 2,670 2,670
Total securities available for $137,053 $ 5,207 $ 92 $142,168
sale
At December 31, 2000
(dollars in thousands)
Amortized Cost Gross Unrealized Gross Unrealized Estimated Market
Gains Losses Value
-------------- ---------------- ---------------- ----------------
Securities held to maturity
Obligations of states & $ 18,422 $ 119 $ 38 $ 18,503
political subdivisions
Securities available for sale
Obligations of U.S. Treasury & $ 32,252 $ 748 $ 3 $ 32,997
other U.S. Agencies
Mortgage-backed securities 67,629 107 750 66,986
Obligations of states & 33,067 757 29 33,795
political subdivisions
Equity securities 1,311 1,311
Total securities available for $134,259 $ 1,612 $ 782 $135,089
sale
At September 30, 2001, the contractual maturities of securities held to maturity
and securities available for sale are as follows: (dollars in thousands):
24
Securities held to Maturity Securities Available for Sale
------------------------------------ ------------------------------------
Amortized Cost Market Value Amortized Cost Market Value
-------------- ------------ -------------- ------------
Within 1 year $ 1,663 $ 1,677 $ 10,461 $ 10,610
After 1 but within 5 years 8,656 8,896 89,221 92,488
After 5 but within 10 years 4,981 5,108 18,777 20,071
After 10 years 4,112 4,112 15,924 16,329
Equity securities 0 0 2,670 2,670
-------- -------- -------- --------
Total $ 19,412 $ 19,793 $137,053 $142,168
Deposits
Total deposits at September 30, 2001 increased $99.5 million, or 18.0%, to
$652.7 million from $553.3 million at December 31, 2000. Non-interest bearing
deposits at September 30, 2001 increased $3.9 million, or 5.7%, to $73.0 million
from $69.1 million at December 31, 2000. Interest-bearing deposits at September
30, 2001 increased $95.5 million, or 19.7%, to $579.6 million from $484.1
million at December 31, 2000. Interest-bearing transaction accounts (NOW
deposits) decreased $5.8 million, primarily in public fund deposits. Savings
deposits increased $23.3 million, or 12.7%, to $206.6 million at September 30,
2001, when compared to $183.4 million at December 31, 2000. Time deposits
(including time, $100,000 and over and other time) increased $78.0 million
(includes increase of $70.3 million in time deposits over $100,000), or 31.1%,
to $329.2 million at September 30, 2001, when compared to $251.2 million at
December 31, 2000. Brokered CD's totaled $43.3 million at September 30, 2001
compared to $11.5 million at December 31, 2000. Typically, overall deposits for
the first six months tend to decline slightly as a result of the seasonality of
the Company's customer base as customers draw down deposits during the early
first half of the year in anticipation of the summer tourist season. As a result
of the Company's expansion into new markets in recent years, this effect has
been reduced as additional branch facilities in less seasonal locations have
provided deposit growth and seasonal stability. In addition, acquisition of
brokered deposits has enabled the Company to meet short term funding
requirements.
Emphasis has been, and will continue to be, placed on generating additional core
deposits in 2001 through competitive pricing of deposit products and through the
branch delivery systems that have already been established. The Company will
also attempt to attract and retain core deposit accounts through new product
offerings and quality customer service.
Short Term Borrowings and Other Borrowings
Short-term borrowings at September 30, 2001 consist of securities under
agreements to repurchase. Total short-term borrowings at September 30, 2001
decreased $76.5 million to $3.8 million from $80.3 million at
25
December 31, 2000. Customer repurchase agreements increased $553,000 from $3.3
million at December 31, 2000 to $3.8 million at September 30, 2001. Advances
from the Federal Home Loan Bank ("FHLB") decreased from $42 million at December
31, 2000 to no advances at September 30, 2001. Federal funds purchased decreased
from $35 million at December 31, 2000 to no funds purchased at September 30,
2001 accounting for the balance of the decrease in the balance of short-term
borrowings. These have decreased as a result of deposit growth for the first
nine months of 2001, including brokered CD's, and additional borrowings from
FHLB in the form of term loans.
