UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
{X} QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2002
--------------------------------------------------
OR
{ } TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
--------------------- ------------------------
Commission file number 0-8679
---------------------------------------------------------
BAYLAKE CORP.
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Wisconsin 39-1268055
- --------------------------------------------------------------------------------
(State or other jurisdiction of incorporation (Identification No.)
or organization)
217 North Fourth Avenue, Sturgeon Bay, WI 54235
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
(920)-743-5551
- --------------------------------------------------------------------------------
(Registrant's telephone number, including area code)
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 November 12, 2002: 7,477,576 shares
BAYLAKE CORP. AND SUBSIDIARIES
INDEX
PART 1 - FINANCIAL INFORMATION PAGE NUMBER
Item 1. Financial Statements
Consolidated Balance Sheets as of September 30, 2002
and December 31, 2001 3 - 4
Consolidated Statements of Income for the three and
nine months ended September 30, 2002 and 2001 5
Consolidated Statements of Comprehensive Income for the three
and nine months ended September 30, 2002 and 2001 6
Consolidated Statements of Cash Flows for the nine months ended
September 30, 2002 and 2001 7 - 8
Notes to Consolidated Condensed Financial Statements 9
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 10 - 39
Item 3. Quantitative and Qualitative Disclosures About Market Risk 39
Item 4. Controls and Procedures 40
PART II - OTHER INFORMATION 40 - 41
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 42
Section 302 Certification 43 - 46
EXHIBIT INDEX 41
Exhibit 11 Statement re: computation of per share earnings 47
Exhibit 15 Letter re: unaudited interim financial information 48
Exhibit 99.1 Certification pursuant to 18 U.S.C. Section 1350 49
Exhibit 99.2 Certification pursuant to 18 U.S.C. Section 1350 50
2
PART 1 - FINANCIAL INFORMATION
BAYLAKE CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(dollars in thousands)
SEPTEMBER 30, DECEMBER 31,
ASSETS 2002 2001
------ ---- ----
Cash and due from banks $ 33,465 $ 24,033
Federal funds sold 0 4,452
--------- ---------
Cash and cash equivalents 33,465 28,485
Investment securities available for sale (at market) 146,710 144,895
Investment securities held to maturity (market 19,523 22,205
value $20,024 and $22,398, at September 30, 2002
and December 31, 2001, respectively)
Loans held for sale 2,469 2,428
Loans 649,894 605,287
Less: Allowance for loan losses 9,320 7,992
--------- ---------
Loans, net of allowance for loan losses 640,574 597,295
Bank premises and equipment 23,439 21,792
Federal Home Loan Bank stock (at cost) 6,630 6,376
Accrued interest receivable 4,519 5,112
Income taxes receivable 657 1,673
Deferred income taxes 1,141 2,048
Goodwill 4,969 4,969
Other Assets 21,267 8,513
--------- ---------
Total Assets $ 905,363 $ 845,791
========= =========
LIABILITIES
-----------
Domestic deposits
Non-interest bearing $ 83,343 $ 76,051
Interest bearing
NOW 57,585 49,709
Savings 201,016 218,736
Time, $100,000 and over 194,823 137,148
Other time 198,937 188,246
--------- ---------
Total interest bearing 652,361 593,839
Total deposits 735,704 669,890
Short-term borrowings
Federal funds purchased, repurchase 15,779 2,837
Agreements, and Federal Home Loan
Bank advances
Accrued expenses and other liabilities 8,200 6,779
Dividends payable 0 897
Other borrowings 65,000 90,000
Long-term debt 106 158
Guaranteed preferred beneficial interest in the 16,100 16,100
company's junior subordinated debt --------- ---------
Total liabilities 840,889 786,661
--------- ---------
SHAREHOLDERS' EQUITY
--------------------
Common stock, $5 par value: authorized 10,000,000
Shares; issued 7,500,735 shares as of September 30,
2002 and 7,494,734 as of December 31, 2001;
outstanding 7,477,576 as of September 30, 2002 and 37,504 37,474
7,471,575 as of December 31, 2001
Additional paid-in capital 7,344 7,319
Retained earnings 16,430 12,843
Treasury stock (625) (625)
Net unrealized gain on securities available 3,821 2,119
--------- ---------
For sale, net of tax of $2,053 as of September 30,
2002 and $1,146 as of December 31, 2001
Total shareholders' equity 64,474 59,130
--------- ---------
Total liabilities and shareholders' equity $ 905,363 $ 845,791
========= =========
3
BAYLAKE CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(dollars in thousands, except per share amounts)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2002 2001 2002 2001
---- ---- ---- ----
Interest income
Interest and fees on loans $ 11,031 $ 12,246 $ 32,352 $ 37,985
Interest on investment securities
Taxable 1,517 1,648 4,708 5,064
Exempt from federal income taxes 734 657 2,088 1,959
Other interest income 5 141 21 150
-------- -------- -------- --------
Total interest income 13,287 14,692 39,169 45,158
-------- -------- -------- --------
Interest expense
Interest on deposits 4,376 6,235 12,971 19,178
Interest on short-term borrowings 73 27 379 1,160
Interest on other borrowings 664 1,144 2,206 3,933
Interest on long-term debt 1 4 4 12
Interest on guaranteed preferred beneficial 410 402 1,233 997
-------- -------- -------- --------
Interest in the company's junior subordinated
debt
Total interest expense 5,524 7,812 16,793 25,280
-------- -------- -------- --------
Net interest income 7,763 6,880 22,376 19,878
Provision for loan losses 1,654 425 2,700 1,075
-------- -------- -------- --------
Net interest income after provision for 6,109 6,455 19,676 18,803
Loan losses -------- -------- -------- --------
Other income
Fees from fiduciary activities 170 205 494 500
Fees from loan servicing 273 357 765 937
Fees for other services to customers 1,109 709 3,092 2,045
Gains from sales of loans 386 206 830 570
Securities gains, net 511 0 511 0
Other income 518 120 1,294 341
-------- -------- -------- --------
Total other income 2,967 1,597 6,986 4,393
-------- -------- -------- --------
Other expenses
Salaries and employee benefits 3,589 3,058 10,394 8,992
Occupancy expense 505 440 1,520 1,308
Equipment expense 395 353 1,180 1,059
Data processing and courier 261 247 768 726
Operation of other real estate (49) 85 161 249
Other operating expenses 1,352 1,182 3,807 3,383
-------- -------- -------- --------
Total other expenses 6,053 5,365 17,830 15,717
-------- -------- -------- --------
Income before income taxes 3,023 2,687 8,832 7,479
Income tax expense 809 785 2,555 2,216
-------- -------- -------- --------
Net Income $ 2,214 $ 1,902 $ 6,277 $ 5,263
======== ======== ======== ========
Basic earnings per common share (1) $ 0.30 $ 0.25 $ 0.84 $ 0.70
Diluted earnings per common share (1) $ 0.30 $ 0.25 $ 0.83 $ 0.69
Cash dividends per share $ 0.12 $ 0.11 $ 0.36 $ 0.33
(1) Based on 7,473,598 average shares outstanding in 2002 and 7,466,776 in 2001.
