UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
{X} QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 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
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 October 31, 2003: 7,560,476 shares
BAYLAKE CORP. AND SUBSIDIARIES
INDEX
PAGE NUMBER
-----------
PART 1 - FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Condensed Balance Sheet as of September 30, 2003
and December 31, 2002 3 - 4
Consolidated Condensed Statement of Income for the three
and nine months ended September 30, 2003 and 2002 5 - 6
Consolidated Statement of Comprehensive Income for the three
and nine months ended September 30, 2003 and 2002 7
Consolidated Statement of Cash Flows for the nine months ended
September 30, 2003 and 2002 8 - 9
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 35
Item 4. Controls and Procedures 35
PART II - OTHER INFORMATION 36
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 37
EXHIBIT INDEX 36
Exhibit 11 Statement re: computation of per share earnings 42
Exhibit 15 Letter re: unaudited interim financial information 43
Exhibit 31.1 Certification pursuant to Section 302 38
Exhibit 31.2 Certification pursuant to Section 302 39
Exhibit 32.1 Certification pursuant to 18 U.S.C. Section 1350 40
Exhibit 32.2 Certification pursuant to 18 U.S.C. Section 1350 41
2
PART 1 - FINANCIAL INFORMATION
BAYLAKE CORP. AND SUBSIDIARIES
CONSOLIDATED CONDENSED BALANCE SHEET (UNAUDITED)
(dollars in thousands)
SEPTEMBER 30 DECEMBER 31,
2003 2002
------------ ------------
ASSETS
Cash and due from banks $ 17,307 $ 33,300
Federal funds sold 0 0
--------- ---------
Cash and cash equivalents 17,307 33,300
Investment securities available for sale
(at market) 154,009 133,139
Investment securities held to
maturity (market value $17,598 and
$18,524, at September 30, 2003 and
December 31, 2002, respectively) 17,303 18,227
Loans held for sale 0 1,602
Loans 674,074 664,285
Less: Allowance for loan losses 12,634 11,410
--------- ---------
Loan, net of allowance for loan losses 661,440 652,875
Bank premises and equipment 21,536 23,446
Federal Home Loan Bank stock (at cost) 7,122 6,713
Accrued interest receivable 3,969 4,580
Income taxes receivable 0 340
Deferred income taxes 3,518 2,878
Goodwill 4,969 4,969
Other Assets 26,918 22,587
--------- ---------
Total Assets $ 918,091 $ 904,656
========= =========
LIABILITIES
Domestic deposits
Non-interest bearing $ 98,190 $ 89,848
Interest bearing
NOW 83,707 64,281
Savings 199,558 195,232
Time, $100,000 and over 176,514 176,605
Other time 195,587 214,358
--------- ---------
Total interest bearing 655,366 650,476
--------- ---------
Total deposits 753,556 740,324
Short-term borrowings
Federal funds purchased, repurchase 8,283 10,056
agreements and Federal Home Loan Bank
advances
Accrued expenses and other liabilities 6,926 6,698
Dividends payable 0 972
Other borrowings 65,093 65,000
Long-term debt 53 106
Guaranteed preferred beneficial
interest in the company's junior
subordinated debt 16,100 16,100
--------- ---------
Total liabilities 850,011 839,256
--------- ---------
3
SHAREHOLDERS' EQUITY
Common stock, $5 par value:
authorized 10,000,000 shares
issued 7,583,635 shares as of
September 30, 2003 and 7,506,435 as
of December 31, 2002; outstanding
7,560,476 as of September 30, 2003
and 7,483,276 as of December 31, 2002 37,918 37,532
Additional paid-in capital 7,865 7,373
Retained earnings 20,901 17,903
Treasury Stock (625) (625)
Net unrealized gain on securities available
for sale, net of tax of $1,044 as
of September 30, 2003 and $1,716
as of December 31, 2002 2,021 3,217
--------- ---------
Total shareholders' equity 68,080 65,400
--------- ---------
Total liabilities and
shareholders' equity $ 918,091 $ 904,656
========= =========
4
BAYLAKE CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(dollars in thousands, except per share amounts)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
------------------ -----------------
2003 2002 2003 2002
------- -------- ------- -------
Interest income
Interest and fees on loans $10,104 $ 11,031 $30,494 $32,352
Interest on investment securities
Taxable 1,258 1,517 3,362 4,708
Exempt from federal income taxes 587 734 1,840 2,088
Other interest income 2 5 17 21
------- -------- ------- -------
Total interest income 11,951 13,287 35,713 39,169
Interest expense
Interest on deposits 3,411 4,376 11,484 12,971
Interest on short-term borrowings 30 73 80 379
Interest on other borrowings 488 664 1,596 2,206
Interest on long-term debt 0 1 2 4
Interest on guaranteed preferred
beneficial interest in the company's
junior subordinated debt 412 410 1,234 1,233
------- -------- ------- -------
Total interest expense 4,341 5,524 14,396 16,793
------- -------- ------- -------
Net interest income 7,610 7,763 21,317 22,376
Provision for loan losses 1,212 1,654 3,137 2,700
------- -------- ------- -------
Net interest income after provision for
loan losses 6,398 6,109 18,180 19,676
------- -------- ------- -------
Other income
Fees from fiduciary activities 216 170 509 494
Fees from loan servicing 701 273 1,763 765
Fees for other services to customers 1,045 1,109 3,144 3,092
Gains from sales of loans 653 386 1,696 830
Gains from sale of subsidiary 0 0 350 0
Securities gains, net 0 511 0 511
Other income 440 518 981 1,294
------- -------- ------- -------
Total other income 3,055 2,967 8,443 6,986
------- -------- ------- -------
Other expenses
Salaries and employee benefits 3,721 3,589 11,067 10,394
Occupancy expense 495 505 1,442 1,520
Equipment expense 467 395 1,283 1,180
Data processing and courier 269 261 807 768
Operation of other real estate 71 (49) 208 161
Other operating expenses 1,358 1,352 3,685 3,807
------- -------- ------- -------
Total other expenses 6,381 6,053 18,492 17,830
------- -------- ------- -------
Income before income taxes 3,072 3,023 8,131 8,832
Income tax expense 831 809 2,197 2,555
------- -------- ------- -------
Net Income $ 2,241 $ 2,214 $ 5,934 $ 6,277
======= ======== ======= =======
5
Basic earnings per common share(1) $ 0.30 $ 0.30 $ 0.79 $ 0.84
Diluted earnings per common share(1) $ 0.30 $ 0.30 $ 0.78 $ 0.83
Cash dividends per share $ 0.13 $ 0.12 $ 0.39 $ 0.36
(1) Based on 7,520,021 average shares outstanding in 2003 and 7,473,598 in 2002.
