1
FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1998
--------------------------
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (D) 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 (I.R.S. Employer
incorporation or organization) Identification No.)
217 North Fourth Ave., 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:
Indicate the number of shares outstanding of each of issuer's classes of common
stock as of November 12, 1998.
$5.00 Par Value Common
3,671,387 shares
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BAYLAKE CORP. AND SUBSIDIARIES
INDEX
PART I - FINANCIAL INFORMATION PAGE NUMBER
Item 1.
Consolidated Condensed Balance Sheet 3
as of September 30, 1998 and December 31, 1997
Consolidated Condensed Statement of Income 4
Three and nine months ended September 30, 1998
and 1997
Consolidated Statement of Comprehensive Income 5
Three and nine months ended September 30, 1998
and 1997
Consolidated Statement of Cash Flows 6 - 7
Nine months ended September 30, 1998 and 1997
Notes to Consolidated Condensed Financial Statements 8 - 9
Item 2.
Managements Discussion and Analysis of Financial 10 - 22
Condition and Results of Operations
Part II. Other Information 23
Signatures 24
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PART 1 - FINANCIAL INFORMATION
BAYLAKE CORP. AND SUBSIDIARIES
CONSOLIDATED CONDENSED BALANCE SHEET (UNAUDITED)
(In thousands of dollars)
SEPTEMBER 30 DECEMBER 31
ASSETS 1998 1997
------ ------------ -----------
Cash and due from banks $ 11,773 $ 15,065
Investment securities available for
sale (at market) 110,947 102,962
Investment securities held to maturity (market value
$12,567 on 9/30/98; $12,382 on 12/31/97) 12,498 11,937
Federal funds sold 5,218
Loans 319,356 293,438
Less: Allowance for loan losses (4,286) (3,881)
-------- --------
Loans, net of allowance for loan losses 315,070 289,557
Bank premises and equipment 14,430 13,493
Federal Home Loan Bank 2,300 4,633
Accrued interest receivable 3,591 3,267
Income tax receivable 371 191
Deferred income taxes 1,021 567
Other assets 7,930 8,390
-------- --------
TOTAL ASSETS $485,149 $450,062
======== ========
LIABILITIES
Domestic Deposits
Non-interest bearing deposits $ 50,138 $ 44,216
Interest bearing deposits
Now 38,820 40,721
Savings 116,538 96,382
Time, $100,000 and over 43,083 32,333
Other time 130,100 132,324
Interest bearing deposits $328,541 $301,760
-------- --------
Total deposits $378,679 $345,976
Short term borrowings 54,994 56,649
Long term debt 329 383
Accrued income taxes
Accrued expenses and other liabilities 5,212 4,588
Dividends payable 611
TOTAL LIABILITIES $439,214 $408,207
-------- --------
STOCKHOLDERS EQUITY
Common Stock $5.00 par value - authorized
10,000,000 shares; issued 3,684,746 shares
on 9/30/98 and 2,460,481 on 12/31/97;
outstanding 3,661,587 shares on 9/30/98
and 2,444,537 shares on 12/31/97 $ 18,424 $ 12,302
Additional paid-in capital 6,071 6,038
Reserve for market adjustment of
securities 3,151 1,311
Retained earnings 18,914 22,618
Treasury Stock (625) (414)
-------- --------
TOTAL STOCKHOLDERS EQUITY 45,935 41,855
-------- --------
TOTAL LIABILITIES AND STOCKHOLDERS EQUITY $485,149 $450,062
======== ========
See accompanying notes to unaudited consolidated financial statements
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BAYLAKE CORP. AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF INCOME (UNAUDITED)
(IN THOUSANDS OF DOLLARS EXCEPT AMOUNTS PER SHARE)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPT 30 SEPT 30
1998 1997 1998 1997
-------- -------- -------- --------
Interest Income
Interest and fees on loans $ 7,230 $ 6,503 $ 20,990 $ 18,920
Interest on investment securities
Taxable 1,264 994 3,781 3,091
Exempt from federal income tax 579 469 1,756 1,249
Other interest income 26 1 26 1
-------- -------- -------- --------
Total Interest Income 9,099 7,967 26,553 23,261
Interest Expense
Interest on deposits 3,739 3,418 10,714 9,513
Interest on short-term borrowings 764 205 2,569 1,033
Interest on long-term debt 7 8 21 24
-------- -------- -------- --------
Total Interest Expense 4,510 3,631 13,304 10,570
-------- -------- -------- --------
Net Interest Income 4,589 4,336 13,249 12,691
Provision for loan losses 150 154 451 457
-------- -------- -------- --------
Net interest income after
provision for loan losses 4,439 4,182 12,798 12,234
-------- -------- -------- --------
Other Income
Fees for fiduciary activities 102 139 336 337
Fees from loan servicing 240 166 569 478
Fees for other services to customers 475 372 1,307 1,117
Gains from sales of loans 287 123 686 439
Securities gains (losses) 0 47
Other income 34 78 123 223
-------- -------- -------- --------
Total Other Income 1,138 878 3,021 2,641
-------- --------- -------- --------
Other Expenses
Salaries and employee benefits 2,034 1,790 5,830 5,430
Occupancy expense 247 261 768 784
Equipment expense 246 243 732 754
Data processing and courier 185 155 519 471
Operation of other real estate 4 29
Other operating expense 710 715 2,052 2,114
-------- -------- -------- --------
Total Other Expenses 3,422 3,168 9,901 9,582
-------- -------- -------- --------
Income before income taxes 2,155 1,892 5,918 5,293
Income tax expense (benefit) 624 543 1,665 1,542
-------- -------- -------- --------
Net Income $ 1,531 $ 1,349 $ 4,253 $ 3,751
======== ======== ======== ========
Net Income per share (1) $ 0.42 $ 0.37 $ 1.16 $ 1.02
Cash dividends per share $ 0.17 $ 0.16 $ 0.51 $ 0.48
(1) Based on 3,659,313 shares average outstanding in 1998 and 3,683,037 in 1997.