Other borrowings consist primarily of term loans with FHLB. These borrowings
totaled $90 million at September 30, 2001 compared to $70 million at December
31, 2000. Three separate borrowings outstanding at December 31, 2000 totaling
$7.7 million lent to Baylake by an unaffiliated bank were paid off during the
quarter ended March 31, 2001.
Typically, short-term borrowings and other borrowings increase in order to fund
growth in the loan portfolio. Although total borrowings decreased during the
quarter, the Company will borrow monies if borrowing is a less costly form of
funding loans compared to the cost of acquiring deposits. Additionally, the
availability of deposits also determines the amount of funds the Company needs
to borrow in order to fund loan demand. The Company anticipates it will continue
to use wholesale funding sources of this nature, if these borrowings add
incrementally to overall profitability.
Long Term Debt
Long-term debt of $158,000 at September 30, 2001 consists of a land contract
requiring annual payments of $53,000 plus interest calculated at prime + -1/4%.
The land contract is for debt used to purchase one of the properties in the
Green Bay region for a branch location.
Liquidity
Liquidity management refers to the ability of management to ensure that cash is
available to meet loan demand and depositors' needs, and to service other
liabilities as they become due, without undue cost or risk, and without causing
a disruption to normal operating activities. The Company and Baylake Bank
("Bank") have different liquidity considerations.
The Company's primary sources of funds are dividends and interest, and proceeds
from the issuance of its securities. The Company manages its liquidity position
in order to provide funds necessary to pay dividends to its shareholders and
distributions to holders of the Company's trust preferred securities. Dividends
received from Bank totaled $800,000 for the first nine months of 2001 and will
continue to be the Company's main source of long-term liquidity. The dividends
from the Bank along with existing cash were sufficient to pay cash dividends to
the Company's shareholders of $3.3 million in the first nine months of 2001. In
February 2001, the Company issued trust preferred securities,
26
which received quarterly distributions beginning in the second quarter of 2001.
The Bank meets its cash flow needs by having funding sources available 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, maturing loans, the maturity of the investment portfolio, access
to other funding sources, marketability of certain of its assets and strong
capital positions.
Maturing investments have been a primary source of liquidity at the Bank. For
the nine months ended September 30, 2001, principal payments totaling $20.2
million were received on investments. These proceeds in addition to other
Company cash were used to purchase $35.8 million in investments for the period.
At September 30, 2001, the carrying or book value of investment securities
maturing within one year amounted to $12.3 million or 7.6% of the total
investment securities portfolio. This compares to an 8.3% level for investment
securities with one year or less maturities as of December 31, 2000. Within the
investing activities of the statement of cash flows, sales and maturities of
investment securities during the first nine months of 2001 totaled $20.2
million. At September 30, 2001, the investment portfolio contained $105.0
million of U.S. Treasury and federal agency backed securities representing 65.0%
of the total investment portfolio. These securities tend to be highly marketable
and had a market value above amortized cost at September 30, 2001 amounting to
$3.7 million.
Deposit growth is another source of liquidity for the Bank. As a financing
activity reflected in the 2001 Consolidated Statements of Cash Flows, deposits
provided $99.5 million of cash flow during the first nine months of 2001. The
Company's overall deposit base grew 18.0% for the nine months ended September
30, 2001. Deposit growth, especially core deposits, is the most stable source of
liquidity for the Bank.
The scheduled maturity of loans can provide a source of additional liquidity.
The Bank has $181.1 million, or 30.4%, of loans maturing within one year.
Within the classification of short-term borrowings and other borrowings at
September 30, 2001, federal funds purchased and securities sold under agreements
to repurchase totaled $3.8 million compared to $38.3 million at the end of 2000.
Federal funds are purchased from various upstream correspondent banks while
securities sold under agreements to repurchase are obtained from a base of
business customers. Borrowings from FHLB, short-term or long-term, are another
source of funds. They total $90.0 million at September 30, 2001, compared to
$112.3 million at the end of 2000.
The Bank's liquidity resources were sufficient in the first nine months of 2001
to fund the growth in loans and investments, increase the volume of interest
earning assets and meet other cash needs when necessary.