6
BAYLAKE CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME (UNAUDITED)
(dollars in thousands)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ -----------------
2003 2002 2003 2002
------- ------ ------- ------
Net Income $ 2,241 $2,214 $ 5,934 $6,277
------- ------ ------- ------
Other comprehensive income, net of tax:
Unrealized gains (losses) on securities:
Unrealized gains (losses) arising during period (2,031) 419 (1,196) 1,702
------- ------ ------- ------
Comprehensive income $ 210 $2,633 $ 4,738 $7,979
======= ====== ======= ======
7
BAYLAKE CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASHFLOWS (UNAUDITED)
(dollars in thousands)
NINE MONTHS ENDED
SEPTEMBER 30
-----------------
2003 2002
---- ----
Cash flows from operating activities:
Interest received from:
Loans $ 30,901 $ 32,636
Investments 5,876 6,894
Fees and service charges 6,812 5,774
Interest paid to depositors (11,877) (12,460)
Interest paid to others (2,973) (3,967)
Cash paid to suppliers and employees (14,778) (15,458)
Income taxes paid (1,815) (1,538)
-------- --------
Net cash provided by operating activities 12,146 11,881
Cash flows from investing activities:
Proceeds from sales of investment securities 0 8,506
Principal payments received on investments 59,429 36,610
Purchase of investments (82,158) (36,965)
Purchase of insurance contracts (4,000) (13,000)
Proceeds from sale of other real estate owned 1,623 1,582
Proceeds from sale of subsidiary's assets 1,884 0
Loans made to customers in excess of principal
collected (12,076) (46,594)
Capital expenditures (1,310) (2,761)
-------- --------
Net cash used in investing activities (36,608) (52,622)
Cash flows from financing activities:
Net increase (decrease) in demand deposits,
NOW accounts, and savings accounts 32,094 (2,552)
Net increase (decrease) in short term borrowing (1,773) 12,943
Net increase (decrease) in time deposits (18,863) 68,367
Proceeds from (payments on) other borrowings
and long-term debt 93 (25,000)
Payments on other borrowings and long term debt (53) (53)
Proceeds from issuance of common stock 878 55
Dividends paid (3,907) (3,587)
-------- --------
Net cash provided by financing activities 8,469 50,173
-------- --------
Net increase (decrease) in cash and cash equivalents (15,993) 9,432
Cash and cash equivalents, beginning 33,300 24,033
-------- --------
Cash and cash equivalents, ending $ 17,307 $ 33,465
======== ========
8
SEPTEMBER 30
----------------------
2003 2002
--------- --------
Reconciliation of net income to net cash provided
by operating activities:
Net income $ 5,934 $ 6,277
Adjustments to reconcile net income to net cash
provided by operating Activities:
Depreciation 1,336 1,220
Provision for losses on loans and real estate owned 3,137 2,700
Amortization of premium on investments 635 175
Accretion of discount on investments (130) (142)
Cash surrender value increase (540) (218)
(Gain) Loss from disposal of ORE (59) (7)
Gain on sale of loans (1,697) (830)
Proceeds from sale of loans held for sale 130,396 51,209
Originations of loans held for sale (128,699) (50,379)
Gain on sale of subsidiary (350) 0
Loss from disposal of fixed assets 0 (107)
Equity in income of service center (231) (230)
Amortization of mortgage servicing rights 393 267
Mortgage servicing rights booked (467) (154)
Deferred compensation 313 194
Changes in assets and liabilities:
Interest receivable 611 592
Prepaids and other assets 1,328 (429)
Unearned income (52) 10
Interest payable (455) 366
Taxes payable 382 1,017
Other liabilities 361 861
--------- --------
Total adjustments 6,212 5,604
--------- --------
Net cash provided by operating activities $ 12,146 $ 11,881
========= ========
9
BAYLAKE CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 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 September 30, 2003 and December 31, 2002. The
results of operations for the three and nine months ended September 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:
SEPTEMBER 30, DECEMBER 31,
2003 2002
------------- ------------
(dollars in thousands)
Investment securities held to maturity:
Obligations of state and political subdivisions $ 17,303 $ 18,227
-------- --------
Investment securities held to maturity $ 17,303 $ 18,227
======== ========
Investment securities available for sale:
U.S. Treasury and other U.S. government agencies $ 37,195 $ 40,593
Obligations of states and political subdivisions 35,878 37,654
Mortgage-backed securities 75,476 50,851
Other 5,460 4,041
-------- --------
Investment securities available for sale $154,009 $133,139
======== ========
3. At September 30, 2003 and December 31, 2002, loans were as follows:
SEPTEMBER 30 DECEMBER 31,
2003 2002
------------ ------------
(dollars in thousands)
Commercial, financial and agricultural $ 88,212 $ 89,207
Real estate-commercial 379,571 351,425
Real estate-construction 66,750 75,688
Real estate-mortgage 125,125 133,365
Installment 14,680 14,916
Less: Deferred loan origination
fees, net of costs (264) (316)
--------- ---------
$ 674,074 $ 664,285
Less allowance for loan losses (12,634) (11,410)
--------- ---------
Net loans $ 661,440 $ 652,875
========= =========
10
4. Baylake Corp. declared a cash dividend of $0.13 per share payable on
September 15, 2003 to shareholders of record as of September 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 Nine months ended September 30
----------------------------------------
Three months ended Nine months ended
September 30, September 30,
------------------ -----------------
(In thousands, except per share amounts)
2003 2002 2003 2002
--------- --------- --------- ---------
Net income, as reported $ 2,241 $ 2,214 $ 5,934 $ 6,277
Less: Total stock-based
employee compensation
cost determined under
the fair value based
method, net of income
taxes (80) (94) (238) (282)
--------- --------- --------- ---------
Pro forma net income 2,161 2,120 5,696 5,995
Earnings per share:
Basic - as reported $ 0.30 $ 0.30 $ 0.79 $ 0.84
Basic - pro forma $ 0.29 $ 0.29 $ 0.76 $ 0.80
Diluted - as reported $ 0.30 $ 0.30 $ 0.78 $ 0.83
Diluted - pro forma $ 0.29 $ 0.29 $ 0.75 $ 0.79
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 nine months ended September 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 September 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.
Forward-looking statements, by their nature, are subject to risks and
uncertainties. A number of factors, many of which are beyond the control of
Baylake Corp., could cause actual conditions, events, or results to differ
significantly from those indicated by the forward-looking statements. The
statements contained herein describe some of these factors, including certain
credit, market, operational, liquidity and interest rate risks associated with
the Company's business and operations. Other factors include changes in general
business and economic conditions, world events (especially those which could
affect our customers' tourism-related businesses), competition which among other
things affects the demand for our products and services and our customers'
ability to repay loans, fiscal and monetary policies and the possibilities of
changes in laws affecting financial institutions as well as on customers'
businesses.
