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 MARCH 31, 2002
--------------------------------------------------
OR
{ } TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
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Commission file number 0-8679
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BAYLAKE CORP.
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(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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None (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 May 12, 2002: 7,471,576 shares
BAYLAKE CORP. AND SUBSIDIARIES
INDEX
PART 1 - FINANCIAL INFORMATION PAGE NUMBER
Item 1. Financial Statements
Consolidated Condensed Balance Sheet as of March 31, 2002 3 - 4
and December 31, 2001
Consolidated Condensed Statement of Income for the three 5
months ended March 31, 2002 and 2001
Consolidated Statement of Comprehensive Income for the three 6
months ended March 31, 2002 and 2001
Consolidated Statement of Cash Flows for the three months ended 7 - 8
March 31, 2002 and 2001
Notes to Consolidated Condensed Financial Statements 9
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 10 - 32
Item 3. Quantitative and Qualitative Disclosures About Market Risk 31 - 32
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 34
EXHIBIT INDEX 33
Exhibit 11 Statement re: computation of per share earnings 35
Exhibit 15 Letter re: unaudited interim financial information 36
2
PART 1 - FINANCIAL INFORMATION
BAYLAKE CORP. AND SUBSIDIARIES
CONSOLIDATED CONDENSED BALANCE SHEET (UNAUDITED)
(dollars in thousands)
MARCH 31, DECEMBER 31,
ASSETS 2002 2001
---- ----
Cash and due from banks $ 15,782 $ 24,033
Federal funds sold 0 4,452
--------- ---------
Cash and cash equivalents 15,782 28,485
Investment securities available for sale (at market) 152,073 144,895
Investment securities held to maturity (market 19,936 22,205
value $20,215 and $22,398, at March 31, 2002 and
December 31, 2001, respectively)
Loans held for sale 435 2,428
Loans 620,157 605,287
Less: Allowance for loan losses 8,325 7,992
--------- ---------
Loan, net of allowance for loan losses 611,832 597,295
Bank premises and equipment 24,221 21,792
Federal Home Loan Bank stock (at cost) 6,469 6,376
Accrued interest receivable 5,176 5,112
Income taxes receivable 1,120 1,673
Deferred income taxes 2,119 2,048
Goodwill 4,969 4,969
Other Assets 8,493 8,513
--------- ---------
Total Assets $ 852,625 $ 845,791
========= =========
LIABILITIES
Domestic deposits
Non-interest bearing $ 66,971 $ 76,051
Interest bearing
NOW 44,054 49,709
Savings 208,294 218,736
Time, $100,000 and over 148,863 137,148
Other time 182,664 188,246
--------- ---------
Total interest bearing 583,875 593,839
--------- ---------
Total deposits 650,846 669,890
Short-term borrowings
Federal funds purchased, repurchase 44,068 2,837
Agreements, borrowings from unaffiliated banks and
Federal Home Loan Bank advances
Accrued expenses and other liabilities 6,536 6,779
Dividends payable 0 897
Other borrowings 75,000 90,000
Long-term debt 106 158
Guaranteed preferred beneficial interest in the
company's junior subordinated debt 16,100 16,100
--------- ---------
Total liabilities 792,656 786,661
--------- ---------
SHAREHOLDERS' EQUITY
Common stock,$5 par value: authorized 10,000,000
shares; issued 7,494,735 shares as of March 31, 2002
and 7,494,734 as of December 31, 2001; outstanding 37,474 37,474
7,471,576 as of March 31, 2002 and 7,471,575 as of
December 31, 2001
3
Additional paid-in capital 7,319 7,319
Retained earnings 13,819 12,843
Treasury Stock (625) (625)
Net unrealized gain (loss) on securities available
for sale, net of tax of $1,075 as of March 31, 2002
and $1,146 as of December 31, 2001 1,982 2,119
--------- ---------
Total shareholders' equity 59,969 59,130
--------- ---------
Total liabilities and shareholders' equity $ 852,625 $ 845,791
========= =========
4
BAYLAKE CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(dollars in thousands, except per share amounts)
THREE MONTHS ENDED
MARCH 31,
2002 2001
------- -------
Interest income
Interest and fees on loans $10,434 $12,939
Interest on investment securities
Taxable 1,582 1,713
Exempt from federal income taxes 688 649
Other interest income 12 0
------- -------
Total interest income 12,716 15,301
Interest expense
Interest on deposits 4,383 6,472
Interest on short-term borrowings 126 817
Interest on other borrowings 816 1,526
Interest on long-term debt 1 4
Interest on guaranteed preferred beneficial
interest in the company's junior subordinated
debt 411 197
------- -------
Total interest expense 5,737 9,016
------- -------
Net interest income 6,979 6,285
Provision for loan losses 500 202
------- -------
Net interest income after provision for
loan losses 6,479 6,083
------- -------
Other income
Fees from fiduciary activities 181 150
Fees from loan servicing 273 196
Fees for other services to customers 1,076 598
Gains from sales of loans 265 113
Other income 91 75
------- -------
Total other income 1,886 1,132
------- -------
Other expenses
Salaries and employee benefits 3,242 2,927
Occupancy expense 443 430
Equipment expense 386 351
Data processing and courier 255 236
Operation of other real estate 144 24
Other operating expenses 1,234 926
------- -------
Total other expenses 5,704 4,894
------- -------
Income before income taxes 2,661 2,321
Income tax expense 788 709
------- -------
Net Income $ 1,873 $ 1,612
======= =======
Basic earnings per common share (1) $ 0.25 $ 0.22
Diluted earnings per common share (1) $ 0.25 $ 0.21
Cash dividends per share $ 0.12 $ 0.11
(1) Based on 7,471,575 average shares outstanding in 2002 and 7,457,018 in 2001.