See accompanying notes to unaudited consolidated financial statements.
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BAYLAKE CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
(IN THOUSANDS OF DOLLARS)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPT 30 SEPT 30
1998 1997 1998 1997
------ ------ ------ -----
Net Income
Other comprehensive income,
net of tax: $1,531 $1,349 $4,253 $3,751
------ ------ ------ ------
Unrealized gains on securities:
Unrealized holding gains
arising during period 1,856 33 1,840 362
------ ------ ------ ------
Comprehensive Income $3,387 $1,382 $6,093 $4,113
------ ------ ------ ------
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BAYLAKE CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASHFLOWS (UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30
------------------------------
1998 1997
---------- ----------
(thousands of dollars)
Cash flows from operating activities:
Interest received from:
Loans $ 20,690 $ 18,699
Investments 5,373 4,055
Fees and service charges 2,849 2,574
Interest paid to depositors (10,421) 9,055)
Interest paid to others (2,567) 1,061)
Cash paid to suppliers and employees (8,150) (8,074)
Income taxes paid (1,845) (1,514)
---------- ----------
Net cash provided by operating activities 5,929 5,624
Cash flows from investing activities
Proceeds from sales of investment securities 0 3,817
Principal payments received on investments 20,512 19,409
Purchase of investments (30,473) (31,687)
Proceeds from sale of other real estate owned 0 93
Loans made to customers in excess of principal collected (25,946) (23,449)
Capital expenditures (1,682) (1,226)
---------- ----------
Net cash used in investing activities (37,589) (33,043)
Cash flows from financing activities:
Net increase (decrease) in demand deposits, NOW accounts 24,122 (4,866)
and savings accounts
Net increase (decrease) in advances from borrowers (1,709) (4,281)
Net increase (decrease) in time deposits 8,579 35,897
Proceeds from issuance of common stock 52 0
Stock reacquired (210) (365)
Dividends paid (2,466) (2,359)
---------- ----------
Net cash provided by financing activities 28,368 24,026
---------- ----------
Net decrease in cash and cash equivalent (3,292) (3,393)
Cash and cash equivalents, beginning 15,065 13,853
---------- ----------
Cash and cash equivalents, ending $ 11,773 $ 10,460
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1998 1997
---------- ----------
(thousands of dollars)
Reconciliation of net income to net cash provided by
operating activities:
Net Income $ 4,253 $ 3,751
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization 1,037 1,029
Provision for loan losses and real estate owned 451 457
Amortization of premium on investments 128 152
Accretion of discount on investments (212) (216)
Cash surrender value increase (41) (41)
(Gain) loss from disposal of other real estate 0 17
(Gain) loss on sale of investment securities 0 (47)
(Gain) loss on sale of loans and other assets (686) (417)
Proceeds from sale of loans held for sale 10,601 5,831
Originations of loans held for sale (9,914) (5,414)
(Gain) loss from disposal of fixed assets 21
Equity in income of service center (27) (48)
Deferred compensation 36 132
Deferred Taxes
Changes in assets and liabilities:
Interest receivable (323) (410)
Prepaids and other assets 236 (88)
Unearned income (18) 17
Interest payable 316 453
Taxes payable (179) 22
Deferred taxes 0 6
Other liabilities 271 417
---------- ----------
Total adjustments 1,676 1,873
--------- ----------
Net cash provided by operating activities $ 5,929 $ 5,624
========== ==========
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BAYLAKE CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1998
1. The accompanying unaudited consolidated financial statements
should be read in conjunction with Baylake Corp.'s ("Company")
1997 annual report on Form 10-K. 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, 1998 and December 31, 1997. The results of
operations for the three and nine months ended September 30, 1998
and 1997 are not necessarily indicative of results to be expected
for the entire year.
