UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2006
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 (Identification No.)
of incorporation 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
----- -----
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer" and "large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check
one):
Large accelerated filer [ ] Accelerated filer [X] Non-accelerated filer [ ]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).
Yes No X
----- -----
Applicable Only to Corporate Issuers:
Number of outstanding shares of common stock as of May 1, 2006: 7,800,427 shares
BAYLAKE CORP. AND SUBSIDIARIES
INDEX
PAGE NO.
--------
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets (Unaudited) as of March 31, 2006 and
December 31, 2005 3
Consolidated Statements of Income and Comprehensive Income
(Unaudited) for the three months ended March 31, 2006 and 2005 4
Consolidated Statements of Changes in Stockholders' Equity
(Unaudited) for the three months ended March 31, 2006 and 2005 5
Consolidated Statements of Cash Flows (Unaudited) for the three
months ended March 31, 2006 and 2005 6-7
Notes to Unaudited Consolidated Financial Statements 8-10
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 11-33
Item 3. Quantitative and Qualitative Disclosures About Market Risk 33-34
Item 4. Controls and Procedures 34-35
PART II - OTHER INFORMATION
Signatures 36
EXHIBIT INDEX
Exhibit 31.1 Certification pursuant to Section 302 37
Exhibit 31.2 Certification pursuant to Section 302 39
Exhibit 32.1 Certification pursuant to 18 U.S.C. Section 1350 41
Exhibit 32.2 Certification pursuant to 18 U.S.C. Section 1350 42
BAYLAKE CORP.
CONSOLIDATED BALANCE SHEETS (Unaudited)
March 31, 2006 and December 31, 2005
(Amounts in thousands of dollars)
March 31, December 31,
2006 2005
---------- ------------
ASSETS
Cash and due from financial institutions $ 24,443 $ 32,855
Federal funds sold 117 199
---------- ----------
Cash and cash equivalents 24,560 33,054
Securities available for sale 173,384 171,638
Loans held for sale 475 374
Loans, net of allowance after $9,738 and $9,551 822,274 802,745
Cash value of life insurance 23,623 22,814
Premises held for sale 1,168 1,167
Premises and equipment, net 24,759 24,703
Federal Home Loan Bank stock 8,081 8,081
Foreclosed assets, net 1,799 3,333
Goodwill 5,723 5,723
Accrued interest receivable 5,877 5,354
Other assets 10,445 10,422
---------- ----------
Total assets $1,102,168 $1,089,408
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits
Non-interest-bearing $ 93,835 $ 110,641
Interest-bearing 757,251 746,070
---------- ----------
Total deposits 851,086 856,711
Federal Home Loan Bank advances 120,184 125,185
Federal funds purchased and repurchase agreements 25,860 1,315
Subordinated debentures 16,100 16,100
Accrued expenses and other liabilities 10,432 10,310
Dividends payable -- 1,243
Total liabilities 1,023,662 1,010,864
---------- ----------
Common stock, $5 par value, authorized 50,000,000 shares; issued-
7,823,586 shares in 2006, 7,805,586 shares in 2005; outstanding-
7,800,427 shares in 2006, 7,782,427 shares in 2005 39,118 39,028
Additional paid-in capital 9,620 9,466
Retained earnings 32,539 32,461
Treasury stock (23,159 shares in 2006 and 2005) (625) (625)
Accumulated other comprehensive loss (2,146) (1,786)
---------- ----------
Total stockholders' equity 78,506 78,544
---------- ----------
Total liabilities and stockholder equity $1,102,168 $1,089,408
========== ==========
See accompanying notes to Unaudited Consolidated Financial Statements.
3
BAYLAKE CORP.
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
(Unaudited)
Three months ended March 31, 2006 and 2005
(Amounts in thousands of dollars except per share data)
2006 2005
------- -------
Interest and dividend income
Loans, including fees $14,664 $11,663
Taxable securities 1,571 1,729
Tax exempt securities 360 403
Federal funds sold and other 51 17
------- -------
Total interest and dividend income 16,646 13,812
Interest expense
Deposits 6,342 3,827
Federal funds purchased and repurchase agreements 175 173
Federal Home Loan Bank advances and other debt 1,362 737
Subordinated debentures 889 461
------- -------
Total interest expense 8,768 5,198
------- -------
NET INTEREST INCOME 7,878 8,614
Provision for loan losses 200 30
------- -------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 7,678 8,584
Other income
Fees from fiduciary activities 301 179
Fees from loan servicing 260 283
Fees for other services to customers 1,139 1,098
Gains from sales of loans 201 208
Increase in cash surrender value of life insurance 226 227
Other income 111 268
------- -------
Total other income 2,238 2,263
Noninterest expenses
Salaries and employee benefits 4,992 4,528
Occupancy expense 579 536
Equipment expense 395 307
Data processing and courier 300 278
Operation of other real estate 43 48
Other operating expenses 1,815 1,348
------- -------
Total other expenses 8,124 7,045
------- -------
INCOME BEFORE INCOME TAX EXPENSE 1,792 3,802
Income tax expense 468 1,218
------- -------
NET INCOME $ 1,324 $ 2,584
======= =======
COMPREHENSIVE INCOME $ 964 $ 592
======= =======
Basic earnings per common share $ 0.17 $ 0.34
Diluted earnings per common share $ 0.17 $ 0.33
See accompanying notes to Unaudited Consolidated Financial Statements
4
BAYLAKE CORP.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (Unaudited)
Three months ended March 31,
(Amounts in thousands of dollars except for per share data)
Accumulated
Common Stock Additional Other
------------------- Paid-in Retained Treasury Comprehensive Total
Shares Amount Capital Earnings Stock Income Equity
--------- ------- ---------- -------- -------- ------------- -------
BALANCE, JANUARY 1, 2005 7,692,777 $38,580 $8,806 $28,275 $(625) $ 1,169 $76,205
Net income for the period -- -- -- 2,584 -- -- 2,584
Net changes in unrealized gain (loss)
on securities available for sale,
net of $(1,108) deferred taxes -- -- -- -- -- (1,992) (1,992)
-------
Total comprehensive income 592
Stock options exercised 5,000 25 24 -- -- -- 49
Tax benefit from exercise of stock
options -- -- 15 -- -- -- 15
Cash dividends declared ($0.15 per
share) -- -- -- (1,155) -- -- (1,155)
--------- ------- ------ ------- ----- ------- -------
BALANCE, MARCH 31, 2005 7,697,777 $38,605 $8,845 $29,704 $(625) $ (823) $75,706
========= ======= ====== ======= ===== ======= =======
BALANCE, JANUARY 1, 2006 7,782,427 $39,028 $9,466 $32,461 $(625) $(1,786) $78,544
Net income for the period -- -- -- 1,324 -- -- 1,324
Net changes in unrealized gain (loss)
on securities available for sale,
net of $(201) deferred taxes -- -- -- -- -- (360) (360)
-------
Total comprehensive income 964
Stock options exercised 18,000 90 71 -- -- -- 161
Stock compensation expense recognized -- -- 13 -- -- -- 13
Tax benefit from exercise of stock
options -- -- 70 -- -- -- 70
Cash dividends declared ($0.16 per
share) -- -- -- (1,246) -- -- (1,246)
--------- ------- ------ ------- ----- ------- -------
BALANCE, MARCH 31, 2006 7,800,427 $39,118 $9,620 $32,539 $(625) $(2,146) $78,506
========= ======= ====== ======= ===== ======= =======
See accompanying notes to Unaudited Consolidated Financial Statements
5
BAYLAKE CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
Three months ended March 31, 2006 and 2005
(Amounts in thousands of dollars)
2006 2005
-------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Reconciliation of net income to net cash provided by
operating activities:
Net income $ 1,324 $ 2,584
Adjustments to reconcile net income to net cash
provided to operating activities:
Depreciation 402 361
Amortization of debt issuance costs 475 59
Amortization of core deposit intangible 13 13
Provision for losses on loans 200 30
Net amortization of securities 44 163
Increase in cash surrender value of life insurance (226) (227)
Federal Home Loan Bank stock dividend -- (106)
Net gain on sale of loans (201) (208)
Proceeds from sale of loans held for sale 9,003 8,499
Origination of loans held for sale (8,904) (7,754)
Provision for valuation allowance on other real estate owned 47 20
Net gain from disposal of other real estate (78) (41)
Net loss from disposal of premises and equipment 2 --
Stock option compensation expense recognized 13 --
Tax benefit from exercises of stock options (70) --
Changes in assets and liabilities:
Accrued interest receivable and other assets (694) 260
Accrued expenses and other liabilities 122 115
-------- --------
Net cash provided by operating activities 1,473 3,768
CASH FLOWS FROM INVESTING ACTIVITIES:
Principal payments on securities available-for-sale 4,195 2,938
Purchase of securities available-for-sale (6,545) (10,530)
Proceeds from sale of other real estate owned 1,764 215
Proceeds from sale of premises and equipment -- 157
Loan originations and payments, net (19,928) (26,847)
Additions to premises and equipment (461) (2,273)
Investment in bank-owned life insurance (583) (470)
-------- --------
Net cash used in investing activities (21,558) (36,810)
See accompanying notes to Unaudited Consolidated Financial Statements
6
BAYLAKE CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
Three months ended March 31, 2006 and 2005
(Amounts in thousands of dollars)
2006 2005
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net change in deposits $ (5,625) $(14,583)
Net change in federal funds purchased and
repurchase agreements 24,545 24,210
Proceeds from Federal Home Loan Bank advances 10,000 15,000
Repayments on Federal Home Loan Bank advances (15,001) (2)
Redemption of subordinated debt (16,100) --
Proceeds from issuance of subordinated debt 16,100 --
Proceeds from exercise of stock options 161 49
Cash dividends paid (2,489) (2,309)
-------- --------
Net cash provided by financing activities 11,591 22,365
-------- --------
Net change in cash and cash equivalents (8,494) (10,677)
Beginning cash and cash equivalents 33,054 26,172
-------- --------
ENDING CASH AND CASH EQUIVALENTS $ 24,560 $ 15,495
======== ========
See accompanying notes to Unaudited Consolidated Financial Statements
7
BAYLAKE CORP.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2006
1. The accompanying consolidated financial statements should be read in
conjunction with Baylake Corp.'s 2005 annual report on Form 10-K. The
accompanying consolidated financial statements are unaudited. These interim
financial statements are prepared in accordance with the requirements of
Form 10-Q, and accordingly do not include all of the information and
footnotes required by U.S. generally accepted accounting principles for
complete financial statements. In the opinion of management, the unaudited
financial information included in this report reflects all adjustments,
consisting of normal recurring accruals, which are necessary for a fair
statement of the financial position as of March 31, 2006 and December 31,
2005. The results of operations for the three months ended March 31, 2006
are not necessarily indicative of results to be expected for the entire
year.