Forward-looking statements speak only as of the date they are made, and Baylake
Corp. does not undertake to update forward-looking statements to reflect
circumstances or events that occur after the date the forward-looking statements
are made.
Results of Operations
For the three months ended September 30, 2003, earnings increased $27,000, or
1.2%, to $2.2 million from $2.2 million for the third quarter last year. Basic
operating earnings per share of $0.30 was reported for the
12
quarter ended September 30, 2003 compared to $0.30 for the same period last
year. On a fully diluted basis, the Company recorded $0.30 per share for the
third quarter in 2003 and $0.30 for the same period in 2002.
TABLE 1
SUMMARY RESULTS OF OPERATIONS
($ IN THOUSANDS, EXCEPT PER SHARE DATA)
Three months Three months Nine months Nine months
ended September 30, ended September 30, ended September 30, ended September 30,
2003 2002 2003 2002
------------------- ------------------- ------------------- -------------------
Net income, as reported 2,241 2,214 5,934 6,277
EPS-basic, as reported 0.30 0.30 0.79 0.84
EPS-diluted, as reported 0.30 0.30 0.78 0.83
Return on average assets, as reported 0.97% 0.99% 0.88% 0.97%
Return on average equity, as reported 13.09% 13.80% 11.83% 13.62%
Efficiency ratio, as reported (1) 58.18% 54.49% 60.22% 58.58%
(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 September 30, 2003 were 0.97% and 13.09%, respectively,
compared to 0.99% and 13.80%, respectively, for the same period a year ago.
The increase in net income for the period was primarily due to an increase in
other income and a reduction in the provision for loan loss. This was partially
offset by decreased net interest income, an increase in other expenses and an
increase in income tax expense.
Cash dividends declared in the third quarter of 2003 increased 8.3% to $0.13 per
share compared with $0.12 for the same period in 2002.
For the nine months ended September 30, 2003, net income decreased $343,000 or
5.5% to 5.9 million from $6.3 million for the same period a year earlier. The
change in net income for the nine months ended September 30, 2003 was due to an
increase in other expense and an increase in provision for loan loss and a
decrease in net interest income. This was partially offset by an increase in
other income and a decrease in income tax expense. Basic operating earnings per
share decreased to $0.79 compared to $0.84 per share for the nine months ended
September 30, 2002. On a fully diluted basis, the Company reported $0.78 per
share for the first nine months of 2003 and $0.83 for the same period a year
earlier.
Cash dividends declared for the first nine months of 2003 increased 8.3% to
$0.39 per share compared with $0.36 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 72.5% of
total operating income for the first nine months of
13
2003, as compared to 77.0% 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 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
September 30, 2003 decreased $230,000, or 2.8%, to $7.9 million from $8.1
million for the same period a year ago. As a result of a lower interest rate
environment, total interest income for the third quarter of 2003 decreased $1.4
million, or 10.3%, to $12.3 million from $13.7 million for the third quarter of
2002, while interest expense in the third quarter of 2003 decreased $1.2
million, or 21.4%, to $4.3 million when compared to $5.5 million in the third
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 25 basis point decrease in
the prime lending rate in the latter part of the third quarter of 2003 impacted
interest income for the third 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
partially by an increase in interest paying liabilities. The decline in total
interest expense in the third quarter of 2003 versus the third quarter of 2002
did not offset the decline in interest income.
For the three months ended September 30, 2003, average-earning assets increased
$39.7 million, or 5.0%, when compared to the same period last year. The Company
recorded an increase in average loans of $29.8 million, or 4.6%, for the third
quarter of 2003 compared to the same period a year ago. Loans have typically
resulted in higher rates of interest income to the Company than have investment
securities.
Interest rate spread is the difference between the tax-equivalent rate earned on
average earning assets and the rate paid on average interest-bearing
liabilities. The interest rate spread decreased for the quarter ended September
30, 2003 when compared to the same period a year ago. The interest rate spread
decreased 31 basis points to 3.49% at September 30, 2003 from 3.80% in the same
quarter in 2002. While the average yield on earning assets decreased 100 basis
points during the period, the average rate paid on interest-bearing liabilities
decreased 68 basis points over the same period as a result of a lower cost of
funding from deposits and other wholesale funding such as federal funds
purchased and loans from the Federal Home Loan Bank.
TABLE 2
NET INTEREST INCOME ANALYSIS ON A TAX-EQUIVALENT BASIS
($ IN THOUSANDS)
THREE MONTHS ENDED SEPTEMBER 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) $ 675,220 $ 645,452
Less: non-accrual loans (12,866) (18,259)
--------- ---------
Loans, net 662,354 $ 10,104 6.05% 627,193 $ 11,032 6.98%
14
Investments 169,584 2,139 5.00% 169,615 2,631 6.15%
Other earning assets 5,528 10 0.72% 1,002 3 1.19%
--------- -------- ------ --------- -------- -----
Total earning assets $ 837,467 $ 12,253 5.80% $ 797,810 $ 13,666 6.80%
Allowance for loan losses (12,222) (8,124)
Non-accrual loans 12,866 18,259
Cash and due from banks 17,907 19,902
Other assets 59,684 60,722
--------- ---------
Total assets $ 915,701 $ 888,569
--------- ---------
LIABILITIES AND STOCKHOLDER'S EQUITY
Interest-bearing liabilities:
NOW accounts $ 80,966 $ 156 0.76% $ 57,575 $ 154 1.06%
Savings accounts 199,630 399 0.79% 198,994 757 1.51%
Time deposits > $100M 174,750 1,340 3.04% 183,893 1,723 3.72%
Time deposits < $100M 201,852 1,517 2.98% 191,353 1,742 3.61%
--------- -------- ------ --------- ------- -----
Total interest-bearing deposits 657,198 3,412 2.06% 631,815 4,376 2.75%
Short-term borrowings 8,497 27 1.26% 12,604 64 2.01%
Customer repurchase agreements 1,067 3 1.12% 2,079 9 1.72%
Other borrowings 61,335 487 3.15% 70,003 664 3.76%
Long term debt 53 1 7.49% 107 1 3.71%
Trust preferred securities 16,100 411 10.13% 16,100 410 10.10%
Total interest-bearing liabilities $ 744,250 $ 4,341 2.31% $ 732,708 $ 5,524 2.99%
--------- ------- ------ --------- ------- -----
Demand deposits 96,676 82,314
Accrued expenses and other liabilities 6,846 9,877
Stockholders' equity 67,929 63,670
--------- ---------
Total liabilities and stockholders' equity $ 915,701 $ 888,569
--------- ---------
Interest rate spread $ 7,912 3.49% $ 8,142 3.80%
Contribution of free funds 0.26% 0.24%
----- -----
Net interest margin 3.75% 4.05%
----- -----
15
TABLE 2 (CONT'D)
NET INTEREST INCOME ANALYSIS ON A TAX-EQUIVALENT BASIS
($ IN THOUSANDS)
NINE MONTHS ENDED SEPTEMBER 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) $ 677,449 $ 628,251
Less: non-accrual loans (11,642) (15,269)
--------- ---------
Loans, net 665,807 $ 30,494 6.12% 612,982 $ 32,352 7.06%