Management expects that deposit growth will continue to be the primary funding
source of the Bank's liquidity on a long-term basis, along with a stable
earnings base, the resulting cash generated by operating
27
activities, and a strong capital position. Although federal funds purchased and
borrowings from the FHLB provided funds in 2001, management expects deposit
growth, including brokered CD's, to be a reliable funding source in the future
as a result of branch expansion efforts and marketing efforts to attract and
retain core deposits. Shorter-term liquidity needs will mainly be derived from
growth in short-term borrowings, maturing federal funds sold and portfolio
investments, loan maturities and access to other funding sources.
Management believes that, in the current economic environment, the Company's and
the Bank's liquidity position is adequate. To management's knowledge, there are
no known trends nor any known demands, commitments, events or uncertainties that
will result or are reasonably likely to result in a material increase or
decrease in the Bank's or the Company's liquidity.
Interest Rate Sensitivity
Interest rate risk is the exposure to a bank's earnings and capital arising from
changes in future interest rates. All banks assume interest rate risk as an
integral part of normal banking operations. Control and monitoring of interest
rate risk is a primary objective of asset/liability management. The Bank uses an
Asset/Liability Committee ("ALCO") to manage risks associated with changing
interest rates, changing asset and liability mixes, and measuring the impact of
such changes on earnings. The sensitivity of net interest income to market rate
changes is evaluated monthly by the ALCO using "static gap analysis" and
simulation of earnings modeling.
In order to limit exposure to interest rate risk, the Company has developed
strategies to manage its liquidity, shorten the effective maturities of certain
interest-earning assets, and increase the effective maturities of certain
interest-bearing liabilities. The Company has focused on the establishment of
adjustable rate mortgages ("ARM's") in its residential lending product line; the
concerted efforts made to attract and sell core deposit products through the use
of Company's branching and delivery systems and marketing efforts; and the use
of other available sources of funding to provide longer term funding
possibilities.
Interest rate sensitivity analysis can be performed in several different ways.
The traditional method of measuring interest sensitivity is called "gap"
analysis. The mismatch between asset and liability repricing characteristics in
specific time intervals is referred to as "interest rate sensitivity gap." If
more liabilities than assets reprice in a given time interval a liability
sensitive gap position exists. In general, liability sensitive gap positions in
a declining interest rate environment increase net interest income.
Alternatively, asset sensitive positions, where assets reprice more quickly than
liabilities, negatively impact the net interest income in a declining rate
environment. In the event of an increasing rate environment, opposite results
would occur such that a liability sensitivity gap position would decrease net
interest income and an asset sensitivity gap position would increase net
interest income. The sensitivity of net interest income to changing interest
rates can be
28
reduced by matching the repricing characteristics of assets and liabilities.
The following table entitled "Asset and Liability Maturity Repricing Schedule"
indicates that the Company is liability sensitive. The analysis considers money
market index accounts and 25% of NOW accounts to be rate sensitive within three
months. Regular savings, money market deposit accounts and 75% of NOW accounts
are considered to be rate sensitive within one to five years. While these
accounts are contractually short-term in nature, it is the Company's experience
that repricing occurs over a longer period of time. The Company views its
savings and NOW accounts to be core deposits and relatively non-price sensitive,
as it believes it could make repricing adjustments for these types of accounts
in small increments without a material decrease in balances. All other earning
categories, including loans and investments as well as other paying liability
categories such as time deposits, are scheduled according to their contractual
maturities. The "static gap analysis" provides a representation of the Company's
earnings sensitivity to changes in interest rates. It is a static indicator and
does not reflect various repricing characteristics. Accordingly, a "static gap
analysis" may not necessarily be indicative of the sensitivity of net interest
income in a changing rate environment.