2. To prepare financial statements in conformity with U.S. generally accepted
accounting principles, management makes estimates and assumptions based on
available information. These estimates and assumptions affect the amounts
reported in the financial statements and the disclosures provided, and
actual results could differ. The allowance for loan losses, foreclosed
assets, and fair values of financial instruments are particularly subject
to change.
3. Diluted earnings per share, which reflects the potential dilution that
could occur if outstanding stock options were exercised and stock awards
were fully vested and resulted in the issuance of common stock that then
shared in the earnings of the Company, is computed by dividing net income
by weighted average number of common shares and common stock equivalents.
The following table shows the computation of the basic and diluted earnings
per share for the three months ended March 31 (dollars in thousands, except
per share amounts):
Three months ended March 31,
----------------------------
2006 2005
---------- ----------
(NUMERATOR):
Net income $ 1,324 $ 2,584
(DENOMINATOR):
Weighted average number of common shares outstanding-basic 7,784,960 7,695,721
Dilutive effect of stock options 53,796 100,849
---------- ----------
Weighted average of common shares outstanding and assumed
conversion-diluted 7,838,756 7,796,570
BASIC EPS $ 0.17 $ 0.34
DILUTED EPS $ 0.17 $ 0.33
See accompanying notes to Unaudited Consolidated Financial Statements
8
BAYLAKE CORP.
4. Baylake Corp. declared a cash dividend of $0.16 per share payable on March
15, 2006 to shareholders of record as of March 1, 2006.
5. The Company has a non-qualified stock option plan, which is described more
fully in the Company's December 31, 2005 Annual Report on Form 10-K.
Beginning in 2006, the Company accounts for stock compensation expense
under the provisions of FASB Statement No. 123R, "Accounting for
Stock-Based Compensation" ("FAS 123R") on a modified prospective basis. FAS
123R requires all public companies to record compensation cost for stock
options provided to employees in return for employee service. The cost is
measured at the fair value of the options when granted, and this cost is
expensed over the employment service period, which is normally the vesting
period of the options. This applies to awards granted, modified or vesting
in fiscal years beginning in 2006. Compensation cost is recorded for prior
option grants that vest after the date of adoption. The effect on results
of operations will depend on the level of future option grants and the
calculation of the fair value of the options granted at such future date,
as well as the vesting periods provided, and so cannot currently be
predicted. The Company may no longer issue stock options under the current
plan and thus there will be no further grants thereunder. Existing options
that will vest after the adoption date are expected to result in an
immaterial amount of compensation expense during 2006 through 2008. For the
first quarter of 2006, the amount of compensation expense reflected in the
financial statements is $13,000. As a matter of comparing the first quarter
in 2006 with 2005, 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 for periods prior to January 1, 2006.
Three months ended
March 31, 2005
---------------------
Amounts in thousands,
except per share data
Net income, as reported $2,584
Less: Total stock-based employee compensation cost
determined under the fair value based method,
net of income taxes (14)
------
Pro forma net income $2,570
Earnings per share:
Basic - as reported $ 0.34
Basic - pro forma $ 0.33
Diluted - as reported $ 0.33
Diluted - pro forma $ 0.33
See accompanying notes to Unaudited Consolidated Financial Statements
9
BAYLAKE CORP.
The fair value of each option granted was estimated as of the date of grant
using the Black-Scholes option pricing model. The resulting compensation
cost was amortized over the vesting period.
The following table indicates the options outstanding at March 31, 2006. A
market price of $16.40 was used to compute intrinsic value for March 31,
2006, which was the closing market price on that date. Fully vested options
include only those share options that have vested or are expected to vest
at March 31, 2006 and have economic value.
Weighted-average Aggregate intrinsic Weighted average remaining
Description of options Number of shares exercise price value (In thousands) life (In years)
- ---------------------- ---------------- ---------------- -------------------- --------------------------
Options outstanding 408,869 $12.55 $1,575 3.3
Options exercisable 367,512 $12.43 $1,457 3.3
There were 18,000 options exercised during the three months ended March 31,
2006 amounting to $135,780 in intrinsic value.
6. The Company has redeemed on March 31, 2006 all of its 10.00% Cumulative
Trust Preferred Securities (the "Trust Preferred Securities") and its
10.00% Common Securities (the "Trust Common Securities") at a redemption
price equal to the $10.00 liquidation amount of each security plus all
accrued and unpaid interest per security to March 31, 2006, the redemption
date through Baylake Capital Trust I (the "Trust").
The Trust has taken such action in connection with the concurrent
redemption by Baylake Corp. of all of its $16.6 million 10.00% debentures
due March 31, 2031 (the "Debentures") which are held exclusively by the
Trust. The Debentures were redeemed on March 31, 2006 at a redemption price
equal to the principal outstanding of the Debentures plus interest accrued
on the Debentures up to March 31, 2006. In connection with the redemption
of the Debentures, the Company expensed during the first quarter $475,015,
net of tax, of unamortized origination cost associated with the Debentures.
The Company has funded the redemption through the issuance of $16.1 million
of trust preferred securities and $498,000 of trust common securities that
will adjust quarterly at a rate equal to 1.35% over the three-month LIBOR.
The initial rate for the second quarter will be 6.31%.
See accompanying notes to Unaudited Consolidated Financial Statements
10
PART 1 - FINANCIAL INFORMATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL
Baylake is a full-service financial services company, providing a wide variety
of loan, deposit and other banking products and services to its business,
individual or retail, and municipal customers, as well as a full range of trust,
investment and cash management services. The Company is the bank holding company
of Baylake Bank ("Bank"), chartered as a state bank in Wisconsin and a member
bank of the Federal Reserve and Federal Home Loan Bank.
The following sets forth management's discussion and analysis of the
consolidated financial condition and results of operations of Baylake Corp.
("Baylake" or the "Company") for the three months ended March 31, 2006 and 2005
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.
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. Also, discussions of or
including any periods ending after the period for which this report is filed are
forward-looking statements. The statements contained herein and in such
forward-looking statements involve or may involve certain assumptions, risks and
uncertainties, many of which are beyond the control of the Company, that may
cause actual future results to differ materially from what may be expressed or
forecasted in such forward-looking statements. Readers should not place undue
expectations on any forward-looking statements. In addition to the assumptions
and other factors referenced specifically in connection with such statements and
those discussed in Item 1A of our annual report on Form 10-K for the year ended
December 31, 2005, the following factors could impact the business and financial
prospects of the relationships; demand for financial products and financial
services; the degree of competition by traditional and non-traditional financial
services competitors; changes in banking legislation or regulations; changes in
tax laws and the results of recent Wisconsin state tax developments; changes in
interest rates; changes in prices; the impact of technological advances;
governmental and regulatory policy changes; trends in customer behavior as well
as their ability to repay loans; and changes in the general economic conditions,
nationally or in the State of Wisconsin.
11
CRITICAL ACCOUNTING POLICIES
In the course of the Company's normal business activity, management must select
and apply many accounting policies and methodologies that lead to the financial
results presented in the consolidated financial statements of the Company. Some
of these policies are more critical than others.
