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 JUNE 30, 2003
------------------------------------------------
OR
{ } TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
------------------ --------------------
Commission file number 0-8679
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BAYLAKE CORP.
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Wisconsin 39-1268055
- --------------------------------------------------------------------------------
(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 August 10, 2003: 7,542,176 shares
BAYLAKE CORP. AND SUBSIDIARIES
INDEX
PART 1 -- FINANCIAL INFORMATION PAGE NUMBER
Item 1. Financial Statements
Consolidated Condensed Balance Sheet as of June 30, 2003 3 - 4
and December 31, 2002
Consolidated Condensed Statement of Income for the three 5 - 6
and six months ended June 30, 2003 and 2002
Consolidated Statement of Comprehensive Income for the three 7
and six months ended June 30, 2003 and 2002
Consolidated Statement of Cash Flows for the six months ended 8 - 9
June 30, 2003 and 2002
Notes to Consolidated Condensed Financial Statements 10 - 11
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 12 - 33
Item 3. Quantitative and Qualitative Disclosures About Market Risk 34
Item 4. Controls and Procedures 35
PART II -- OTHER INFORMATION 35
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 36
EXHIBIT INDEX 35 - 36
Exhibit 11 Statement re: computation of per share earnings 41
Exhibit 15 Letter re: unaudited interim financial information 42
Exhibit 31.1 Certification pursuant to Section 302 37
Exhibit 31.2 Certification pursuant to Section 302 38
Exhibit 32.1 Certification pursuant to 18 U.S.C. Section 1350 39
Exhibit 32.2 Certification pursuant to 18 U.S.C. Section 1350 40
2
PART 1 -- FINANCIAL INFORMATION
BAYLAKE CORP. AND SUBSIDIARIES
CONSOLIDATED CONDENSED BALANCE SHEET (UNAUDITED)
(dollars in thousands)
JUNE 30 DECEMBER 31,
ASSETS 2003 2002
---- ----
Cash and due from banks $ 21,204 $ 33,300
Federal funds sold 9 0
-------- --------
Cash and cash equivalents 21,213 33,300
Investment securities available for sale (at market) 137,428 133,139
Investment securities held to maturity (market 17,345 18,227
value $17,781 and $18,524, at June 30, 2003 and
December 31, 2002, respectively)
Loans held for sale 1,538 1,602
Loans 678,036 664,285
Less: Allowance for loan losses 12,885 11,410
-------- --------
Loan, net of allowance for loan losses 665,151 652,875
Bank premises and equipment 21,466 23,446
Federal Home Loan Bank stock (at cost) 7,009 6,713
Accrued interest receivable 4,546 4,580
Income taxes receivable 559 340
Deferred income taxes 2,401 2,878
Goodwill 4,969 4,969
Other Assets 26,376 22,587
-------- --------
Total Assets $910,001 $904,656
======== ========
LIABILITIES
Domestic deposits
Non-interest bearing $ 88,703 $ 89,848
Interest bearing
NOW 74,202 64,281
Savings 194,843 195,232
Time, $100,000 and over 176,795 176,605
Other time 213,376 214,358
-------- --------
Total interest bearing 659,216 650,476
-------- --------
Total deposits 747,919 740,324
Short-term borrowings
Federal funds purchased, repurchase 5,932 10,056
agreements and Federal Home Loan Bank
advances
Accrued expenses and other liabilities 6,496 6,698
Dividends payable 0 972
Other borrowings 65,000 65,000
Long-term debt 53 106
Guaranteed preferred beneficial interest in the 16,100 16,100
company's junior subordinated debt -------- --------
Total liabilities 841,500 839,256
-------- --------
3
SHAREHOLDERS' EQUITY
Common stock, $5 par value: authorized 37,802 37,532
10,000,000 shares issued 7,560,335 shares as of June
30, 2003 and 7,506,435 as of December 31, 2002;
outstanding 7,537,176 as of June 30, 2003 and
7,483,276 as of December 31, 2002
Additional paid-in capital 7,629 7,373
Retained earnings 19,643 17,903
Treasury Stock (625) (625)
Net unrealized gain on securities available
for sale, net of tax of $2,161 as of June 30,
2003 and $1,716 as of December 31, 2002 4,052 3,217
-------- --------
Total shareholders' equity 68,501 65,400
--------- --------
Total liabilities and shareholders' equity $910,001 $904,656
======== ========
4
BAYLAKE CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(dollars in thousands, except per share amounts)
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30 JUNE 30
2003 2002 2003 2002
---- ---- ---- ----
Interest income
Interest and fees on loans $10,194 $10,887 $20,390 $21,321
Interest on investment securities
Taxable 1,053 1,609 2,104 3,191
Exempt from federal income taxes 608 666 1,253 1,354
Other interest income 9 4 15 16
------- ------- ------- -------
Total interest income 11,864 13,166 23,762 25,882
Interest expense
Interest on deposits 3,977 4,212 8,073 8,595
Interest on short-term borrowings 26 180 50 306
Interest on other borrowings 553 726 1,108 1,542
Interest on long-term debt 1 2 2 3
Interest on guaranteed preferred beneficial
interest in the company's junior
subordinated debt 411 412 822 823
------- ------- ------- -------
Total interest expense 4,968 5,532 10,055 11,269
------- ------- ------- -------
Net interest income 6,896 7,634 13,707 14,613
Provision for loan losses 1,032 546 1,925 1,046
------- ------- ------- -------
Net interest income after provision for
loan losses 5,864 7,088 11,782 13,567
------- ------- ------- -------
Other income
Fees from fiduciary activities 159 143 293 324
Fees from loan servicing 600 219 1,062 492
Fees for other services to customers 1,025 907 2,099 1,983
Gains from sales of loans 618 179 1,043 444
Gains from sale of subsidiary 0 0 350 0
Other income 342 685 541 776
------- ------- ------- -------
Total other income 2,744 2,133 5,388 4,019
------- ------- ------- -------
Other expenses
Salaries and employee benefits 3,645 3,563 7,346 6,805
Occupancy expense 478 572 947 1,015
Equipment expense 423 399 816 785
Data processing and courier 266 252 538 507
Operation of other real estate 34 66 137 210
Other operating expenses 1,233 1,221 2,327 2,455
------- ------- ------- -------
Total other expenses 6,079 6,073 12,111 11,777
------- ------- ------- -------
Income before income taxes 2,529 3,148 5,059 5,809
Income tax expense 662 958 1,366 1,746
------- ------- ------- -------
Net Income $ 1,867 $ 2,190 $ 3,693 $ 4,063
======= ======= ======= =======
5
Basic earnings per common share (1) $ 0.25 $ 0.29 $ 0.49 $ 0.54
Diluted earnings per common share (1) $ 0.24 $ 0.28 $ 0.48 $ 0.53
Cash dividends per share $ 0.13 $ 0.12 $ 0.26 $ 0.24
(1) Based on 7,506,591 average shares outstanding in 2003 and 7,471,576 in
2002.
