BAYLAKE CORP.

10-Q 1 bylk10q.htm BAYLAKE CORP.

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

{X} QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED

JUNE 30, 2007

{ } TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission file number 0-8679

BAYLAKE CORP.

(Exact name of registrant as specified in its charter)

Wisconsin 39-1268055

(State or other jurisdiction of incorporation (I.R.S. Employer Identification No.)

or organization)

217 North Fourth Avenue, Sturgeon Bay, WI 54235

(Address of principal executive offices)

(Zip Code)

(920)-743-5551

(Registrant’s telephone number, including area code)

None

(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes X No

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

Number of outstanding shares of common stock as of July 23, 2007: 7,884,222 shares

BAYLAKE CORP. AND SUBSIDIARIES

INDEX


PART I – FINANCIAL INFORMATION	PAGE NO.

Item 1. Financial Statements

Consolidated Balance Sheets (Unaudited) as of June 30, 2007 and December 31, 2006	3
Consolidated Statements of Income and Comprehensive Income (Unaudited) for three and six months ended June 30, 2007 and 2006	4
Consolidated Statement of Changes in Stockholders’ Equity (Unaudited) for the six months ended June 30, 2007	5
Consolidated Statements of Cash Flows (Unaudited) for the six months ended June 30, 2007 and 2006	6 – 7

Notes to the Consolidated Unaudited Financial Statements	8 – 12
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	13 – 33

Item 3. Quantitative and Qualitative Disclosure about Market Risk	33 – 34

Item 4. Controls and Procedures	34

PART II – OTHER INFORMATION

Item 1. Legal Proceedings	34

Item 1A. Risk Factors	34

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	35

Item 3. Default Upon Senior Securities	35

Item 4. Submission of Matters to a Vote of Security Holders	35

Item 5. Other Information	35

Item 6. Exhibits	35 – 36

Signatures
Exhibit 3.1 Articles of Amendment to Articles of Incorporation Exhibit 3.2 Composite Articles of Incorporation Exhibit 10.1 Amendments to Deferred Compensation Arrangements with Mr. Thomas Herlache and Summary of Benefits for serving as Chairman Exhibit 31.1 Certification pursuant to Section 302 Exhibit 31.2 Certification pursuant to Section 302 Exhibit 32.1 Certification pursuant to 18 U.S.C. Section 1350 Exhibit 32.2 Certification pursuant to 18 U.S.C. Section 1350

PART 1 – FINANCIAL INFORMATION

Item 1. Financial Statements

BAYLAKE CORP.

CONSOLIDATED BALANCE SHEETS (Unaudited)

June 30, 2007 and December 31, 2006

(Dollar amounts in thousands except share data)


	June 30,	December 31,
	2007	2006

ASSETS
Cash and cash equivalents	$ 21,795	$ 22,685

Securities available for sale	185,989	188,315
Loans held for sale	397	889
Loans, net of allowance of $11,548 and $8,058 at June 30, 2007 and December 31, 2006, respectively	803,202	811,510
Cash value of life insurance	23,014	24,239
Premises held for sale	673	673
Premises and equipment, net	27,200	27,732
Federal Home Loan Bank stock	6,792	6,792
Foreclosed assets, net	5,919	5,760
Goodwill	5,840	5,723
Accrued interest receivable	6,133	6,183
Other assets	15,169	11,183

Total assets	$ 1,102,123	$ 1,111,684

LIABILITIES AND STOCKHOLDERS’ EQUITY
Deposits
Non-interest-bearing	$ 98,362	$ 96,895
Interest-bearing	800,182	782,016
Total deposits	898,544	878,911
Federal Home Loan Bank advances	65,175	115,179
Federal funds purchased and repurchase agreements	30,496	4,480
Subordinated debentures	16,100	16,100
Accrued expenses and other liabilities	12,595	13,568
Dividends payable	-	1,253
Total liabilities	1,022,910	1,029,491

Common stock, $5 par value, authorized 50,000,000; issued- 8,018,235 shares in 2007, 7,922,154 shares in 2006; outstanding- 7,876,222 shares in 2007, 7,830,141 shares in 2006	40,091	39,611
Additional paid-in capital	11,322	10,403
Retained earnings	32,782	35,134
Treasury stock (142,013 shares in 2007 and 92,013 shares in 2006)	(2,494)	(1,726)
Accumulated other comprehensive loss	(2,488)	(1,229)
Total stockholders’ equity	79,213	82,193

Total liabilities and stockholders’ equity	$ 1,102,123	$ 1,111,684

See accompanying notes to Unaudited Consolidated Financial Statements.