4
BAYLAKE CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Dollars in thousands)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2002 2001 2002 2001
---- ---- ---- ----
Net Income $ 2,214 $ 1,902 $ 6,277 $ 5,263
------- ------- ------- -------
Other comprehensive income, net of tax:
Unrealized gains (losses) on securities:
Unrealized gains (losses) arising during period 419 1,146 1,702 2,767
------- -------- ------- -------
Comprehensive income $ 2,633 $ 3,048 $ 7,979 $ 8,030
======= ======= ======= =======
5
BAYLAKE CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(dollars in thousands)
NINE MONTHS ENDED
SEPTEMBER 30,
2002 2001
---- ----
Cash flows from operating activities:
Interest received from:
Loans $ 32,636 $ 37,850
Investments 6,894 7,191
Fees and service charges 5,774 3,958
Interest paid to depositors (12,460) (18,465)
Interest paid to others (3,967) (6,413)
Cash paid to suppliers and employees (15,458) (14,326)
Income taxes paid (1,538) (2,358)
-------- --------
Net cash provided by operating activities 11,881 7,437
Cash flows from investing activities:
Proceeds from sales of investment securities 8,506 0
Principal payments received on investments 36,610 20,189
Purchase of investments (36,965) (35,825)
Purchase of insurance contracts (13,000) 0
Proceeds from sale of other real estate owned 1,582 1,112
Loans made to customers in excess of principal collected (46,594) (42,469)
Capital expenditures (2,761) (740)
-------- --------
Net cash used in investing activities (52,622) (57,733)
Cash flows from financing activities:
Net increase (decrease) in demand deposits, NOW accounts, and savings
Accounts (2,552) 21,409
Net increase (decrease) in short term borrowing 12,943 (76,447)
Net increase (decrease) in time deposits 68,367 78,041
Proceeds from (payments on) other borrowings and long-term debt (25,000) 35,000
Payments on other borrowings and long term debt (53) (22,753)
Proceeds from issuance of common stock 55 211
Proceeds from issuance of trust preferred securities 0 16,100
Dividends paid (3,587) (3,284)
-------- --------
Net cash provided by financing activities 50,173 48,277
-------- --------
Net increase (decrease) in cash and cash equivalents 9,432 (2,019)
Cash and cash equivalents, beginning 24,033 21,695
-------- --------
Cash and cash equivalents, ending $ 33,465 $ 19,676
======== ========
6
SEPTEMBER 30,
2002 2001
---- ----
Reconciliation of net income to net cash provided by operating activities:
Net income $ 6,277 $ 5,263
Adjustments to reconcile net income to net cash provided by operating
Activities:
Depreciation 1,220 1,175
Provision for losses on loans and real estate owned 2,700 1,075
Amortization of premium on investments 175 139
Accretion of discount on investments (142) (112)
Cash surrender value increase (218) (41)
Gain from disposal of ORE (7) (49)
Gain on sale of investments (511) 0
Gain on sale of loans (830) (570)
Proceeds from sale of loans held for sale 51,209 59,183
Originations of loans held for sale (50,379) (58,613)
Equity in income of service center (230) (189)
Gain from disposal of fixed assets (107) 0
Amortization of goodwill 0 364
Amortization of mortgage servicing rights 267 108
Mortgage servicing rights booked (154) (296)
Deferred compensation 194 173
Changes in assets and liabilities:
Interest receivable 592 56
Prepaids and other assets (429) (963)
Unearned income 10 (2)
Interest payable 366 402
Taxes payable 1,017 (142)
Other liabilities 861 476
-------- --------
Total adjustments 5,604 2,174
-------- --------
Net cash provided by operating activities $ 11,881 $ 7,437
======== ========
7
BAYLAKE CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 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 September 30, 2002 and December 31, 2001. The results of
operations for the three and nine months ended September 30, 2002 and 2001
are not necessarily indicative of results to be expected for the entire
year.
2. The market value of investment securities, by type, held by Baylake Corp.
are as follows:
SEPTEMBER 30, DECEMBER 31,
2002 2001
---- ----
(dollars in thousands)
Investment securities held to maturity:
Obligations of state and political subdivisions $ 19,523 $ 22,205
-------- --------
Investment securities held to maturity $ 19,523 $ 22,205
-------- --------
Investment securities available for sale:
U.S. Treasury and other U.S. government agencies $ 23,795 $ 22,740
Obligations of states and political subdivisions 40,005 33,504
Mortgage-backed securities 66,824 74,348
Other 16,086 14,303
-------- --------
Investment securities available for sale $146,710 $144,895
======== ========
3. At September 30, 2002 and December 31, 2001, loans were as follows:
SEPTEMBER 30, DECEMBER 31,
2002 2001
---- ----
(dollars in thousands)
Commercial, financial and agricultural $411,162 $377,034
Real estate - construction 82,747 67,939
Real estate - mortgage 140,470 143,748
Installment 15,849 16,890
Less: Deferred loan origination fees, net of costs (334) (324)
-------- --------
$649,894 $605,287
Less allowance for loan losses (9,320) (7,992)
-------- --------
Net loans $640,574 $597,295
======== ========
4. Baylake Corp. declared a cash dividend of $0.12 per share payable on
September 16, 2002 to shareholders of record as of September 3, 2002.
8
PART 1 - FINANCIAL INFORMATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
General
The following sets forth management's discussion and analysis of the
consolidated financial condition and results of operations of Baylake Corp.
("Baylake" or the "Company") for the three and nine months ended September 30,
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 September 30, 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
9
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 September 30, 2002, earnings increased $312,000, or
16.4%, to $2.2 million from $1.9 million for the third quarter last year. Basic
operating earnings per share of $0.30 was reported for the quarter ended
September 30, 2002 compared to $0.25 for the same period last year, an
improvement of 20%. On a fully diluted basis, the Company recorded $0.30 per
share for the third quarter in 2002 and $0.25 for the same period in 2001.
TABLE 1
Summary results of operations
($ in Thousands, except per share data)
Three months Three months Nine months Nine months
ended ended ended ended
September 30, September 30, September 30, September 30,
2002 2001 2002 2001
------------ ------------ ------------ ------------
Net income, 2,214 1,902 6,277 5,263
as reported
Net income, 2,214 2,023 6,277 5,627
as adjusted (1)
EPS-basic, as reported 0.30 0.25 0.84 0.70
EPS-basic, as 0.30 0.27 0.84 0.75
adjusted (1)
EPS-diluted, as 0.30 0.25 0.83 0.69
reported
EPS-diluted, as 0.30 0.27 0.83 0.74
adjusted (1)
Return on average 0.99% 0.92% 0.97% 0.88%
assets, as reported
Return on average 0.99% 0.98% 0.97% 0.94%
assets, as adjusted (1)
Return on average 13.80% 13.17% 13.62% 12.63%
equity, as reported
10
Return on average 13.80% 14.00% 13.62% 13.51%
equity, as adjusted (1)
Efficiency ratio, as 54.49% 62.04% 58.58% 62.17%
reported
Efficiency ratio, as 54.49% 60.65% 58.58% 60.73%
adjusted (1), (2)
(1) Selected 2001 financial data has been adjusted to exclude the
amortization of goodwill affected by SFAS 142.
(2) Noninterest expense divided by sum of taxable equivalent net
interest income plus noninterest income, excluding investment
securities gains, net.
The annualized return on average assets and return on average equity for the
three months ended September 30, 2002 were 0.99% and 13.80%, respectively,
compared to 0.92% and 13.17%, 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.
For the nine months ended September 30, 2002, net income increased $1.0 million,
or 19.3%, to $6.3 million from $5.3 million for the first nine months of 2001.
The change in net income is due for the same reasons as listed above. Basic
operating earnings per share increased to $0.84 for the first nine months of
2002 compared to $0.70 for the nine months ended September 30, 2001, an increase
of 20.0%. On a fully diluted basis, the Company recorded $0.83 per share for the
first nine months of 2002 and $0.69 for the same period in 2001.
Cash dividends declared in the first nine months of 2002 increased 9.1% to $0.36
per share compared with $0.33 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 77.0% of
total operating income for the first nine months of 2002, as compared to 82.6%
for the first nine 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
11
is adjusted to a level that reflects such income as if it were fully taxable.