5
BAYLAKE CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
(dollars in thousands)
THREE MONTHS ENDED
MARCH 31,
2002 2001
---- ----
Net Income $ 1,873 $ 1,612
------- -------
Other comprehensive income, net of tax:
Unrealized gains (losses) on securities:
Unrealized gains (losses) arising during period (137) 1,509
------- -------
Comprehensive income $ 1,736 $ 3,121
======= =======
6
BAYLAKE CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASHFLOWS (UNAUDITED)
(dollars in thousands)
THREE MONTHS ENDED
MARCH 31,
2002 2001
-------- --------
Cash flows from operating activities:
Interest received from:
Loans $ 10,407 $ 12,394
Investments 2,285 2,382
Fees and service charges 1,759 1,065
Interest paid to depositors (4,443) (5,978)
Interest paid to others (1,441) (2,462)
Cash paid to suppliers and employees (5,830) (4,992)
Income taxes paid (157) (133)
-------- --------
Net cash provided by operating activities 2,580 2,276
Cash flows from investing activities:
Principal payments received on investments 20,755 5,484
Purchase of investments (25,982) (5,850)
Proceeds from sale of other real estate owned 914 249
Loans made to customers in excess of principal collected (13,493) (26,449)
Capital expenditures (2,820) (118)
-------- --------
Net cash used in investing activities (20,626) (26,684)
Cash flows from financing activities:
Net decrease in demand deposits, NOW accounts, and savings
Accounts (25,176) (8,861)
Net increase (decrease) in short term borrowing 41,231 (43,248)
Net increase in time deposits 6,134 29,490
Proceeds from other borrowings and long-term debt (15,000) 35,000
Payments on other borrowings and long term debt (53) (7,753)
Proceeds from issuance of common stock 0 211
Proceeds from issuance of trust preferred stock 0 16,100
Dividends paid (1,793) (1,640)
-------- --------
Net cash provided by financing activities 5,343 19,299
-------- --------
Net decrease in cash and cash equivalents (12,703) (5,109)
Cash and cash equivalents, beginning 28,485 21,695
-------- --------
Cash and cash equivalents, ending $ 15,782 $ 16,586
======== ========
7
MARCH 31,
2002 2001
-------- --------
Reconciliation of net income to net cash provided by operating activities:
Net income $ 1,873 $ 1,613
Adjustments to reconcile net income to net cash provided by operating
Activities:
Depreciation 391 391
Provision for losses on loans and real estate owned 500 202
Amortization of premium on investments 51 43
Accretion of discount on investments (34) (39)
Cash surrender value increase (13) (14)
Gain from disposal of ORE 68 (8)
Gain on sale of loans (265) (113)
Proceeds from sale of loans held for sale 19,945 12,366
Originations of loans held for sale (19,680) (12,253)
Equity in income of service center (52) (51)
Amortization of goodwill 0 121
Amortization of mortgage servicing rights 83 46
Mortgage servicing rights booked (61) (58)
Deferred compensation 62 64
Changes in assets and liabilities:
Interest receivable (65) (493)
Prepaids and other assets (493) (64)
Unearned income 22 21
Interest payable (147) 576
Taxes payable 631 575
Other liabilities (236) (72)
-------- --------
Total adjustments 707 663
-------- --------
Net cash provided by operating activities $ 2,580 $ 2,276
======== ========
8
BAYLAKE CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2002
1. The accompanying unaudited consolidated financial statements should be read
in conjunction with Baylake Corp.'s 2001 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 March 31, 2002 and December 31, 2001. The results of
operations for the three months ended March 31, 2002 and 2001 are not
necessarily indicative of results to be expected for the entire year.