6
BAYLAKE CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME (UNAUDITED)
(dollars in thousands)
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
2003 2002 2003 2002
---- ---- ---- ----
Net Income $1,867 $2,190 $3,693 $4,063
------ ------ ------ ------
Other comprehensive income, net of tax:
Unrealized losses on securities:
Unrealized losses arising during period 988 1,420 835 1,283
------ ------ ------ ------
Comprehensive income $2,855 $3,610 $4,528 $5,346
====== ====== ====== ======
7
BAYLAKE CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASHFLOWS (UNAUDITED)
(dollars in thousands)
SIX MONTHS ENDED JUNE
30
2003 2002
---- ----
Cash flows from operating activities: Interest received from:
Loans $ 20,137 $ 21,131
Investments 4,040 4,555
Fees and service charges 4,473 3,686
Interest paid to depositors (8,164) (9,180)
Interest paid to others (1,998) (2,776)
Cash paid to suppliers and employees (14,441) (11,011)
Income taxes paid (1,569) (477)
-------- --------
Net cash provided by operating activities 2,478 5,928
Cash flows from investing activities:
Principal payments received on investments 42,188 42,112
Purchase of investments (45,002) (30,798)
Purchase of insurance contracts 0 (13,000)
Proceeds from sale of other real estate owned 1,304 1,305
Proceeds from sale of subsidiary's assets 1,884 0
Loans made to customers in excess of principal collected (15,181) (24,828)
Capital expenditures (775) (3,582)
-------- --------
Net cash used in investing activities (15,582) (28,791)
Cash flows from financing activities:
Net decrease in demand deposits, NOW accounts, and savings 8,386 (11,376)
Accounts
Net increase (decrease) in short term borrowing (4,124) 17,187
Net increase in time deposits (792) 30,293
Proceeds from other borrowings and long-term debt 0 (15,000)
Payments on other borrowings and long term debt
(53) (53)
Proceeds from issuance of common stock 525 0
Dividends paid (2,925) (2,690)
-------- --------
Net cash provided by financing activities 1,017 18,361
-------- --------
Net decrease in cash and cash equivalents (12,087) (4,502)
Cash and cash equivalents, beginning 33,300 24,033
-------- --------
Cash and cash equivalents, ending $ 21,213 $ 19,531
======== ========
8
JUNE 30
2003 2002
---- ----
Reconciliation of net income to net cash provided by operating
activities:
Net income $ 3,693 $ 4,063
Adjustments to reconcile net income to net cash provided by
operating Activities:
Depreciation 871 811
Provision for losses on loans and real estate owned 1,925 1,046
Amortization of premium on investments 474 103
Accretion of discount on investments (85) (69)
Cash surrender value increase (336) (42)
(Gain) Loss from disposal of ORE (25) 67
Gain on sale of loans (1,043) (444)
Proceeds from sale of loans held for sale 82,185 33,821
Originations of loans held for sale (81,142) (33,377)
Gain on sale of subsidiary (350) 0
Equity in income of service center (135) (138)
Amortization of mortgage servicing rights 185 176
Mortgage servicing rights booked (259) (91)
Deferred compensation 210 128
Changes in assets and liabilities:
Interest receivable 35 (19)
Prepaids and other assets (3,119) (620)
Unearned income (8) 11
Interest payable (106) (688)
Taxes payable (203) 1,268
Other liabilities (289) 29
-------- --------
Total adjustments (1,215) 1,865
-------- --------
Net cash provided by operating activities $ 2,478 $ 5,928
======== ========
9
BAYLAKE CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2003
1. The accompanying unaudited consolidated financial statements should be
read in conjunction with Baylake Corp.'s 2002 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 June 30, 2003 and December 31, 2002. The
results of operations for the three and six months ended June 30, 2003
and 2002 are not necessarily indicative of results to be expected for
the entire year.
2. The book value of investment securities, by type, held by Baylake Corp.
are as follows:
JUNE 30, DECEMBER 31,
2003 2002
---- ----
(dollars in thousands)
Investment securities held to maturity:
Obligations of state and political subdivisions $ 17,345 $ 18,227
-------- --------
Investment securities held to maturity $ 17,345 $ 18,227
======== ========
Investment securities available for sale:
U.S. Treasury and other U.S. government agencies $ 38,882 $ 40,593
Obligations of states and political subdivisions 36,845 37,654
Mortgage-backed securities 53,311 50,851
Other 8,390 4,041
-------- --------
Investment securities available for sale $137,428 $133,139
======== ========
3. At June 30, 2003 and December 31, 2002, loans were as follows:
JUNE 30 DECEMBER 31,
2003 2002
---- ----
(dollars in thousands)
Commercial, financial and agricultural $ 90,495 $ 89,207
Real estate-commercial 375,096 351,425
Real estate -- construction 66,045 75,688
Real estate -- mortgage 131,650 133,365
Installment 15,058 14,916
Less: Deferred loan origination fees, net of costs (308) (316)
--------- ---------
$ 680,728 $ 664,285
Less allowance for loan losses (12,885) (11,410)
--------- ---------
Net loans $ 665,151 $ 652,875
========= =========
10
4. Baylake Corp. declared a cash dividend of $0.13 per share payable on
June 16, 2003 to shareholders of record as of June 2, 2003.
5. The Company has a non-qualified stock option plan, which is described
more fully in the Company's December 31, 2002 Annual Report on Form
10-K. The Company accounts for this plan under the recognition and
measurement principles of APB Opinion No. 25, "Accounting for Stock
Issued to Employees," and related interpretations. No stock-based
employee compensation cost is reflected in net income, as all options
granted under these plans had an exercise price at least equal to the
fair market value of the underlying common stock on the grant date. The
following table illustrates the effect on net income and earnings per
share if the Company had applied the fair value provisions of SFAS 123
"Accounting for Stock-Based Compensation," to stock-based employee
compensation.
Three and Six months ended June 30
Three months ended June 30, Six months ended June 30,
(In thousands, except per share amounts)
2003 2002 2003 2002
---- ---- ---- ----
Net income, as reported $ 1,867 $ 2,190 $ 3,693 $ 4,063
Less: Total stock-based employee
compensation cost determined under
the fair value based method, net of
income taxes (114) (133) (158) (188)
--------- --------- --------- ---------
Pro forma net income 1,753 2,057 3,535 3,875
Earnings per share:
Basic -- as reported $ 0.25 $ 0.29 $ 0.49 $ 0.54
Basic -- pro forma $ 0.23 $ 0.27 $ 0.47 $ 0.52
Diluted -- as reported $ 0.24 $ 0.28 $ 0.48 $ 0.53
Diluted -- pro forma $ 0.23 $ 0.27 $ 0.47 $ 0.52
11
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 six months ended June 30, 2003
and 2002 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 June 30, 2003, since that
amount, if any, is not estimable.
Forward-Looking Information
This discussion and analysis of financial condition and results of operations,
and other sections of this report, may contain forward-looking statements that
are based on the current expectations of management. Such expressions of
expectations are not historical in nature and are forward-looking statements
within the meaning of the Private Securities Litigation Reform Act of 1995.
Words such as "anticipates," "believes," "estimates," "expects," "forecasts,"
"intends," "is likely," "plans," "projects," and other such words are intended
to identify in such forward-looking statements. The statements contained herein
and in such forward-looking statements involve or may involve certain
assumptions, risks and uncertainties, many of which are beyond the control of
the Company, that may cause actual future results to differ materially from what
may be expressed or forecasted in such forward-looking statements. Readers
should not place undue expectations on any forward-looking statements. In
addition to the assumptions and other factors referenced specifically in
connection with such statements, the following factors could impact the business
and financial prospects of the relationships; demand for 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 June 30, 2003, earnings decreased $323,000, or 14.7%,
to $1.9 million from $2.2 million for the second quarter last year. Basic
operating earnings per share of $0.25 was reported for the quarter ended June
30, 2003 compared to $0.29 for the same period last year, a decrease of 13.8%.
On a fully diluted basis, the Company recorded $0.24 per share for the second
quarter in 2003 and $0.28 for the same period in 2002.