BAYLAKE CORP.

CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (Unaudited)

Three and six months ended June 30, 2007 and 2006

(Dollar amounts in thousands, except per share data)


	Three months ended June 30,		Six months ended June 30,
	2007	2006	2007	2006
Interest and dividend income
Loans, including fees	$ 15,285	$ 15,418	$ 30,779	$ 30,082
Taxable securities	1,522	1,570	3,119	3,141
Tax exempt securities	522	378	1,028	738
Federal funds sold and other	38	156	91	207
Total interest and dividend income	17,367	17,522	35,017	34,168

Interest expense
Deposits	8,101	7,090	16,053	13,432
Federal funds purchased and repurchase agreements	209	89	297	264
Federal Home Loan Bank advances and other debt	1,321	1,399	2,803	2,761
Subordinated debentures	262	257	546	1,146
Total interest expense	9,893	8,835	19,699	17,603

Net interest income	7,474	8,687	15,318	16,565
Provision for loan losses	-	61	5,985	261
Net interest income after provision for loan losses	7,474	8,626	9,333	16,304
Non-interest income
Fees from fiduciary activities	256	240	523	541
Fees from loan servicing	237	275	508	535
Fees for other services to customers	1,290	1,246	2,503	2,385
Gains from sales of loans	183	209	289	410
Net gains (loss) from sale and disposal of premises and equipment	(4)	185	(4)	185
Increase in cash surrender value of life insurance	312	175	536	401
Other income	139	151	303	262
Total other income	2,413	2,481	4,658	4,719

Non-interest expenses
Salaries and employee benefits	4,711	4,525	9,862	9,517
Occupancy expense	621	585	1,230	1,164
Equipment expense	394	445	766	840
Data processing and courier	320	315	633	615
Operation of other real estate	265	74	545	117
Other operating expenses	1,933	1,749	3,673	3,564
Total non-interest expenses	8,244	7,693	16,709	15,817

Income (loss) before income tax expense (benefit)	1,643	3,414	(2,718)	5,206
Income tax expense (benefit)	229	1,044	(1,836)	1,512
Net income (loss)	$ 1,414	$ 2,370	$ (882)	$ 3,694
Comprehensive income (loss)	$ (275)	$ 1,095	$ (2,141)	$ 2,059
Basic earnings (loss) per share	$ 0.18	$ 0.30	$ (0.11)	$ 0.47
Diluted earnings (loss) per share	$ 0.18	$ 0.30	$ (0.11)	$ 0.47
Dividends declared per share	$ 0.16	$ 0.16	$ 0.32	$ 0.32

See accompanying notes to Unaudited Consolidated Financial Statements.

BAYLAKE CORP.

CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (Unaudited)

Six months ended June 30, 2007

(Dollar amounts in thousands except for share and per share data)


											Accumulated
					Additional						Other
	Common Stock				Paid-in		Retained		Treasury		Comprehensive		Total
	Shares		Amount		Capital		Earnings		Stock		Income (loss)		Equity