2. The book value of investment securities, by type, held by Baylake Corp. are
as follows:
MARCH 31, DECEMBER 31,
2002 2001
---- ----
(dollars in thousands)
Investment securities held to maturity:
Obligations of state and political subdivisions $ 19,936 $ 22,205
-------- --------
Investment securities held to maturity $ 19,936 $ 22,205
======== ========
Investment securities available for sale:
U.S. Treasury and other U.S. government agencies $ 26,408 $ 22,740
Obligations of states and political subdivisions 34,963 33,504
Mortgage-backed securities 71,516 74,348
Other 19,186 14,303
-------- --------
Investment securities available for sale $ 152,073 $144,895
========= ========
3. At March 31, 2002 and December 31, 2001, loans were as follows:
MARCH 31, DECEMBER 31,
2002 2001
---- ----
(dollars in thousands)
Commercial, financial and agricultural $386,957 $377,034
Real estate - construction 75,370 67,939
Real estate - mortgage 142,062 143,748
Installment 16,115 16,890
Less: Deferred loan origination fees, net of costs (347) (324)
-------- --------
$620,157 $605,287
Less allowance for loan losses (8,325) (7,992)
-------- --------
Net loans $611,832 $597,295
======== ========
4. Baylake Corp. declared a cash dividend of $0.12 per share payable on March
15, 2002 to shareholders of record as of March 1, 2002.
9
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 months ended March 31, 2002 and 2001
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 March 31, 2002, 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
10
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 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 March 31, 2002, earnings increased $261,000, or
16.2%, to $1.9 million from $1.6 million for the first quarter last year. Basic
operating earnings per share of $0.25 was reported for the quarter ended March
31, 2002 compared to $0.22 for the same period last year, an improvement of
13.6%. On a fully diluted basis, the Company recorded $0.25 per share for the
first quarter in 2002 and $0.21 for the same period in 2001.
The annualized return on average assets and return on average equity for the
three months ended March 31, 2002 were 0.90% and 12.64%, respectively, compared
to 0.84% and 12.09%, 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 and income tax expense.
Cash dividends declared in the first three months of 2002 increased 9.1% to
$0.12 per share compared with $0.11 for the same period in 2001.
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 79.5% of
total operating income for the first three months of 2002, as compared to 85.4%
for the first three months of 2001. 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
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 March
31, 2002 increased $714,000, or 10.8%, to $7.3 million from $6.6 million for the
same period a year ago. As a result of a lower interest rate environment, total
interest income for the first quarter of 2002
11
decreased $2.5 million, or 16.4%, to $13.1 million from $15.6 million for the
first quarter of 2001, while interest expense in the first quarter of 2002
decreased $3.3 million, or 36.4%, to $5.7 million when compared to $9.0 million
in the first quarter of 2001. The increase in net interest income between these
two quarterly periods occurred partially as a result of growth in the average
volume of interest earning assets and non-interest bearing deposits offset to a
lesser extent by an increase in interest paying liabilities. In addition, lower
funding costs from deposits and other wholesale funding sources relative to
rates earned on earning assets such as loans and investments also contributed to
an improvement in net interest income.
For the three months ended March 31, 2002, average earning assets increased
$60.0 million, or 8.4%, when compared to the same period last year. The Company
recorded an increase in average loans of $44.1 million, or 7.8%, for the first
quarter of 2002 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. The interest rate spread increased for the quarter ended March 31,
2002 when compared to the same period a year ago. The interest rate spread
increased 45 basis points to 3.52% at March 31, 2002 from 3.07% in the same
quarter in 2001. While the average yield on earning assets decreased 179 basis
points during the period, the average rate paid on interest-bearing liabilities
decreased 227 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 March 31, 2002 increased from 3.73% to 3.81% compared to the same period a
year ago. The average yield on interest earning assets amounted to 6.79% for the
first quarter of 2002, representing a decrease of 182 basis points from the same
period last year. Total loan yields decreased 213 basis points to 7.04%, while
total investment yields decreased 62 basis points to 6.03%, as compared to the
same period a year ago. The Company's average cost on interest-bearing deposit
liabilities decreased 229 basis points to 3.02% for the first quarter of 2002
when compared to the first quarter of 2001, while short-term borrowing costs
decreased 402 basis points to 1.97% comparing the two periods. Other borrowing
costs decreased 181 basis points to 4.10% during the same time period. These
factors contributed to an increase in the Company's interest margin for the
three months ended March 31, 2002 compared to the same period a year ago.
12
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 92.3% for the first quarter of 2002 compared with 92.5%
for the same period in 2001. The ratio increased slightly in 2001, primarily as
a result of growth in earning assets offset to a slightly greater 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 March 31, 2002
increased $298,000 to $500,000 compared with $202,000 for the first quarter of
2001. 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 $754,000, or 66.6%, to $1.9 million for the
first quarter of 2002 when compared to the first quarter of 2001. This increase
occurred as a result of increased fees on other customer services, increased
gains from sales of loans, increased fees from loan servicing, increased trust
income and increased other income.
Trust fees increased $31,000, or 20.7%, in the first quarter of 2002 compared to
the same quarter in 2001, primarily as a result of increased trust and estate
business.
Loan servicing fees increased $77,000, or 39.3%, to $273,000 in the first
quarter of 2002, when compared to the same quarter in 2001. The increase in 2002
resulted from an increase in commercial loan servicing income.