Net interest income on a tax equivalent basis for the three months ended
September 30, 2002 increased $924,000, or 12.8%, to $8.1 million from $7.2
million for the same period a year ago. As a result of a lower interest rate
environment, total interest income for the third quarter of 2002 decreased $1.4
million, or 9.1%, to $13.7 million from $15.0 million for the third quarter of
2001, while interest expense in the third quarter of 2002 decreased $2.3
million, or 29.3%, to $5.5 million when compared to $7.8 million in the third
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 September 30, 2002, average earning assets increased
$38.5 million, or 5.1%, when compared to the same period last year. The Company
recorded an increase in average loans of $54.7 million, or 9.3%, for the third
quarter of 2002 compared to the same period a year ago. Loans have typically
resulted in higher rates of interest income to the Company than have investment
securities.
Interest rate spread is the difference between the tax-equivalent rate earned on
average earning assets and the rate paid on average interest-bearing
liabilities. The interest rate spread increased for the quarter ended September
30, 2002 when compared to the same period a year ago. The interest rate spread
increased 49 basis points to 3.80% at September 30, 2002 from 3.31% in the same
quarter in 2001. While the average yield on earning assets decreased 105 basis
points during the period, the average rate paid on interest-bearing liabilities
decreased 156 basis points over the same period as a result of a lower cost of
funding from deposits and other wholesale funding such as federal funds
purchased and loans from the Federal Home Loan Bank.
TABLE 2
Net Interest Income Analysis on a Tax-equivalent basis
($ in Thousands)
Nine months ended Nine months ended
September 30, 2002 September 30, 2001
Average Interest Average Average Interest Average
Balance Income/ Yield/ Balance Income/ Yield/
Expense Rate Expense Rate
-------- -------- ------- -------- -------- -------
ASSETS
Earning Assets:
Loans, net (1)(2)(3) $628,251 $582,710
Less: non-accrual loans (15,269) (10,173)
-------- --------
Loans, net 612,982 $32,352 7.06% 572,537 $37,985 8.87%
Investments 175,185 7,872 6.01% 162,000 8,032 6.63%
Other earning assets 1,645 21 1.71% 6,255 150 3.21%
-------- ------- ------ -------- ------- ------
12
Total earning assets $789,812 $40,245 6.81% $740,792 $46,167 8.33%
-------- ------- ----- -------- ------- -----
Allowance for loan losses (8,315) (7,367)
Non-accrual loans 15,269 10,173
Cash and due from banks 17,820 15,886
Other assets 50,366 41,692
------ ------
Total assets $864,952 $801,176
-------- --------
LIABILITIES AND
STOCKHOLDERS EQUITY
Interest bearing
liabilities
Interest bearing $441,412 $8,155 2.47% $437,169 $14,927 4.57%
deposits, excluding time
> $100M
Time deposits > $100M 163,363 4,816 3.94% 99,466 4,251 5.71%
------- ----- ----- ------ ----- -----
Total interest bearing $604,775 $12,971 2.87% $536,635 $19,178 4.78%
deposits
Short-term borrowings 25,374 379 2.00% 28,133 1,160 5.51%
Other borrowings 75,290 2,210 3.92% 94,884 3,945 5.56%
Trust preferred 16,100 1,233 10.24% 13,387 997 9.96%
securities ------ ----- ------ ------ --- -----
Total interest bearing $721,539 $16,793 3.11% $673,039 $25,280 5.02%
liabilities -------- ------- ----- -------- ------- -----
Demand deposits 73,657 64,453
Accrued expenses and 8,124 7,992
other liabilities
Stockholders' equity 61,632 55,692
-------- --------
Total liabilities and $864,952 $801,176
stockholders' equity -------- --------
Interest rate spread $23,452 3.70% $20,887 3.31%
Contribution of free 0.27% 0.46%
funds ----- -----
Net interest margin 3.97% 3.77%
----- -----
13
TABLE 2 (continued)
Net Interest Income Analysis on a Tax-equivalent basis
($ in Thousands)
Three months ended September 30, 2002 Three months ended September 30, 2001
------------------------------------- -------------------------------------
Average Interest Average Average Interest Average
Balance Income/ Yield/ Balance Income/ Yield/
Expense Rate Expense Rate
-------- -------- ------- -------- -------- -------
ASSETS
Earning Assets:
Loans, net (1)(2)(3) $645,452 $590,749
Less: non-accrual loans (18,259) (10,982)
-------- --------
Loans, net 627,193 $11,032 6.98% 579,767 $12,246 8.38%
Investments 169,615 2,631 6.15% 162,393 2,643 6.46%
Other earning assets 1,002 3 1.19% 17,160 141 3.26%
-------- ------- ----- -------- ------- -----
Total earning assets $797,810 $13,666 6.80% $759,320 $15,030 7.85%
-------- ------- ----- -------- ------- -----
Allowance for loan losses (8,124) (7,287)
Non-accrual loans 18,259 10,982
Cash and due from banks 19,902 17,263
Other assets 60,722 41,710
-------- --------
Total assets $888,569 $821,988
-------- --------
LIABILITIES AND
STOCKHOLDERS EQUITY
Interest bearing
liabilities
Interest bearing $447,922 $2,653 2.35% $449,019 $4,511 3.99%
deposits, excluding time
> $100M
Time deposits > $100M 183,893 1,723 3.72% 127,798 1,724 5.35%
------- ----- ----- ------- ----- -----
Total interest bearing $631,815 $4,376 2.75% $576,817 $6,235 4.29%
deposits
Short-term borrowings 14,683 73 1.97% 1,307 12 3.64%
Other borrowings 70,110 665 3.76% 87,636 1,163 5.27%
Trust preferred securities 16,100 410 10.10% 16,100 402 9.91%
------ --- ------ ------ --- -----
14
Total interest bearing $732,708 $5,524 2.99% $681,860 $7,812 4.55%
liabilities -------- ------ ----- -------- ------ -----
Demand deposits 82,314 72,844
Accrued expenses and 9,877 9,971
other liabilities
Stockholders' equity 63,670 57,313
-------- --------
Total liabilities and $888,569 $821,988
stockholders' equity -------- --------
Interest rate spread $8,142 3.80% $7,218 3.31%
Contribution of free 0.24% 0.46%
funds ----- -----
Net interest margin 4.05% 3.77%
----- -----
(1) The yield on tax exempt loans and securities is computed on a
tax-equivalent basis using a tax rate of 34% for all periods
presented
(2) Interest income includes net loan fees
(3) Nonaccrual loans and loans held for sale have been included in
the average balances
Net interest margin is tax-equivalent net interest income expressed as a
percentage of average earning assets. The net interest margin exceeds the
interest rate spread because of the use of non-interest bearing sources of funds
to fund a portion of earning assets. As a result, the level of funds available
without interest cost (demand deposits and equity capital) is an important
component increasing net interest margin.
Net interest margin (on a federal tax-equivalent basis) for the three months
ended September 30, 2002 increased from 3.77% to 4.05% compared to the same
period a year ago. The average yield on interest earning assets amounted to
6.80% for the third quarter of 2002, representing a decrease of 105 basis points
from the same period last year. Total loan yields decreased 140 basis points to
6.98%, while total investment yields decreased 31 basis points to 6.15%, as
compared to the same period a year ago. The Company's average cost on
interest-bearing deposit liabilities decreased 154 basis points to 2.75% for the
third quarter of 2002 when compared to the third quarter of 2001, while
short-term borrowing costs decreased 167 basis points to 1.97% comparing the two
periods. Other borrowing costs decreased 151 basis points to 3.76% during the
same time period. These factors contributed to an increase in the Company's
interest margin for the three months ended September 30, 2002 compared to the
same period a year ago.