Allowance for Loan Losses: The allowance for loan losses ("ALL") is a valuation
allowance for probable incurred credit losses. Loan losses are charged against
the allowance when management believes the uncollectibility of a loan balance is
confirmed. Subsequent recoveries, if any, are credited to the allowance.
Management estimates the allowance balance required using past loan loss
experience, the nature and volume of the portfolio, information about specific
borrower situations and the estimated collateral values, economic conditions,
and other factors. Allocations of the allowance may be made for specific loans,
but the entire allowance is available for any loan that, in management's
judgment, should be charged-off.
The allowance consists of specific and general components. The specific
component relates to loans that are individually classified as impaired or loans
otherwise classified as substandard or doubtful. The general component covers
non-classified loans and is based on historical loss experience adjusted for
current factors.
A loan is impaired when full payment under the loan terms is not expected.
Commercial and commercial real estate loans are individually evaluated for
impairment. If a loan is impaired, a portion of the allowance is allocated so
that the loan is reported, net, at the present value of estimated future cash
flows using the loan's existing rate or at the fair value of collateral, if
repayment is expected solely from the collateral. Large groups of smaller
balance homogeneous loans, such as consumer and residential real estate loans,
are collectively evaluated for impairment, and accordingly, they are not
separately identified for impairment disclosures.
Foreclosed Assets: Foreclosed assets acquired through or instead of loan
foreclosure are initially recorded at fair value when acquired, less estimated
costs to sell, establishing a new cost basis. If fair value declines subsequent
to foreclosure, a valuation allowance is recorded through expense. Costs after
acquisition are expensed.
Provision for Impairment of Standby Letter of Credit: The provision for
impairment of letter of credit represents management's estimate of probable
incurred losses on an off-balance sheet standby letter of credit which is used
to accommodate our customer's borrowing arrangements with an unrelated third
party. In the event, of further impairment, a provision for impairment of
standby letter of credit is charged to operations based on management's periodic
evaluation of the factors affecting this standby letter of credit.
Income tax accounting: The assessment of tax assets and liabilities involves the
use of estimates, assumptions, interpretations, and judgments concerning certain
accounting pronouncements and federal and state tax codes. There can be no
assurance that future events, such as court decisions or positions of federal
and state taxing authorities, will not differ from management's current
assessment, the impact of which could be significant to the consolidated results
of the Company's operations and reported earnings. The Company believes that the
tax assets and liabilities are adequate and properly recorded in the
consolidated financial statements. The reserve does not include any specific
reserves relative to any position recently taken by state taxing authorities.
12
Income tax expense may be affected by developments in the state of Wisconsin.
Like many financial institutions that are located in Wisconsin, a subsidiary of
the Bank located in the state of Nevada holds and manages various investment
securities. Due to that fact that these subsidiaries are out of state, income
from their operations has not been subject to Wisconsin state taxation. Although
the Wisconsin Department of Revenue issued favorable tax rulings regarding
Nevada subsidiaries of Wisconsin financial institutions, the Department
representatives have recently stated that the Department intends to revoke those
rulings and tax some or all these subsidiaries' income, even though there has
been no intervening change in the law. The Department also implemented a program
in 2003 for the audit of Wisconsin financial institutions who have formed and
contributed assets to subsidiaries located in Nevada; to date, the Company and
its subsidiaries have not been audited on these matters.
The Department sent letters in July 2004 to financial institutions in Wisconsin,
whether or not they are undergoing an audit, reporting on settlements involving
17 banks and their out-of-state investment subsidiaries. The letter provided a
summary of currently available settlement parameters. For periods before 2004,
they include: restrictions on the types of subsidiary income excluded from
Wisconsin taxation; assessment of certain back taxes for a limited period of
time; and interest (but not penalties) on any past-due taxes. For 2004 and going
forward, there are similar provisions plus limits on the amount of subsidiaries'
assets as to which their income will be excluded from Wisconsin tax. Settlement
on the terms outlined would result in the Department's rescission of related
prior letter rulings, and would purport to be binding going forward except for
future legislation or change by mutual agreement. By implication, the Department
appears to accept the general proposition that some out-of-state investment
subsidiary income is not subject to Wisconsin taxes.
The Company continues to believe that it has reported income and paid Wisconsin
taxes correctly in accordance with applicable tax laws and the Department's
prior longstanding interpretations thereof, including interpretations issued
specifically to it. However, in view of the Department's subsequent change in
position (even if that change does not have a basis in law), the aggressive
stance now being taken by the Department, the settlements by some other banks,
and the potential effect that decisions by other similarly situated institutions
may have on the Company's alternatives going forward, the Company has determined
that it would consider a settlement proposal from the Department; however, the
Company has not yet received a specific proposal nor has any assessment been
made against the Company or its subsidiaries. The Company will need to review
any settlement proposal in more specific detail to quantify in any definitive
way the Department's view of its exposure and to evaluate alternatives. Although
there will likely be challenges to the Department's actions and interpretations,
the Bank's net income would be reduced if the Department succeeds in its actions
and interpretations. The Bank could also incur costs in the future to address
any action taken against it by the Department.
RESULTS OF OPERATIONS
The following table sets forth the Company's net income and related summary
information for the three-months periods ended March 31, 2006 and 2005, as well
as comparisons between the respective periods.
TABLE 1
SUMMARY RESULTS OF OPERATIONS
($ in thousands, except per share data)
13
Three months ended Three months ended % Increase
March 31, 2006 March 31, 2005 or decrease
------------------ ------------------ -----------
Net income $1,324 $2,584 - 48.8%
EPS-basic $ 0.17 $ 0.34 - 50.0%
EPS-diluted $ 0.17 $ 0.33 - 48.5%
Return on average assets 0.48% 0.98% - 51.0%
Return on average equity 6.81% 13.49% - 49.5%
Efficiency ratio (1) 78.24% 63.03% - 24.1%
(1) Non-interest expense divided by sum of taxable equivalent net interest
income plus non-interest income, excluding investment securities gains, net
The decrease in net income for the period is primarily due to decreased net
interest income, an increase in the provision for loan losses, a decrease in
other income and an increase in other expenses. These items were partially
offset by a decrease in income tax expense.
NET INTEREST INCOME
Net interest income is the largest component of the Company's operating income
(net interest income on a tax-equivalent basis plus other non-interest income),
accounting for 78.5% of total operating income for the three months ended March
31, 2006, as compared to 79.8% for the same period in 2005. Net interest income
represents the difference between interest earned on loans, investments and
other interest earning assets offset by the interest expense attributable to the
deposits and the borrowings that fund such assets. Interest fluctuations
together with changes in the volume and types of earning assets and
interest-bearing liabilities combine to affect total net interest income. This
analysis discusses net interest income on a tax-equivalent basis in order to
provide comparability among the various types of earned interest income.
Tax-exempt interest income is adjusted to a level that reflects such income as
if it were fully taxable.
Net interest income on a tax equivalent basis for the three months ended March
31, 2006 decreased $770,000, or 8.6%, to $8.1 million from $8.9 million over the
comparable period a year ago. The decrease results from a decrease in our net
interest margin which resulted partially from an increase in the amount of
non-accrual loan interest of $406,534 (due to an increase in the level of
non-performing loans, which did not accrue interest) and the amortization
expense of issuance costs related to the redemption of the trust preferred
securities (totaling $475,015), offset partially by an increase in average loans
for the period. As a result of the new basis for computing interest on these
securities, we expect the interest paid on trust securities to be $145,507 lower
in the second quarter than it would have been with the prior securities. See
"Balance Sheet Analysis - Long Term Debt" below.
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 impacting net interest margin.
14
The net interest margin for the first quarter of 2006 was 3.23%, down 43 basis
points ("bps") from 3.66% for the comparable period in 2005. The 43 bps decrease
in net interest margin is attributable to a 56 bps decrease in interest rate
spread (the net result of a 88 bps increase in the yield on earning assets
substantially offset by a 144 bps increase in the cost of interest-bearing
liabilities), and a 13 bps higher contribution from net free funds.
As the Federal Reserve Board ("FRB") has continued the trend of steadily
increased interest rates during the latter half of 2004 thru the first quarter
of 2006 in an attempt to keep inflation in control, average interest rates were
higher in 2006 than in 2005. Comparatively, the Federal Funds rate at March 31,
2006 was at 4.75% compared to 2.75% at March 31, 2005, while the average Federal
Funds rate for the first quarter of 2006 was 199 bps higher than for the same
period in 2005. Market demand for deposit products has driven up the cost of
funds and as a result, net interest margin decreased in the first quarter of
2006. Net interest margin was affected by the impact of short-term rate changes
and its affect on wholesale funding costs for the first quarter of 2006.
For the three months ended March 31, 2006, average-earning assets increased
$36.2 million, or 3.7%, when compared to the same period last year. The Company
recorded an increase in average loans of $60.0 million, or 7.8%, for the first
quarter of 2006 compared to the same period a year ago. Loans have typically
resulted in higher rates of interest income to the Company than have investment
securities, which further positively affect interest income.