Gains on sales of loans in the secondary market increased $152,000 to $265,000
in the first quarter of 2002, when compared to the same quarter in 2001,
primarily as a result of increased gains from sales of mortgage and commercial
loans. Declines in interest rates have continue to stimulate mortgage
production, including an increase in refinancing activity, although that trend
is expected to decline in the near future.
Service charges on deposit accounts for the first quarter of 2002 showed an
increase of $251,000, or 62.3%, over 2001 results, accounting for much of the
improvement in fee income generated for other services to
13
customers. Financial service income increased $44,000, or 67.7%. Revenues
generated from the operation of Arborview LLC ("Arborview") (a recently formed
subsidiary created to manage a community based residential facility) amounted to
$124,000 for the first quarter.
Non-Interest Expense
Non-interest expense increased $810,000, or 16.6%, for the three months ended
March 31, 2002 compared to the same period in 2001. Salaries and employee
benefits showed an increase of $315,000, or 10.8%, 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 290 persons from 272
a year earlier. Increases in occupancy (amounting to $13,000 or 3.0%) and
equipment expenses (amounting to $35,000 or 10.0%) occurred as a result of
expansion in the Green Bay and Waupaca markets and costs related to
modernization of various facilities.
Expenses related to the operation of other real estate owned increased $120,000
to $144,000 for the quarter ended March 31, 2002 compared to the same period in
2001. Included in the increase of these expenses were losses taken on the sale
of other real estate owned amounting to $69,000 for the first quarter of 2002
compared to net gains taken on sale of $14,000 for the same period in 2001. In
addition, costs related to the holding of other real estate owned properties
increased $47,000 to $85,000 for the first quarter of 2002.
Other operating expenses increased $308,000, or 33.3%. Legal expense and loan
collection expense increased $55,000 for the three months ended March 31, 2002
primarily as a result of legal issues related to loan collection efforts of two
commercial real estate loans in the process of foreclosure. Expenses related to
the operation of Arborview amounted to $172,000 for the first quarter of 2002
and are included in other operating expenses.
Included in 2001 expenses for other operating expenses were amortization of
goodwill related to the Four Seasons acquisition (a purchase of a one bank
holding company in July 1996) of $82,000 and amortization of $39,000 related to
the BLBNA acquisition. In July 2001, the Financial Accounting Standards Board
("FASB") issued Statement of Financial Accounting Standard ("SFAS") No. 142,
"Goodwill and Other Intangible Assets." SFAS No. 142 requires that goodwill and
intangible assets with indefinite lives no longer be amortized, but instead
tested for impairment as least annually. SFAS No. 142 requires that intangible
assets with definite useful lives be amortized over their respective estimated
useful lives to their estimated residual values, and be reviewed for impairment
in accordance with SFAS No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets." The adoption of SFAS No. 142 and SFAS No. 144 does not have
a material impact on the Company's financial statements.
Other items (such as supplies, marketing, telephone, postage and director fees)
comprising other operating expense show an increase of $51,000 or 11.4% in the
first quarter of 2002 when compared to the same quarter in 2000. Expenses
related to the amortization of trust
14
preferred expenses (such as legal and underwriting expenses) amounted to $9,000
for the quarter ended March 31, 2002. The overhead ratio, which is computed by
subtracting non-interest income from non-interest expense and dividing by
average total assets, was 1.83% for the three months ended March 31, 2002
compared to 1.93% for the same period in 2001.
Income Taxes
Income tax expense for the Company for the three months ended March 31, 2002 was
$788,000, an increase of $79,000, or 11.1%, compared to the same period in 2000.
The increase in income tax provision 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 three months ended March 31, 2002 compared with 30.5%
for the same period in 2001. The effective tax rate of 29.6% consisted of a
federal effective tax rate of 26.5% and Wisconsin State effective tax rate of
3.1%.
Balance Sheet Analysis
Loans
At March 31, 2002, total loans increased $14.9 million, or 2.5%, to $620.2
million from $605.3 million at December 31, 2001. Growth in the Company's loan
portfolio resulted primarily from an increase in real estate commercial loans to
$301.9 million at March 31, 2002 compared to $288.4 million at December 31,
2001. In addition, real estate construction loans increased to $75.4 million at
March 31, 2002, compared to $67.9 million at December 31, 2001. Real estate
mortgage loans decreased to $142.1 million at March 31, 2002, compared with
$143.7 million at December 31, 2001. Consumer loans decreased to $16.1 million
at March 31, 2002, compared with $16.9 million at December 31, 2001.