2. The book value of investment securities, by type, held by the
Company are as follows:
SEPTEMBER 30 DECEMBER 31
1998 1997
------------ -----------
(thousands of dollars)
Investment securities held to maturity:
Obligations of states and political
subdivisions $ 12,498 $ 11,937
Other
-------- --------
Investment securities held to maturity $ 12,498 $ 11,937
Investment securities available for sale:
U.S. Treasury and other U.S. government
agencies $ 27,762 $ 31,453
Obligations of states and political 33,189 33,214
subdivisions
Mortgage-backed securities 47,718 34,337
Other 2,278 3,958
-------- --------
Investment securities available for sale $110,947 $102,962
======== ========
3. At September 30, 1998 and December 31, 1997, loans were as
follows:
SEPTEMBER 30 DECEMBER 31
1998 1997
------------ -----------
(thousands of dollars)
Commercial, industrial and agricultural $185,382 $165,181
Real estate - construction 15,407 14,760
Real estate - mortgage 106,245 100,555
Installment 12,842 13,480
Less: Deferred loan origination fees,
net of costs (520) (538)
319,356 293,438
Less allowance for loan losses (4,286) (3,881)
-------- --------
Net loans $315,070 $289,557
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4. As of December 31, 1993, the Company adopted STATEMENTS OF
FINANCIAL ACCOUNTING STANDARDS No. 115 (SFAS 115) "ACCOUNTING FOR
CERTAIN INVESTMENTS IN DEBT AND EQUITY SECURITIES." Accordingly,
investment securities available for sale at September 30, 1998
and December 31, 1997 are carried at market value. Adjustments up
or down to market value are recorded as a separate component of
equity, net of tax. Premium amortization and discount accretion
are recognized as adjustments to interest income. Realized gains
or losses on disposition are based on the net proceeds and the
adjusted carrying amount of the securities sold, using the
specific identification method.
5. As of January 1, 1996, the Company adopted SFAS No. 122,
"Accounting for Mortgage Servicing Rights" which amends SFAS No.
65, "Accounting for Certain Mortgage Banking Activities." This
statement required that the rights to service mortgage loans for
others be recognized as separate assets regardless of how those
rights were acquired. The impact on the company's financial
position and the results of operation were not material for the
three and nine months ended September 30, 1998 and 1997.
6. As of January 1, 1998, the Company adopted SFAS No. 130,
"Reporting Comprehensive Income." This statement established
standards for reporting and the display of comprehensive income
in a full set of general-purpose financial statements.
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITIONS AND RESULTS OF OPERATIONS
GENERAL
The following sets forth management's discussion and analysis of the
consolidated financial condition of Baylake Corp. ("Company") at September 30,
1998, and the results of operations for the three and nine months ended
September 30, 1998 and September 30, 1997. This discussion and analysis should
be read in conjunction with the Company's unaudited consolidated financial
statements and the notes thereto included herein.
This discussion and analysis of financial condition and results of operations,
and other sections of this report, contain forward- looking statements that are
based on the current expectations of management. Words such as "anticipates,"
"believes," "estimates," "expects," "forecasts," "intends," "is likely,"
"plans," "projects," and other such words are intended to identify such
forward-looking statements. The statements contained herein and such future
statements involve or may involve certain assumptions, risks and uncertainties,
many of which are beyond the control of the Company, that could materially
differ from what may be expressed or forecasted in such 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 Company: changes in interest
rates and interest rate relationships; demand for products and services; the
degree of competition by traditional and non-traditional competitors; changes in
banking regulations; changes in tax laws; 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
national economy.
SUBSEQUENT EVENTS
On October 1, 1998, the Company consummated its previously announced acquisition
of all of the outstanding shares of common stock of Evergreen Bank, National
Association ("Evergreen"). Evergreen has four full service offices in east
central Wisconsin, and has been renamed "Baylake Bank, N.A." At September 30,
1998, Evergreen had estimated assets of between $95 and $100 million, although
the precise amount of assets is subject to the discussion below.
Baylake acquired the Evergreen shares pursuant to a Stock Purchase Agreement
dated as of September 30, 1998 among Baylake, M&I Marshall & Ilsley Bank ("M&I
Bank") and Evergreen (the "Agreement"). The Agreement provides that Baylake
acquired the Evergreen shares from M&I Bank, the creditor of Evergreen's former
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holding company for cash payable on May 5, 1999, in a formula amount set forth
in the Agreement. In summary, the formula provides for a payment of the lessor
of (a) $2.0 million or (b) the amount of retained earnings generated by
Evergreen (as defined) from the closing date until April 30, 1999. In addition,
upon the closing of the transaction, Baylake made a cash contribution of $7
million to Evergreen to provide it with additional capital. The 316 outstanding
shares of Evergreen Preferred Stock, $10,000 par (and face) value, remain issued
and outstanding.
Prior to its acquisition by Baylake, Evergreen was the victim of substantial
fraud by former Evergreen insiders. Evergreen's regulators had discovered
extensive financial irregularities at Evergreen which resulted from unauthorized
and/or improper transactions effected by former members of Evergreen management.