Balance, January 1, 2007	7,830,141		$ 39,611		$ 10,403		$ 35,134		$ (1,726)		$ (1,229)		$ 82,193
Net loss for the period	-		-		-		(882)		-		-		(882)
Net changes in unrealized gain (loss) on securities
available for sale, net of $682 deferred taxes	-		-		-		-		-		(1,259)		(1,259)
Total comprehensive loss													(2,141)
UFS stock options exercised	-		-		-		(51)		-		-		(51)
Adjustment for adoption of FIN 48	-		-		-		980		-		-		980
Adjustment for adoption of FASB 156, net of tax of $74	-		-		-		117		-		-		117
Stock compensation expense recognized	-		-		12		-		-		-		12
Stock options exercised	41,898		209		313		-		-		-		522
Common stock issued under dividend reinvestment plan	54,183		271		552		-		-		-		823
Treasury stock purchases	(50,000)		-		-		-		(768)		-		(768)
Tax benefit from exercise of stock options	-		-		42		-		-		-		42
Cash dividends declared ($0.32 per share)	-		-		-		(2,516)		-		-		(2,516)
Balance, June 30, 2007		7,876,222		$ 40,091		$ 11,322		$ 32,782		$ (2,494)		$ (2,488)		$ 79,213

See accompanying notes to Unaudited Consolidated Financial Statements.

BAYLAKE CORP.

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

Six months ended June 30, 2007 and 2006

(Dollar amounts in thousands)

2007

2006

Cash flows from operating activities:

Reconciliation of net income (loss) to net cash provided by

operating activities:

Net income (loss)

(882)

3,694

Adjustments to reconcile net income (loss) to net cash

provided to operating activities:

Depreciation and amortization

779

812

Amortization of debt issuance costs

475

Amortization of core deposit intangible

Provision for losses on loans

5,985

261

Net amortization of securities

Increase in cash surrender value of life insurance

(523)

(401)

Net gain on sale of loans

(289)

(410)

Proceeds from sale of loans held for sale

25,944

21,882

Origination of loans held for sale

(25,163)

(21,372)

Net change in valuation on mortgage servicing rights

Provision for valuation allowance on other real estate owned

133

Net gain from disposal of other real estate

(111)

(53)

Net loss (gain) from disposal of bank premises and equipment

(185)

Stock option compensation expense recognized

Tax benefit from exercise of stock options

(42)

Changes in assets and liabilities:

Accrued interest receivable and other assets

(2,815)

497

Accrued expenses and other liabilities

(536)

1,273

Net cash provided by operating activities

2,660

6,657

Cash flows from investing activities:

Principal payments on securities available-for-sale

7,861

10,291

Purchase of securities available-for-sale

(7,547)

(25,222)

Proceeds from sale of other real estate owned

2,430

2,356

Loan originations and payments, net

(288)

(10,205)

Additions to premises and equipment

(251)

(3,579)

Proceeds from life insurance death benefit

2,431

Investment in bank-owned life insurance

(683)

(583)

Net cash provided by (used in) investing activities

3,953

(26,942)

See accompanying notes to Unaudited Consolidated Financial Statements.

BAYLAKE CORP.

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

Six months ended June 30, 2007 and 2006

(Dollar amounts in thousands)

2007

2006

Cash flows from financing activities:

Net change in deposits

19,633

14,331

Net change in federal funds purchased and

repurchase agreements

26,016

20,879

Proceeds from Federal Home Loan Bank advances

30,000

45,000

Repayments on Federal Home Loan Bank advances

(80,002)

(65,003)

Redemption of subordinated debt

(16,100)

Proceeds from issuance of subordinated debt

16,100

Proceeds from exercise of stock options

522

211

Tax benefit from exercise of stock options

Treasury stock purchases

(768)

Dividend reinvestment plan

823

Cash dividends paid

(3,769)

(3,737)

Net cash provided by (used in) financing activities

(7,503)

11,761

Net change in cash and cash equivalents

(890)

(8,524)

Beginning cash and cash equivalents

22,685

33,054


Ending cash and cash equivalents	$ 21,795		$ 24,530

See accompanying notes to Unaudited Consolidated Financial Statements.

Notes to the Consolidated Unaudited Financial Statements

The accompanying consolidated financial statements should be read in conjunction with Baylake Corp.’s 2006 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 June 30, 2007 and results of operations for the periods ending June 30, 2007 and 2006. The results of operations for the three and six months ended June 30, 2007 are not necessarily indicative of results to be expected for the entire year.