The ratio of average earning assets to average total assets measures
management's ability to employ overall assets for the production of interest
income. This ratio was 89.8% for the third quarter of 2002
15
compared with 92.4% for the same period in 2001. The ratio decreased in 2002,
primarily as a result of growth in earning assets offset to a greater degree by
an increase in non-accrual loans and a $13 million dollar purchase of business
owned life insurance ("BOLI").
Net interest income on a tax equivalent basis for the nine months ended
September 30, 2002 increased $2.6 million, or 12.3%, to $23.5 million from $20.9
million for the same period a year ago. Total interest income for the nine
months ended September 30, 2002 decreased $5.9 million, or 12.8%, to $40.2
million from $46.1 million for the nine months ended September 30, 2001, while
interest expense decreased $8.5 million, or 33.6%, to $16.8 million when
compared to $25.3 million for the nine months ended September 30, 2001. The
increase in net interest income between these two periods occurred primarily as
a result of growth in the average volume of interest earning assets and
non-interest bearing deposits offset to a lesser degree by an increase in
interest paying liabilities and a decrease in the yield on earning assets.
For the nine months ended September 30, 2002, average-earning assets increased
$49.0 million, or 6.6%, when compared to the same period last year. The Company
recorded an increase in average loans of $45.5 million, or 7.8%, for the first
nine months of 2002 when compared to the same period a year ago. Loans have
typically resulted in higher rates of interest to the Company than have
investment securities.
The interest rate spread increased for the nine months ended September 30, 2002
when compared to the same period a year ago. The interest rate spread increased
39 basis points to 3.70% at September 30, 2002 from 3.31% in the same period in
2001. While the average yield on earning assets decreased 152 basis points
during the period, the average rate paid on interest-bearing liabilities
decreased 191 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 (on a federal tax-equivalent basis) for the nine months
ended September 30, 2002 increased from 3.77% to 3.97% compared to the same
period a year ago. The average yield on interest earning assets amounted to
6.81% for the nine months ended September 30, 2002, representing a decrease of
152 basis points from the same period last year. Total loan yields decreased 181
basis points to 7.06%, while total investment yields decreased 62 basis points
to 6.01%, as compared to the same period a year ago. The Company's average cost
on interest bearing deposit liabilities decreased 191 basis points to 2.87% for
the first nine months of 2002 when compared to the same period in 2001, while
short-term borrowing costs decreased 351 basis points to 2.00%, comparing the
two periods. Other borrowing costs decreased 164 basis points to 3.92% during
the same time period. These factors contributed to an increase in the Company's
interest margin for the nine months ended September 30, 2002 compared to the
same period a year ago.
The ratio of average earning assets to average total assets was 91.3% in the
first nine months of 2002 compared with 92.5% for the same period in 2001. The
ratio decreased slightly in 2002, primarily as a result of
16
growth in earning assets offset to a 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 September 30, 2002
increased $1.2 million to $1.7 million compared with $425,000 for the third
quarter of 2001. For the nine months ended September 30, 2002, the provision for
loan losses increased $1.6 million to $2.7 million compared with $1.1 million
for the same period last year. Management believes that the current allowance
(giving effect to the increased provision) conforms with the Company's loan loss
reserve policy and is adequate in view of the present condition of the Company's
loan portfolio. See "Risk Management and the Allowance for Possible Loan Losses"
below.
Non-Interest Income
Total non-interest income increased $1.4 million, or 85.8%, to $3.0 million for
the third quarter of 2002 when compared to the third quarter of 2001. This
increase occurred as a result of increased fees on other customer services, an
increase in gains from sales of loans, an increase in securities gains, and
increased other income offset to a lesser degree by a decrease in trust revenues
and decreased fees from loan servicing.
TABLE 3
NONINTEREST INCOME
($ in Thousands)
Third Third
Quarter Quarter Percent YTD YTD Percent
2002 2001 change 2002 2001 change
------- ------- ------- ---- ---- -------
Trust 170 205 (17.1)% 494 500 (1.2)%
Service charges on 761 466 63.3% 2,113 1,343 57.3%
deposit accts
Loan servicing fees 273 357 (23.5)% 765 937 (18.4)%
Brokerage commissions 170 81 109.9% 444 244 82.0%
17
Bank owned life 176 14 NM 218 41 431.7%
insurance income
Non-bank subsidiary 327 71 360.6% 752 189 297.9%
income
Gain on sales of 386 206 87.4% 830 570 45.6%
loans
Gains on sales of 511 0 Na 511 0 Na
investments
Asset sales gains, 0 0 Na 107 0 Na
net
Other 193 197 (2.0)% 752 569 32.2%
----- ----- ------ ----- ----- -----
Total 2,967 1,597 85.8% 6,986 4,393 59.0%
Service charges on deposit accounts for the third quarter of 2002 showed an
increase of $295,000, or 63.3%, over 2001 results, accounting for much of the
improvement in fee income generated for other services to customers.
As a result of a purchase of $13 million in business owned life insurance
("BOLI") made during the year, income from BOLI improved by $162,000 for the
quarter ended September 30, 2002. In addition, revenues generated by the
operation of Arborview LLC ("Arborview") (a recently formed subsidiary created
to manage a community based residential facility) amounted to $195,000 for the
third quarter.
Trust fees decreased $35,000, or 17.1%, in the third quarter of 2002 compared to
the same quarter in 2001, primarily as a result of lower market values on
various trust accounts for which fees are assessed.
Loan servicing fees decreased $84,000 to $273,000 in the third quarter of 2002,
when compared to the same quarter in 2001. The decrease in 2002 resulted from a
decrease in commercial loan servicing income.
Gains on sales of loans in the secondary market increased $180,000 to $386,000
in the third 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. Recent declines in interest rates continue to stimulate mortgage
production, including an increase in refinancing activity. Sales of loans for
the three months ended September 30, 2002 decreased to $17.4 million, compared
to $19.7 million for the same period a year earlier.
For the quarter ended September 30, 2002, gains from sale of securities totaled
$511,000.
For the first nine months of 2002, non-interest income increased $2.6 million,
or 59.0%, to $7.0 million from $4.4 million for the same period
18
a year ago. This includes revenues received from Arborview totaling $523,000 for
the period.
Trust fee income decreased $6,000, or 1.2%, to $494,000 for the first nine
months of 2002 compared to $500,000 for the same period in 2001 as a result of
lower market values on various trust accounts for which fees are calculated and
assessed.
For the first nine months, service charges on deposit accounts increased
$770,000, or 57.3%, to $2.1 million from $1.3 million for the same period in
2001 as a result of better collection efforts and a recent price adjustment.
Other income increases consisted of a gain of $107,000 related to the sale of
bank land not deemed necessary for development at this time. Another item
contributing to other income increases was income of $133,000 on previously
amended tax returns which was received during the quarter.
Income from BOLI improved by $177,000 for the nine months ended September 30,
2002 as a result of a prior BOLI purchase made during the year.
Loan servicing fees decreased $172,000, or 18.4%, to $765,000 for the first nine
months of 2002 compared to $937,000 for the same period in 2001.
Gains on sales of loans in the secondary market increased $260,000 to $830,000
for the first nine months of 2002, when compared to the same period in 2001,
primarily as a result of increased gains from sales of mortgage loans. Sales of
loans for the nine months ended September 30, 2002 decreased to $50.4 million,
compared to $59.2 million for the same period a year earlier.