Evergreen has been in the process of investigating and correcting these
situations, which process has continued after the transaction. Evergreen and
Baylake therefore may discover additional "assets" on Evergreen's books which
are not valid assets or are otherwise impaired as a result of the fraud. The
ongoing status of these reviews forms part of the reason for the formula- based
purchase price described above, which will cause the purchase price to vary
according to the ultimate determination of Evergreen's financial condition prior
to closing.
Because of the situation and circumstances, Baylake anticipates that ongoing
operations of Evergreen may differ significantly from its past operations
because these former operations were substantially affected by the unauthorized
and improper transactions by former members of Evergreen management. As a result
of these unauthorized activities, Evergreen was designated a "troubled
institution" by the Office of the Comptroller of the Currency ("OCC") and was
also determined to be "critically undercapitalized" and thus required to address
its capital needs promptly. Baylake expects that the "troubled institution"
designation to be removed by the OCC upon its demonstration of resolution of
related issues, and believes that with the capital infusion by Baylake discussed
above, it has addressed, on a current basis, Evergreen's regulators' request for
infusion of additional capital.
The acquisition transaction was negotiated at arm's length between Baylake and
the representatives of M&I and Evergreen (none of whom were affiliated at that
time with Baylake, its affiliates, its directors and officers and their
associates. The transaction is being accounted for by Baylake using the purchase
method of accounting.
RESULTS OF OPERATIONS
For the three months ended September 30, 1998, net income increased $182,000, or
13.5%, to $1.53 million from $1.35 million for the third quarter of 1997. The
annualized return on average assets and return on average equity for the three
months ended September 30,
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1998, were 1.28% and 13.63% respectively compared to 1.31% and 13.33%,
respectively, for the same period a year ago.
For the nine months ended September 30, 1998, net income was $4.25 million, an
increase of 13.4% from the $3.75 million earned during the first nine months of
1997. The annualized return on average assets and return on average equity, were
1.23% and 12.95%, respectively, compared to 1.26% and 12.71%, respectively for
the same period a year ago.
The change in net income for the period is primarily due to improved net
interest income and an increase in other income offset by increased other
expenses.
NET INTEREST INCOME
Net interest income for the three months ended September 30, 1998 increased
$253,000, or 5.8%, to $4.59 million from $4.34 million for the same period a
year ago. Total interest income for the third quarter of 1998 increased $1.13
million, or 14.2%, to $9.1 million from $7.97 million for the third quarter of
1997, while interest expense increased $879,000, or 24.2%, to $4.51 million from
$3.63 million in the third quarter of 1997. These changes were primarily the
result of a favorable increase in the average volume of earning assets offset by
increased competition related to loan pricing, particularly in the commercial
sector, and deposit pricing, primarily in time deposits.
For the three months ended September 30, 1998, average earning assets increased
$67.1 million, or 18.1%, when compared to the same period last year. The Company
registered an increase in average loans of $32.1 million, or 11.7% for the third
quarter of 1998 compared to the same period a year ago. Loans have typically
resulted in higher rates of interest payable to the Company than have investment
securities.
Net interest margin (on a federal tax-equivalent basis) for the three months
ended June 30, 1998 decreased from 4.83% to 4.42% compared to a year ago. The
average yield on interest earning assets amounted to 8.49% for the third quarter
of 1998, representing a decrease of 17 basis points from the same period last
year. Total loan yields declined 9 basis points to 9.07%, while total investment
yields decreased 22 basis points to 6.91% as compared to the same period a year
ago. The Company's average cost on interest-bearing deposit liabilities
increased 13 basis points to 4.59% for the third quarter of 1998, while
short-term borrowing costs decreased 20 basis points to 5.54% comparing the two
periods. The above factors contributed to a decrease in the Company's overall
interest margin for the three months ended September 30, 1998.
For the nine months ended September 30, 1998 average earning assets increased by
$60.1 million, or 17.2%, when compared to the same
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period last year. Loans have continued to grow as the Company registered an
increase in average loans of $33.1 million, or 12.1%, for the first nine months
of 1998 compared to the same period in 1997.
Net interest margin (on a federal tax-equivalent basis) for the first nine
months of 1998 declined to 4.48% from 4.86% for the same period last year. The
average yield on interest-earning assets amounted to 8.61% for the first nine
months of 1998, representing a decrease of 16 basis points over the same period
last year. Total loan yields increased 8 basis points to 9.31% while yields on
investment securities decline 5 basis points to 7.08%. The Company's average
cost on interest-bearing deposit liabilities increased 25 basis points to 4.61%
for the first nine months of 1998, while short-term borrowing costs decreased 2
basis point to 5.68% comparing the two periods. The above factors contributed to
a decrease in the Company's overall interest margin for the nine months ended
September 30, 1998.
Another factor affecting interest margin has been the Company's effort intended
to increase interest-earning assets and thus reduce the percentage of equity to
total assets (known as leveraging) by acquiring additional funding, primarily
from the Federal Home Loan Bank (FHLB) of Chicago.