Investments 160,290 6,132 5.11% 175,185 7,872 6.01%
Other earning assets 5,192 33 0.85% 1,645 21 1.71%
--------- -------- ------ --------- -------- ------
Total earning assets $ 831,289 $ 36,659 5.90% $ 789,812 $ 40,245 6.81%
Allowance for loan losses (12,222) (8,315)
Non-accrual loans 11,642 15,269
Cash and due from banks 17,734 17,820
Other assets 59,318 50,366
--------- ---------
Total assets $ 907,761 $ 866,952
--------- ---------
LIABILITIES AND STOCKHOLDER'S EQUITY
Interest-bearing liabilities:
NOW accounts $ 70,895 $ 496 0.94% $ 50,746 $ 357 0.94%
Savings accounts 195,695 1,381 0.94% 204,070 2,380 1.56%
Time deposits > $100M 181,388 4,397 3.24% 163,363 4,816 3.94%
Time deposits < $100M 212,035 5,210 3.29% 186,596 5,418 3.88%
--------- -------- ------ --------- -------- ------
Total interest-bearing deposits 660,013 11,484 2.33% 604,775 12,971 2.87%
Short-term borrowings 6,728 70 1.39% 22,880 347 2.03%
Customer repurchase agreements 1,211 10 1.10% 2,494 32 1.72%
Other borrowings 63,765 1,596 3.35% 75,184 2,206 3.92%
Long term debt 53 2 5.05% 106 4 5.05%
Trust preferred securities 16,100 1,234 10.25% 16,100 1,233 10.24%
Total interest-bearing liabilities $ 747,870 $ 14,396 2.57% $ 721,539 $ 16,793 3.11%
--------- -------- ------ --------- -------- ------
Demand deposits 85,039 73,657
16
Accrued expenses and other liabilities 7,812 8,124
Stockholders' equity 67,040 61,632
--------- ---------
Total liabilities and stockholders' equity $ 907,761 $ 864,952
--------- ---------
Interest rate spread $ 22,263 3.32% $ 23,452 3.70%
Contribution of free funds 0.26% 0.27%
------ -----
Net interest margin 3.58% 3.97%
------ -----
Net interest margin is tax-equivalent net interest income expressed as a
percentage of average earning assets. The net interest margin exceeds the
interest rate spread because of the use of non-interest bearing sources of funds
to fund a portion of earning assets. As a result, the level of funds available
without interest cost (demand deposits and equity capital) is an important
component increasing net interest margin.
Net interest margin (on a federal tax-equivalent basis) for the three months
ended September 30, 2003 decreased from 4.05% to 3.75% compared to the same
period a year ago. The average yield on interest earning assets amounted to
5.80% for the third quarter of 2003, representing a decrease of 100 basis points
from the same period last year. Total loan yields decreased 93 basis points to
6.05%, while total investment yields decreased 115 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 69 basis points to 2.06% for the
third quarter of 2003 when compared to the third quarter of 2002, while
short-term borrowing costs decreased 75 basis points to 1.26% comparing the two
periods. Other borrowing costs decreased 61 basis points to 3.15% during the
same time period. These factors contributed to a decrease in the Company's
interest margin for the three months ended September 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 91.5% for the third quarter of 2003 compared to 89.8% for
the third quarter of 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 nine months ended
September 30, 2003 decreased $1.2 million, or 5.1%, to $22.3 million from $23.5
million for the same period a year earlier. As a result of a lower interest rate
environment, total interest income for the nine months ended September 30, 2003
decreased $3.6 million to $36.7 million from $40.3 million for the same period a
year ago. Interest expense decreased $2.4 million, or 14.3%, to $14.4 million
from $16.8 million for the same comparable periods. Decrease in net interest
income occurred primarily as a result of the reasons listed earlier.
For the nine months ended September 30, 2003, average-earning assets increased
$41.4 million, or 5.3%, when compared to the same period last year. The Company
recorded an increase in average loans of $49.2 million or 7.8% for the first
nine months of 2003 when compared the same period a year earlier. Loans have
typically resulted in higher rates of interest income to the Company than have
investment securities.
The interest rate spread decreased 38 basis points to 3.32% for the nine months
ended September 30, 2003 from 3.70% for the same period in 2002. While the
average yield on earning assets decreased 91 basis points during the period, the
average rate paid on interest-bearing liabilities decreased 54 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 nine months
ended September 30, 2003 decreased 39 basis points from 3.97% to 3.58% compared
to the same period last year. The average on interest earning assets amounted to
5.90% for the nine months ended September 30, 2003, representing a decrease of
91 basis points from the same period a year earlier. Total loan yields decreased
94 basis points to 6.12%, while total investment yields decreased 90 basis
points to 5.11% compared to the same period a
17
year ago. The Company's average cost on interest bearing deposit liabilities
decreased 54 basis points to 2.33% for the nine months ended September 30, 2003
when compared to the same period a year ago, while short-term borrowing costs
decreased 64 basis points to 1.39%, comparing the two periods. Other borrowing
costs decreased 57 basis points to 3.35% over the same time horizon. These
factors contributed to a decrease in the Company's interest margin for the nine
months ended September 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 nine months of 2003 compared with 91.1% 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 September 30, 2003
decreased $442,000 to $1.2 million compared with $1.7 million for the third
quarter of 2002. For the nine months ended September 30, 2003, the provision for
loan losses increased $437,000 to $3.1 million compared with $2.7 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 $88,000, or 3.0%, to $3.1 million for the
third quarter of 2003 when compared to the third quarter of 2002. This increase
occurred as a result of increased gains from sales of loans, increased fees from
loan servicing and increased income from business owned life insurance partially
offset by a decrease in brokerage income, other income, non-bank subsidiary
income and a decrease in securities gains.
TABLE 3
NONINTEREST INCOME
($ in Thousands)
Third Quarter Third Quarter Percent YTD YTD Percent
2003 2002 change 2003 2002 change
------------- ------------- -------- ------ ------- --------
Trust 216 170 27.1% 509 494 3.0%
Service charges on deposit accts 741 761 (2.6%) 2,172 2,113 2.8%
Other fee income 171 177 (3.4%) 486 535 (9.2%)
Loan servicing income 701 273 156.8% 1,763 765 130.5%
Brokerage commissions 133 170 (21.8%) 361 444 (18.7%)
Business owned life insurance 204 176 15.9% 540 218 147.7%
18
Non-bank subsidiary income 0 328 NM 125 752 (83.4%)
Gains from sales of loans 653 386 69.2% 1,696 830 104.3%
Gain from sale of non-bank subsidiary 0 0 NM 350 0 NM
Securities gains 0 511 NM 0 511 NM
Other 236 15 NM 441 324 36.1%
----- ----- ------- ----- ----- -------
Total 3,055 2,967 3.0% 8,443 6,986 20.9%
Trust fees increased $46,000, or 27.1%, in the third quarter of 2003 compared to
the same quarter in 2002, primarily as a result of increased trust estate
business.