Non-Interest Expense
Non-interest expense increased $688,000, or 12.8%, for the three months ended
September 30, 2002 compared to the same period in 2001. Salaries and employee
benefits showed an increase of $531,000, or 17.4%, for the period as a result of
additional staffing to operate newer facilities and regular salary and related
benefit increases. Full time equivalent staff increased to 293 persons from 283
a year earlier. Increases in occupancy (amounting to $65,000 or 14.8%) and
equipment expenses (amounting to $42,000 or 11.9%) occurred as a result of
expansion in the Green Bay and Waupaca markets and costs related to
modernization of various facilities.
19
TABLE 4
NONINTEREST EXPENSE
($ in Thousands)
Third Third
Quarter Quarter Percent YTD YTD Percent
2002 2001 change 2002 2001 change
------- ------- ------- ---- ---- -------
Personnel 3,589 3,058 17.4% 10,394 8,992 15.6%
Occupancy 505 440 14.8% 1,520 1,308 16.2%
Equipment 395 353 11.9% 1,180 1,059 11.4%
Data processing 261 247 5.7% 768 726 5.8%
Supplies and printing 161 107 50.5% 452 326 38.7%
Business development/ 175 119 47.1% 470 403 16.6%
Advertising
FDIC 28 28 0.0% 85 81 4.9%
Goodwill amortization 0 121 Na 0 364 Na
Amortization of MSR's 90 28 221.4% 266 108 146.3%
Legal and 82 72 13.9% 239 219 9.1%
professional
Operation of other (49) 85 Na 161 249 (35.3)%
real estate owned
Other 816 707 15.4% 2,295 1,882 21.9%
--- --- ----- ----- ----- -----
Total 6,053 5,365 12.8% 17,830 15,717 13.4%
Expenses related to the operation of other real estate owned decreased $134,000
to net revenues of $49,000 for the quarter ended September 30, 2002 compared to
the same period in 2001. Included in the decrease of these expenses were gains
taken on the sale of other real estate owned amounting to $75,000 for the third
quarter of 2002 compared to net gains taken on sale of $44,000 for the same
period in 2001. In addition, costs related to the holding of other real estate
owned properties decreased $103,000 to $26,000 for the third quarter of 2002.
Other operating expenses increased $170,000, or 14.4%. Legal expense and loan
collection expense increased $10,000 for the three months ended September 30,
2002 primarily as a result of increased legal issues related to loan collection
efforts. Expenses related to the operation of Arborview amounted to $250,000 for
the third quarter of 2002 and are consolidated in various expense categories.
Included in the third quarter 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 $83,000 and amortization of $38,000
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
20
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.
Mortgage servicing rights expense includes the amortization of the mortgage
servicing rights asset. Amortization of mortgage servicing rights increased by
$62,000, reflecting the decline in interest rates in 2002 and subsequent
refinancing, thereby accelerating the writedown of mortgage servicing rights.
Other items (such as marketing, telephone, postage and director fees) comprising
other operating expense show an increase of $109,000 or 15.4% in the third
quarter of 2002 when compared to the same quarter in 2001. The overhead ratio,
which is computed by subtracting non-interest income from non-interest expense
and dividing by average total assets, was 1.38% for the three months ended
September 30, 2002 compared to 1.82% for the same period in 2001.
Non-interest expense increased $2.1 million, or 13.4%, for the nine months ended
September 30, 2002 compared to the same period in 2001. Salaries and employee
benefits showed an increase of $1.4 million, or 15.6%, for the period as a
result of additional staffing to operate new facilities and regular salary and
related benefit increases. Increases in occupancy (amounting to $212,000 or
16.2%) and equipment expense (amounting to $121,000 or 11.4%) occurred as a
result of expansion in the Green Bay and Waupaca markets and costs related to
modernization of various facilities.
Operation of other real estate expense shows a decrease of $88,000. The decrease
is related to reduced expenses related to the operation of other real estate
owned amounting to $211,000 for the first nine months of 2002 compared to
$308,000 for the same period in 2001. Net gains on sale of other real estate
owned properties amounted to $28,000 compared to net gains taken of $43,000 in
the same period one year earlier.
Other operating expenses increased $424,000, or 12.5%, for the nine months ended
September 30, 2002 when compared to the same period a year ago. Included in 2001
expenses were amortization of goodwill amounting to $364,000 related to the Four
Seasons and BLBNA acquisition. Expenses related to the operation of Arborview
total $671,000 for the nine month period ended September 30, 2002 and are
included in various expense categories of non-interest expense.
Amortization of mortgage servicing rights increased by $158,000, or 146.3%, for
the nine months ended September 30, 2002 when compared to the same period in
2001.
Other items (such as marketing, telephone, postage and director fees) comprising
other operating expense shows an increase of $413,000 or 21.9% for the period
ended September 30, 2002 when compared to the same period in 2001. The overhead
ratio, which is computed by subtracting non-interest income from non-interest
expense and dividing by average total assets, was 1.68% for the nine months
ended September 30, 2002 compared to 1.89% for the same period in 2001.
21
Income Taxes
Income tax expense for the Company for the three months ended September 30, 2002
was $809,000, an increase of $24,000, or 3.1%, compared to the same period in
2001. The increase in income tax provision for the period was due to increased
taxable income.
Income tax expense for the Company for the nine months ended September 30, 2002
was $2.6 million, an increase of $339,000, or 15.3%, compared to the same period
in 2001. 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 28.9% for the nine months ended September 30, 2002 compared with
29.6% for the same period in 2001. The effective tax rate of 28.9% consisted of
a federal effective tax rate of 25.8% and Wisconsin State effective tax rate of
3.1%.
Balance Sheet Analysis
Loans
At September 30, 2002, total loans increased $44.6 million, or 7.4%, to $649.9
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
$327.1 million at September 30, 2002 compared to $288.4 million at December 31,
2001. In addition, real estate construction loans increased to $82.7 million at
September 30, 2002, compared to $67.9 million at December 31, 2001. Real estate
mortgage loans decreased to $140.4 million at September 30, 2002, compared with
$143.7 million at December 31, 2001. Consumer loans decreased to $15.8 million
at September 30, 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):
September 30, December 31,
2002 2001
------------ -----------
Amount of loans by type (dollars in thousands)
Real estate-mortgage
Commercial $327,072 $288,385
1-4 family residential
First liens 91,161 96,626
Junior liens 23,051 24,748
Home equity 26,258 22,374
Commercial, financial and agricultural 84,090 88,649
Real estate-construction 82,747 67,939
Installment
Credit cards and related plans 2,060 2,145
Other 13,789 14,745
Less: deferred origination fees, net of costs 334 324
-------- --------
Total $649,894 $605,287
22
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
23
Every significant problem credit is reviewed by the loan review process and
assessments are performed quarterly to confirm the risk rating to that credit,
proper accounting and the adequacy of loan loss reserve assigned.
After reviewing the gradings in the loan portfolio, management will allocate or
assign a portion of the ALL to groups of loans and individual loans to cover
management's estimate of probable loss. Allocation is related to the grade of
the loan and includes a component resulting from the application of the
measurement criteria of Statements of Financial Accounting Standards No. 114,
"Accounting by Creditors for Impairment of a Loan" ("SFAS 114") and No. 118,
"Accounting by Creditors for Impairment of a Loan-Income Recognition and
Disclosures" ("SFAS 118"). Allocations also are made for unrated loans, such as
credit card loans, based on historical loss experience adjusted for portfolio
activity. These allocated reserves are further supplemented by unallocated
reserves based on management's judgment regarding risk of error, local economic
conditions and any other relevant factors. Management then compares the amounts
allocated for probable losses to the current allowance. To the extent that the
current allowance is insufficient to cover management's best estimate of
probable losses, management records additional provision for credit loss. If the
allowance is greater than required at that point in time, provision expense is
adjusted accordingly.