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):
March December
31, 2002 31, 2001
Amount of loans by type (dollars in thousands)
Real estate-mortgage
Commercial $301,924 $288,385
1-4 family residential
First liens 95,070 96,626
Junior liens 24,300 24,748
Home equity 22,692 22,374
Commercial, financial and agricultural 85,033 88,649
Real estate-construction 75,370 67,939
Installment
15
Credit cards and related plans 2,075 2,145
Other 14,040 14,745
Less: deferred origination fees, net of costs 347 324
-------- --------
Total $620,157 $605,287
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 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
16
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 March 31, 2002 was $8.3 million
compared with $8.0 million at the end of 2001. Loans increased 2.5% from
December 31, 2001 to March 31, 2002, 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 quarter of 2002. The March 31, 2002 ratio of ALL to
outstanding loans was 1.34% compared with 1.32% at December 31, 2001 and the ALL
as a percentage of nonperforming loans was 39.1% at March 31, 2002 compared to
54.5% at end of year 2001. Based on management's analysis of the loan portfolio
risk at March 31, 2002, a provision expense of $500,000 was recorded for the
three months ended March 31, 2002, an increase of $298,000 or 147.5% compared to
the same period in 2001. Net loan charge-offs of $167,000 occurred in the first
quarter of 2002, and the ratio of net charge-offs to average loans for the
period ended March 31, 2002 was 0.11% compared to (0.02%) at March 31, 2001.
Commercial, agricultural and other loan net charge-offs represented 88.6% of the
total net recoveries for the first three months of 2002. Loans charged-off are
subject to periodic review and specific efforts are taken to achieve maximum
recovery of principal and accrued interest.
Allowance for Loan Losses and Nonperforming Assets
(dollars in thousands)
For the period ended For the period ended For the period ended
March 31, 2002 March 31, 2001 December 31, 2001
Allowance for
Loan Losses
("ALL")
Balance at $7,992 $ 7,006 $ 7,006
17
beginning of
period
Provision for
loan losses 500 202 2,880
Charge-offs 246 111 2,729
Recoveries 79 142 835
------- ------- -------
Balance at end
of period 8,325 7,239 7,992
Net charge-offs
("NCOs") 167 (31) 1,894
Nonperforming
Assets:
Nonaccrual loans $16,008 9,883 9,929
Accruing loans
past due 90 599 0 0
days or more
Restructured loans 4,710 4,657 4,744
------- ------- -------
Total
nonperforming
loans ("NPLs") 21,317 14,540 14,673
Other real
estate owned 3,385 1,230 1,673
------- ------- -------
Total
nonperforming
assets ("NPAs") $24,702 15,770 16,346
Ratios:
ALL to NCO's
(annualized) 12.46 (58.38) 4.22
NCO's to average
loans 0.11% (0.02%) 0.32%
(annualized)
ALL to total loans 1.34% 1.25% 1.32%
NPL's to total
loans 3.44% 2.50% 2.42%
NPA's to total
assets 2.90% 1.98% 1.93%
ALL to NPL's 39.05% 49.79% 54.47%
While management uses available information to recognize losses on loans, future
adjustments to the ALL may be necessary based on changes 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.
18
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 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
19
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)
March 31, March 31, Dec 31,
2002 2001 2001
Amount Percent Amount Percent Amount Percent
------ of ------ of ------- of
loans loans loans
to to to
total total total
loans loans loans
----- ----- -----
Commercial,
financial
& agricultural $1,150 13.71% 1,200 15.08% 972 14.65%
Commercial
real estate 4,600 48.63% 3,250 43.68% 4,158 47.59%
Real Estate:
Construction 546 12.15% 360 11.56% 503 11.22%
Residential 1,090 19.25% 1,420 22.28% 1,078 20.05%
Home equity
lines 165 3.66% 142 4.32% 178 3.70%
Consumer 190 2.26% 140 2.69% 162 2.44%
Credit card 83 0.34% 52 0.39% 93 0.35%
Loan
commitments 141 147 144
Not
specifically
allocated 360 528 704
------ ------ ------
Total $8,325 100.00% $7,239 100.00% $7,992 100.00%
20
allowance
Allowance for credit 1.34% 1.25% 1.32%
loss as a percentage
of total loans
Period end loans $620,157 $577,807 $605,287
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 March 31, 2002. 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 March 31, 2002 were $24.7 million compared to $16.3
million at December 31, 2001. Other real estate owned totaled $1.1 million and
consisted of three residential and seven commercial properties. In addition,
investment in Arborview, an operating subsidiary of the Company, totals $2.3
million at March 31, 2002. Non-accrual loans represented $16.0 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
$14.8 million of the total, of which $3.3 million was residential real estate
and $11.5 million was commercial real estate, while commercial and industrial
non-accruals accounted for $934,000. Loans past due over 90 days totaled
$599,000 and consisted of one commercial real estate credit. This credit was
transferred to the Company in mid-April 2002 as
21
a result of a deed in lieu of foreclosure and a subsidiary was formed to operate
the business. The business is currently available for sale.