Loan servicing fees increased $428,000, or 156.8%, to $701,000 in the third
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 $267,000 to $653,000
in the third 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 third quarter of 2003 showed a
decrease of $20,000, or 2.6%, over 2002 results. Financial service income
decreased $37,000, or 21.8%. Income from business owned life insurance ("BOLI")
amounted to $204,000 for the third quarter of 2003 compared to $176,000 a year
earlier. A $13 million purchase of BOLI had been made in the second quarter of
2002 along with an additional purchase of $4 million in the second quarter of
2003. 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 third
quarter compared to $328,000 a year earlier.
Other income increased $221,000 to $236,000 in the third quarter of 2003
compared to 2002. $89,000 of income was realized as a result of interest paid on
tax refunds from previously amended returns. In addition, $36,000 of income was
realized from in-house attorney fees on various loan issues satisfied during the
quarter ended September 30, 2003.
For the first nine months of 2003, non-interest income increased $1.5 million,
or 20.9%, to $8.4 million from $7.0 million for the same period a year ago.
Trust fee income increased $15,000, or 3.0%, to $509,000 for the first nine
months of 2003 compared to $494,000 for the same period in 2002, primarily a
result of increased trust business partially offset by reduced fees assessed on
various trust accounts as a result of lower market values.
For the first nine months of 2003, service charges on deposit accounts increased
$59,000, or 2.8%, to $2.2 million from $2.1 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.
19
Loan servicing fee income increased $998,000, or 130.5%, to $1.8 million for the
first nine months of 2003 compared to $765,000 for the same period in 2002.
Income from business owned life insurance increased $322,000 to $540,000 for the
nine months ended September 30, 2003 compared to $218,000 for the same period in
2002 based on the purchase made in June 2002.
Gains on sales of loans in the secondary market increased $866,000 to $1.7
million for the first nine 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 nine months ended September 30, 2003 increased to $130.4
million, compared to $51.2 million for the same period a year earlier.
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 $328,000, or 5.4%, for the three months ended
September 30, 2003 compared to the same period in 2002. Salaries and employee
benefits showed an increase of $132,000, or 3.7%, 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 300 persons from 293
a year earlier. A decrease in occupancy expense (amounting to $10,000 or 2.0%)
and an increase in equipment expenses (amounting to $72,000 or 18.2%) occurred
as a result of additional depreciation expense on new technology equipment and
software in 2003 compared to 2002.
TABLE 4
NONINTEREST EXPENSE
($ in Thousands)
Third quarter Third quarter Percent YTD YTD Percent
2003 2002 change 2003 2002 change
------------- ------------- -------- ------- ------- --------
Personnel 3,721 3,589 3.7% 11,067 10,394 6.5%
Occupancy 495 505 (2.0%) 1,442 1,520 (5.1%)
Equipment 467 395 18.2% 1,283 1,180 8.7%
Data processing 269 261 3.1% 807 768 5.1%
Business development/advertising 223 176 26.7% 531 470 13.0%
Supplies and printing 101 161 (37.3%) 342 452 (24.3%)
Director fees 106 105 1.0% 306 315 (2.9%)
FDIC 27 28 (3.6%) 86 85 1.2%
Amortization of MSR's 208 90 131.1% 393 266 47.7%
Legal and professional 76 82 (7.3%) 299 239 25.1%
Operation of other real estate 71 (49) NM 208 161 29.2%
Other 617 710 (13.1%) 1,728 1,980 (12.7%)
----- ----- ------- ----- ----- -------
Total 6,381 6,053 5.4% 18,492 17,830 3.7%
Expenses related to the operation of other real estate owned increased $120,000
to $71,000 for the quarter ended September 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 $34,000 for the third quarter of 2003
20
compared to net gains taken on sale of $75,000 for the same period in 2002. In
addition, costs related to the holding of other real estate owned properties
increased $87,000 to $113,000 for the third quarter of 2003.
Mortgage servicing rights expense includes the amortization of the mortgage
servicing rights asset. Amortization of mortgage servicing rights increased by
$118,000 to $208,000 for the three months ended September 30, 2003 compared to
the same period in 2002. The increase reflects the decline in interest rates and
subsequent refinancing, thereby accelerating the writedown of mortgage servicing
rights asset.
In July 2001, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standard ("SFAS") No. 142, "Goodwill and Other
Intangible Assets." SFAS No. 142 requires that goodwill and intangible assets
with indefinite lives no longer be amortized, but instead tested for impairment
as least annually. SFAS No. 142 requires that intangible assets with definite
useful lives be amortized over their respective estimated useful lives to their
estimated residual values, and be reviewed for impairment in accordance with
SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets."
The adoption of SFAS No. 142 and SFAS No. 144 does not have a material impact on
the Company's financial statements. There was no impairment for 2002 and
impairment testing for 2003 will occur in the fourth quarter of 2003.
Other items (such as supplies, marketing, telephone, postage and director fees)
comprising other operating expense show a decrease of $112,000 or 8.9% in the
third 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 1.44% for the three months
ended September 30, 2003 compared to 1.38% for the same period in 2002.
Non-interest expense increased $662,000, or 3.7%, for the nine months ended
September 30, 2003 compared to the same period in 2002. Salaries and employee
benefits showed an increase of $673,000, or 6.5%, 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 $78,000 or
5.1%) and an increase in equipment expense (amounting to $103,000 or 8.7%)
reflects the reduced activity in expansion activity for the first nine months of
2003 compared to the same period in 2002.
Operation of other real estate shows an increase of $47,000. The increase is
related primarily to net gains taken on the sale of other real estate amounting
to $77,000 in the first nine months of 2003 compared to net gains of $28,000
taken in the same period in 2002. Other expenses related to the operation of
other real estate owned amounted to $295,000 for the first nine months of 2003.
Other operating expenses decreased $122,000, or 3.2%, for the nine months ended
September 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 $671,000 in 2002.
The overhead ratio was 1.48% for the nine months ended September 30, 2003
compared to 1.67% for the same period in 2002.
Income Taxes
Income tax expense for the Company for the three months ended September 30, 2003
was $831,000, an increase of $22,000, or 2.7%, compared to the same period in
2002. The increase in income tax provision for the period was due to increased
taxable income.