PROVISION FOR LOAN LOSSES
The provision for loan losses for the three months ended September 30, 1998
decreased $4,000, or 2.6%, to $150,000 from $154,000 for the third quarter a
year ago. For the nine months ended September 30, 1998, the provision for loan
losses decreased $6,000, or 1.3%, to $451,000 from $457,000 for the same period
last year. Management believes that the current allowance is adequate in view of
the present condition of the Company's loan portfolio.
NON-INTEREST INCOME
Total non-interest income increased $260,000, or 29.6%, to $1.14 million for the
third quarter of 1998, from $878,000 for the same period a year ago. This
increase has occurred as a result of increased gains on sales of loans,increased
loan servicing fees, fees on other customer services offset by decreased trust
income, decreased other income and a decline in securities gains taken.
For the first nine months of 1998, non-interest income has improved $380,000, or
14.4%, to $3.02 million from $2.64 million for the same period a year ago.
Trust revenues remained stable as a result of increased trust offset by reduced
estate business. Loan servicing fees showed improvement as an increase in
portfolio size has provided approximately $91,000 in increased servicing fee
income for the first nine months of 1998 as compared to the same period in 1997.
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Gain on the sale of loans increased in the third quarter of 1998 as compared to
the third quarter of 1997 as a result of increased loan sales. For the first
nine months gain on sales of loans has increased $247,000, or 56.3%. Company
sold the Small Business Administration ("SBA") guaranteed portion of commercial
loans totaling $6.7 million and $3.9 million of mortgage loans in the nine
months ended September 30, 1998, as compared to $3.8 million of commercial loans
and $2.0 million in mortgage loans for the same period in 1997. The increase in
fees for other services to customers primarily resulted from increased service
charges on deposit products.
NON-INTEREST EXPENSE
Non-interest expense increased $254,000, or 8.0%, for the three months ended
September 30, 1998 compared to the same period in 1997. Salaries and employee
benefits showed an increase of $244,000 or 13.6% for the period as a result of
salary increases and related benefit expense increases. Total occupancy and
equipment expenses remain stable in spite of expansion efforts in the Green Bay
market. Data processing expense increased $30,000 in the third quarter of 1998
primarily as a result of additional transaction volume. Other operating expense
shows a decrease of $5,000 in the third quarter of 1998 as related to the same
period in 1997. The overhead ratio, which is computed by subtracting
non-interest income from non-interest expense and dividing by average total
assets, was 1.91% for the three months ended September 30, 1998 compared to
2.22% for the same period in 1997.
Non-interest expense increased $319,000, or 3.3%, for the first nine months
ended September 30, 1998, compared to the same period in 1997. Salaries and
employee benefits showed an increase of $400,000, or 7.6%, primarily for the
same reasons as listed previous. Occupancy and equipment expenses shows a
decrease of $38,000, or 2.5%, as a result of reduced depreciation expense. Data
processing expense increased $48,000, or 10.2%, for the nine months ended
September 30 as compared to the same period a year ago, primarily the result of
additional transaction volume. Other operating expense shows a decrease of
$62,000, or 2.9%, primarily a result of a reduction of $37,000 in expenses
related to the Karsten Resources, Inc. operation. The overhead ratio was 1.99%
for the nine months ended September 30, 1998 compared to 2.33% for the same
period in 1997.
PROVISION FOR INCOME TAXES
The Company's provision for income taxes for the three months ended September
30, 1998 increased $81,000, or 14.9%, to $624,000 from $543,000 for the same
period one year ago. The increase in income tax provision was due to increased
taxable income.
The provision for income taxes for the first nine months ended September 30,
1998 increased $123,000, or 8.0%, to $1.67 million from $1.54 million for the
same period one year ago. The increase
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in income tax provision was due to increased taxable income.
BALANCE SHEET ANALYSIS
LOAN PORTFOLIO
At September 30, 1998, total loans increased $26.0 million, or 8.8%, to $319.4
million from $293.4 million at December 31, 1997. The change in loan mix in the
Company's portfolio resulted from an increase in commercial loans to $185.4
million at September 30, 1998 compared to $165.2 million at December 31, 1997.
In addition, real estate construction loans increased to $15.4 million at
September 30, 1998 compared to $14.8 million at December 31, 1997 and real
estate-mortgage loans increased to $106.2 million at September 30, 1998 compared
to $100.6 million at December 31, 1997.
NON-PERFORMING ASSETS
At September 30, 1998, non-performing assets amounted to $5.8 million compared
to $4.7 million at December 31, 1997. Nonperforming assets at September 30, 1998
were 1.19% of total assets compared to 1.04% that existed on December 31, 1997.
The ratio of non-performing assets to total loans at September 30, 1998 was
1.81% compared to 1.60% at December 31, 1997.