ASSET AND LIABILITY MATURITY REPRICING SCHEDULE
AS OF September 30, 2001
Within Four to Seven to One Year Over
Three Six Twelve To Five Five
Months Months Months Years Years Total
--------- --------- --------- --------- --------- ---------
(In thousands)
Earning assets:
Investment securities $ 9 005 $ 4 045 $ 6 735 $ 101 144 $ 46 930 $ 167 859
Federal funds sold 11 501 11 501
Loans and leases
Variable rate 215 543 20 058 0 26 512 0 262 113
Fixed rate 53 429 33 604 66 418 158 608 10 182 322 241
--------- --------- --------- --------- --------- ---------
Total loans and leases $ 268 972 $ 53 662 $ 66 418 $ 185 120 $ 10 182 $584 354
--------- --------- --------- --------- --------- ---------
Total earning assets $ 289 478 $ 57 707 $ 73 153 $ 286 264 $ 57 112 $763 714
========= ========= ========= ========= ========= =========
Interest bearing liabilities:
NOW Accounts $ 10 954 $ 0 $ 0 $ 32 862 $ 0 $ 43 816
Savings Deposits 154 317 0 0 52 305 0 206 622
Time Deposits 84 488 71 642 104 077 68 959 30 329 196
Borrowed Funds 33 842 15 052 0 45 106 0 94 000
Trust Preferred Securities 0 0 0 0 16 100 16 100
--------- --------- --------- --------- --------- ---------
Total interest bearing Liabilities $ 283 601 $ 86 694 $104 077 $ 199 232 $ 16 130 $ 689 734
========= ========= ========= ========= ========= =========
Interest sensitivity gap (within $ 5 877 $(28 987) $(30 924) $ 87 032 $ 40 982 $ 73 980
periods)
Cumulative interest sensitivity gap $ 5 877 $(23 110) $(54 034) $ 32 998 $ 73 980
Ratio of cumulative interest 0.77% - 3.03 - 7.08 4.32% 9.69%
Sensitivity gap to rate
Sensitive assets
Ratio of rate sensitive assets 102.07% 66.56% 70.29% 143.68% --
To rate sensitive
Liabilities
29
Cumulative ratio of rate 102.07% 93.76% 88.61% 104.90% 110.73%
Sensitive assets to rate
Sensitive liabilities
In addition to the "static gap analysis", determining the sensitivity of future
earnings to a hypothetical plus or minus 200 basis point parallel rate shock can
be accomplished through the use of simulation modeling. Simulation of earnings
includes the modeling of the balance sheet as an ongoing entity. Balance sheet
items are modeled to project income based on a hypothetical change in interest
rates. The resulting net income for the next twelve-month period is compared to
the net income amount calculated using flat rates. This difference represents
the Company's earnings sensitivity to a plus or minus 200 basis point parallel
rate shock. The resulting simulations indicated a plus 1.6% or minus 5.1%
adjustment in net income under these scenarios for the period ended September
30, 2001. This result was within the policy limits established by the Company.
Management continually reviews its interest rate risk position through the ALCO
process. 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.
Capital Resources
Shareholders' equity at September 30, 2001 increased $5.8 million or 10.9% to
$58.9 million, compared with $53.1 million at end of year 2000. This increase
includes a change of $2.8 million to capital in 2001 due to the impact of
STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NO. 115. Disregarding the effect of
this change, shareholders' equity would have increased $3.0 million or 5.7% for
the period between September 30, 2001 and December 31, 2000.
The Company's capital base (before SFAS 115 change) increased primarily due to
the retention of earnings. The Company's dividend reinvestment plan typically
provides capital improvement, as the holders of approximately 26% of Company's
Common Stock participate in the plan.
On February 16, 2001, the Company, through Baylake Capital Trust I, issued $16.1
million in trust preferred stock with a coupon rate of 10.0% and maturing on
March 31, 2031. These securities qualify as Tier 1 Capital for purposes of
calculating regulatory capital requirements. Baylake Capital Trust I, a finance
subsidiary of the Company, is a Delaware statutory business trust created
exclusively for the purposes of issuing and selling its capital securities and
using the proceeds to purchase 10.00% subordinated debentures, due 2031, issued
by the Company. Accordingly, the subordinated debentures are the sole assets of
Baylake Capital Trust I, and payments under the subordinated debentures will be
the sole revenue of Baylake Capital Trust I. All of the common securities of
Baylake Capital Trust I are owned by the Company.
Cash dividends paid for the first nine months of 2001 were $0.33 per share
compared with $0.30 in the first nine months of 2000. The
30
Company provided a 10.0% increase in normal dividends per share in 2001 over
2000 as a result of above average earnings.