Income tax expense for the Company for the nine months ended September 30, 2003
was $2.2 million, a decrease of $358,000, or 14.0%, 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 nine months ended September 30, 2003 compared with
30.1% for the same period in 2002. The effective
21
tax rate of 27.0% consisted of a federal effective tax rate of 23.3% and
Wisconsin State effective tax rate of 3.7%.
Balance Sheet Analysis
Loans
At September 30, 2003, total loans increased $9.8 million, or 1.5%, to $674.1
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
$379.6 million at September 30, 2003 compared to $351.4 million at December 31,
2002. In addition, commercial loans decreased to $88.2 million at September 30,
2003, compared to $89.2 million at December 31, 2002. Real estate construction
loans decreased to $66.8 million at September 30, 2003, compared to $75.7
million at December 31, 2002. Real estate mortgage loans decreased to $125.1
million at September 30, 2003, compared with $133.4 million at December 31,
2002. Consumer loans were $14.7 million and $14.9 million at September 30, 2003
and December 31, 2002, respectively.
Growth in commercial real estate mortgages and commercial loans occurred
principally as a result of the Company's expansion efforts (primarily in the
Green Bay market) and the strong economic growth existing in that market.
The following table reflects the composition (mix) of the loan portfolio
(dollars in thousands):
TABLE 5
LOAN PORTFOLIO ANALYSIS
($ in Thousands)
September 30, December 31,
2003 2002
------------- ------------
Amount of loans by type (dollars in thousands)
Real estate-mortgage
Commercial $379,571 $351,425
1-4 family residential
First liens 76,458 86,161
Junior liens 19,673 21,789
Home equity 28,994 25,415
Commercial, financial and agricultural 88,212 89,207
Real estate-construction 66,750 75,688
Installment
Credit cards and related plans 2,113 2,057
Other 12,567 12,859
Less: deferred origination fees, net of costs 264 316
-------- --------
Total $674,074 $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
22
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 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 September 30, 2003 was $12.6
million compared with $11.4 million at the end of 2002. Loans increased 1.5%
from December 31, 2002 to September 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 nine months of 2003. The September 30,
2003 ratio of ALL to outstanding loans was 1.87% compared with 1.72% at December
31, 2002 and the ALL as a percentage of non-performing loans was 64.9% at
September 30, 2003 compared to 51.7% at end of year 2002. Based on management's
analysis of the loan portfolio risk at September 30, 2003, a provision expense
of $3.1 million was recorded for the nine months ended September 30, 2003, an
increase of $437,000 or 16.2% compared to the same period in 2002. Net loan
charge-offs of $1.9 million occurred in the first nine months of 2003, and the
ratio of net charge-offs to average loans for the period ended September 30,
2003 was 0.38% compared to 0.29% at September 30, 2002. Real estate mortgage
loan net charge-offs represented 54.2%
23
of the total net charge-offs and commercial loans represented 39.9% of the net
charge-offs for the first nine months of 2003. Loans charged-off are subject to
periodic review and specific efforts are taken to achieve maximum recovery of
principal and accrued interest.
TABLE 6
ALLOWANCE FOR LOAN LOSSES AND NONPERFORMING ASSETS
($ in thousands)
For the period ended For the period ended For the period ended
September 30, 2003 September 30, 2002 December 31, 2002
------------------ ------------------ -----------------
Allowance for Loan Losses ("ALL")
Balance at beginning of period $ 11,410 $ 7,992 $ 7,992
Provision for loan losses 3,137 2,700 5,700
Charge-offs 2,770 1,925 3,055
Recoveries 857 553 773
-------- -------- --------
Balance at end of period 12,634 9,320 11,410
Net charge-offs ("NCOs") 1,913 1,372 2,282
Nonperforming Assets:
Nonaccrual loans $ 11,783 $ 18,490 $ 12,244
Accruing loans past due 90 days or more 0 0 0
Restructured loans 7,674 4,099 9,844
-------- -------- --------
Total nonperforming loans ("NPLs") $ 19,457 $ 22,589 $ 22,088
Other real estate owned 1,359 2,639 2,890
-------- -------- --------
Total nonperforming assets ("NPAs") $ 20,816 $ 25,228 $ 24,978
Ratios:
ALL to NCO's (annualized) 4.94 5.09 5.00
NCO's to average loans (annualized) 0.38% 0.29% 0.36%
ALL to total loans 1.87% 1.43% 1.72%
NPL's to total loans 2.89% 3.48% 3.33%
NPA's to total assets 2.27% 2.79% 2.76%
ALL to NPL's 64.93% 41.26% 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.
24
The second component is statistically based and is intended to provide for
losses that have occurred in large groups of smaller balance loans, the credit
quality of which is impracticable to re-grade at end of period. These loans
would include residential real estate, consumer loans and loans to small
businesses generally in principal amounts of $100,000 and less. The loss factors
are based primarily on the Company's historical loss experience tracked over a
three-year period and accordingly will change over time. Due to the fact that
historical loss experience varies for the different categories of loans, the
loss factors applied to each category also differ.
The final or "unallocated" component of the ALL is a component that is intended
to absorb losses that may not be provided for by the other components. There are
several primary reasons that the other components discussed above might not be
sufficient to absorb the losses present in portfolios, and the unallocated
portion of the ALL is used to provide for the losses that have occurred because
of these reasons.
The first is that there are limitations to any credit risk grading process. Even
for experienced loan reviewers, grading loans and estimating losses involves a
significant degree of judgment regarding the present situation with respect to
individual loans and the portfolio as a whole. The overall number of loans in
the portfolio also makes it impracticable to re-grade every loan each quarter.
Therefore, it is possible that some currently performing loans not recently
graded will not be as strong as their last grading and an insufficient portion
of the allowance will have been allocated to them. In addition, it is possible
that grading and loan review may be done without knowing whether all relevant
facts are at hand. For example, troubled borrowers may inadvertently or
deliberately omit important information from correspondence with lending
officers regarding their financial condition and the diminished strength of
repayment sources.
The second is that loss estimation factors are based on historical loss totals.
As such, the factors may not give sufficient weight to such considerations as
the current general economic and business conditions that affect the Company's
borrowers and specific industry conditions that affect borrowers in that
industry. For example, with respect to loans to borrowers who are influenced by
trends in the local tourist industry, management considers the effects of
weather conditions, market saturation, and the competition for borrowers from
other tourist destinations and attractions.
Third, the loss estimation factors do not give consideration to the seasoning of
the loan portfolio. Seasoning is relevant because losses are less likely to
occur in loans that have been performing satisfactorily for several years than
in loans that are more recent.
Finally, the loss estimation factors do not give consideration to the interest
rate environment. Most obviously, borrowers with variable rate 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.