Interest rate spread is the difference between the tax-equivalent rate earned on
average earning assets and the rate paid on average interest-bearing
liabilities. The interest rate spread decreased for the quarter ended March 31,
2006 when compared to the same period a year ago. The interest rate spread
decreased 56 bps to 2.84% at March 31, 2006 from 3.40% in the same quarter in
2005. While the average yield on earning assets increased 88 bps during the
period, the average rate paid on interest-bearing liabilities increased 144 bps
over the same period. The increase in the rates paid on interest-bearing
liabilities occurred as a result of a higher cost of funding from deposits and
other wholesale funding such as federal funds purchased and loans from the
Federal Home Loan Bank in addition to amortization of issuance costs from the
trust preferred redemption as discussed earlier. We would expect that trend to
continue in light of the recent continuing Federal Reserve Board interest rate
increases.
TABLE 2
NET INTEREST INCOME ANALYSIS ON A TAX -EQUIVALENT BASIS
($ In thousands)
Three months ended March 31,
-----------------------------------------------------------------
2006 2005
------------------------------- -------------------------------
Interest Average Interest Average
Average income/ yield/ Average income/ yield/
Balance expense rate Balance expense Rate
---------- -------- ------- ---------- -------- -------
ASSETS
Earning assets:
Loans, net $ 826,052 $14,748 7.14% $ 766,068 $11,756 6.14%
Taxable securities 146,309 1,571 4.30% 169,410 1,729 4.08%
Tax exempt securities 32,938 543 6.59% 35,243 611 6.95%
15
Federal funds sold and interest
bearing due from banks 4,907 51 4.16% 3,281 17 2.07%
---------- ------- ----- ---------- ------- -----
Total earning assets 1,010,206 16,913 6.68% 974,002 14,113 5.80%
Non-interest earning assets 82,334 76,598
---------- ----------
Total assets $1,092,540 $1,050,600
========== ==========
LIABILITIES AND STOCKHOLDERSEQUITY
Interest-bearing liabilities:
Total interest-bearing deposits 754,535 6,342 3.36% 721,631 3,827 2.12%
Short-term borrowings 13,083 163 4.98% 23,256 165 2.84%
Customer repurchase agreements 1,344 12 3.57% 1,538 8 2.08%
Federal Home Loan Bank advances 124,573 1,362 4.37% 102,024 737 2.89%
Subordinated debentures 16,816 889 21.15% 16,100 461 11.45%
---------- ------- ----- ---------- ------- -----
Total interest-bearing liabilities $ 910,351 $ 8,768 3.84% $ 864,549 $ 5,198 2.40%
========== ======= ===== ========== ======= =====
Demand deposits 93,259 102,036
Accrued expenses and other liabilities 11,154 7,373
Stockholders' equity 77,776 76,642
---------- ----------
Total liabilities and stockholders'
equity $1,092,540 $1,050,600
========== ==========
Interest rate spread $ 8,145 2.84% $ 8,915 3.40%
Net interest margin 3.23% 3.66%
===== =====
16
The ratio of average earning assets to average total assets measures
management's ability to employ overall assets for the production of interest
income. This ratio was 92.5% and 92.7% for the first three months of 2006 and
2005, respectively.
Provision for Loan Losses
The provision for loan losses ("PFLL") is the periodic cost of providing an
allowance for probable incurred losses. As previously discussed, the allowance
consists of specific and general components. The Company's internal risk system
is used to identify loans that meet the criteria as being "impaired" under the
definition of SFAS 114. The specific component relates to loans that are
individually classified as impaired or loans otherwise classified as substandard
or doubtful. These identified loans for potential impairment are assigned a loss
allocation based upon that analysis. The general component covers non-classified
loans and is based on historical loss experience adjusted for current factors.
These current factors include loan growth, net charge-offs, changes in the
composition of the loan portfolio, delinquencies, management's evaluation of
loan quality, general economic factors and collateral values.
As a result of this process, the PFLL for the first three months of 2006 was
$200,000 as compared to a PFLL of $30,000 for the first three months in 2005.
The calculation of the amount took into account overall asset quality in the
loan portfolio during the period. Net loan charge-offs in the first three months
of 2006 were $13,000 compared with net charge-offs of $196,000 for the same
period in 2005. Net charge-offs as a percentage of average loans is a key
measure of asset quality. Net charge-offs to average loans were 0.01% for the
first three months of 2006 compared to 0.10% for the same period in 2005. For
the three months ended March 31, 2006, non-performing loans increased $19.5
million; see below for further information.
TABLE 3
ALLOWANCE FOR LOAN LOSSES
($ in thousands)
For the three months For the three months
ended March 31, 2006 ended March 31, 2005
-------------------- --------------------
Allowance for Loan Losses ("ALL)
Balance at beginning of period $9,551 $10,445
Provision for loan losses 200 30
Charge-offs 83 336
Recoveries 70 140
Balance at end of period $9,738 $10,279
Net charge-offs ("NCOs:) $ 13 $ 196
As described more fully in Table 7, non-accrual loans increased significantly
during the period from December 31, 2005. However, despite the increase in
non-accrual loans during the quarter ended March 31, 2006, the required
allocation of the allowance for these loans only increased $110,000. These facts
in addition to the net charge-offs for the three months ended March 31, 2006
were factors in the determination of a provision of $200,000 for the first
quarter of 2006. Although the amount of non-performing loans increased
substantially during the quarter, the
17
provision did not increase as significantly because of management's belief and
expectation that collateral values on these loans and other factors will likely
ultimately minimize any related loss (although there can be no assurances). See
"Balance Sheet Analysis - Non-Performing Loans, Potential Problem Loans and
Other Real Estate" below.
Management believes that the current provision conforms to the Company's loan
loss reserve policy and is adequate in view of the present condition of the
Company's loan portfolio. However, a decline in the quality of our loan
portfolio, as a result of general economic conditions, factors affecting
particular borrowers or our market area, or otherwise, could affect the adequacy
of the allowance. If there are significant charge-offs against the allowance, or
we otherwise determine that the allowance is inadequate, we will need to make
higher provisions in the future. See "Risk Management and the Allowance for Loan
Losses" and "Non-Performing Loans, Potential Problem Loans and Other Real
Estate" below for more information related to non-performing loans.
Non-Interest Income
Total non-interest income decreased $25,000, or 1.1% to $2.2 million for the
first quarter of 2006 when compared to the first quarter of 2005. The
non-interest income to average assets ratio was 0.82% for the three months ended
March 31, 2006 compared to 0.86% for the same period in 2005. The decrease in
non-interest income for the three-month period is mainly due to the
non-recurrence of gains on the sale of bank assets in other income offset
partially by increases in fiduciary fee income ("trust fees") and fees for other
services to customers.
Table 4 reflects the various components of non-interest income for the
comparable quarters.
TABLE 4
NON-INTEREST INCOME
($ in thousands)
Three months ended Three months ended % Change from
March 31, 2006 March 31, 2005 prior year
------------------ ------------------ -------------
Fees from fiduciary activities 301 179 68.2%
Fees from loan servicing 260 283 (8.1%)
Service charges on deposit accounts 794 725 9.5%
Other fee income 165 187 (11.8%)
Financial services income 180 186 (3.2%)
Gains from sales of loans 201 208 (3.4%)
Increase in cash surrender value of life insurance 226 227 (0.4%)
Gain on sale of bank assets 0 179 NM
Other income 111 89 24.7%
Total Other Income 2,238 2,263 (1.1%)
Service charges on deposit accounts increased $69,000 for the three-month period
ended March 31, 2006 due in part to the implementation of new product offerings
such as High Performance Checking ("HPC") and other price increases implemented
during the latter part of 2005.
18
In the first quarter of 2006, gains from sales of loans totaling $201,000 were
similar to the $208,000 recorded in the first quarter of 2005. During the first
quarter of 2006, secondary mortgage loan activity improved although gains from
sale of those loans decreased as a result of tighter spreads and competitive
pressures with respect to pricing. Although interest rates have increased over
the quarter, the Company has not seen a decrease in the number of loan
applications. Secondary loan production increased 14.8% between the comparable
first three-month periods ($8.9 million in the first three months of 2006 versus
$7.8 million in the first three months of 2005). The increase in production was
driven primarily by secondary mortgage and commercial loan production (loan
production to be sold to the secondary market) and resulting sales.
For the three-month period ended March 31, 2006 compared to the same period in
2005, the decrease in gain on sale of bank assets was related to a gain on sale
of stock of $179,000 taken in the first quarter of 2005 in connection with a
third party acquisition of Pulse (an ATM operator/provider) in which the Bank
held an ownership interest.
Non-Interest Expense
Non-interest expense increased $1.1 million or 15.3%, to $8.1 million for the
three months ended March 31, 2006 compared to the same period in 2005. The
non-interest expense to average assets ratio was 2.97% for the three months
ended March 31, 2006 compared to 2.68% for the same period in 2005.