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 $5.4 million. These credits are in the process of
a workout and it is anticipated that the specific reserve applied to this loan
(approximately $1.2 million) will be sufficient to cover the entire amount of
potential loss. $4.7 million of troubled debt restructured loans existed at
March 31, 2002 and December 31, 2001. Approximately $3.5 million of troubled
debt restructured loans at March 31 consists of two commercial real estate
credits which were granted various payment concessions and had experienced past
cashflow problems. These credits were current at March 31, 2002. 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 March 31, 2002 was 3.4% compared to 2.4% at 2001 year end. The
Company's ALL was 39.1% of total non-performing loans at March 31, 2002 compared
to 54.4% at end of year 2001.
Potential problem loans at March 31, 2002 are restricted to one commercial
borrower with credits aggregating approximately $465,000. Potential problem
loans totaled $10.5 million at December 31, 2001. The commercial loan customer
is undergoing management changes and, as a result, has experienced liquidity
problems. This credit was not current at March 31, 2002, and continues to 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 March 31, 2002, the investment portfolio (which includes investment
securities available for sale and held to maturity) increased $4.9 million, or
2.9%, to $172.0 million from $167.1 million at December 31, 2001. At March 31,
2002, the investment portfolio represented 20.2% of total assets compared with
19.8% at December 31, 2001.
Securities held to maturity and securities available for sale consist of the
following:
At March 31, 2002
(dollars in thousands)
Amortized Gross Gross Estimated
Cost Unrealized Unrealized Market Value
Gains Losses
Securities held to
maturity
Obligations of
states & political
subdivisions $ 19,936 $ 289 $ 10 $ 20,215
22
Securities
available for sale
Obligations of U.S. 25,605 941 138 26,408
Treasury & other
U.S. Agencies
Mortgage-backed 70,326 1,316 126 71,516
securities
Obligations of 33,900 1,078 15 34,963
states & political
subdivisions
Equity securities 19,186 19,186
Total securities $ 149,017 $3,335 $ 279 $152,073
available for sale
At December 31, 2001
(dollars in thousands)
Amortized Gross Gross Estimated
Cost Unrealized Unrealized Market Value
Gains Losses
Securities held to
maturity
Obligations of $ 22,205 $ 216 $ 23 $ 22,398
states & political
subdivisions
Securities
available for sale
Obligations of U.S. $ 21,505 $ 1,235 $ 0 $ 22,740
Treasury & other
U.S. Agencies
Mortgage-backed 73,183 1,359 194 74,348
securities
Obligations of 32,639 889 24 33,504
states & political
subdivisions
Equity securities 14,303 14,303
Total securities $141,630 $ 3,483 $ 218 $144,895
available for sale
At March 31, 2002, the contractual maturities of securities held to maturity and
securities available for sale are as follows: (dollars in thousands):
Securities held to Maturity Securities Available for Sale
--------------------------- -----------------------------
23
Amortized Cost Market Value Amortized Cost Market Value
-------------- ------------ -------------- ------------
Within 1 year $ 1,515 $ 1,523 $ 27,781 $ 27,907
After 1 but 9,642 9,825 84,734 87,061
within 5 years
After 5 but 3,191 3,277 21,525 21,981
within 10 years
After 10 years 5,588 5,590 13,541 13,688
Equity 0 0 1,436 1,436
securities
Total $ 19,936 $ 20,215 $149,017 $152,073
Deposits
Total deposits at March 31, 2002 decreased $19.0 million, or 2.8%, to $650.8
million from $669.9 million at December 31, 2001. Non-interest bearing deposits
at March 31, 2002 decreased $9.1 million, or 11.9%, to $67.0 million from $76.1
million at December 31, 2001. Interest-bearing deposits at March 31, 2002
decreased $9.9 million, or 1.7%, to $583.9 million from $593.8 million at
December 31, 2001. Interest-bearing transaction accounts (NOW deposits)
decreased $5.7 million, primarily in public fund deposits. Savings deposits
decreased $10.4 million, or 4.8%, to $208.3 million at March 31, 2002, when
compared to $218.7 million at December 31, 2001. Time deposits (including time,
$100,000 and over and other time) increased $6.1 million (includes increase of
$11.7 million in time deposits over $100,000), or 1.9%, to $331.5 million at
March 31, 2002, when compared to $325.4 million at December 31, 2001. Brokered
CD's totaled $63.7 million at March 31, 2002 compared to $47.6 million at
December 31, 2001. Time deposits greater than $100,000 and brokered time
deposits were priced within the framework of the Company's rate structure and
did not materially increase the average rates on deposit liabilities. Increased
competition for consumer deposits and customer awareness of interest rates
continues to limit the Company's core deposit growth in these types of deposits.
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.
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. The Company also may increase brokered
time deposits during the remainder of the year 2002 as an additional source of
funds to provide for loan growth.