As the following table indicates, the ALL at September 30, 2002 was $9.3 million
compared with $8.0 million at the end of 2001. Loans increased 7.4% from
December 31, 2001 to September 30, 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 nine months of 2002. The September 30, 2002 ratio
of ALL to outstanding loans was 1.43% compared with 1.32% at December 31, 2001
and the ALL as a percentage of nonperforming loans was 41.3% at September 30,
2002 compared to 54.5% at end of year 2001. Based on management's analysis of
the loan portfolio risk at September 30, 2002, a provision expense of $2.7
million was recorded for the nine months ended September 30, 2002, an increase
of $1.6 million compared to the same period in 2001. Net loan charge-offs of
$1.4 million occurred in the first nine months of 2002, and the ratio of net
charge-offs to average loans for the period ended September 30, 2002 was 0.29%
compared to 0.08% at September 30, 2001. Commercial real estate loan net
charge-offs represented 88.7% of the total net loan charge-offs for the first
nine 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
September 30, 2002 September 30, 2001 December 31, 2001
------------------ ------------------ -----------------
Allowance for Loan Losses
("ALL")
Balance at beginning of $ 7,992 $ 7,006 $ 7,006
period
24
Provision for loan losses 2,700 1,075 2,880
Charge-offs 1,925 1,097 2,729
Recoveries 553 737 835
------- ------- -------
Balance at end of period 9,320 7,721 7,992
Net charge-offs ("NCOs") 1,372 360 1,894
Nonperforming Assets:
Nonaccrual loans 18,490 11,411 9,929
Accruing loans past due 90 0 0 0
days or more
Restructured loans 4,099 4,914 4,744
------- ------- -------
Total nonperforming loans 22,589 16,325 14,673
("NPLs")
Other real estate owned 2,639 1,868 1,673
------- ------- -------
Total nonperforming assets $25,228 18,193 16,346
("NPAs")
Ratios:
ALL to NCO's (annualized) 5.09 16.09 4.22
NCO's to average loans 0.29% 0.08% 0.32%
(annualized)
ALL to total loans 1.43% 1.30% 1.32%
NPL's to total loans 3.48% 2.74% 2.42%
NPA's to total assets 2.79% 2.19% 1.93%
ALL to NPL's 41.26% 47.30% 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 loan portfolio,
the ALL consists of several components.
25
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
26
loans may be less able to manage their debt service if interest rates rise.
For these reasons, management regards it as both a more practical and prudent
practice to maintain the total allowance at an amount larger than the sum of the
amounts allocated as described above.
The following table shows the amount of the ALL allocated for the time periods
indicated to each loan type as described. It also shows the percentage of
balances for each loan type to total loans. In general, it would be expected
that those types of loans which have historically more loss associated with them
will have a proportionally larger amount of the allowance allocated to them than
do loans which have less risk.
Consideration for making such allocations is consistent with the factors
discussed above, and all of the factors are subject to change; thus, the
allocation is not necessarily indicative of the loan categories in which future
loan losses will occur. It would also be expected that the amount allocated for
any particular type of loan will increase or decrease proportionately to both
the changes in the loan balances and to increases or decreases in the estimated
loss in loans of that type. In other words, changes in the risk profile of the
various parts of the loan portfolio should be reflected in the allowance
allocated.
Allocation of the Allowance for Loan Losses
(dollars in thousands)
Sept 30, Sept 30, Dec 31,
2002 2001 2001
------ Percent ------ Percent ------ Percent
Amount of Amount of Amount of
------ loans ------ loans ------ loans
to to to
total total total
loans loans loans
----- ----- -----
Commercial, financial $ 1,612 12.94% 1,760 15.82% 972 14.65%
& agricultural
Commercial real estate 5,200 50.28% 3,400 44.99% 4,158 47.59%
Real Estate:
Construction 380 12.73% 370 11.35% 503 11.22%
Residential 1,320 17.57% 1,400 20.95% 1,078 20.05%
Home Equity 150 4.04% 142 3.94% 178 3.70%
Consumer 150 2.12% 140 2.56% 162 2.44%
Credit card 70 0.32% 60 0.39% 93 0.35%
Loan commitments 158 149 144
Not specifically allocated 280 300 704
----- --- ---
Total allowance $ 9,320 100.00% $7,721 100.00% $ 7,992 100.00%
27
Allowance for credit 1.43% 1.30% 1.32%
loss as a percentage
of total loans
Period end loans $649,894 $595,733 $605,287
While there exists probable asset quality problems in the loan portfolio,
management believes sufficient reserves have been provided in the ALL to absorb
probable losses in the loan portfolio at September 30 2002. Ongoing efforts are
being made to collect these loans, and the Company involves the legal process
when necessary to minimize the risk of further deterioration of these loans for
full collectibility.
As an integral part of their examination process, various regulatory agencies
also review the Company's ALL. Such agencies may require that changes in the ALL
be recognized when their credit evaluations differ from those of management,
based on their judgments about information available to them at the time of
their examination.
Non-Performing Loans, Potential Problem Loans and Other Real Estate
Management encourages early identification of non-accrual and problem loans in
order to minimize the risk of loss. This is accomplished by monitoring and
reviewing credit policies and procedures on a regular basis.
The accrual of interest income is discontinued when a loan becomes 90 days past
due as to principal or interest. When interest accruals are discontinued,
interest credited to income is reversed. If collectibility is in doubt, cash
receipts on non-accrual loans are used to reduce principal rather than recorded
as interest income.
Non-performing assets at September 30, 2002 were $25.2 million compared to $16.3
million at December 31, 2001. Other real estate owned totaled $663,000 and
consisted of two residential and four commercial properties. In addition,
investment in Arborview, an operating subsidiary of the Company, totals $2.0
million at September 30, 2002. Non-accrual loans represented $18.5 million of
the total of non-performing assets, of which $3.6 million was acquired by the
Company with the BLBNA acquisition. Real estate non-accrual loans accounted for
$17.0 million of the total, of which $4.0 million was residential real estate
and $13.0 million was commercial real estate, while commercial and industrial
non-accruals accounted for $1.2 million.
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. $4.1 million
28
of troubled debt restructured loans existed at September 30, 2002 and $4.7
million at December 31, 2001. Approximately $3.4 million of troubled debt
restructured loans at September 30, 2002 consists of two commercial real estate
credits which were granted various payment concessions and had experienced past
cashflow problems. These credits were current at September 30, 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 September 30, 2002 was 3.5% compared to 2.4% at 2001 year-end.
The Company's ALL was 41.3% of total non-performing loans at September 30, 2002
compared to 54.4% at end of year 2001.