Net overhead expense is total non-interest expense less total non-interest
income excluding securities gains. The net overhead expenses to average assets
ratio was 2.15% for the three months ended March 31, 2006 compared to 1.82% for
the same period in 2005. The efficiency ratio is total non-interest expense as a
percentage of the sum of net-interest income on a fully taxable equivalent basis
and total non-interest income. The efficiency ratio for the three months ended
March 31, 2006 was 78.24% compared to 63.03% for the same period in 2005.
TABLE 5
NON-INTEREST EXPENSE
($ in thousands)
Three months ended Three months ended % Change from
March 31, 2006 March 31, 2005 prior year
------------------ ------------------ -------------
Salaries and employee benefits 4,992 4,528 10.2%
Occupancy 579 536 8.0%
Equipment 395 307 28.7%
Data processing and courier 300 278 7.9%
Operation of other real estate 43 48 (10.4%)
Business development and advertising 234 204 14.7%
Charitable contributions 76 92 (17.4%)
Stationary and supplies 104 112 (7.1%)
Director fees 119 82 45.1%
FDIC 27 27 0.0%
19
Mortgage servicing rights amortization 55 62 (11.3%)
Legal and professional 205 176 16.5%
Other operating 995 593 67.8%
Total non-interest expense 8,124 7,045 15.3%
Salaries and employee benefits showed an increase of $464,000, or 10.2%, to $5.0
million for the first quarter of 2006 compared to the same period in 2005. The
number of full-time equivalent employees was 324 as of March 31, 2006 compared
to 308 as of March 31, 2005, primarily the result of additional staffing for the
remodeled downtown Green Bay branch opened in June 2005. For the three months
ended March 31, 2006, salary-related expenses increased $369,000, or 13.1%, due
principally to merit increases between the years and increased staffing. In the
first quarter of 2005, the Company implemented the Baylake Bank Supplemental
Executive Retirement Plan ("Plan"), which is intended to provide certain
management and highly compensated employees of the Bank who have contributed,
and are expected to continue to contribute, to the Bank's success by providing
for deferred compensation in addition to that available under the Bank's other
retirement programs. It amounted to approximately $335,000 in expenses related
to the vested portion of the Plan contributions in the first quarter of 2006
compared to $300,000 for the same period in 2005. Benefit costs, principally for
health insurance and pension costs, represent the remaining increase in
personnel-related costs. The increase in health insurance costs is expected to
continue for the balance of 2006. Bonus expense decreased $75,000 to $151,000
for the first quarter of 2006, as various income-related goals were not met
during the period. Management will continue its efforts to control salaries and
employee benefits expense, although increases in these expenses are likely to
continue in future years.
Occupancy and equipment expense, collectively, increased $131,000, or 15.5%, to
$974,000 for the first quarter of 2006 compared to the same period in 2005. The
increase in expense was attributable to additional depreciation expense
resulting from the remodeled downtown Green Bay branch as mentioned previously,
costs related to various equipment upgrades and increased utility costs.
Expenses related to the operation of other real estate owned decreased $5,000 to
$43,000 for the 2006 three-month period compared to the same period in 2005.
Included in these expenses were net gains taken on the sale of other real estate
owned amounting to $78,000 for the first three months of 2006 compared to net
gains taken on sale of $41,000 for the same period in 2005. In addition, costs
related to the holding of other real estate owned properties increased $32,000
to $121,000 for the first three months of 2006.
Other operating expense increased $402,000 to $995,000. The increase was due in
part to costs of $211,000 related to various employee recruitment and search
expenses, including those costs related to the searches for a new bank
president/chief operating officer and a market president. $103,000 of the
increase was related to new product offering costs, including those for the High
Performance Checking ("HPC") product introduced in the fourth quarter of 2005.
Income Taxes
Income tax expense for the Company for the three months ended March 31, 2006 was
$468,000, a decrease of $750,000, compared to the same period in 2005. The lower
tax expense in 2006 reflected the Company's decrease in income before income tax
resulting in an increase proportion of non-taxable income to total income before
income taxes.
20
The Company's effective tax rate (income tax expense divided by income before
taxes) was 26.1% for the three months ended March 31, 2006 compared with 32.0%
for the same period in 2005. The effective tax rate of 26.1% consisted of a
federal effective tax rate of 19.9% and Wisconsin State effective tax rate of
6.2%. Taxable income decreased while tax-exempt interest income from municipal
investments and income from BOLI increased proportionately, which caused the
change in the effective tax rate.
Income tax expense recorded in the consolidated statements of income involves
interpretation and application of certain accounting pronouncements and federal
and state tax codes, and is, therefore, considered a critical accounting policy.
The Company undergoes examination by various taxing authorities. Such taxing
authorities may require that changes in the amount of tax expense or valuation
allowance be recognized when their interpretations differ from those of
management, based on their judgments about information available to them at the
time of their examinations. See "Critical Accounting Policies-Income Tax
Accounting" above regarding Wisconsin tax matters which may affect our income
tax expense.
BALANCE SHEET ANALYSIS
Loans
At March 31, 2006, total loans increased $19.7 million, or 2.4%, to $832.0
million from $812.3 million at December 31, 2005. Growth in the Company's loan
portfolio resulted primarily from an increase in real estate commercial loans to
$478.7 million at March 31, 2006 compared to $468.0 million at December 31,
2005. In addition, growth in real estate construction loans increased to $93.9
million at March 31, 2006 compared to $85.7 million at December 31, 2005. Growth
in commercial real estate mortgages and commercial loans occurred principally as
a result of the Company's expansion efforts (primarily in the Green Bay market)
and the strong economic growth in that market.
The following table reflects the composition (mix) of the loan portfolio
(dollars in thousands):
TABLE 6
LOAN PORTFOLIO ANALYSIS
($ in thousands)
March 31, December 31, Percent
2006 2005 change
--------- ------------ -------
Amount of loans by type
Real estate-mortgage
Commercial $478,656 $467,956 2.3%
1-4 family residential
First liens 93,152 90,946 2.4%
Junior liens 24,525 23,470 4.5%
Home equity 31,943 34,320 (6.9%)
Commercial, financial and agricultural 81,512 80,260 1.6%
Real estate-construction 93,896 85,729 9.5%
Installment
Credit cards and related plans 2,089 2,088 0.0%
Other 12,804 12,175 5.2%
21
Obligations of states and political subdivisions 13,945 15,785 (11.7%)
Less: deferred origination fees, net of costs 510 433 17.8%
Total $832,012 $812,296 2.4%
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 for probable
incurred 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 controlled 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 charged off against the allowance. Charged-off loans are subject to
periodic review, and specific efforts are taken to achieve maximum recovery of
principal and interest.
As indicated in Table 3 above, the ALL at March 31, 2006 was $9.7 million
compared with $9.6 million at the end of 2005. This was based on management's
analysis of the loan portfolio risk at March 31, 2006. As such a provision
expense of $200,000 was recorded for the quarter ended March 31, 2006. The
quarter to date provision has increased by $170,000 compared to the same period
in 2005, as discussed previously.
The provision for loan losses is predominately a function of management's
evaluation of the loan portfolio, with particular emphasis directed toward
non-performing and other potential problem loans. During these evaluations,
consideration is also given to such factors as management's evaluation of
specific loans, the level and composition of impaired loans, other
non-performing loans, historical loan experience, results of examinations by
regulatory agencies and various other factors.
On a quarterly basis, management reviews the adequacy of the ALL. Commercial
credits are graded by the loan officers and the loan review function validates
the officers' grades. In the event that the loan review function downgrades the
loan, it is included in the allowance analysis at the lower grade. The grading
system is in compliance with the regulatory classifications and the allowance is
allocated to the loans based on the regulatory grading, except in instances
where there are known differences (i.e., collateral value is nominal, etc.). To
establish the appropriate level of the allowance, a sample of loans (including
impaired and non-performing loans) are reviewed and classified as to potential
loss exposure.
Based on an estimation computed pursuant to the requirements of Financial
Accounting Standards Board ("FASB") Statement No. 5, "Accounting for
Contingencies," and FASB Statements No. 114 and 118, "Accounting by Creditors
for Impairment of a Loan," the analysis of the ALL consists of two components:
(i) specific credit allocation established for expected losses resulting from
analysis developed through specific credit allocations on individual loans for
which the recorded investment in the loan exceeds its fair value; (ii) general
portfolio allocation based on historical loan loss experience for each loan
category and adjusted for economic conditions as well as specific and other
factors in the markets in which the Company operates.
The specific credit allocation of the ALL is based on a regular analysis of
loans over a fixed-dollar amount where the internal credit rating is at or below
a predetermined classification. The fair value of the loan is determined based
on either the present value of expected future cash flows
22
discounted at the loan's effective interest rate, the market price of the loan,
or, if the loan is collateral dependent, the fair value of the underlying
collateral less cost of sale.