12
TABLE 1
SUMMARY RESULTS OF OPERATIONS
($ IN THOUSANDS, EXCEPT PER SHARE DATA)
Three months Three months Six months ended Six months ended
ended June 30, ended June 30, June 30, 2003 June 30, 2002
2003 2002
Net income, as 1,867 2,190 3,693 4,063
reported
EPS-basic, as reported 0.25 0.29 0.49 0.54
EPS-diluted, as 0.24 0.28 0.48 0.53
reported
Return on average 0.83% 1.02% 0.83% 0.96%
assets, as reported
Return on average 11.14% 14.38% 11.18% 13.52%
equity, as reported
Efficiency ratio, as 61.08% 60.07% 61.35% 60.93%
reported (1)
(1) 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 June 30, 2003 were 0.83% and 11.14%, respectively, compared
to 1.02% and 14.38%, respectively, for the same period a year ago.
The decrease in net income for the period is primarily due to decreased net
interest income, an increase in provision for loan loss and an increase in other
expenses offset to a lesser extent by an increase in other income and a
reduction in income tax expense.
Cash dividends declared in the second quarter of 2003 increased 8.3% to $0.13
per share compared with $0.12 for the same period in 2002.
For the six months ended June 30, 2003, net income decreased $370,000 or 9.1% to
3.7 million from $4.1 million for the same period a year earlier. The change in
net income for the six months ended June 30, 2003 is due to the same reasons as
listed previously. Basic operating earnings per share decreased to $0.49
compared to $0.54 per share for the six months ended June 30, 2002. On a fully
diluted basis, the Company reported $0.48 per share for the first six months of
2003 and $0.53 for the same period a year earlier.
Cash dividends declared for the first six months of 2003 increased 8.3% to $0.26
per share compared with $0.24 for the same period in 2002.
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 72.7% of
total operating income for the first six months of 2003, as compared to 79.2%
for the same period in 2002. 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
13
interest income. This analysis discusses net interest income on a tax-equivalent
basis in order to provide comparability among the various types of earned
interest income. Tax-exempt interest income is adjusted to a level that reflects
such income as if it were fully taxable.
Net interest income on a tax equivalent basis for the three months ended June
30, 2003 decreased $769,000, or 9.6%, to $7.2 million from $8.0 million for the
same period a year ago. As a result of a lower interest rate environment, total
interest income for the second quarter of 2003 decreased $1.3 million, or 9.9%,
to $12.2 million from $13.5 million for the second quarter of 2002, while
interest expense in the second quarter of 2003 decreased $564,000, or 10.2%, to
$5.0 million when compared to $5.5 million in the second quarter of 2002. The
major contributing factor to the decline in net interest income was net interest
margin compression due to the asset sensitive position of Baylake's balance
sheet. This margin compression was due to continued downward repricing of
earning assets without a point-for-point decrease in interest bearing liability
rates. The effect of the 50 basis point decrease in the prime lending rate in
the latter part of the fourth quarter of 2002 impacted interest income for the
second quarter. The decrease in net interest income between these two quarterly
periods occurred in spite 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. The decline in total interest expense
in the second quarter of 2003 versus the second quarter of 2002 did not offset
the decline in interest income.
For the three months ended June 30, 2003, average-earning assets increased $44.4
million, or 5.6%, when compared to the same period last year. The Company
recorded an increase in average loans of $57.7 million, or 9.2%, for the second
quarter of 2003 compared to the same period a year ago. Loans have typically
resulted in higher rates of interest income to the Company than have investment
securities.
Interest rate spread is the difference between the tax-equivalent rate earned on
average earning assets and the rate paid on average interest-bearing
liabilities. The interest rate spread decreased for the quarter ended June 30,
2003 when compared to the same period a year ago. The interest rate spread
decreased 58 basis points to 3.19% at June 30, 2003 from 3.77% in the same
quarter in 2002. While the average yield on earning assets decreased 100 basis
points during the period, the average rate paid on interest-bearing liabilities
decreased 42 basis points over the same period as a result of a lower cost of
funding from deposits and other wholesale funding such as federal funds
purchased and loans from the Federal Home Loan Bank.
TABLE 2
NET INTEREST INCOME ANALYSIS ON A TAX-EQUIVALENT BASIS
($ IN THOUSANDS)
THREE MONTHS ENDED JUNE 30,
2003 2002
---- ----
Average Interest Average Average Interest Average
Balance income/exp yield/rate Balance income/exp yield/rate
ASSETS
Earning assets:
Loans, net (1)(2)(3) $ 683,450 $ 625,799
Less: non-accrual loans (9,694) (15,535)
--------- ---------
Loans, net 673,756 $ 10,194 6.07% 610,264 $ 10,887 7.16%
Investments 158,213 1,974 5.00% 179,769 2,618 5.84%
Other earning assets 2,862 9 1.26% 425 4 3.78%
--------- - ----- --------- - -----
Total earning assets $ 834,831 $ 12,176 5.85% $ 790,458 $ 13,509 6.85%
Allowance for loan (12,602) (8,597)
14
losses
Non-accrual loans 9,694 15,535
Cash and due from banks 16,064 16,900
Other assets 58,844 44,428
--------- ---------
Total assets $ 906,830 $ 858,724
--------- ---------
LIABILITIES AND
STOCKHOLDER'S EQUITY
Interest-bearing
liabilities:
NOW accounts $ 67,401 $ 176 1.05% $ 47,607 $ 108 0.91%
Savings accounts 190,908 461 0.97% 189,759 773 1.63%
Time deposits > $100M 185,526 1,501 3.25% 162,259 1,590 3.93%
Time deposits < $100M 217,868 1,838 3.38% 193,183 1,741 3.61%
--------- -------- ----- --------- -------- -----
Total interest-bearing 661,702 3,976 2.41% 592,808 4,212 2.85%
deposits
Short-term borrowings 6,308 24 1.53% 32,984 169 2.06%
Customer repurchase 892 2 0.90% 2,665 11 1.66
agreements
Other borrowings 65,000 555 3.46% 74,998 728 3.89%
Long term debt 53 1 7.65% 107 1 3.79%
Trust preferred 16,100 411 10.35% 16,100 411 10.35%
securities
Total interest-bearing $ 750,055 $ 4,968 2.66% $ 719,662 $ 5,532 3.08%
liabilities --------- -------- ----- --------- -------- -----
Demand deposits 81,143 70,623
Accrued expenses and 8,397 7,412
other liabilities
Stockholders' equity 67,236 61,069
--------- ---------
Total liabilities and $ 906,830 $ 858,724
stockholders' equity --------- ---------
Interest rate spread $ 7,208 3.19% $ 7,977 3.77%
Contribution of free 0.27% 0.28%
funds ---- -----
Net interest margin 3.46% 4.05%
---- -----
15
TABLE 2 (CONT'D)
NET INTEREST INCOME ANALYSIS ON A TAX-EQUIVALENT BASIS
($ IN THOUSANDS)
SIX MONTHS ENDED JUNE 30,
2003 2002
---- ----
Average Interest Average Average Interest Average
Balance income/exp yield/rate Balance income/exp yield/rate
ASSETS
Earning assets:
Loans, net (1)(2)(3) $ 678,582 $ 619,508
Less: non-accrual loans (11,020) (13,749)
--------- ---------
Loans, net 667,562 $ 20,390 6.16% 605,759 $ 21,320 7.10%
Investments 158,107 4,002 5.10% 178,016 5,241 5.94%
Other earning assets 2,480 15 1.22% 1,972 18 1.84%
--------- -------- ----- --------- -------- -----
Total earning assets $ 828,149 $ 24,407 5.94% $ 785,747 $ 26,579 6.82%
Allowance for loan losses (12,222) (8,412)
Non-accrual loans 11,020 13,749
Cash and due from banks 17,646 16,762
Other assets 59,132 45,102
--------- ---------
Total assets $ 903,725 $ 852,948
--------- ---------
LIABILITIES AND
STOCKHOLDER'S EQUITY
Interest-bearing
liabilities:
NOW accounts $ 65,776 $ 340 1.04% $ 47,275 $ 203 0.87%
Savings accounts 193,695 982 1.02% 206,650 1,623 1.58%
Time deposits > $100M 184,762 3,057 3.34% 152,928 3,093 4.08%
Time deposits < $100M 217,211 3,693 3.43% 184,178 3,676 4.03%