Use of Estimates

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, uncertain tax positions and fair values of financial instruments are particularly subject to change.

Earnings Per Share

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 our earnings, 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 and six months ended June 30 (dollars in thousands, except per share amounts):


	Three months ended June 30,		Six months ended June 30,
	(Net income in thousands)
	2007	2006	2007	2006
(Numerator):
Net income (loss)	$1,414	$2,370	$ (882)	$ 3,694
(Denominator):
Weighted average number of common shares outstanding-basic	7,851,622	7,803,193	7,851,785	7,794,127
Dilutive effect of stock options	15,405	50,450	-	51,745
Weighted average number of common shares outstanding-diluted	7,867,027	7,853,643	7,851,785	7,845,872
Basic EPS	$0.18	$0.30	$(0.11)	$0.47
Diluted EPS	$0.18	$0.30	$(0.11)	$0.47

At June 30, 2007 and 2006, there are 191,294 and 60,000 outstanding stock options, which are not included in the computation of diluted earnings per share because they are considered anti-dilutive.

Cash Dividends

Baylake Corp. paid a cash dividend of $0.16 per share on June 15, 2007 to shareholders of record as of June 1, 2007.

Notes to the Consolidated Unaudited Financial Statements

5. Adoption of New Accounting Standards:

The company adopted FASB Interpretation 48, Accounting for Uncertainty in Income Taxes (“FIN 48”), as of January 1, 2007. A tax position is recognized as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination. For tax positions not meeting the “more likely than not” test, no tax benefit is being recorded.

In 2002, we purchased Bank Owned Life Insurance (BOLI) in two separate issuances. At the time of our purchases, there were uncertainties with respect to the tax treatment of these BOLI products in general that served as a basis for establishing a tax liability. The primary concern revolved around the taxability of the income derived from the separate account BOLI product due to issues surrounding the concept of investor control and other issues that arose in Corporate-Owned-Life Insurance (COLI). We conducted a review of this uncertain tax position as of January 1, 2007 in accordance with FIN 48. As a result of that analysis, we concluded that no tax liability was required. Subsequent to our analysis, we reviewed IRS Revenue Ruling (2007-7), which clarifies their prior ruling positions on this subject and further supported our analysis. Based on this new ruling, it appears much of the uncertainty regarding the IRS position has been resolved and the favorable tax status has been confirmed.

We have recorded a cumulative effect adjustment as of January 1, 2007 as follows (dollars in thousands):


Gross tax liability, beginning of period	$1,552
Current period change in tax benefits	11
Reduction in tax liability due to adoption of FIN 48	(980)

Gross tax liability, end of period		$ 583

The gross tax liability, end of period, is related to income earned by our subsidiary located in the state of Nevada. Due to the State of Wisconsin Department of Revenue’s (DOR) change in position on the taxability of income from Nevada subsidiaries, and based on our analysis of FIN 48, we have accrued a liability of $583,000 as of June 30, 2007. Our liability was $572,000 as of December 31, 2006. Although these amounts have been accrued for, we anticipate to challenge any settlement proposal offered by the DOR, if offered.

We and our subsidiaries are subject to U.S. federal income tax as well as income tax of multiple state jurisdictions. We are no longer subject to examination by U.S. Federal taxing authorities for years before 2002 and for Wisconsin state income taxes through 2000. We do not expect the total amount of unrecognized tax benefits to significantly increase or decrease in the next twelve months.

The company recognizes interest and/or penalties related to income tax matters in income tax expense. Included in the $583,000 referred to above, is $116,000 of interest and penalties, net of federal tax benefit.