Potential problem loans at September 30, 2002 are restricted to two commercial
borrowers with credits aggregating approximately $1.3 million. Potential problem
loans totaled $10.5 million at December 31, 2001. The commercial loan customers
are undergoing cashflow problems and, as a result, have experienced liquidity
problems. These credits were not current at September 30, 2002, and continue 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 September 30, 2002, the investment portfolio (which includes investment
securities available for sale and held to maturity) decreased $867,000, or 0.5%,
to $166.2 million from $167.1 million at December 31, 2001. At September 30,
2002, the investment portfolio represented 18.4% 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 September 30, 2002
(dollars in thousands)
Gross Gross
Amortized Unrealized Unrealized Estimated
Cost Gains Losses Market Value
---- ----- ------ ------------
Securities held to maturity
Obligations of states & $ 19,523 $ 501 $ 0 $ 20,024
political subdivisions
Securities available for sale
Obligations of U.S. Treasury & 21,616 2,179 0 23,795
other U.S. Agencies
Mortgage-backed securities 65,564 1,299 39 66,824
Obligations of states & 37,571 2,434 0 40,005
political subdivisions
Equity securities 16,086 16,086
Total securities available for $140,837 $ 5,912 $ 39 $146,710
sale
29
At December 31, 2001
(dollars in thousands)
Gross Gross
Amortized Unrealized Unrealized Estimated
Cost Gains Losses Market Value
---- ----- ------ ------------
Securities held to maturity
Obligations of states & $ 22,205 $ 216 $ 23 $ 22,398
political subdivisions
Securities available for sale
Obligations of U.S. Treasury & $ 21,505 $ 1,235 $ 0 $ 22,740
other U.S. Agencies
Mortgage-backed securities 73,183 1,359 194 74,348
Obligations of states & 32,639 889 24 33,504
political subdivisions
Equity securities 14,303 14,303
Total securities available for $141,630 $ 3,483 $ 218 $144,895
sale
At September 30, 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
--------------------------- -----------------------------
Amortized Cost Market Value Amortized Cost Market Value
-------------- ------------ -------------- ------------
Within 1 year $ 2,857 $ 2,887 $ 38,017 $ 37,553
After 1 but within 5 years 8,160 8,489 54,633 58,605
After 5 but within 10 years 3,096 3,238 18,861 20,438
After 10 years 5,410 5,410 13,240 14,028
Equity securities 0 0 16,086 16,086
-------- -------- -------- --------
Total $ 19,523 $ 20,024 $140,835 $146,710
30
Deposits
Total deposits at September 30, 2002 increased $65.8 million, or 9.8%, to $735.7
million from $669.9 million at December 31, 2001. Non-interest bearing deposits
at September 30, 2002 increased $7.2 million, or 9.6%, to $83.3 million from
$76.1 million at December 31, 2001. Interest-bearing deposits at September 30,
2002 increased $58.6 million, or 9.9%, to $652.4 million from $593.8 million at
December 31, 2001. Interest-bearing transaction accounts (NOW deposits)
increased $7.9 million, primarily in public fund deposits. Savings deposits
decreased $17.7 million, or 8.1%, to $201.0 million at September 30, 2002, when
compared to $218.7 million at December 31, 2001. Time deposits (including time,
$100,000 and over and other time) increased $68.4 million (includes increase of
$57.7 million in time deposits over $100,000), or 21.0%, to $393.8 million at
September 30, 2002, when compared to $325.4 million at December 31, 2001.
Brokered CD's totaled $109.3 million at September 30, 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 2002 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.
Short Term Borrowings and Other Borrowings
Short-term borrowings at September 30, 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 September 30, 2002 increased
$12.9 million to $15.8 million from $2.8 million at December 31, 2001. Customer
repurchase agreements decreased
31
from $2.7 million at December 31, 2001 to $2.0 million at September 30, 2002.
FHLB advances increased from $0 at December 31, 2001 to $3.8 million at
September 30, 2002. Federal funds purchased increased from $0 at December 31,
2001 to $10.0 million at September 30, 2002 accounting for the balance of the
increase in the balance of short-term borrowings. These have increased as a
result of loan growth and a reduction in term borrowings from FHLB.
Other borrowings consist of term loans with FHLB. These borrowings totaled $65
million at September 30, 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 September 30, 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.
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 $2.8 million for the first nine months of
2002 and will continue to be the Company's main source of long-term liquidity.
The dividends from the Bank along
32
with existing cash were sufficient to pay cash dividends to the Company's
shareholders of $3.6 million in the first nine months 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 nine months ended September 30, 2002, principal payments totaling $36.6
million were received on investments. These proceeds in addition in other
Company cash were used to purchase $37.0 million in investments for the period.
At September 30, 2002, the carrying or book value of investment securities
maturing within one year amounted to $40.4 million or 24.3% 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 nine months of 2002 totaled $45.1
million. At September 30, 2002, the investment portfolio contained $90.6 million
of U.S. Treasury and federal agency backed securities representing 54.5% of the
total investment portfolio. These securities tend to be highly marketable and
had a market value above amortized at September 30, 2002 amounting to $3.5
million.
Deposit growth is typically another source of liquidity for the Bank. As a
financing activity reflected in the September 30, 2002 Consolidated Statements
of Cash Flows, deposits increased and resulted in $65.8 million of cash inflow
during the first nine months of 2002. The Company's overall deposit base
increased 9.8% for the nine months ended September 30, 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 $172.6 million, or 26.6%, of loans maturing within one year.
Within the classification of short-term borrowings and other borrowings at
September 30, 2002, federal funds purchased and securities sold under agreements
to repurchase totaled $15.8 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 $68.8 million at September 30, 2002, compared to $90.0
million at the end of 2001.
The Bank's liquidity resources were sufficient in the first nine months 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
33
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 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
34
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 asset sensitive. The analysis considers money
market index accounts and 25% of NOW accounts to be rate sensitive within three
months. Regular savings, money market deposit accounts and 75% of NOW accounts
are considered to be rate sensitive within one to five years. While these
accounts are contractually short-term in nature, it is the Company's experience
that repricing occurs over a longer period of time. The Company views its
savings and NOW accounts to be core deposits and relatively non-price sensitive,
as it believes it could make repricing adjustments for these types of accounts
in small increments without a material decrease in balances. All other earning
categories, including loans and investments as well as other paying liability
categories such as time deposits, are scheduled according to their contractual
maturities. The "static gap analysis" provides a representation of the Company's
earnings sensitivity to changes in interest rates. It is a static indicator and
does not reflect various repricing characteristics. Accordingly, a "static gap
analysis" may not necessarily be indicative of the sensitivity of net interest
income in a changing rate environment.
ASSET AND LIABILITY MATURITY REPRICING SCHEDULE
AS OF September 30, 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 $ 26 126 $ 19 245 $ 14 977 $ 66 515 $ 46 000 $172 863
Loans and leases
Variable rate 320 609 7 009 17 780 18 777 0 364 175
Fixed rate 46 925 19 312 38 645 157 673 7 143 269 698
-------- -------- -------- -------- -------- --------
Total loans and leases $367 534 $ 26 321 $ 56 425 $176 450 $7 143 $633 873
-------- -------- -------- -------- -------- --------
Total earning assets $393 660 $ 45 566 $ 71 402 $242 965 $ 53 143 $806 736
======== ======== ======== ======== ======== ========
Interest bearing liabilities:
NOW Accounts $ 14 396 $ 0 $ 0 $ 43 189 $ 0 $ 57 585
Savings Deposits 156 148 0 0 44 868 0 201 016
Time Deposits 71 877 35 393 126 675 159 815 0 393 760
Borrowed Funds 45 779 52 0 35 054 0 80 885
Trust Preferred Stock 0 0 0 0 16 100 16 100
======== ======== ========= ======== ======== ========
Total interest bearing $288 200 $ 35 445 $ 126 675 $282 926 $ 16 100 $749 346
======== ======== ========= ======== ======== ========
Liabilities
Interest sensitivity gap (within $105 460 $ 10 121 $(55 273) $(39 961) $ 37 043 $ 57 390
periods)
Cumulative interest sensitivity gap $105 460 $115 581 $60 308 $20 347 $ 57 390
Ratio of cumulative interest 13.07% 14.33% 7.48% 2.52% 7.11%
Sensitivity gap to rate
Sensitive assets
Ratio of rate sensitive assets 136.59% 128.55% 56.37% 85.88% 330.08%
To rate sensitive
Liabilities
Cumulative ratio of rate 136.59% 135.71% 113.39% 102.77% 107.66%
35
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 3.6% if rates rose by a 100 basis point shock, and
projected that net interest income would decrease by approximately 8.2% if rates
fell by a 100 basis point shock under these scenarios for the period ended
September 30, 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 rate risk position through the ALCO process.