--------- -------- ----- --------- -------- -----
Total interest-bearing 661,444 8,072 2.46% 591,031 4,212 2.93%
deposits
Short-term borrowings 5,829 43 1.49% 28,103 283 2.03%
Customer repurchase 1,284 7 1.10% 2,705 23 1.71%
agreements
Other borrowings 65,000 1,109 3.44% 77,817 1,542 4.00%
Long term debt 53 1 3.80% 106 3 5.71%
Trust preferred 16,100 823 10.31% 16,100 823 10.31%
securities
Total interest-bearing $ 749,710 $ 10,055 2.70% $ 715,862 $ 11,269 3.17%
liabilities --------- -------- ----- --------- -------- -----
Demand deposits 79,124 69,257
Accrued expenses and 8,303 7,233
other liabilities
Stockholders' equity 66,588 60,596
--------- ---------
16
Total liabilities and $ 903,725 $ 852,948
stockholders' equity --------- ---------
Interest rate spread $ 14,351 3.24% $ 15,310 3.65%
Contribution of free 0.26% 0.28%
funds ----- -----
Net interest margin 3.49% 3.93%
----- -----
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 June 30, 2003 decreased from 4.05% to 3.46% compared to the same period a
year ago. The average yield on interest earning assets amounted to 5.85% for the
second quarter of 2003, representing a decrease of 100 basis points from the
same period last year. Total loan yields decreased 109 basis points to 6.07%,
while total investment yields decreased 84 basis points to 5.00%, as compared to
the same period a year ago. The Company's average cost on interest-bearing
deposit liabilities decreased 42 basis points to 2.66% for the second quarter of
2003 when compared to the second quarter of 2002, while short-term borrowing
costs decreased 53 basis points to 1.53% comparing the two periods. Other
borrowing costs decreased 43 basis points to 3.46% during the same time period.
These factors contributed to a decrease in the Company's interest margin for the
three months ended June 30, 2003 compared to the same period a year ago.
The ratio of average earning assets to average total assets measures
management's ability to employ overall assets for the production of interest
income. This ratio was 92.1% for the second quarter of 2003 and 2002. The ratio
was the same for both periods as a result of growth in earning assets offset by
a decrease in non-accrual loans.
Net interest income on a tax equivalent basis for the six months ended June 30,
2003 decreased $959,000, or 6.3%, to $14.4 million from $15.3 million for the
same period a year earlier. As a result of a lower interest rate environment,
total interest income for the six months ended June 30, 2003 decreased $2.2
million to $24.4 million from $26.6 million for the same period a year ago.
Interest expense decreased $1.2 million, or 10.8%, to $10.1 million from $11.3
million for the same comparable periods. Decrease in net interest income
occurred primarily as a result of the reasons listed earlier.
For the six months ended June 30, 2003, average-earning assets increased $42.4
million, or 5.4%, when compared to the same period last year. The Company
recorded an increase in average loans of $59.1 million or 9.5% for the first six
months of 2003 when compared the same period a year earlier. Loans have
Typically resulted in higher rates of interest of interest income to the Company
than have investment securities.
The interest rate spread decreased 41 basis points to 3.24% for the six months
ended June 30, 2003 from 3.65% for the same period in 2002. While the average
yield on earning assets decreased 88 basis points during the period, the average
rate paid on interest-bearing liabilities decreased 47 basis points over the
same period as a result of a lower cost of funding from deposits and other
wholesale funding sources such as loans from the Federal Home Loan Bank.
Net interest margin (on a federal tax-equivalent basis) for the six months ended
June 30, 2003 decreased 44 basis points from 3.93% to 3.49% compared to the same
period last year. The average on interest earning assets amounted to 5.94% for
the six months ended June 30, 2003, representing a decrease of 88 basis points
from the same period a year earlier. Total loan yields decreased 94 basis points
to 5.94%, while total investment yields decreased 84 basis points to 5.10%
compared to the same period a year ago. The Company's average cost on interest
bearing deposit liabilities 47 basis points to 2.46% for the six months ended
June 30, 2003 when compared to the same period a year ago, while short-term
borrowing costs decreased 54 basis points to 1.49%, comparing the two periods.
Other borrowing costs decreased 56 basis
17
points to 3.44% over the same time horizon. These factors contributed to a
decrease in the Company's interest margin for the six months ended June 30, 2003
compared to the same period a year ago.
The ratio of average earning assets to average total assets was 91.6% in the
first six months of 2003 compared with 92.2% for the same period in 2002.
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 non-performing 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 June 30, 2003 increased
$486,000 to $1.0 million compared with $546,000 for the second quarter of 2002.
For the six months ended June 30, 2003, the provision for loan losses increased
$879,000 to $1.9 million compared with $1.0 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 $611,000, or 28.6%, to $2.7 million for the
second quarter of 2003 when compared to the second quarter of 2002. This
increase occurred as a result of increased gains from sales of loans, increased
fees from loan servicing and increased income from business owned life insurance
offset to a lesser degree by a decrease in brokerage income, other income,
non-bank subsidiary income and other fee income.
TABLE 3
NONINTEREST INCOME
($ in Thousands)
Second Second Percent YTD YTD Percent
Quarter 2003 Quarter 2002 change 2003 2002 change
Trust 159 143 11.2% 293 324 (9.6%)
Service charges 725 698 3.9% 1,431 1,352 5.8%
on deposit accts
Other fee income 152 169 (10.1%) 315 358 (12.0%)
Loan servicing 600 219 174.0% 1,062 492 115.9%
income
Brokerage 148 165 (10.3%) 228 274 (16.8%)
commissions
Business owned 194 28 592.9% 336 42 700.0%
life insurance
Non-bank 0 300 NM 125 424 (70.5%)
18
subsidiary
income
Gains from 618 179 245.3% 1,043 444 134.9%
sales of loans
Gain from sale 0 0 NM 350 0 NM
of non-bank
subsidiary
Other 148 232 (36.2%) 205 309 (33.7%)
----- ----- ------ ----- ----- -------
Total 2,744 2,133 28.6% 5,388 4,019 34.1%
Trust fees increased $16,000, or 11.2%, in the second quarter of 2003 compared
to the same quarter in 2002, primarily as a result of increased trust estate
business.
Loan servicing fees increased $381,000, or 174.0%, to $600,000 in the second
quarter of 2003, when compared to the same quarter in 2002. The increase in 2003
resulted from an increase in commercial loan servicing income.
Gains on sales of loans in the secondary market increased $439,000 to $618,000
in the second quarter of 2003, when compared to the same quarter in 2002,
primarily as a result of increased gains from sales of mortgage and commercial
loans. Declines in interest rates continue to stimulate mortgage production,
including an increase in refinancing activity, although that trend is expected
to decline in the near future.
Service charges on deposit accounts for the second quarter of 2003 showed an
increase of $27,000, or 3.9%, over 2002 results, accounting for much of the
improvement in fee income generated for other services to customers. Financial
service income decreased $17,000, or 10.3%. Income from business owned life
insurance ("BOLI") amounted to $194,000 for the second quarter of 2003 compared
to $28,000 a year earlier. A $13 million purchase of BOLI had been made in the
second quarter of 2002. Revenues generated from the operation of Arborview LLC
("Arborview") (a subsidiary formed in 2002 to manage a community based
residential facility and sold in the first quarter of 2003) as a result of the
sale were $0 for the second quarter compared to $300,000 a year earlier.