ALLOWANCE FOR POSSIBLE LOAN LOSSES
At September 30, 1998, the allowance for loan losses increased $405,000 from
year end 1997 to $4.3 million due to a provision expense of $451,000 offset by
net charge offs over recoveries of $46,000 year to date. Although loans have
continued to grow at an above average rate, the allowance for loan losses as a
percent of total loans has improved slightly. The allowance is at a level
currently believed to be acceptable by management. At September 30, 1998 and
December 31, 1997, the allowance for loan losses as a percentage of total loans
were at 1.34% and 1.32%, respectively.
INVESTMENT PORTFOLIO
At September 30, 1998, the investment portfolio increased $8.5 million, or 7.4%,
to $123.4 million from $114.9 million at December 31, 1997. At September 30,
1998, the investment portfolio represented 25.4% of total assets compared with
25.5% at December 31, 1997. The increase in total investments occurred as a
result of net growth in other funding sources such as Federal Home Loan Bank
borrowings as compared to growth in the loan portfolio.
DEPOSITS
Total deposits at September 30, 1998 increased $32.7 million, or 9.5%, to $378.7
million from $346.0 million at December 31, 1997. Non-interest bearing deposits
at September 30, 1998 increased $5.9 million, or 13.4%, to $50.1 million from
$44.2 million at December
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31, 1997. Interest-bearing deposits at September 30, 1998 increased $26.8
million, or 8.9%, to $328.5 million from $301.8 million at December 31, 1997.
Time deposits over $100,000 show an increase of $10.7 million resulting
primarily from attracting various municipal deposits. Overall deposits for the
first six months tend to slightly decline as a result of the seasonality of the
customer base as they drawdown deposits during the early first half of the year
in anticipation of the summer tourist season.
SHORT-TERM BORROWINGS
Total short-term borrowings at September 30, 1998 decreased $1.6 million to
$55.0 million from $56.6 million at December 31, 1997. The decrease in
short-term borrowings resulted from more growth in the overall deposits compared
to growth in the investment and loan portfolios.
LIQUIDITY
As shown in the Company's Consolidated Statements of Cashflows for the nine
months ended September 30, 1998, cash and cash equivalents decreased $3.3
million during the period to $11.8 million at September 30, 1998. The increase
primarily reflected $5.9 million in net cash provided by operating activities
and $28.4 million provided by financing activities offset by $37.6 million used
in investing activities. Net cash provided by operating activities consisted of
the Company's net income for the periods increased by adjustments for non-cash
expenditures. Net cash used in investing activities consisted of a net increase
in loans and investment securities plus necessary capital expenditures. Net cash
provided by financing activities resulted primarily from a net decrease as a
result of treasury stock purchased, dividends paid and a reduction in borrowed
funds offset by a net increase in short term deposits and time deposits. An
increase in loan demand offset by increased deposits for the first nine months
of 1998 has resulted in a reduction in short term funding requirements through
overnight correspondent fed funds purchases and Federal Home Loan Bank
borrowings. A component of the Company's strategy to enter additional markets
will continue to concentrate on core deposit growth and utilize other funding
sources such as the Federal Home Loan Bank so as to reduce reliance on
short-term funding needs.
The Company manages its liquidity to provide adequate funds to support the
borrowing requirements and deposit flow of its customers. Management views its
liquidity as the ability to raise cash at reasonable costs or with a minimum of
loss and as a measure of balance sheet flexibility to react to marketplace,
regulatory and competitive changes. The primary sources of the Company's
liquidity are marketable assets maturing within one year. The Company attempts,
when possible, to match relative maturities of assets and liabilities, while
maintaining the desired net interest margin. Although the percentage of earning
assets represented by loans is increasing, management believes that liquidity is
adequate to support anticipated borrowing requirements and deposit flows.
17
INTEREST RATE SENSITIVITY
The following table entitled "Asset and Liability Maturity Repricing Schedule"
indicates that the Company is slightly liability gap sensitive, although
management believes that a range of plus or minus 15% (from 100% matching)
within a one year pricing schedule is acceptable. The analysis considers money
market index accounts and 40% of NOW accounts to be rate sensitive within three
months. Regular savings, money market deposit accounts and 60% 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.
Interest rate sensitivity analysis can be performed in several different ways.
The traditional method of measuring interest sensitivity is called "gap"
analysis. This 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 gap
position exists. In general, liability sensitive gap positions in a declining
interest rate environment increases 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 in
that a liability sensitive 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. For the time
frame within three months as of September 30, 1998, rate sensitive liabilities
exceeded rate sensitive assets by $34.7 million, or a ratio of rate sensitive
assets to rate sensitive liabilities of 80.8%. For the next time frame of four
to six months, rate sensitive liabilities exceeded rate sensitive assets by
$16.1 million, or a ratio of rate sensitive assets to rate sensitive liabilities
of 61.8%. For all assets and liabilities priced within a one year time frame,
the cumulative ratio of rate sensitive assets to rate sensitive liabilities was
73.0%, which is outside the range of plus or minus 15% deemed acceptable by
management. When the Company requires funds beyond its ability to generate them
internally, it can borrow from a number of sources, including the Federal Home
Loan Bank of Chicago and other correspondent banks.