The general portfolio allocation component of the ALL is determined
statistically using a loss migration analysis that examines historical loan loss
experience. The loss migration analysis is performed quarterly and loss factors
are updated regularly based on actual experience. The general portfolio
allocation element of the ALL also includes consideration of the amounts
necessary for concentrations and changes in portfolio mix and volume.
The ALL is based on estimates, and ultimate losses will vary from current
estimates. These estimates are reviewed monthly, and as adjustments, either
positive or negative, become necessary, a corresponding increase or decrease is
made in the provision for loan losses. The composition of the loan portfolio has
not significantly changed since year-end 2005.
Management remains watchful of credit quality issues and believes that issues
within the portfolio are reflective of the challenging economic environment
experienced over the past few years. Should the economic climate deteriorate
from current levels, borrowers may experience difficulty, and the level of
non-performing loans, charge-offs and delinquencies could rise and require
further increases in the provision.
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.
While there exists probable asset quality problems in the loan portfolio,
management believes sufficient reserves have been provided in the ALL to absorb
probable incurred losses in the loan portfolio at March 31, 2006. 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 collection.
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.
Non-performing loans are a leading indicator of future loan loss potential.
Non-performing loans are defined as non-accrual loans, guaranteed loans 90 days
or more past due but still accruing, and restructured loans. Additionally,
whenever management becomes aware of facts or circumstances that may adversely
impact on the collection of principal or interest on loans, it is
23
the practice of management to place such loans on non-accrual status immediately
rather than waiting until the loans become 90 days past due. 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 collection is in doubt, cash receipts on
non-accrual loans are used to reduce principal rather than recorded as interest
income.
The process of restructuring loans involves the granting of some concession to
the borrower involving a loan modification, such as payment schedule or interest
rate changes.
TABLE 7
NON-PERFORMING ASSETS
($ in thousands)
At or for the period At or for the period At or for the period
ended March 31, 2006 ended March 31, 2005 ended December 31, 2005
-------------------- -------------------- -----------------------
Nonperforming Assets:
Nonaccrual loans $26,385 $ 8,288 $ 6,942
Accruing loans past due 90 days or more 0 0 0
Restructured loans 0 0 0
------- ------- -------
Total nonperforming loans ("NPLs") $26,385 $ 8,288 $ 6,942
Other real estate owned 1,799 2,378 3,333
------- ------- -------
Total nonperforming assets ("NPAs") $28,184 $10,666 $10,275
Ratios:
ALL to NCO's (annualized) 184.70 12.93 2.32
NCO's to average loans (annualized) 0.01% 0.10% 0.52%
ALL to total loans 1.17% 1.31% 1.18%
NPL's to total loans 3.17% 1.06% 0.85%
NPA's to total assets 2.56% 1.00% 0.94%
ALL to NPL's 36.91% 124.02% 137.58%
As indicated in Table 7, non-performing loans at March 31, 2006 were $26.4
million compared to $6.9 million at December 31, 2005. Non-accrual loans
represented $26.4 million of the total non-performing loans. Real estate
non-accrual loans accounted for $25.9 million of the total, of which $2.8
million was residential real estate, $5.5 million was real estate construction
and $17.6 million was commercial real estate, while commercial and industrial
non-accrual loans total $514,000.
Non-accrual loans increased during this quarter by $19.4 million and is
primarily attributable to six commercial loans for businesses that are
experiencing difficulties in sales, cash flow, fiscal operations, and/or general
management issues. Of these, two loans totaling $2.9 million are commercial real
estate development loans, two loans totaling $11.4 million are recreational real
24
estate golf course properties, one loan totaling $898,223 is a restaurant and
one loan totaling $4.3 million is a retail shopping mall.
Each of these six non-performing loans is secured primarily by commercial or
residential real estate, and secondarily, by personal guarantees from principals
of the respective borrowers. The Company has initiated foreclosure actions on
three of these loans totaling $7.1 million and it anticipates protracted
litigation of at least twelve months in duration in each case. Management has
provided $1.1 million (including $231,006 in the current period) in the ALL for
any loss estimated with respect to these loans. The other loans totaling $12.3
million are subject to voluntary liquidation plans that propose to sell
underlying real estate assets in amounts sufficient to repay the outstanding
loan balances. Of these, two loans, totaling $9.0 million, have full purchase
price offers currently pending for the underlying collateral. However, the
Company cannot identify a time line for final disposition of those loans because
of the necessity for settlement of liens and claims against the properties, nor
can the Company provide assurances that there will not be any further losses
relating to these or other credits.
Current impairments have been established for each of these credits and the
Company does not anticipate any further loss at this time, in part due to
expected collateral values.
As a result the ratio of non-performing loans to total loans at March 31, 2006
was 3.17% compared to 0.85% at end of year 2005. The Company's ALL was 36.9% of
total non-performing loans at March 31, 2006 compared to 137.6% at end of year
2005.
Non-performing assets (non-performing loans plus other real estate owned assets)
at March 31, 2006 were $28.2 million compared to $10.3 million at December 31,
2005. Other real estate owned, which represents property that the Company
acquired through foreclosure or in satisfaction of debt, consisted of twelve
commercial properties totaling $1.8 million. Other real estate owned at December
31, 2005 totaled $3.3 million and consisted of seventeen properties.
Potential problem loans are currently performing loans that management believes
may incur difficulties in complying with loan repayment terms. Management's
decision to place loans in this category does not necessarily mean that the
Company expects to take losses on such loans, but that management needs to be
more vigilant in its efforts to oversee the loans and recognize that a higher
degree of risk is associated with these potential problem loans. At March 31,
2006, potential problem loans amounted to $5.8 million compared to a total of
$10.0 million at December 31, 2005. A portion of this decrease results from a
transfer during the period to non-accrual (non-performing) status of $4.3
million of these problem loans which were identified at year end.
Investment Portfolio
The investment portfolio is intended to provide the Company with adequate
liquidity, flexibility in asset/liability management and, lastly, an increase in
its earning potential.
At March 31, 2006, the investment portfolio (which includes investment
securities available for sale) increased $1.7 million, or 1.0%, to $173.4
million from $171.6 million at December 31, 2005. At March 31, 2006 and December
31, 2005, the investment portfolio represented 15.7% and 15.8%, respectively, of
total assets.
Securities available for sale consist of the following:
25
TABLE 8
INVESTMENT SECURITY ANALYSIS
At March 31, 2006
($ in thousands)
Gross Gross
Unrealized Unrealized
Gains Losses Fair Value
---------- ---------- ----------
Securities available for sale
Obligations of U.S. Treasury & other U.S. agencies $ 91 $1,445 $ 64,148
Mortgage-backed securities 1 2,236 71,189
Obligations of states & political subdivisions 379 199 32,929
Private placement 43 0 1,040
Other securities 0 0 4,078
---- ------ --------
Total securities available for sale $514 $3,880 $173,384
==== ====== ========
At December 31, 2005
($ in thousands)
Gross Gross
Unrealized Unrealized
Gains Losses Fair Value
---------- ---------- ----------
Securities available for sale
Obligations of U.S. Treasury & other U.S. Agencies $179 $1,153 $ 59,819
Mortgage-backed securities 2 2,015 72,531
Obligations of states & political subdivisions 407 269 33,827
Private placement 44 0 1,040
Other securities 0 0 4,421
---- ------ --------
Total investment securities $632 $3,437 $171,638
==== ====== ========
26
Deposits
Total deposits at March 31, 2006 decreased $5.6 million, or 0.7%, to $851.1
million from $856.7 million at December 31, 2005. Non-interest bearing deposits
at March 31, 2006 decreased $16.8 million, or 15.2%, to $93.8 million from
$110.6 million at December 31, 2005. Interest-bearing deposits at March 31, 2006
increased $11.2 million, or 1.5%, to $757.3 million from $746.1 million at
December 31, 2005. Brokered CD's totaled $152.1 million at March 31, 2006
compared to $155.1 million at December 31, 2005. 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. If liquidity concerns arose, the Company has alternative
sources of funds such as lines with correspondent banks and borrowing
arrangements with FHLB should the need present itself. Increased competition for
consumer deposits and customer awareness of interest rates continue 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 first half of the year in anticipation of the summer tourist season.
Emphasis has been, and will continue to be, placed on generating additional core
deposits in 2006 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 2006 as an additional source of
funds to provide for loan growth in the event that core deposit growth goals
would not be accomplished. Under that scenario, the Company will continue to
look at other wholesale sources of funds, if the brokered CD market became
illiquid or more costly in terms of interest rate.
Other Funding Sources
Federal funds purchased and securities under agreements to repurchase at March
31, 2006 increased $24.5 million to $25.9 million from $1.3 million at December
31, 2005. Federal funds purchased increased from no funds purchased at December
31, 2005 to $24.5 million at March 31, 2006 accounting for the majority of the
increase. These have increased to fund the growth in the loan portfolio which
was coupled with a decrease in core deposits during the quarter ended March 31,
2006.