For the first six months of 2003, non-interest income increased $1.4 million, or
34.1%, to $5.4 million from $4.0 million for the same period a year ago.
Trust fee income decreased $31,000, or 9.6%, to $293,000 for the first six
months of 2003 compared to $324,000 for the same period in 2002 as a result of
lower market values on various trust accounts for which fees are assessed.
For the first six months of 2003, service charges on deposit accounts increased
$79,000, or 5.8%, to $1.43 million from $1.35 million for the same period in
2002 as a result of a lower rate environment that has provided lower earnings
credits on transaction accounts resulting in more deposit fees.
Loan servicing fee income increased $570,000, or 115.9%, to $1.1 million for the
first six months of 2003 compared to $492,000 for the same period in 2002.
Income from business owned life insurance increased $294,000 to $336,000 for the
six months ended June 30, 2003 compared to $42,000 for the same period in 2002
based on the purchase made in June 2002.
Gains on sales of loans in the secondary market increased $599,000 to $1.0
million for the first six months of 2003, when compared to the same period in
2002, primarily the result of increased gains from the sales of mortgage loans.
Sales of loans for the six months ended June 30, 2003 increased $81.1 million,
compared to $33.8 million for the same period a year earlier.
19
Gains from the sale of a non-bank subsidiary consisted of a gain made on the
sale of Arborview in February 2003 in the amount of $350,000.
Non-Interest Expense
Non-interest expense increased $6,000, or 0.1%, for the three months ended June
30, 2003 compared to the same period in 2002. Salaries and employee benefits
showed an increase of $174,000, or 5.0%, for the period as a result of
additional staffing to operate new facilities and regular salary and related
benefit increases. Full time equivalent staff increased to 298 persons from 289
a year earlier. A decrease in occupancy expense (amounting to $50,000 or 9.5%)
and an increase in equipment expenses (amounting to $26,000 or 6.5%) occurred as
a result of reduced expansion efforts in 2003 compared to 2002.
TABLE 4
NONINTEREST EXPENSE
($ in Thousands)
Second Second Percent YTD YTD Percent
quarter quarter change 2003 2002 change
2003 2002
Personnel 3,645 3,563 2.3% 7,346 6,805 8.0%
Occupancy 478 572 (16.4%) 947 1,015 (6.7%)
Equipment 423 399 6.0% 816 785 3.9%
Data processing 266 252 5.6% 538 507 6.1%
Business 191 207 (7.7%) 308 294 4.8%
development/advertising
Supplies and printing 138 148 (6.8%) 241 291 (17.2%)
Director fees 106 113 (6.2%) 200 210 (4.8%)
FDIC 30 28 7.1% 59 57 3.5%
Amortization of MSR's 95 93 2.2% 185 176 5.1%
Legal and professional 122 83 47.0% 223 157 42.0%
Operation of other real 34 66 (48.5%) 137 210 (34.8%)
estate
Other 551 549 0.4% 1,111 1,270 (12.5%)
----- ----- ------ ------ ------ ------
Total 6,079 6,073 0.1% 12,111 11,777 2.8%
Expenses related to the operation of other real estate owned decreased $32,000
to $34,000 for the quarter ended June 30, 2003 compared to the same period in
2002. Included in these expenses were net gains taken on the sale of other real
estate owned amounting to $19,000 for the second quarter of 2003 compared to net
losses taken on sale of $24,000 for the same period in 2002. In addition, costs
related to the holding of other real estate owned properties increased $11,000
to $53,000 for the second quarter of 2003.
Other operating expenses increased $12,000, or 1.0%. Legal expense and loan
collection expense increased $39,000 for the three months ended June 30, 2003
primarily as a result of legal issues related to loan collection efforts of one
commercial real estate loan in the process of foreclosure.
In July 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standard ("SFAS") No. 142, "Goodwill and Other
Intangible Assets." SFAS No. 142 requires that goodwill and intangible assets
with indefinite lives no longer be amortized, but instead tested for impairment
as least annually. SFAS No. 142 requires that intangible assets with definite
useful lives be amortized over their respective estimated useful lives to their
estimated residual values, and be reviewed for impairment in accordance with
SFAS No. 144, "Accounting for the Impairment or Disposal of Long-
20
Lived Assets." The adoption of SFAS No. 142 and SFAS No. 144 does not have a
material impact on the Company's financial statements. There was no impairment
for 2002 and impairment testing for 2003 will occur in the third quarter of
2003.
Other items (such as supplies, marketing, telephone, postage and director fees)
comprising other operating expense show a decrease of $165,000 or 12.9% in the
second quarter of 2003 when compared to the same quarter in 2002. The overhead
ratio, which is computed by subtracting non-interest income from non-interest
expense and dividing by average total assets, was 1.48% for the three months
ended June 30, 2003 compared to 1.84% for the same period in 2002.
Non-interest expense increased $334,000, or 2.8%, for the six months ended June
30, 2003 compared to the same period in 2002. Salaries and employee benefits
showed an increase of $541,000, or 8.0%, for the period as a result of
additional staffing to operate new facilities and regular salary and related
benefit increases. A decrease in occupancy expense (amounting to $68,000 or
6.7%) and an increase in equipment expense (amounting to $31,000 or 3.9%)
reflects the reduced activity in expansion activity for the first half of 2003
compared to the same period in 2002.
Operation of other real estate shows a decrease of $73,000. The decrease is
related primarily to net gains taken on the sale of other real estate amounting
to $11,000 in the first six months of 2003 compared to net losses of $47,000
taken in the same period in 2002. Other expenses related to the operation of
other real estate owned amounted to $148,000 for the first six months of 2003.
Other operating expenses decreased $128,000, or 5.2%, for the six months ended
June 30, 2003 when compared to the same period a year ago. Included in these
expenses are costs related to the operation of Arborview of $169,000 in 2003 and
$420,000 in 2002.
The overhead ratio was 1.50% for the six months ended June 30, 2003 compared to
1.84% for the same period in 2002.
Income Taxes
Income tax expense for the Company for the three months ended June 30, 2003 was
$662,000, a decrease of $296,000, or 30.9%, compared to the same period in 2002.
The decrease in income tax provision for the period was due to decreased taxable
income.
Income tax expense for the Company for the six months ended June 30, 2003 was
$1.4 million, a decrease of $380,000, or 21.8%, compared to the same period in
2002.
The Company's effective tax rate (income tax expense divided by income before
taxes) was 27.0% for the six months ended June 30, 2003 compared with 30.1% for
the same period in 2002. The effective tax rate of 27.0% consisted of a federal
effective tax rate of 23.5% and Wisconsin State effective tax rate of 3.5%.
Balance Sheet Analysis
Loans
At June 30, 2003, total loans increased $13.8 million, or 2.1%, to $678.0
million from $664.3 million at December 31, 2002. Growth in the Company's loan
portfolio resulted primarily from an increase in real estate commercial loans to
$375.1 million at June 30, 2003 compared to $351.4 million at December 31, 2002.
In addition, commercial loans increased to $90.5 million at June 30, 2003,
compared to $89.2 million at December 31, 2002. Real estate construction loans
decreased to $66.0 million at June 30, 2003, compared to $75.7 million at
December 31, 2002. Real estate mortgage loans decreased to $131.7 million at
June 30, 2003, compared with $133.4 million at December 31, 2002. Consumer loans
were $15.1 million and $14.9 million at June 30, 2003 and December 31, 2002,
respectively.