Management continually review its interest risk position through
its committee processes. Managements' philosophy is to maintain a
18
relatively matched rate sensitive asset and liability position, within the range
described above, in order to provide earnings stability in the event of
significant interest rate changes.
19
ASSET AND LIABILITY MATURITY REPRICING SCHEDULE
AS OF SEPTEMBER 30, 1998
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 $ 7,420 $ 1,952 $ 2,968 $ 52,496 $ 60,909 $ 125,745
Federal funds sold 5,218 5,218
Loans and Leases:
Variable Rate 107,421 1,444 36,430 8 145,303
Fixed Rate 25,452 22,687 26,383 93,681 3,450 171,653
--------- ---------- ---------- ---------- ---------- ----------
Total Loans and Leases $ 132,873 $ 24,131 $ 26,383 $ 130,111 $ 3,458 $ 316,956
--------- ---------- ---------- ---------- ---------- ----------
Total Earning Assets $ 145,511 $ 26,083 $ 29,351 $ 182,607 $ 64,367 $ 447,919
========= ========== ========== ========== ========== ==========
Interest Bearing Liabilities:
NOW Accounts $ 20,138 $ $ $ 30,000 $ $ 50,138
Saving Deposits 65,431 51,107 116,538
Time Deposits 55,556 32,224 46,783 38,607 13 173,183
Borrowed Funds 39,047 10,000 6,000 276 0 55,323
--------- ---------- ---------- ---------- ---------- ----------
Total Interest Bearing Liabilities $ 180,172 $ 42,224 $ 52,783 $ 119,990 $ 13 $ 395,182
========= ========== ========== ========== ========== ==========
Interest Sensitivity GAP $ (34,661) $ (16,141) $ (23,432) $ 62,617 $ 64,354 $ 52,737
(within periods)
Cumulative Interest Sensitivity (34,661) (50,802) (74,234) (11,617) $ 52,737
GAP
Ratio of Cumulative Interest -7.74% -11.34% -16.57% -2.59% 11.77%
Sensitivity GAP to Rate
Sensitive Assets
Ratio of Rate Sensitive Assets to 80.76% 61.77% 55.61% 152.19% ---
Rate Sensitive Liabilities
Cumulative Ratio of Rate Sensitive 80.76% 77.16% 73.02% 97.06% 113.34%
Assets to Rate Sensitive
Liabilities
20
CAPITAL RESOURCES
At September 30, 1998, stockholders' equity increased $4.0 million, or 3.1%, to
$45.9 million from $41.9 million at December 31, 1997. The increase resulted
from net income and an increase in the market value of available for sale
securities related to FAS 115 of $1.8 million less dividends paid. In addition
treasury stock purchases of $211,000 were made in the nine months ended
September 30, 1998, also reducing capital. At September 30, 1998, the Company's
risk- based Tier 1 Capital Ratio was 10.88%, the total risk-based capital ratio
was 12.02% and the leverage ratio was 8.21%. The Company and Baylake Bank
continue to exceed all applicable regulatory capital requirements.
Year 2000
The Year 2000 issue relates to systems designed to use two digits rather than
four to define the particular year. The Company's computer equipment, software
and devices with imbedded technology that are time-sensitive may recognize date
using "00" as the year 1900 rather than the Year 2000. This could result in a
system failure or miscalculations causing disruptions of operations, including,
among other things, a temporary inability to process transactions such as the
accrual of interest, send billings, or engage in similar normal business
activities.
The Company has undertaken various initiatives intended to ensure that its
computer equipment and software will function properly with respect to dates in
the Year 2000 and thereafter. For analysis purposes, the term "computer
equipment and software" include systems that are commonly thought of as
informational technology ("IT") systems, including accounting, data processing,
teller and proof machines and other miscellaneous systems, as well as systems
that are not commonly thought of as IT systems, such as security systems, fax
machines, heating, venting, air conditioning or other miscellaneous systems.
Both IT and non-IT systems may contain imbedded technology, which complicates
the Company's Year 2000 identification, assessment, remediation, and testing
efforts. As a result of the identification and assessment efforts to date, the
Company believes that certain of the data processing equipment and software it
currently employs will require replacement or modification. Currently the
Company attempts to obtain replacement equipment that are Year 2000 ready. With
the use of internal and external resources to identify and assess needed Year
2000 remediation, the Company presently anticipates that its Year 2000
identification, assessment, remediation and testing efforts, which began in
October 1997, will be completed by July 1998, and those efforts will be
completed prior to any currently anticipated impact on computer hardware and
software. As of November 1, 1998, the Company estimates that approximately 70%
of the initiatives that it believes will be required to fully address Year 2000
issues related to its computer hardware and software. The projects that comprise
the remaining 30% of the initiatives are in process and are
21
expected to be completed on or about July 1998.