24
Short Term Borrowings and Other Borrowings
Short-term borrowings at March 31, 2002 consist of federal funds purchased,
securities under agreements to repurchase, and advances from the Federal Home
Loan Bank ("FHLB"). Total short-term borrowings at March 31, 2002 increased
$41.2 million to $44.1 million from $2.8 million at December 31, 2001. Customer
repurchase agreements were approximately the same at March 31, 2002 and December
31, 2001 totaling $2.8 million. FHLB advances increased from $0 at December 31,
2001 to $10 million at March 31, 2002. Federal funds purchased increased from $0
at December 31, 2001 to $31.3 million at March 31, 2002 accounting for the
balance of the decrease in the balance of short-term borrowings. These have
increased as a result of loan growth and a decline in deposits for the first
quarter.
Other borrowings consist of term loans with FHLB. These borrowings totaled $75
million at March 31, 2002 compared to $90 million at December 31, 2001.
Typically, short-term borrowings and other borrowings increase in order to fund
growth in the loan portfolio. Although total borrowings increased 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 $106,000 at March 31, 2002 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.
In connection with the issuance of Trust Preferred Securities in 2001 (see
"Capital Resources"), the Company issued long-term subordinated debentures to
Baylake Capital Trust I, a Delaware Business Trust subsidiary of the Company.
The aggregate principal amount of the debentures due 2031, to the trust
subsidiary is $16,597,940. For additional details, please make reference to the
Consolidated Financial Statements and the accompanying footnotes on the
Company's Form 10-K for the year 2001.
Liquidity
Liquidity management refers to the ability of the Company 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 the Bank have
different liquidity considerations.
25
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.
Dividends received from Bank totaled $900,000 for the first quarter of 2002 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 $1.8 million in the first quarter of
2002.
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 quarter ended March 31, 2002, principal payments totaling $20.8 million were
received on investments. These proceeds in addition in other Company cash were
used to purchase $26.0 million in investments for the quarter. At March 31,
2002, the carrying or book value of investment securities maturing within one
year amounted to $29.4 million or 17.1% of the total investment securities
portfolio. This compares to a 12.3% level for investment securities with one
year or less maturities as of December 31, 2001. Within the investing activities
of the statement of cash flows, sales and maturities of investment securities
during the first quarter of 2002 totaled $20.8 million. At March 31, 2002, the
investment portfolio contained $97.9 million of U.S. Treasury and federal agency
backed securities representing 56.9% of the total investment portfolio. These
securities tend to be highly marketable and had a market value above amortized
at March 31, 2002 amounting to $2.0 million.
Deposit growth is typically another source of liquidity for the Bank. As a
financing activity reflected in the March 31, 2002 Consolidated Statements of
Cash Flows, deposits declined and resulted in $19.0 million of cash outflow
during the first quarter of 2002. The Company's overall deposit base decreased
2.8% for the quarter ended March 31, 2002. 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 $167.0 million, or 26.9%, of loans maturing within one year.
Within the classification of short-term borrowings and other borrowings at March
31, 2002, federal funds purchased and securities sold under agreements to
repurchase totaled $44.1 million compared to $2.8 million at the end of 2001.
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 term, are another source
of funds. They total $85.0 million at March 31, 2002, compared to $90.0 million
at the end of 2001.
26
The Bank's liquidity resources were sufficient in the first quarter of 2002 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 activities, and a
strong capital position. Although federal funds purchased and borrowings from
the FHLB provided funds in 2002, 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 Risk
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 ALCO.
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
27
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 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 March 31, 2002
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 $ 28,528 $ 2,984 $ 4,382 $ 96,760 $ 45,824 $178,478
Loans and leases
Variable rate 286,470 7,251 15,001 21,982 0 330,704
Fixed rate 42,115 24,661 48,545 154,920 3,639 273,880
-------- -------- -------- -------- -------- --------
Total loans and leases $328,585 $ 31,912 $ 63,546 $176,902 $3,639 $273,880
-------- -------- -------- -------- -------- --------
Total earning assets $357,113 $ 34,896 $ 67,928 $273,662 $ 49,463 $783,062
======== ======== ======== ======== ======== ========
Interest bearing liabilities:
NOW Accounts $ 11,013 $ 0 $ 0 $ 33,041 $ 0 $ 44,054
Savings Deposits 168,605 0 0 39,689 0 208,294
Time Deposits 115,015 39,525 74,619 102,368 0 331,527
Borrowed Funds 74,068 10,000 52 35,054 0 119,174
Trust Preferred Stock 0 0 0 0 16,100 16,100
======== ======== ======== ======== ======== ========
Total interest bearing $368,701 $ 49,525 $ 74,671 $210,152 $ 16,100 $719,149
======== ======== ======== ======== ======== ========
Liabilities
Interest sensitivity gap (within $(11,588) $(14,629) $ (6,743) $ 63,510 $ 33,363 $ 63,913
periods)
Cumulative interest sensitivity gap $(11,588) $(26,217) $(32,960) $ 30,550 $ 63,913
28
Ratio of cumulative interest - 1.48% - 3.35% - 4.21% 3.90% 8.16%
Sensitivity gap to rate
Sensitive assets
Ratio of rate sensitive assets 96.86% 70.46% 90.97% 130.22% 307.22%
To rate sensitive
Liabilities
Cumulative ratio of rate 96.86% 93.73% 93.31% 104.35% 108.89%
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 100 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 100 basis point parallel
rate shock. The resulting simulations indicated that net interest income would
increase by approximately 3.9% if rates rose by a 100 basis point shock, and
projected that net interest income would decrease by approximately 8.5% if rates
fell by a 100 basis point shock under these scenarios for the period ended March
31, 2003. This result was within the policy limits established by the Company.