21
Growth in commercial real estate mortgages and commercial loans occurred
principally as a result of the Company's expansion efforts (primarily in the
Green Bay market) and the strong economic growth existing in that market.
The following table reflects the composition (mix) of the loan portfolio
(dollars in thousands):
TABLE 5
LOAN PORTFOLIO ANALYSIS
($ in Thousands)
June 30, 2003 December 31,
2002
Amount of loans by type (dollars in thousands)
Real estate-mortgage
Commercial $375,096 $351,425
1-4 family residential
First liens 82,838 86,161
Junior liens 20,873 21,789
Home equity 27,939 25,415
Commercial, financial and agricultural 90,495 89,207
Real estate-construction 66,045 75,688
Installment
Credit cards and related plans 2,152 2,057
Other 12,906 12,859
Less: deferred origination fees, net of costs 308 316
-------- --------
Total $678,036 $664,285
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 non-performing 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
22
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
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 June 30, 2003 was $12.9 million
compared with $11.4 million at the end of 2002. Loans increased 2.1% from
December 31, 2002 to June 30, 2003, 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 six months of 2003. The June 30, 2003 ratio of ALL to
outstanding loans was 1.90% compared with 1.72% at December 31, 2002 and the ALL
as a percentage of non-performing loans was 66.0% at June 30, 2003 compared to
51.7% at end of year 2002. Based on management's analysis of the loan portfolio
risk at June 30, 2003, a provision expense of $1.9 million was recorded for the
six months ended June 30, 2003, an increase of $879,000 or 84.0% compared to the
same period in 2002. Net loan charge-offs of $450,000 occurred in the first six
months of 2003, and the ratio of net charge-offs to average loans for the period
ended June 30, 2003 was 0.19% compared to 0.10% at June 30, 2002. Real estate
mortgage loan net charge-offs represented 54.0% of the total net charge-offs and
commercial loans represented 33.3% of the net charge-offs for the first six
months of 2003. Loans charged-off are subject to periodic review and specific
efforts are taken to achieve maximum recovery of principal and accrued interest.
TABLE 6
ALLOWANCE FOR LOAN LOSSES AND NONPERFORMING ASSETS
($ in thousands)
For the period ended For the period ended For the period ended
June 30, 2003 June 30, 2002 December 31, 2002
Allowance for Loan Losses
("ALL")
Balance at beginning of $11,410 $ 7,992 $ 7,992
period
Provision for loan losses 1,925 1,046 5,700
Charge-offs 856 500 3,055
Recoveries 406 194 773
------- ------- -------
23
Balance at end of period 12,885 8,732 11,410
Net charge-offs ("NCOs") 450 306 2,282
Nonperforming Assets:
Nonaccrual loans $10,987 $17,448 $12,244
Accruing loans past due 90 0 0 0
days or more
Restructured loans 8,528 4,506 9,844
------- ------- -------
Total nonperforming loans $19,515 $21,954 $22,088
("NPLs")
Other real estate owned 668 3,228 2,890
------- ------- -------
Total nonperforming assets $20,183 $25,182 $24,978
("NPAs")
Ratios:
ALL to NCO's (annualized) 14.21 28.54 5.00
NCO's to average loans 0.19% 0.10% 0.36%
(annualized)
ALL to total loans 1.90% 1.38% 1.72%
NPL's to total loans 2.88% 3.48% 3.33%
NPA's to total assets 2.22% 2.90% 2.76%
ALL to NPL's 66.03% 39.85% 51.66%
While management uses available information to recognize losses on loans, future
adjustments to the ALL may be necessary based on changes in economic conditions
and the impact of such change on the Company's borrowers.
Consistent with generally accepted accounting principles ("GAAP") and with the
methodologies used in estimating the unidentified losses in the loss portfolio,
the ALL consists of several components.
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
24
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 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.
TABLE 7
ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES
($ in thousands)
June 30, June 30, Dec 31,
2003 2002 2002
Amount Percent of Amount Percent of Amount Percent of
------ loans to ------ loans to ------ loans to
total loans total loans total loans
----------- ----------- -----------
Commercial, financial $ 4,122 13.34% $ 1,472 13.49% $ 3,679 13.43%
& agricultural
Commercial real estate 5,480 55.29% 4,250 48.52% 4,639 52.85%
Real Estate:
Construction 800 9.74% 380 12.93% 814 11.39%
Residential 1,450 15.30% 1,400 18.61% 1,467 16.25%
Home equity lines 225 4.12% 145 3.88% 228 3.83%
Consumer 160 1.90% 150 2.23% 139 1.94%
Credit card 69 0.31% 67 0.33% 83 0.31%
Loan commitments 279 164 154
Not specifically 300 704 207
allocated -------- -------- --------
Total allowance $ 12,885 100.00% $ 8,732 100.00% $ 11,410 100.00%
Allowance for credit 1.90% 1.38% 1.72%
loss as a percentage
of total loans
Period end loans $678,036 $631,220 $664,285
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 June 30, 2003. 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.
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. 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 June 30, 2003 were $20.2 million compared to $25.0
million at December 31, 2002. Other real estate owned totaled $668,000 and
consisted of six residential and six commercial properties. Other real estate
owned at December 31, 2002 totaled $2.9 million, including an investment in
Arborview, an operating subsidiary of the Company, totaling $2.0 million. This
subsidiary was sold in February 2003, resulting in a gain on sale of
approximately $350,000. Non-accrual loans represented $11.0 million of the total
of non-performing assets at June 30, 2003. Real estate non-accrual loans
accounted for $9.8 million of the total, of which $3.3 million was residential
real estate and $6.5 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. Troubled debt restructured loans
represent $8.5 million of non-performing loans at June 30, 2003 and $9.8 million
at December 31, 2002. Approximately $6.8 million of troubled debt restructured
loans at June 30 consists of two commercial real estate credits which were
granted various payment concessions and had experienced past cash flow problems.
These credits were current at June 30, 2003. Management believes that collateral
is sufficient in those loans classified as troubled debt in event of default,
with the exception that $2.4 million in loan loss provision has been allocated
to a commercial credit totaling $4.0 million (included in credits totaling $6.8
million). Management is monitoring this loan credit on a monthly basis and
working with the borrower to minimize any additional loss exposure. As a result,
the ratio of non-performing loans to total loans at June 30, 2003 was 2.9%
compared to 3.3% at end of year
26
2002. The Company's ALL was 66.0% of total non-performing loans at June 30, 2003
compared to 51.7% at end of year 2002.
Potential problem loans at June 30, 2003 amounted to $2.1 million compared to a
total of $5.2 million at December 31, 2002. $1.1 million of the problem loans
stem from one commercial credit experiencing cash flow concerns. Various
commercial loans totaling $1.0 million make up the balance of the total
potential problem loans. With the exceptions noted above, potential problem
loans are not concentrated in a particular industry but rather cover a diverse
range of businesses. Except as noted above, management does not presently expect
significant losses from credits in the potential problem loan category.
Investment Portfolio
At June 30, 2003, the investment portfolio (which includes investment securities
available for sale and held to maturity) increased $3.4 million, or 2.3%, to
$154.8 million from $151.4 million at December 31, 2002. At June 30, 2003, the
investment portfolio represented 17.0% of total assets compared with 16.7% at
December 31, 2002.