In 1997, the Company's Board of Directors authorized management, in its
discretion, to repurchase up to 7,000 shares of the Company's common stock each
calendar quarter in the open market. The shares repurchased would be used to
fill its needs for the dividend reinvestment program, any future benefit plans,
and the Company's stock purchase plan. Shares repurchased are held as treasury
stock and accordingly, are accounted for as a reduction of stockholders' equity.
The Company repurchased none of its common shares in the first nine months of
2001.
The adequacy of the Company's 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. Management believes that, because of
current capital levels and projected earnings levels, capital levels are
adequate to meet the ongoing and future concerns of the Company.
The Company and the Bank are subject to capital adequacy requirements
established by the federal banking agencies. The federal banking agencies have
adopted risk-based capital requirements for assessing bank holding company and
bank capital adequacy. Failure to meet minimum capital requirements can result
in certain mandatory and possibly additional discretionary actions by regulators
that, if undertaken, could have a direct material effect on the Company's
financial statements.
These standards define capital and establish minimum capital requirements in
relation to assets and off-balance sheet exposure, adjusted for credit risk. The
risk-based capital standards currently in effect are designed to make regulatory
capital requirements more sensitive to differences in risk profiles among bank
holding companies and banks to account for off-balance sheet exposure and to
minimize disincentives for holding liquid assets. Assets and off-balance sheet
items are assigned to broad risk categories, each with appropriate relative risk
weights. The resulting capital ratios represent capital as a percentage of total
risk-weighted assets and off-balance sheet items.
A banking organization's total qualifying capital includes two components: core
capital (Tier 1 capital) and supplementary capital (Tier 2 capital). Core
capital, which must comprise at least half of total capital, includes common
shareholders' equity, qualifying perpetual preferred stock, trust preferred
securities (subject to certain limitations) and minority interests, less
goodwill. Supplementary capital includes the allowance for loan losses (subject
to certain limitations), other perpetual preferred stock, trust preferred
securities, certain other capital instruments and term subordinated debt. Total
capital is the sum of core and supplementary capital.
31
At September 30, 2001, the minimum risk-based capital requirements to be
considered adequately capitalized were 4% for Tier 1 capital and 8% for total
capital.
Federal banking regulators have also adopted leverage capital guidelines to
supplement the risk-based measures. The leverage ratio is determined by dividing
Tier 1 capital as defined under the risk-based guidelines by average total
assets (non risk-adjusted) for the preceding quarter. At September 30, 2001, the
minimum leverage ratio requirement to be considered adequately capitalized was
4%.
The capital levels of the Company and the Bank at September 30, 2001 and the two
highest capital adequacy levels recognized under the guidelines established by
the federal banking agencies are included in the following table. The Company's
and the Bank's ratios all exceeded the well-capitalized guidelines shown in the
table.
The Company's and the Bank's capital amounts and ratios are as follows:
(dollars in thousands)
To Be Well
Capitalized
Under Prompt
For Capital Corrective
Adequacy Action
Actual Purposes Provisions
----------------- ------------------ -----------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
As of September 30, 2001
Total Capital (to
Risk Weighted Assets)
Company 74,225 11.38% 52,159 8.00% 65,199 10.00%
Bank 69,094 10.57% 52,278 8.00% 65,348 10.00%
Tier 1 Capital (to
Risk Weighted Assets)
Company 66,504 10.20% 26,080 4.00% 39,119 6.00%
Bank 61,372 9.39% 26,139 4.00% 39,209 6.00%
Tier 1 Capital (to
Average Assets)
Company 66,504 8.14% 32,697 4.00% N/A N/A
Bank 61,372 7.51% 32,697 4.00% 40,871 5.00%
As of December 31, 2000
Total Capital (to
Risk Weighted Assets)
Company 54,055 8.92% 48,464 8.00% 60,580 10.00%
Bank 61,237 10.10% 48,512 8.00% 60,640 10.00%
Tier 1 Capital (to
Risk Weighted Assets)
Company 47,049 7.77% 24,232 4.00% 36,348 6.00%
Bank 54,232 8.94% 24,255 4.00% 36,384 6.00%
Tier 1 Capital (to
Average Assets)
Company 47,049 6.38% 29,518 4.00% N/A N/A
32
Bank 54,232 7.35% 29,518 4.00% 36,897 5.00%
Item 3 Quantitative and Qualitative Disclosure about Market Risk.