Federal Home Loan Bank Advances totaled $120.2 million at March 31, 2006
compared to $125.2 million at December 31, 2005. Typically, borrowings increase
in order to fund growth in the loan portfolio in periods when borrowings
increase more rapidly than deposits. The Company will borrow monies if borrowing
is a less costly form of funding loans compared to the cost of acquiring
deposits or if deposit growth is not sufficient. 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
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, formed by the Company. The
aggregate principal amount of the debentures due
27
2031, to the trust was $16,597,940. These securities were redeemed on March 31,
2006, as noted in our press release dated February 28, 2006.
The redemption of these securities were funded through the issuance of $16.1
million of trust preferred securities and $498,000 of trust common securities,
and underlying debt securities, that will adjust quarterly at a rate equal to
1.35% over the three month LIBOR. The rate on this financing for the second
quarter is 6.31%. This lower interest rate will provide interest savings in the
second quarter of 2006, and thereafter depending upon changes in the interest
rate environment. Management believes that the new financing should provide a
better match for the overall interest rate sensitivity position of the Company
going forward.
For additional details, please make reference to the Consolidated Financial
Statements and the accompanying footnotes on the Company's Form 10-Q for the
period ended March 31, 2006.
CONTRACTUAL OBLIGATIONS, COMMITMENTS, OFF-BALANCE SHEET RISK, AND CONTINGENT
LIABILITIES
The Company utilizes a variety of financial instruments in the normal course of
business to meet the financial needs of its customers. These financial
instruments include commitments to extend credit, commitments to originate
residential mortgage loans held for sale, commercial letters of credit, standby
letters of credit, and forward commitments to sell residential mortgage loans.
Please refer to the Company's Annual Report on Form 10-K for the year ended
December 31, 2005 for discussion with respect to the Company's quantitative and
qualitative disclosures about its fixed and determinable contractual
obligations. Items disclosed in Form 10-K have not materially changed since that
report was filed.
The following is a summary of our off-balance sheet commitments, all of which
were lending-related commitments:
TABLE 9
LENDING RELATED COMMITMENTS
($ in thousands)
March 31, 2006 December 31, 2005
-------------- -----------------
Commitments to fund home equity line loans $ 47,253 $ 45,435
Commitments to fund commercial real estate loans 2,192 3,409
Commitments unused on various other lines of credit loans 159,313 164,112
-------- --------
Total commitments to extend credit $208,758 $212,956
Financial standby letters of credit $ 22,146 $ 22,160
The following table summarizes the Company's significant contractual obligations
and commitments at March 31, 2006:
28
TABLE 10
CONTRACTUAL OBLIGATIONS
($ in thousands)
(IN THOUSANDS) WITHIN 1 YEAR 1-3 YEARS 3-5 YEARS AFTER 5 YEARS TOTAL
------------- --------- --------- ------------- --------
Certificates of deposit and other
time deposit obligations $251,259 $161,498 $4,795 $ 0 $417,552
Federal funds purchased and
repurchase agreements 25,860 0 0 0 25,860
Federal Home Loan Bank advances 70,000 25,083 101 25,000 120,184
Purchase of land 1,580 0 0 0 1,580
Construction of branch facility 582 0 0 0 582
Subordinated debentures 0 0 0 16,100 16,100
Operating leases 41 17 0 0 58
-------- -------- ------ ------- --------
Total $349,322 $186,598 $4,896 $41,100 $581,916
======== ======== ====== ======= ========
LIQUIDITY
Liquidity management refers to the ability of the Company to ensure that cash is
available in a timely manner 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 from the Bank, investment
income, and net proceeds from borrowings and the offerings of junior
subordinated obligations, in addition to the issuance of its common stock
securities. The Company manages its liquidity position in order to provide funds
necessary to pay dividends to its shareholders. Dividends received from Bank
totaled $1.5 million for the first three months of 2006 and will continue to be
the Company's main source of long-term liquidity. The dividends from the Bank
along with existing cash were sufficient to pay cash dividends to the Company's
shareholders of $2.5 million in the first three months of 2006.
The Bank meets its cash flow needs by having funding sources available to it 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
29
investment portfolio, access to other funding sources, marketability of certain
of its assets; the ability to use its loan and investment portfolios as
collateral for secured borrowings and strong capital positions.
Maturing investments have been a primary source of liquidity at the Bank. For
the three months ended March 31, 2006, principal payments totaling $4.2 million
were received on investments. $6.5 million in investments were purchased in the
first three months of 2006. This resulted in net cash of $2.3 million used in
investing activities for the first three months of 2006. At March 31, 2006 the
investment portfolio contained $135.4 million of U.S. Treasury and federal
agency backed securities representing 78.1% of the total investment portfolio.
These securities tend to be highly marketable.
Deposit growth is typically another source of liquidity for the Bank in the
latter half of each year, although deposits typically shrink in the first half
resulting in a use of cash. As a financing activity reflected in the March 31,
2006 Consolidated Statements of Cash Flows, deposits decreased and resulted in
$5.6 million of cash outflow during the first three months of 2006. The
Company's overall deposit base decreased 0.7% for the three months ended March
31, 2006. Deposit growth is generally the most stable source of liquidity for
the Bank, although brokered deposits are inherently less stable than locally
generated core deposits. Affecting liquidity are core deposit growth levels,
certificate of deposit maturity structure and retention, and characteristics and
diversification of wholesale funding sources affecting the channels by which
brokered deposits are acquired. Conversely, deposit outflow will cause the Bank
to develop alternative sources of funds which may not be as liquid and
potentially a more costly alternative.
The scheduled maturity of loans can provide a source of additional liquidity.
The Bank has $258.5 million, or 31.1%, of loans maturing within one year.
Factors affecting liquidity relative to loans are loan origination volumes, loan
prepayment rates and the maturity structure of existing loans. The Bank's
liquidity position is influenced by changes in interest rates, economic
conditions and competition. Conversely, loan demand as a need for liquidity will
cause the Company to acquire other sources of funding which could be harder to
find; therefore more costly to acquire.
Within the classification of short-term borrowings at March 31, 2006, federal
funds purchased and securities sold under agreements to repurchase totaled $25.9
million compared to $1.3 million at the end of 2005. 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 long-term, are another source of funds. They totaled $120.2
million at March 31, 2006 and $125.2 million at December 31, 2005.
The Bank's liquidity resources were sufficient in the first three months of 2006
to fund the growth in loans and investments, increase the volume of interest
earning assets and meet other cash needs when necessary.
Management expects that deposit growth will continue to be the primary funding
source of the Bank's liquidity on a long-term basis, along with a stable
earnings base, the resulting cash generated by operating activities, and a
strong capital position. Although federal funds purchased and borrowings from
the FHLB provided funds in the first three months of 2006, management expects
deposit growth 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. In addition, Bank may acquire additional brokered deposits as funding
for short-term liquidity needs. Shorter-term liquidity needs will mainly be
derived from growth in short-term borrowings,
30
maturing federal funds sold and portfolio investments, loan maturities and
access to other funding sources.
In assessing liquidity, historical information such as seasonality (loan
demand's affect on liquidity which starts before and during the tourist season
and deposit draw down which affects liquidity shortly before and during the
early part of the tourist season), local economic cycles and the economy in
general are considered along with the current ratios, management goals and the
unique characteristics of the Company. 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.
Capital Resources
Stockholders' equity at March 31, 2006 and December 31, 2005 was $78.5 million.
In total, stockholders' equity decreased $38,000 or 0.1%. The decrease in
stockholders' equity in 2006 was primarily composed of the change in unrealized
losses on available for sale securities and the payment of dividends, almost
completely offset by net income and proceeds from the exercise of stock options.
The change in unrealized losses on available for sale securities amounted to
$360,000 for the first three months of 2006; this change resulted from the
effects of the increasing interest rate environment. Total dividends paid
increased to $2.5 million in the quarter from $2.3 million in 2005, primarily as
a result of an increase in the per share dividends rate to $0.16 from $0.15.
Stockholders' equity to assets at March 31, 2006 was 7.12% compared to 7.21% at
the end of 2005.
On March 31, 2006, the Company redeemed its outstanding junior subordinated
indentures and trust preferred securities for a total of $16.6 million which
constitutes the $16.1 million stated principal values of those amounts plus
$510,389 in accrued interest. See "Management's Discussion of Analysis of
Financial Condition and Results of Operations - Balance Sheet Analysis - Long
Term Debt" above.
The redemption of these securities were funded through the issuance of $16.1
million of trust preferred securities and $498,000 of trust common securities
issued under the name Baylake Capital Trust II ("Trust II") that will adjust
quarterly at a rate equal to 1.35% over the three month LIBOR. The initial rate
on this financing for the second quarter is 6.31%. This lower rate will provide
savings beginning in the second quarter of 2006 and management believes that the
new financing should provide a better match for the overall interest rate
sensitivity position of the Company going forward. For banking regulatory
purposes, these securities are considered Tier 1 capital.