Securities held to maturity and securities available for sale consist of the
following:
TABLE 8
INVESTMENT SECURITY ANALYSIS
At June 30, 2003
($ in Thousands)
Gross Unrealized Gross Unrealized Estimated Market
Amortized Cost Gains Losses Value
-------------- ---------------- ---------------- ----------------
Securities held to maturity
Obligations of states & $ 17,345 $ 436 $ 0 $ 17,781
political subdivisions -------- -------- -------- --------
Securities available for sale
Obligations of U.S. Treasury & 36,290 2,592 0 38,882
other U.S. Agencies
Mortgage-backed securities 52,544 835 68 53,311
Obligations of states & 34,012 2,833 0 36,845
political subdivisions
Other securities 8,370 20 8,390
-------- -------- --------
Total securities available for $131,216 $ 6,280 $ 68 $137,428
sale
At December 31, 2002
($ in Thousands)
Gross Unrealized Gross Unrealized Estimated Market
Amortized Cost Gains Losses Value
-------------- ---------------- ---------------- ----------------
Securities held to maturity
Obligations of states & $ 18,227 $ 297 $ 0 $ 18,524
political subdivisions -------- -------- -------- --------
Securities available for sale
27
Obligations of U.S. Treasury & $ 38,379 $ 2,214 $ 0 $ 40,593
other U.S. Agencies
Mortgage-backed securities 49,968 941 58 50,851
Obligations of states & 35,840 1,817 3 37,654
political subdivisions
Other securities 4,019 22 4,041
-------- -------- --------
Total securities available for $128,206 $ 4,994 $ 61 $133,139
sale
At June 30, 2003, the contractual maturities of securities held to maturity and
securities available for sale are as follows:
TABLE 9
INVESTMENT PORTFOLIO MATURITY
($ in Thousands)
Securities held to Maturity Securities Available for Sale
--------------------------- -----------------------------
Amortized Cost Market Value Amortized Cost Market Value
-------------- ------------ -------------- ------------
Within 1 year $ 2,387 $ 2,399 $ 28,650 $ 28,829
After 1 but within 5 years 7,185 7,529 70,097 73,114
After 5 but within 10 years 2,585 2,665 18,392 20,433
After 10 years 5,188 5,188 12,641 13,616
Equity securities 0 0 1,436 1,436
-------- -------- -------- --------
Total $ 17,345 $ 17,781 $131,216 $137,428
Deposits
Total deposits at June 30, 2003 increased $7.6 million, or 1.0%, to $747.9
million from $740.3 million at December 31, 2002. Non-interest bearing deposits
at June 30, 2003 decreased $1.1 million, or 1.3%, to $88.7 million from $89.8
million at December 31, 2002. Interest-bearing deposits at June 30, 2003
increased $8.7 million, or 1.3%, to $659.2 million from $650.5 million at
December 31, 2002. Interest-bearing transaction accounts (NOW deposits)
increased $9.9 million, primarily in public fund deposits. Savings deposits
decreased $400,000, or 0.2%, to $194.8 million at June 30, 2003, when compared
to $195.2 million at December 31, 2002. Time deposits (including time, $100,000
and over and other time) decreased $792,000 (includes increase of $190,000 in
time deposits over $100,000), or 0.2%, to $390.2 million at June 30, 2003, when
compared to $391.0 million at December 31, 2002. Brokered CD's totaled $93.5
million at June 30, 2003 compared to $87.1 million at December 31, 2002. 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.
28
Emphasis has been, and will continue to be, placed on generating additional core
deposits in 2003 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 2003 as an additional source of
funds to provide for loan growth.
Short Term Borrowings and Other Borrowings
Short-term borrowings at June 30, 2003 consist of federal funds purchased and
securities under agreements to repurchase. Total short-term borrowings at June
30, 2003 decreased $4.2 million to $5.9 million from $10.1 million at December
31, 2002. Customer repurchase agreements totaled $932,000 at June 30, 2003
compared to $1.8 million at December 31, 2002. Federal funds purchased decreased
from $8.3 million at December 31, 2002 to $5.0 million at June 30, 2003
accounting for the balance of the decrease in the balance of short-term
borrowings. These have decreased as a result of obtaining other funding sources
during the quarter including brokered time deposits.
Other borrowings consist of term loans with FHLB. These borrowings totaled $65
million at June 30, 2003 and December 31, 2002.
Typically, short-term borrowings and other borrowings increase in order to fund
growth in the loan portfolio. Although total borrowings decreased during the
quarter, the Company will borrow monies if borrowing is a less costly form of
funding loans compared to the cost of acquiring deposits. Additionally, the
availability of deposits also determines the amount of funds the Company needs
to borrow in order to fund loan demand. The Company anticipates it will continue
to use wholesale funding sources of this nature, if these borrowings add
incrementally to overall profitability.
Long Term Debt
Long-term debt of $53,000 at June 30, 2003 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 2002.
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 $2.2 million for the first half of 2003 and
will continue to be the Company's main source of long-term liquidity. The
dividends from the Bank along with existing cash were sufficient to pay cash
dividends to the Company's shareholders of $2.9 million in the first half of
2003.
29
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 six months ended June 30, 2003, principal payments totaling $42.2 million
were received on investments. These proceeds in addition to other Company cash
were used to purchase $45.0 million in investments for the six months ended June
30, 2003. At June 30, 2003, the carrying or book value of investment securities
maturing within one year amounted to $31.2 million or 20.2% of the total
investment securities portfolio. This compares to a 33.2% level for investment
securities with one year or less maturities as of December 31, 2002. Within the
investing activities of the statement of cash flows, sales and maturities of
investment securities during the first six months of 2003 totaled $42.2 million.
At June 30, 2003, the investment portfolio contained $92.2 million of U.S.
Treasury and federal agency backed securities representing 59.6% of the total
investment portfolio. These securities tend to be highly marketable and had a
market value above amortized cost at June 30, 2003 amounting to $3.4 million.
Deposit growth is typically another source of liquidity for the Bank. As a
financing activity reflected in the June 30, 2003 Consolidated Statements of
Cash Flows, deposits increased and resulted in $7.6 million of cash inflow
during the first six months of 2003. The Company's overall deposit base
increased 1.0% for the six months ended June 30, 2003. 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 $235.7 million, or 34.8%, of loans maturing within one year.
Within the classification of short-term borrowings and other borrowings at June
30, 2003, federal funds purchased and securities sold under agreements to
repurchase totaled $5.9 million compared to $10.1 million at the end of 2002.
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 $65.0 million at June 30, 2003 and December 31, 2002.
The Bank's liquidity resources were sufficient in the first six months of 2003
to fund the growth in loans and investments, increase the volume of interest
earning assets and meet other cash needs when necessary.
Management expects that deposit growth will continue to be the primary funding
source of the Bank's liquidity on a long-term basis, along with a stable
earnings base, the resulting cash generated by operating activities, and a
strong capital position. Although federal funds purchased and borrowings from
the FHLB provided funds in 2003, 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
30
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 interest income to changing interest
rates can be reduced by matching the repricing characteristics of assets and
liabilities.
The following table entitled "Asset and Liability Maturity Repricing Schedule"
indicates that the Company is liability sensitive. The analysis considers money
market index accounts and 25% of NOW accounts to be rate sensitive within three
months. Regular savings, money market deposit accounts and 75% of NOW accounts
are considered to be rate sensitive within one to five years. While these
accounts are contractually short-term in nature, it is the Company's experience
that repricing occurs over a longer period of time. The Company views its
savings and NOW accounts to be core deposits and relatively non-price sensitive,
as it believes it could make repricing adjustments for these types of accounts
in small increments without a material decrease in balances. All other earning
categories, including loans and investments as well as other paying liability
categories such as time deposits, are scheduled according to their contractual
maturities. The "static gap analysis" provides a representation of the Company's
earnings sensitivity to changes in interest rates. It is a static indicator and
does not reflect various repricing characteristics. Accordingly, a "static gap
analysis" may not necessarily be indicative of the sensitivity of net interest
income in a changing rate environment.