25
TABLE 7
ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES
($ in thousands)
September 30, Percent of September 30, Percent of Dec 31, Percent of
2003 loans to 2002 loans to 2002 loans to
Amount total loans Amount total loans Amount total loans
------------- ----------- ------------- ----------- ------- -----------
Commercial, financial
& agricultural $ 4,621 13.09% $ 1,612 12.94% $ 3,679 13.43%
Commercial real estate 5,882 56.27% 5,200 50.28% 4,639 52.85%
Real Estate:
Construction 580 9.90% 380 12.73% 814 11.39%
Residential 799 14.26% 1,320 17.57% 1,467 16.25%
Home equity lines 158 4.30% 150 4.04% 228 3.83%
Consumer 58 1.87% 150 2.12% 139 1.94%
Credit card 42 0.31% 70 0.32% 83 0.31%
Loan commitments 250 158 154
Not specifically
allocated 244 280 207
--------- --------- ---------
Total allowance $ 12,634 100.00% $ 9,320 100.00% $ 11,410 100.00%
Allowance for credit
loss as a percentage
of total loans 1.87% 1.43% 1.72%
Period end loans $674,074 $ 649,894 $ 664,285
While probable asset quality problems exist in the loan portfolio, management
believes sufficient reserves have been provided in the ALL to absorb probable
losses in the loan portfolio at September 30, 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 September 30, 2003 were $20.8 million compared to $25.0
million at December 31, 2002. Other real estate owned totaled $1.4 million and
consisted of five residential and ten commercial
26
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 $11.8
million of the total of non-performing assets at September 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 $1.9 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 $7.7 million of non-performing loans at September 30, 2003 and
$9.8 million at December 31, 2002. Approximately $6.8 million of troubled debt
restructured loans at September 30 consists of two commercial real estate
credits which were granted various payment concessions and had experienced past
cash flow problems. These credits were current at September 30, 2003. Management
believes that collateral is sufficient in those loans classified as troubled
debt in event of default, with the exception that $2.9 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 September 30, 2003 was 2.9% compared to 3.3% at end of year 2002.
The Company's ALL was 64.9% of total non-performing loans at September 30, 2003
compared to 51.7% at end of year 2002.
Potential problem loans at September 30, 2003 amounted to $8.5 million compared
to a total of $5.2 million at December 31, 2002. $7.5 million of the problem
loans stem from three commercial credits 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 September 30, 2003, the investment portfolio (which includes investment
securities available for sale and held to maturity) increased $19.9 million, or
13.2%, to $171.3 million from $151.4 million at December 31, 2002. At September
30, 2003, the investment portfolio represented 18.7% of total assets compared
with 16.7% at December 31, 2002.
Securities held to maturity and securities available for sale consist of the
following:
TABLE 8
INVESTMENT SECURITY ANALYSIS
At September 30, 2003
($ in Thousands)
Gross Unrealized Gross Unrealized Estimated Market
Amortized Cost Gains Losses Value
-------------- ---------------- ---------------- ----------------
Securities held to maturity
Obligations of states &
political subdivisions $ 17,303 $ 295 $ 0 $ 17,598
-------- ------ ------ --------
Securities available for sale
Obligations of U.S. Treasury &
other U.S. Agencies 35,244 1,951 0 37,195
27
Mortgage-backed securities 76,430 221 1,175 75,476
Obligations of states &
political subdivisions 33,825 2,053 0 35,878
Other securities 5,445 15 5,460
Total securities available for
sale $150,944 $4,240 $1,175 $154,009
-------- ------ ------ --------
At December 31, 2002
($ in Thousands)
Gross Unrealized Gross Unrealized Estimated Market
Amortized Cost Gains Losses Value
-------------- ---------------- ---------------- ----------------
Securities held to maturity
Obligations of states &
political subdivisions $ 18,227 $ 297 $ 0 $ 18,524
-------- ------- --- --------
Securities available for sale
Obligations of U.S. Treasury &
other U.S. Agencies $ 38,379 $ 2,214 $ 0 $ 40,593
Mortgage-backed securities 49,968 941 58 50,851
Obligations of states &
political subdivisions 35,840 1,817 3 37,654
Other securities 4,019 22 4,041
-------- ------- --- --------
Total securities available for
sale $128,206 $ 4,994 $61 $133,139
At September 30, 2003, the contractual maturities of securities held to maturity
and securities available for sale are as follows:
TABLE 9
INVESTMENT PORTFOLIO MATURITY
($ in Thousands)
Securities held to Maturity Securities Available for Sale
------------------------------------ ------------------------------------
Amortized Cost Market Value Amortized Cost Market Value
-------------- ------------ -------------- ------------
Within 1 year $ 2,236 $ 2,240 $ 8,908 $ 9,038
After 1 but within 5 years 7,317 7,548 71,435 73,239
After 5 but within 10 years 3,033 3,093 51,992 52,572
After 10 years 4,717 4,717 15,689 16,240
Equity securities 0 0 2,920 2,920
-------- -------- -------- --------
Total $ 17,303 $ 17,598 $150,944 $154,009
Deposits
28
Total deposits at September 30, 2003 increased $13.3 million, or 1.8%, to $753.6
million from $740.3 million at December 31, 2002. Non-interest bearing deposits
at September 30, 2003 increased $8.3 million, or 9.3%, to $98.2 million from
$89.8 million at December 31, 2002. Interest-bearing deposits at September 30,
2003 increased $4.9 million, or 0.8%, to $655.4 million from $650.5 million at
December 31, 2002. Interest-bearing transaction accounts (NOW deposits)
increased $19.4 million, primarily in individual account deposits. Savings
deposits increased $4.3 million, or 2.2%, to $199.5 million at September 30,
2003, when compared to $195.2 million at December 31, 2002. Time deposits
(including time, $100,000 and over and other time) decreased $18.9 million
(includes decrease of $91,000 in time deposits over $100,000), or 4.8%, to
$372.1 million at September 30, 2003, when compared to $391.0 million at
December 31, 2002. Brokered CD's totaled $97.9 million at September 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.
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 September 30, 2003 consist of federal funds purchased
and securities under agreements to repurchase. Total short-term borrowings at
September 30, 2003 decreased $1.8 million to $8.3 million from $10.1 million at
December 31, 2002. Customer repurchase agreements totaled $1.1 million at
September 30, 2003 compared to $1.8 million at December 31, 2002. Federal funds
purchased decreased from $8.3 million at December 31, 2002 to $7.2 million at
September 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 $65.1
million at September 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 September 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
29
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 $3.2 million for the first nine months 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 $3.9 million in the first nine months
of 2003.
The Bank meets its cash flow needs by having funding sources available to
satisfy the credit needs of customers as well as having available funds to
satisfy deposit withdrawal requests. Liquidity at the Bank is derived from
deposit growth, maturing loans, the maturity of the investment portfolio, access
to other funding sources, marketability of certain of its assets and strong
capital positions.