The Company's financial performance is affected by, among other factors, credit
risk and interest rate risk. The Company does not use derivatives to mitigate
its interest rate risk or credit risk, relying instead on loan review and its
loan loss reserve.
The Company's earnings are derived from the operations of its direct and
indirect subsidiaries with particular reliance on net interest income,
calculated as the difference between interest earned on loans and investments
and the interest expense paid on deposits and other interest bearing
liabilities, including advances from FHLB and other borrowings. Like other
financial institutions, the Company's interest income and interest expense are
affected by general economic conditions and by the policies of regulatory
authorities, including the monetary policies of the Board of Governors of the
Federal Reserve System. Changes in the economic environment may influence, among
other matters, the growth rate of loans and deposits, the quality of the loan
portfolio and loan and deposit pricing. Fluctuations in interest rates are not
predictable or controllable.
As of September 30, 2001, the Company was in compliance with its management
policies with respect to interest rate risk. The Company has not experienced any
material changes to its market risk position since December 31, 2000, as
described in the Company's 2000 Form 10-K Annual Report.
Part II - Other Information
Item 1. Legal Proceedings
The Company is a party to routine litigation involving various aspects of its
businesses, none of which, in the opinion of management and its legal counsel is
expected to have a material adverse impact on the consolidated financial
condition, results of operations or liquidity of the Company.
Item 2. Changes in Securities and Use of Proceeds
On February 23, 2001, Baylake Capital Trust I (the "Trust"), a Delaware business
trust formed by the Company, completed the sale of $16.1 million of 10.00%
Preferred Securities (the "Preferred Securities") in a registered offering made
through an underwriting group led by Howe Barnes Investments, Inc. The Trust
also issued common securities to the Company and used the net proceeds from the
offering to purchase a like amount of 10.00% subordinated debentures, due 2031
(the "Debentures"), of the Company. In connection with the offering, the Company
and the Trust registered a total of $16.1 million of Preferred Securities on a
Form S-3 Registration Statement (Registration Nos. 333-48962 and 333-48962-01).
Total expenses associated with the offering were approximately $881,000,
including $644,000 in underwriting
33
commissions. As of March 31, 2001, the Company had used the net proceeds from
the sale of the Debentures to repay approximately $7.7 million of corporate
indebtedness and invested the remaining $7.5 million in marketable securities to
be used for future acquisitions and general corporate purposes. The initial
dividend payment for trust preferred securities was paid on July 2, 2001 for the
period February 16, 2001 through June 30, 2001 to shareholders of record on the
close of business on June 29, 2001. Subsequent interest payments will be made on
a quarterly basis at the rate of $0.25 per security.
Item 3. Defaults Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
The Bank purchased land in the city of Luxemburg located in Kewaunee County,
Wisconsin in January 1999. The Bank began construction on a full-service branch
facility on this property in the third quarter of 2001 with expected completion
to be in the early first quarter of 2002. Costs to complete the project are
estimated at $924,000.
In the third quarter of 1999, the Bank purchased land and a building in Seymour,
Wisconsin for $475,000. The Bank began remodeling work on the building to make
it a full-service branch. Completion of this project is expected in the fourth
quarter of 2001. Costs to complete this project are estimated at $760,000.
Item 6. Exhibits and Reports on Form 8-K
(a). The following exhibits are furnished herewith:
EXHIBIT NUMBER DESCRIPTION
- -------------- -----------
11 Statement re: computation of per share earnings
15 Letter re: unaudited interim financial information
(b). Report on Form 8-K:
None
34
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
BAYLAKE CORP.
------------------------------------------
Date: November 9, 2001 /s/ Thomas L. Herlache
----------------------- ------------------------------------------
Thomas L. Herlache
President (CEO)
Date: November 9, 2001 /s/ Steven D. Jennerjohn
----------------------- ------------------------------------------
Steven D. Jennerjohn
Treasurer (CFO)
35