Year 2000 Initiative Time Frame % Complete
- ------------------- ---------- ----------
Initial IT system
identification and assessment 6/30/98 100
Remediation and testing
regarding central processing
system issues 12/31/98 85
Remediation and testing regarding
division system issues 12/31/98 50
Remediation and testing regarding
branch delivery systems 6/30/99 50
Upgrades to telephone/communication
and other systems 6/30/99 65
Identification, assessment,
remediation and testing
regarding desktop and individual
system issues 6/30/98 100
Identification and assessment
regarding non-IT system issues 1/31/99 75
Remediation and testing regarding
non-IT system issues 6/30/99 25
The Company has also mailed letters to significant loan customers to determine
the extent to which such entities are vulnerable to Year 2000 issues. There has
been an 85% response from a list of targeted credits identified as of June 15,
1998. An estimated 80% of that list has been reviewed to determine customer
awareness and readiness with regards to Year 2000 issues. Followup to those
customers deemed to be non-compliant is scheduled for the first quarter of 1999.
In addition, unresolved responses will be evaluated prior to June 1999. Those
credits deemed to be non- compliant will be factored into a loan loss
calculation model to provide additional reserves as needed to account for any
additional risk assumed to exist as a result of non-compliance.
The Company has also had written and verbal response from its significant
vendors and service providers.
The Company estimates that the cost of Year 2000 identification, assessment,
remediation and testing efforts, as well as currently anticipated costs to be
incurred by the Company will not exceed $200,000. Such amount represents
approximately 10% of the Company's total actual and anticipated IT expenditures
for 1998 through 1999. As of November 1, 1998, the Company had incurred costs of
approximately $75,000 related to Year 2000 issues. These
22
amounts relate to analysis, repair, or replacement of existing software or
hardware, upgrades of existing software, or evaluation of information received
from significant customers, vendors or other service providers. Other non-Year
2000 IT efforts have not been materially delayed or impacted Year 2000
initiatives. Currently the Company believes that the Year 2000 issue will not
pose significant operational problems for the Company. However, if all Year 2000
issues are not properly identified, or assessment, remediation and testing are
not effected timely with respect to Year 2000 problems that are not identified,
there can be no assurance that the Year 2000 issue will not materially adversely
impact the Customer's results of operations or adversely affect the Company's
relationships with customers, vendors, service providers or others.
Additionally, there can be no assurance that the Year 2000 issues of other
entities will not have a material adverse impact on the Company's systems or
results of operations.
The Company has completed all initial identification and assessment of both
mission critical and mission non-critical. With respect to testing and
remediation, mission critical systems constitute the Company's external
information and data processing provider and the government Federal Reserve
payments system. The Company's primary mission critical system, information and
data processing, has been subject to independent testing and verification,
having been examined by the Office of the Comptroller of the Currency, and has
been found Y2K compliant. The Federal Reserve Bank is pursuing a course of Y2K
compliance to meet all required standards on a timely basis. The Company has
further identified and contacted Y2K sensitive companies to confirm Y2K
preparations of related vendors, suppliers, and service providers. Given the
Company's current condition of readiness, the most negative scenario upon the
occurrence of the Year 2000 is the failure of supporting utilities which would
require the bank to close for lack of heat and electricity. However, even in
that event, the Company will have three days to regain utilities service before
it incurs any interruption of normal business activities. At present, there are
no known consequences which are likely to have a significant negative impact
upon the Company's operations, liquidity, and financial condition.
The Company has completed a formal contingency plan recognizing the most likely
worst case scenarios. The Plan sets forth specific responsibility and
accountability affecting identification of Y2K related failures and processes
for responding. With respect to mission critical systems, including core
information and data processing activities, the Plan establishes information
backup and retrieval procedures and identifies alternative delivery sources,
including existing disaster recovery preparations, to continue limited business
activities. With respect to mission non-critical systems, including non-critical
technical systems, communications, and support equipment, the Plan allows for
minor business interruption regarding inconvenience or time delays in continuing
Company activities. Finally, the Plan addresses in detail plans for resumption
of business activity upon the occurrence of any
23
interruption.
Item 3. Quantitative and Qualitative Disclosures About Market
Risk
Not applicable
PART II - OTHER INFORMATION
Item 5. Other Information
Ground was broken for a branch in the city of Waupaca, located in the Central
region. The facility will offer a full range of retail and deposit services and
is expected to open late spring of 1999. Costs to complete the facility
(including equipment costs) is expected to be $1.3 million.
The Company declared a stock split in the form of a three for two stock dividend
payable on May 15, 1998 to shareholders of record date May 1, 1998.
Item 6. 8-K
(a) Exhibits
None
(b) Reports on Form 8-K filed for three months ended September 30, 1998.
Form 8-K filed October 15, 1998 dealing with the acquisition of Evergreen
Bank.
24
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.
-----------------------------
(Registrant)
Date: November 13, 1998 Thomas L. Herlache
------------------------ -----------------------------
Thomas L. Herlache
President (CEO)
Date: November 13, 1998 Steven D. Jennerjohn
------------------------ -----------------------------
Steven D. Jennerjohn
Treasurer (CFO)