The results of the simulations are based solely on immediate and sustained
parallel changes in market rates and do not reflect the earnings sensitivity
that may arise from such factors as the change in spread between key market
rates and the shape of the yield curve. The above results also are considered to
be conservative estimates due to the fact that no management action is factored
into the analysis to deal with potential income variances. Management
continually reviews its interest 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 March 31, 2002 increased $839,000 or 1.4% to $60.0
million, compared with $59.1 million at end of year 2001. This increase includes
a change of $137,000 to capital in 2002 due to the impact of STATEMENT OF
FINANCIAL ACCOUNTING STANDARDS NO. 115. Disregarding the effect of this change,
shareholders' equity would have increased $1.0 million or 1.7% for the period
between March 31, 2002 and December 31, 2001.
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 24% of Company's
Common Stock participate in the plan.
In 2001, the Company completed a Trust Preferred Security offering in the amount
of $16.1 million to enhance regulatory capital and to add
29
liquidity. 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 the Trust Preferred Securities qualify as Tier 1
Capital. As of March 31, 2002, $16.1 million of the Trust Preferred Securities
qualify as Tier 1 Capital.
Cash dividends paid for the first quarter of 2002 were $0.12 per share compared
with $0.11 in the first quarter of 2001. The Company provided a 9.1% increase in
normal dividends per share in 2002 over 2001 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 quarter of 2002.
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 is confident that because
of current capital levels and projected earnings levels, capital levels are more
than adequate to meet the ongoing and future concerns of the Company.
The Federal Reserve Board has established capital adequacy rules which take into
account risk 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 be
comprised 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 direct material effect on the consolidated
financial statements.
At March 31, 2002 and December 31, 2001, the Company was categorized 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 Company's category.
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%.
30
The following table presents the Company's and the Bank's capital ratios as of
March 31, 2002 and December 31, 2001:
(dollars in thousands)
To Be Well
Capitalized
Under Prompt
For Capital Corrective
Actual Adequacy Action
------ Purposes Provisions
-------- ----------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
As of March 31, 2002
Total Capital (to
Risk Weighted Assets)
Company 77,356 11.25% 55,013 8.00% 68,766 10.00%
Bank 73,602 10.73% 54,887 8.00% 68,609 10.00%
Tier 1 Capital(to
Risk Weighted Assets)
Company 69,031 10.04% 27,507 4.00% 41,260 6.00%
Bank 65,277 9.51% 27,444 4.00% 41,165 6.00%
Tier 1 Capital (to
Average Assets)
Company 69,031 8.21% 33,640 4.00% N/A N/A
Bank 65,277 7.76% 33,640 4.00% 42,051 5.00%
As of December 31, 2001
Total Capital (to
Risk Weighted Assets)
Company 76,044 11.34% 53,663 8.00% 67,144 10.00%
Bank 72,022 10.73% 53,715 8.00% 67,144 10.00%
Tier 1 Capital(to
Risk Weighted Assets)
Company 68,052 10.15% 26,831 4.00% 40,286 6.00%
Bank 64,030 9.54% 26,858 4.00% 40,286 6.00%
Tier 1 Capital (to
Average Assets)
Company 68,052 8.24% 33,032 4.00% N/A N/A
Bank 64,030 7.75% 33,032 4.00% 41,290 5.00%
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. The Company's capital level is
strong, but also must be maintained at an appropriate level to provide the
opportunity for an adequate return on the capital employed. Management actively
reviews capital strategies for the Company to ensure that capital levels are
appropriate based on the perceived business risks, further growth opportunities,
industry standards, and regulatory requirements.
Item 3 Quantitative and Qualitative Disclosure about Market Risk.
31
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 March 31, 2002, 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, 2001, as described in the
Company's 2001 Form 10-K Annual Report.
Part II - Other Information
Item 1. Legal Proceedings
Baylake and its subsidiaries may be involved from time to time in various
routine legal proceedings incidental to its business. Neither Baylake nor any of
its subsidiaries is currently engaged in any legal proceedings that are expected
to have a material adverse effect on the results of operations or financial
position of Baylake.
Item 2. Changes in Securities and Use of Proceeds
None
Item 3. Defaults Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
32
(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
33
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: May 13, 2002 /s/ Thomas L. Herlache
---------------------- --------------------------------------
Thomas L. Herlache
President (CEO)
Date: May 13, 2002 /s/ Steven D. Jennerjohn
---------------------- --------------------------------------
Steven D. Jennerjohn
Treasurer (CFO)
34