Maturing investments have been a primary source of liquidity at the Bank. For
the nine months ended September 30, 2003, principal payments totaling $59.4
million were received on investments. These proceeds in addition to other
Company cash were used to purchase $82.2 million in investments for the nine
months ended September 30, 2003. At September 30, 2003, the carrying or book
value of investment securities maturing within one year amounted to $11.3
million or 6.6% 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 nine
months of 2003 totaled $59.4 million. At September 30, 2003, the investment
portfolio contained $112.7 million of U.S. Treasury and federal agency backed
securities representing 65.8% of the total investment portfolio. These
securities tend to be highly marketable and had a market value above amortized
cost at September 30, 2003 amounting to $1.0 million.
Deposit growth is typically another source of liquidity for the Bank. As a
financing activity reflected in the September 30, 2003 Consolidated Statements
of Cash Flows, deposits increased and resulted in $13.2 million of cash inflow
during the first nine months of 2003. The Company's overall deposit base
increased 1.8% for the nine months ended September 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 $230.0 million, or 34.1%, of loans maturing within one year.
Within the classification of short-term borrowings and other borrowings at
September 30, 2003, federal funds purchased and securities sold under agreements
to repurchase totaled $8.3 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 $65.1 million at September 30, 2003 and December 31, 2002.
The Bank's liquidity resources were sufficient in the first nine 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.
30
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
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.
31
TABLE 10
ASSET AND LIABILITY MATURITY REPRICING SCHEDULE
AS OF September 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 $ 16 346 $ 1 962 $ 3 008 $ 81 561 $ 75 557 $178 434
Loans and leases
Variable rate 382 242 6 318 14 673 9 490 0 412 723
Fixed rate 46 848 25 051 49 556 123 526 4 587 249 568
--------- -------- -------- --------- ------- --------
Total loans and leases $ 429 090 $ 33 331 $ 64 229 $ 133 016 $ 4 587 $249 568
--------- -------- -------- --------- ------- --------
Total earning assets $ 445 436 $ 33 331 $ 67 237 $ 214 577 $ 80 144 $840 725
========= ======== ======== ========= ======== ========
Interest bearing liabilities:
NOW Accounts $ 20 927 $ 0 $ 0 $ 62 780 $ 0 $ 83 707
Savings Deposits 150 323 0 0 49 235 0 199 558
Time Deposits 77 216 94 745 128 624 71 500 16 372 101
Borrowed Funds 48 283 93 53 25 000 0 73 429
Trust Preferred Stock 0 0 0 0 16 100 16 100
========= ======== ========= ========= ======== ========
Total interest bearing $ 296 749 $ 94 838 $ 128 677 $ 208 515 $ 16 116 $744 895
========= ======== ========= ========= ======== ========
Liabilities
Interest sensitivity gap (within $ 148 687 $(61 507) $ (61 440) $ 6 062 $ 64 028 $ 95 830
periods)
Cumulative interest sensitivity gap $ 148 687 $ 87 180 $ 25 740 $ 31 802 $ 95 830
Ratio of cumulative interest
Sensitivity gap to rate
Sensitive assets 17.69% 10.37% 3.06% 3.78% 11.40%
Ratio of rate sensitive assets
To rate sensitive
Liabilities 150.11% 35.15% 52.25% 102.91% 497.29%
Cumulative ratio of rate
Sensitive assets to rate
Sensitive liabilities 150.11% 122.26% 104.95% 104.36% 112.86%
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 8.8% if rates rose by a 100 basis point shock, and
projected that net interest income would decrease by approximately 6.8% if rates
fell by a 100 basis point shock under these scenarios for the period ended
September 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
32
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 September 30, 2003 increased $2.7 million or 4.1% to
$68.1 million, compared with $65.4 million at end of year 2002. This increase
includes a reduction of $1.2 million 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 $3.9 million or 5.9% for
the period from December 31, 2002 to September 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.
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 September 30,
2003, $16.1 million of the Trust Preferred Securities qualify as Tier 1 Capital.
Cash dividends paid for the first nine months of 2003 were $0.39 per share
compared with $0.36 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 nine 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.
33
At September 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
September 30, 2003 and December 31, 2002:
TABLE 11
CAPITAL RATIOS
($ in Thousands)
To Be Well
Capitalized under
For Capital Adequacy Prompt Corrective
Actual Purposes Action Provisions
------------------- -------------------- -----------------
($ in Thousands)
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
As of September 30, 2003
Total Capital (to
Risk Weighted Assets)
Company 86,815 11.20% 62,012 8.00% 77,515 10.00%
Bank 83,388 10.65% 62,610 8.00% 78,263 10.00%
Tier 1 Capital (to
Risk Weighted Assets)
Company 77,089 9.95% 31,006 4.00% 46,509 6.00%
Bank 73,570 9.40% 31,305 4.00% 46,598 6.00%
Tier 1 Capital (to
Average Assets)
Company 77,089 8.47% 36,398 4.00% N/A N/A
Bank 73,570 8.08% 36,398 4.00% 46,958 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.
34
Other Information
Bank has purchased land in the city of West De Pere located in Brown County.
Plans are underway to construct a full-service branch facility with completion
to be late spring of 2004. Costs to complete the project, including land
purchase, are estimated to be $1.7 million.
Baylake Bank will complete the purchase of a branch facility from Marshall &
Ilsley Bank located in Kewaunee, WI on November 21. It is estimated that
approximately $15 million in deposits and $ 2 million in loans will be acquired
as a result of the transaction. Costs to complete the purchase are estimated to
be $660,000.
Item 3 Quantitative and Qualitative Disclosure about Market Risk.
The Company's financial performance is affected by, among other factors, credit
risk and interest rate risk. The Company does not use derivatives to mitigate
its interest rate risk or credit risk, relying instead on loan review and its
loan loss reserve.
The Company's earnings are derived from the operations of its direct and
indirect subsidiaries with particular reliance on net interest income,
calculated as the difference between interest earned on loans and investments
and the interest expense paid on deposits and other interest bearing
liabilities, including advances from FHLB and other borrowings. Like other
financial institutions, the Company's interest income and interest expense are
affected by general economic conditions and by the policies of regulatory
authorities, including the monetary policies of the Board of Governors of the
Federal Reserve System. Changes in the economic environment may influence, among
other matters, the growth rate of loans and deposits, the quality of the loan
portfolio and loan and deposit pricing. Fluctuations in interest rates are not
predictable or controllable.
As of September 30, 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.
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
35
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
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 September 30, 2003. Third quarter
earnings release-Regulation FD Disclosures.
36
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
BAYLAKE CORP.
---------------------------------
Date: November 12, 2003 /s/ Thomas L. Herlache
------------------------------- ---------------------------------------
Thomas L. Herlache
President (CEO)
Date: November 12, 2003 /s/ Steven D. Jennerjohn
------------------------------- ---------------------------------------
Steven D. Jennerjohn
Treasurer (CFO)
37
EXHIBIT INDEX
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
38