On January 1, 2007, we adopted FASB Statement No. 156, Accounting for Servicing of Financial Assets – an amendment of FASB Statement No. 140, and have elected to use the “fair value measurement method” to account for servicing assets. This statement provides the following: 1) revised guidance on when a servicing asset and servicing liability should be recognized; 2) requires all separately recognized servicing assets and liabilities to be initially measured at fair value, if practicable; 3) permits an entity to elect to measure servicing assets and servicing liabilities at fair value each reporting date and report changes in fair value in earnings in the period in which the changes occur; 4) upon initial adoption, permits a one time reclassification of available-for-sale securities to trading

Notes to the Consolidated Unaudited Financial Statements

securities for securities which are identified as offsetting the entity’s exposure to changes in the fair value of servicing assets or liabilities that a servicer elects to subsequently measure at fair value; and 5) requires separate presentation of servicing assets and servicing liabilities subsequently measured at fair value (versus those measures using the amortization method) in the statement of financial position and additional footnote disclosures. As of January 1, 2007, the market value of our servicing assets was $191,000 higher than the carrying value, as such, we recorded a cumulative affect adjustment on that date in accordance with the provisions of the statement.

6. Newly Issued But Not Yet Effective Accounting Standards:

In September 2006, the FASB issued Statement No. 157, Fair Value Measurements. This Statement defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. This Statement establishes a fair value hierarchy about the assumptions used to measure fair value and clarifies assumptions about risk and the effect of restriction on the sale or use of an asset. The standard is effective for fiscal years beginning after November 15, 2007. We have not completed our evaluation of the impact of the adoption of this standard.

In September 2006, the FASB Emerging Issues Task Force finalized Issue No. 06-4, Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements. This issue requires that a liability be recorded during the service period when a split-dollar life insurance agreement continues after participants’ employment or retirement. The required accrued liability will be based on either the post–employment benefit cost for the continuing life insurance or based on the future death benefit depending on the contractual terms of the underlying agreement. This issue is effective for fiscal years beginning after December 15, 2007. We have completed our evaluation of the adoption of EITF 06-4 and have determined that there is no impact to our financial statements.

In February 2007, the FASB issued FSAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities – Including an Amendment of FASB Statement No. 115. SFAS 159 permits an entity to choose to measure many financial instruments and certain other items at fair value. Most of the provisions of SFAS 159 are elective; however, the amendment to SFAS 115, Accounting for Certain Investments in Debt and Equity Securities, applies to all entities with available-for-sale or trading securities. For financial instruments elected to be accounted for at fair value, an entity will report the unrealized gains and losses in earnings. SFAS 159 is effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007. We are currently assessing the financial impact this Statement will have on our financial conditions or results of operations.

7. Equity Investment

We own a 46% interest in United Financial Services, Inc. (“UFS”), a data processing service, as of June 30, 2007. Our ownership interest totaled $3.5 million and $3.4 million at June 30, 2007 and December 31, 2006, respectively, and is reflected in the Other Assets in the “Consolidated Balance Sheets”. In addition to the ownership interest, we appoint a member of the Board of Directors. The investment in this entity is carried under the equity method of accounting, and the pro rata share of its income is included in other income. On June 27, 2006, UFS entered into an amendment to an earlier agreement for employment with a key employee of UFS allowing that individual the option to purchase up to 20%, or 240 shares, of the authorized shares of UFS. The individual exercised 120 shares on January 15, 2007 at $1,000 per share and later sold 37.2854 shares back to UFS. The net result was a reduction of 3.8% to our investment in UFS and recognized goodwill of $117,000 upon redemption of the shares. Current book value of UFS is approximately $7,002 per share. Any future exercise of the options or sale of the shares acquired upon exercise will have an effect of reducing our investment in UFS as well as a decrease of other income as those options are exercised.

Notes to the Consolidated Unaudited Financial Statements

8. Allowance For Loan Losses

During the first quarter, our overall credit process was evaluated and enhancements to the process were made. In January 2007, the position of Chief Credit Officer was created. This position was developed to oversee the credit underwriting, loan processing, documentation, problem loan, credit review and collection areas.

Both as a result of this process and changes with several problem loans, the Provision for Loan Losses (PFLL) for the first three months of 2007 was $5,985,000 as compared to $200,000 for the first three months in 2006. The calculation of the amount during the first quarter took into account overall asset quality in the loan portfolio, including an increase in non-performing assets as well as changes in management philosophy.