Management's philosophy is to maintain relatively matched rate sensitive asset
and liability positions within the range described above in order to provide
earnings stability in the event of significant interest rate changes.
Capital Resources
Shareholders' equity at September 30, 2002 increased $5.4 million or 9.0% to
$64.5 million, compared with $59.1 million at end of year 2001. This increase
includes a change of $1.7 million 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 $3.6 million or 6.2% for
the period between September 30, 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 liquidity. Under
applicable regulatory guidelines, the Trust Preferred Securities qualify as Tier
1 capital up to a maximum of 25% of Tier 1 capital. As of September 30, 2002,
$16.1 million of the Trust Preferred Securities qualify as Tier 1 Capital.
36
Cash dividends paid for the first nine months of 2002 were $0.36 per share
compared with $0.33 in the first nine months 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 nine months 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 September 30, 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%.
The following table presents the Company's and the Bank's capital ratios as of
September 30, 2002 and December 31, 2001:
(Dollars in thousands)
37
To Be Well
Capitalized
Under Prompt
For Capital Corrective
Actual Adequacy Action
----- Purposes Provisions
-------- ----------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
As of September 30, 2002
Total Capital (to
Risk Weighted Assets)
Company 80,915 10.98% 58,932 8.00% 73,665 10.00%
Bank 77,559 10.52% 58,967 8.00% 73,708 10.00%
Tier 1 Capital(to
Risk Weighted Assets)
Company 71,706 9.73% 29,466 4.00% 44,199 6.00%
Bank 68,344 9.27% 29,483 4.00% 44,225 6.00%
Tier 1 Capital (to
Average Assets)
Company 71,706 8.15% 35,211 4.00% N/A N/A
Bank 68,344 7.76% 35,211 4.00% 44,014 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.
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.
38
The Company's earnings are derived from the operations of its direct and
indirect subsidiaries with particular reliance on net interest income,
calculated as the difference between interest earned on loans and investments
and the interest expense paid on deposits and other interest bearing
liabilities, including advances from FHLB and other borrowings. Like other
financial institutions, the Company's interest income and interest expense are
affected by general economic conditions and by the policies of regulatory
authorities, including the monetary policies of the Board of Governors of the
Federal Reserve System. Changes in the economic environment may influence, among
other matters, the growth rate of loans and deposits, the quality of the loan
portfolio and loan and deposit pricing. Fluctuations in interest rates are not
predictable or controllable.
As of September 30, 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.
Item 4. Controls and Procedures.
(a). Evaluation of disclosure controls and procedures. Based on their evaluation
as of a date within 90 days of the filing date of this Quarterly Report on Form
10-Q, the Company's principal executive officer and principal financial officer
have concluded that the Company's disclosure controls and procedures (as defined
in Rules 13 a - 14(c) under the Securities Exchange Act of 1934 (the "Exchange
Act") are effective to ensure that information required to be disclosed by the
Company in reports that it files or submits under the Exchange Act is recorded,
processed, summarized and reported within the time periods specified in
Securities and Exchange Commission rules and forms.
(b). Changes in internal controls. There were no significant changes in the
Company's internal controls or other factors that could significantly affect
these controls subsequent to the date of their evaluation, including any
corrective actions with regards to significant deficiencies and material
weaknesses.
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.
39
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
(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
99.1 Certification pursuant to 18 U.S.C. Section 1350
99.2 Certification pursuant to 18 U.S.C. Section 1350
(b). Report on Form 8-K:
None
40
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
BAYLAKE CORP.
--------------------------------------------
Date: November 13, 2002 /s/ Thomas L. Herlache
------------------------------- --------------------------------------------
Thomas L. Herlache
President (CEO)
Date: November 13, 2002 /s/ Steven D. Jennerjohn
------------------------------- -------------------------------------------
Steven D. Jennerjohn
Treasurer (CFO)
41
SECTION 302 CERTIFICATION
I, Thomas L. Herlache, President and Chief Executive Officer, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Baylake
Corp;
2. Based on my knowledge, this quarterly report does not contain
any untrue statement of a material fact or omit to state a
material fact necessary to make the statements made, in light
of the circumstances under which such statements were made,
not misleading with respect to the period covered by this
quarterly report;
3. Based on my knowledge, the financial statements, and other
financial information included in this quarterly report,
fairly present in all material respects the financial
condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this
quarterly report.
4. The registrant's other certifying officers and I are
responsible for establishing and maintaining disclosure
controls and procedures (as defined in Exchange Act Rules
13a-14 and 15d-14) for the registrant and we have:
a) Designed such disclosure controls and procedures to
ensure that material information relating to the
registrant, including its consolidated subsidiaries,
is made known to us by others within those entities,
particularly during the period in which this
quarterly report is being prepared.
b) Evaluated the effectiveness of the registrant's
disclosure controls and procedures as of a date
within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) Presented in this quarterly report our conclusions
about the effectiveness of the disclosure controls
and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have
disclosed, based on our most recent evaluation, to the
registrant's auditors and the audit committee of registrant's
board of directors (or persons performing the equivalent
function):
a) All significant deficiencies in the design or
operation of internal controls which could adversely
affect the registrant's ability to record, process,
summarize and report financial data and have
identified for the registrant's auditors any material
weaknesses in internal controls; and
b) Any fraud, whether or not material, that involves
management or other employees who have a significant
role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have
indicated in this quarterly report whether or not there were
significant changes in internal controls or in other factors
that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and
material weaknesses.
42
Date: November 13, 2002 /s/ Thomas L. Herlache
----------------------
Thomas L. Herlache
President and Chief Executive Officer
43
SECTION 302 CERTIFICATION
I, Steven D. Jennerjohn, Treasurer and Chief Financial Officer, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Baylake
Corp;
2. Based on my knowledge, this quarterly report does not contain
any untrue statement of a material fact or omit to state a
material fact necessary to make the statements made, in light
of the circumstances under which such statements were made,
not misleading with respect to the period covered by this
quarterly report;
3. Based on my knowledge, the financial statements, and other
financial information included in this quarterly report,
fairly present in all material respects the financial
condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this
quarterly report.
4. The registrant's other certifying officers and I are
responsible for establishing and maintaining disclosure
controls and procedures (as defined in Exchange Act Rules
13a-14 and 15d-14) for the registrant and we have:
a) Designed such disclosure controls and procedures to
ensure that material information relating to the
registrant, including its consolidated subsidiaries,
is made known to us by others within those entities,
particularly during the period in which this
quarterly report is being prepared.
b) Evaluated the effectiveness of the registrant's
disclosure controls and procedures as of a date
within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) Presented in this quarterly report our conclusions
about the effectiveness of the disclosure controls
and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have
disclosed, based on our most recent evaluation, to the
registrant's auditors and the audit committee of registrant's
board of directors (or persons performing the equivalent
function):
a) All significant deficiencies in the design or
operation of internal controls which could adversely
affect the registrant's ability to record, process,
summarize and report financial data and have
identified for the registrant's auditors any material
weaknesses in internal controls; and
b) Any fraud, whether or not material, that involves
management or other employees who have a significant
role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have
indicated in this quarterly report whether or not there were
significant changes in internal controls or in other factors
that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and
material weaknesses.
44
Date: November 13, 2002 /s/ Steven D. Jennerjohn
------------------------
Steven D. Jennerjohn
Treasurer and Chief Financial Officer
45