TABLE 10
ASSET AND LIABILITY MATURITY REPRICING SCHEDULE
AS OF June 30, 2003
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 $ 22 309 $ 8 356 $ 7 560 $ 80 300 $ 43 257 $161 782
Federal funds sold 9 9
Loans and leases
Variable rate 372 277 7 188 14 376 15 235 0 409 076
Fixed rate 43 457 41 616 41 149 130 466 2 823 259 511
--------- -------- -------- --------- -------- --------
Total loans and leases $ 415 734 $ 48 804 $ 55 525 $ 145 701 $ 2 823 $259 511
--------- -------- -------- --------- -------- --------
Total earning assets $ 438 052 $ 57 160 $ 63 085 $ 226 001 $ 46 080 $830 378
========= ======== ======== ========= ======== ========
31
Interest bearing liabilities:
NOW Accounts $ 18 551 $ 0 $ 0 $ 55 651 $ 0 $ 74 202
Savings Deposits 149 615 0 0 45 228 0 194 843
Time Deposits 136 345 48 653 131 773 73 385 15 390 171
Borrowed Funds 15 932 30 000 53 25 000 0 70 985
Trust Preferred Stock 0 0 0 0 16 100 16 100
========= ======== ========= ========= ======== ========
Total interest bearing $ 320 443 $ 78 653 $ 131 826 $ 199 264 $ 16 115 $746 301
========= ======== ========= ========= ======== ========
Liabilities
Interest sensitivity gap (within $ 117 609 $ (21 493) $ (68 741) $ 26 737 $ 29 965 $ 84 077
periods)
Cumulative interest sensitivity gap $ 117 609 $ 96 116 $ 27 375 $ 54 112 $ 84 077
Ratio of cumulative interest 14.16% 11.57% 3.30% 6.52% 10.13%
Sensitivity gap to rate
Sensitive assets
Ratio of rate sensitive assets 136.70% 72.67% 47.85% 113.42% 285.94%
To rate sensitive
Liabilities
Cumulative ratio of rate 136.70% 124.08% 105.16% 107.41% 111.27%
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 4.8% if rates rose by a 100 basis point shock, and
projected that net interest income would decrease by approximately 6.2% if rates
fell by a 100 basis point shock under these scenarios for the period ended June
30, 2004. This result was within the policy limits established by the Company.
The results of the simulations are based solely on immediate and sustained
parallel changes in market rates and do not reflect the earnings sensitivity
that may arise from such factors as the change in spread between key market
rates and the shape of the yield curve. The above results also are considered to
be conservative estimates due to the fact that no management action is factored
into the analysis to deal with potential income variances. Management
continually reviews its interest risk position through the ALCO process.
Management's philosophy is to maintain relatively matched rate sensitive asset
and liability positions within the range described above in order to provide
earnings stability in the event of significant interest rate changes.
Capital Resources
Shareholders' equity at June 30, 2003 increased $3.1 million or 4.7% to $68.5
million, compared with $65.4 million at end of year 2002. This increase includes
a change of $835,000 to capital in 2003 due to the impact of STATEMENT OF
FINANCIAL ACCOUNTING STANDARDS NO. 115. Disregarding the effect of this change,
shareholders' equity would have increased $2.3 million or 3.5% for the period
from December 31, 2002 to June 30, 2003.
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.
32
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. Any additional portion of
the Trust Preferred Securities qualify as Tier 2 Capital. As of June 30, 2003,
$16.1 million of the Trust Preferred Securities qualify as Tier 1 Capital.
Cash dividends paid for the first six months of 2003 were $0.26 per share
compared with $0.24 in the same period of 2002. The Company provided an 8.3%
increase in normal dividends per share in 2003 over 2002 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 six months of
2003.
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 June 30, 2003 and December 31, 2002, 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
June 30, 2003 and December 31, 2002:
33
TABLE 11
CAPITAL RATIOS
($ in Thousands)
Actual For Capital Adequacy To Be Well
Purposes Capitalized under
Prompt Corrective
Action Provisions
($ in Thousands)
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
As of June 30, 2003
Total Capital (to
Risk Weighted Assets)
Company 85,169 11.03% 61,762 8.00% 77,203 10.00%
Bank 81,767 10.58% 61,827 8.00% 77,284 10.00%
Tier 1 Capital (to
Risk Weighted Assets)
Company 75,478 9.78% 30,881 4.00% 46,322 6.00%
Bank 72,066 9.32% 30,914 4.00% 46,371 6.00%
Tier 1 Capital (to
Average Assets)
Company 75,478 8.39% 35,955 4.00% N/A N/A
Bank 72,066 8.01% 35,955 4.00% 44,944 5.00%
As of December 31, 2002
Total Capital (to
Risk Weighted Assets)
Company 82,643 10.99% 60,146 8.00% 75,183 10.00%
Bank 79,436 10.59% 60,031 8.00% 75,039 10.00%
Tier 1 Capital(to
Risk Weighted Assets)
Company 73,220 9.74% 30,073 4.00% 45,110 6.00%
Bank 70,031 9.33% 30,016 4.00% 45,023 6.00%
Tier 1 Capital (to
Average Assets)
Company 73,220 8.24% 35,564 4.00% N/A N/A
Bank 70,031 7.96% 35,564 4.00% 44,455 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.
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 June 30, 2003, 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, 2002, as described in the
Company's 2002 Form 10-K Annual Report.
34
Item 4. Controls and Procedures
DISCLOSURES CONTROLS AND PROCEDURES: The Company's management, with the
participation of the Company's Chief Executive Officer and Chief Financial
Officer, has evaluated the effectiveness of the Company's disclosure controls
and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under
the Securities Exchange Act of 1934, as amended (the "Exchange Act") as of the
end of the period covered by this report. Based on such evaluation, the
Company's Chief Executive Officer and Chief Financial Officer have concluded
that, as of the end of such period, the Company's disclosure controls and
procedures are effective in recording, processing, summarizing and reporting, on
a timely basis, information required to be disclosed by the Company in the
reports that it files or submits under the Exchange Act.
INTERNAL CONTROL OVER FINANCIAL REPORTING: There have not been any changes in
the Company's internal control over financial reporting (as such term is defined
in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the fiscal
quarter to which this report relates that have materially affected, or are
reasonably likely to materially affect, the Company's internal control over
financial reporting.
Part II - Other Information
Item 1. Legal Proceedings
Baylake and its subsidiaries may be involved from time to time in various
routine legal proceedings incidental to its business. Neither Baylake nor any of
its subsidiaries is currently engaged in any legal proceedings that are expected
to have a material adverse effect on the results of operations or financial
position of Baylake.
Item 2. Changes in Securities and Use of Proceeds
None
Item 3. Defaults Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
(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
35
31.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002
31.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002
32.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002
32.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002
(b). Report on Form 8-K:
Reports on Form 8-K during the quarter ended June 30, 2003. Second quarter
earnings release-Regulation FD Disclosures.
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: August 15, 2003 /s/ Thomas L. Herlache
---------------------- -----------------------------------------
Thomas L. Herlache
President (CEO)
Date: August 15, 2003 /s/ Steven D. Jennerjohn
---------------------- -----------------------------------------
Steven D. Jennerjohn
Treasurer (CFO)
36
Exhibit Index
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EXHIBIT NUMBER DESCRIPTION
- -------------- -----------
11 Statement re: computation of per share earnings
15 Letter re: unaudited interim financial information
31.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002