Cash dividends declared in the first three months of 2006 were $0.16 per share
compared with $0.15 in 2005. The Company provided a 6.7% increase in normal
dividends per share in 2006 over 2005 as a result of earnings for 2006. Total
funds utilized in the payment of dividends were $2.5 million in the first three
months of 2006, as compared to $2.3 million in the corresponding period of 2005.
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 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 three months of 2006.
31
The adequacy of the Company's capital is regularly reviewed to ensure that
sufficient capital is available for current and future needs and is in
compliance with regulatory guidelines. The assessment of overall capital
adequacy depends upon a variety of factors, including asset quality, liquidity,
stability of earnings, changing competitive forces, economic conditions in
markets served and strength of management. Management is confident that because
of current capital levels and projected earnings levels, capital levels are more
than adequate to meet the ongoing and future concerns of the Company.
The Federal Reserve Board has established capital adequacy rules which take into
account risk attributable to balance sheet assets and off-balance sheet
activities. All banks and bank holding companies must meet a minimum total
risk-based capital ratio of 8%. Of the 8% required, at least half must be
comprised of core capital elements defined as Tier 1 capital. The federal
banking agencies also have adopted leverage capital guidelines which banking
organizations must meet. Under these guidelines, the most highly rated banking
organizations must meet a leverage ratio of at least 3% Tier 1 capital to
assets, while lower rated banking organizations must maintain a ratio of at
least 4% to 5%. Failure to meet minimum capital requirements can initiate
certain mandatory -and possible additional discretionary- actions by regulators
that, if undertaken, could have a direct material effect on the consolidated
financial statements.
At March 31, 2006 and December 31, 2005, 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
March 31, 2006 and December 31, 2005:
TABLE 11
CAPITAL RATIOS
($ in thousands)
To Be Well Capitalized
For Capital under Prompt Corrective
Actual Adequacy Purposes Action Provisions
--------------- ----------------- -----------------------
Amount Ratio Amount Ratio Amount Ratio
------- ----- ------ ----- ------ ------
As of March 31, 2006
Total Capital (to
Risk Weighted Assets)
Company 100,402 10.60% 75,796 8.00% N/A N/A
Bank 97,931 10.34% 75,757 8.00% 94,696 10.00%
Tier 1 Capital (to
Risk Weighted Assets)
Company 90,664 9.57% 37,898 4.00% N/A N/A
Bank 88,193 9.31% 37,879 4.00% 56,818 6.00%
Tier 1 Capital (to
32
Average Assets)
Company 90,664 8.34% 43,458 4.00% N/A N/A
Bank 88,193 8.13% 43,412 4.00% 54,265 5.00%
As of December 31, 2005
Total Capital (to
Risk Weighted Assets)
Company 99,882 10.73% 74,472 8.00% N/A N/A
Bank 97,327 10.51% 74,404 8.00% 93,005 10.00%
Tier 1 Capital (to
Risk Weighted Assets)
Company 90,332 9.70% 37,236 4.00% N/A N/A
Bank 87,778 9.44% 37,202 4.00% 55,803 6.00%
Tier 1 Capital (to
Average Assets)
Company 90,332 8.27% 43,692 4.00% N/A N/A
Bank 87,778 8.11% 43,590 4.00% 54,488 5.00%
Management believes that a strong capital position is necessary to take
advantage of opportunities for profitable expansion of product and market share,
and to provide depositor and investor confidence. The Company's capital level is
strong, but also must be maintained at an appropriate level to provide the
opportunity for an adequate return on the capital employed. Management actively
reviews capital strategies for the Company to ensure that capital levels are
appropriate based on the perceived business risks, further growth opportunities,
industry standards, and regulatory requirements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK.
The Company's financial performance is affected by, among other factors, credit
risk and interest rate risk. The Company does not use derivatives to mitigate
its interest rate risk or credit risk, relying instead on loan review and its
loan loss reserve.
The Company's earnings are derived from the operations of its direct and
indirect subsidiaries with particular reliance on net interest income,
calculated as the difference between interest earned on loans and investments
and the interest expense paid on deposits and other interest bearing
liabilities, including advances from FHLB and other borrowings. Like other
financial institutions, the Company's interest income and interest expense are
affected by general economic conditions and by the policies of regulatory
authorities, including the monetary policies of the Board of Governors of the
Federal Reserve System. Changes in the economic environment may influence, among
other matters, the growth rate of loans and deposits, the quality of the loan
portfolio and loan and deposit pricing. Fluctuations in interest rates are not
predictable or controllable.
As of March 31, 2006, 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, 2005, as described in the
Company's 2005 Form 10-K Annual Report.
The Company's overall interest rate sensitivity is demonstrated by net interest
income analysis. Net interest income analysis measures the change in net
interest income in the event of hypothetical changes in interest rates. This
analysis assesses the risk of change in net interest
33
income in the event of sudden and sustained 1.0% to 2.0% increases and decreases
in market interest rates. The table below presents the Company's projected
changes in net interest income for the various rate shock levels at March 31,
2006.
TABLE 12
INTEREST SENSITIVITY
($ in thousands)
Change in Net Interest Income over One Year Horizon
-------------------------------------------------------
At March 31, 2006 At December 31, 2005
-------------------------- --------------------------
Change in levels Percentage Percentage
of interest rates Dollar change change Dollar change change
- ----------------- ------------- ---------- ------------- ----------
+200 bp $ 335 3.6% $ 2,572 6.8%
+100 bp 200 2.2% 1,842 4.9%
Base 0 0% 0 0%
- -100 bp (1,853) (4.9%) (2,351) (6.2%)
- -200 bp (4,023) (17.2%) (4,905) (13.0%)
As shown above, at March 31, 2006, the effect of an immediate 200 basis point
increase in interest rates would increase the Company`s net interest income by
$335,000 or 3.6%. The effect of an immediate 200 basis point reduction in rates
would decrease the Company's net interest income by $4.0 million or 17.2%.
Changes in the mix of earning assets and interest-bearing liabilities increased
the Company's asset sensitivity during the past twelve months.
Computations of the prospective effects of hypothetical interest rate changes
are based on numerous assumptions, including the relative levels of market
interest rates and loan prepayments, and should not be relied upon as indicative
of actual results. Actual values may differ from those projections set forth
above, should market conditions vary from the assumptions used in preparing the
analyses. Further, the computations do not contemplate any actions the Company
may undertake in response to changes in interest rates.
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 March
31, 2006. 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 timely alerting
them to material information relating to the Company's disclosure controls and
procedures to the Company required to be included in this quarterly report on
Form 10-Q.
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 controls
subsequent to the date of such evaluation with the exception of enhancements
made during the quarter to the calculation of the allowance for loan loss
reserve. Such enhancement is explained in Item 2,
34
Management's Discussion and Analysis found in the sections entitled "Provision
for Loan Losses" and "Balance Sheet Analysis-Risk Management and the Allowance
for Loan Losses" which discussions are incorporated by reference in this item.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Baylake and its subsidiaries may be involved from time to time in various
routine legal proceedings incidental to its business. Neither Baylake nor any of
its subsidiaries is currently engaged in any legal proceedings that are expected
to have a material adverse effect on the results of operations or financial
position of Baylake.
ITEM 1A. RISK FACTORS
See "Risk Factors" in Item 1A of the Company's annual report on Form 10-K for
the year ended December 31, 2005.
ITEM 2. UNREGISTERED SALES OF EQUITY 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
On March 31, 2006, the Company called its then outstanding trust preferred
securities. Simultaneously, the Company entered into arrangements for new trust
preferred securities. See "Management's Discussion and Analysis - Long Term
Debt" above. Although the transaction involved the termination of the old
arrangements and entry into new ones, the Company does not believe these changes
had an overall material on it, other than to extend the arrangement and to
change the basis on which the interest is determined going forward.
ITEM 6. EXHIBITS
The following exhibits are furnished herewith:
EXHIBIT NUMBER DESCRIPTION
- -------------- -----------
31.1 Certification under Section 302 of Sarbanes-Oxley by Thomas L.
Herlache, Chief Executive Officer, is attached hereto.
35
31.2 Certification under Section 302 of Sarbanes-Oxley by Steven D.
Jennerjohn, Chief Financial Officer, is attached hereto.
32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C.
Section 1350, as Adopted Pursuant to Section 906 of
Sarbanes-Oxley is attached hereto.
32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C.
Section 1350, as Adopted Pursuant to Section 906 of
Sarbanes-Oxley is attached hereto.
"Management agrees to furnish to the Securities and Exchange Commission, upon
request, a copy of any other agreements or instruments of Baylake Corp. and its
subsidiaries defining the rights of holders of any long-term debt whose
authorization does not exceed 10% of total assets."
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
BAYLAKE CORP.
Date: May 9, 2006 /s/ Thomas L. Herlache
----------------------------------------
Thomas L. Herlache
President (CEO)
Date: May 9, 2006 /s/ Steven D. Jennerjohn
----------------------------------------
Steven D. Jennerjohn
Treasurer (CFO)
36