During the second quarter of 2007, net loan charge-offs of $2.3 million were recorded compared to $400,000 for the same period one year ago. Since charge-offs had been related to loans with corresponding specific loan loss allocations, no additional provision was necessary in the quarter. This compares to a provision of $61,000 in the second quarter of 2006.

Late in the first quarter of 2007, borrowings totaling $4.6 million to three related entities were analyzed for impairment. Based on the findings, a specific allocation of $3.6 million was made for these related credits. During the second quarter, a charge-off of $1.5 million was taken related to that credit. Management continues to monitor the credits and is still in the process of attempting to perfect a lien on additional collateral located outside of the country. We expect this process to be completed by the end of the third quarter. In the event this happens, the collateral shortfall may be reduced but there are no assurances that the collateral position will be perfected, nor has the value of this additional collateral been evaluated.

Changes in the allowance for loan losses were as follows ($ in thousands):


	For the six months ended June 30, 2007	For the six months ended June 30, 2006
Allowance for Loan Losses (“ALL”)
Balance at beginning of period	$ 8,058	$ 9,551
Provision for loan losses	5,985	261
Charge-offs	(2,739)	(782)
Recoveries	244	395
Balance at end of period	$ 11,548	$ 9,425

Net charge-offs (“NCOs”:)	($ 2,495)	($ 387)

Notes to the Consolidated Unaudited Financial Statements

Information regarding impaired loans is as follows ($ in thousands):


	June 30, 2007	March 31, 2007	December 31, 2006

Impaired loans with no allocated allowance for loan loss	$13,956	$7,910	$12,118
Impaired loans with allocated allowance for loan loss	31,917	29,819	15,614
Allowance allocated to impaired loans	5,736	7,790	2,176
Average impaired loans during the period	37,883	31,859	23,952

Nonperforming loans were as follows ($ in thousands):


		At June 30, 2007		At March 31, 2007		At December 31, 2006

Nonaccrual loans	$ 45,873		$ 37,729		$ 27,352
Loans restructured in a troubled debt restructuring	475		1,410		496
Accruing loans past due 90 days or more	-		-		-

Total nonperforming loans ("NPLs")	$ 46,348		$ 39,139		$ 27,848

In previous reports, we indicated that one loan of about $8.1 million might be repaid upon sale of collateral real estate under an accepted full price offer to purchase, but that closing was subject to settlement of liens and claims against the property. We then filed and completed foreclosure on a portion of the loans in the amount of $4.0 million. We also previously reported that we were initiating additional foreclosure proceedings on the remaining loans of about $4.1 million. However, despite negotiations with the Borrower and other third parties, the lien claims have not been resolved and previous foreclosure actions have been vacated by rulings granted in the courts. We are seeking a consolidated foreclosure action on all of the loans and have recently commenced a new lawsuit against a municipality third party for damages relating to delays and obstructions of our right to pursue disposition of the property.

On April 30, 2007, management was notified that negotiations to sell or lease the commercial property with a previously interested purchaser had dissolved. The loans remain on non-accrual, with no impairment valuation recognized (based on the analysis conducted by management under the provisions of SFAS 114.) We believe that the value assigned to the loans in this relationship will not result in a material loss; however, our current intentions are to obtain a certified appraisal within a reasonable timeframe. If, based on any future information we determine that impairment exists; we will recognize the impairment at that time. As of June 30, 2007, our maximum exposure for these and related credits is $9.6 million.

On July 23, 2007, bankruptcy documents were filed relating to this commercial credit and the court approved a debtor-in-control account. The debtor attorney is in contact with a number of interested parties. The objection period for creditors expires September 30, 2007, at which point the bank expects to take possession and liquidate the property.

ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

General

We are a full-service financial services company, providing a wide variety of loan, deposit and other banking products and services to our business, individual or retail, and municipal customers, as well as a full range of trust, investment and cash management services. We are a bank holding company of Baylake Bank, a Wisconsin state-chartered bank and member 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. for the three and six months ended June 30, 2007 and 2006 which may not be otherwise apparent from the consolidated financial statements included in this report. 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. The statements contained herein and in such forward-looking statements involve or may involve certain assumptions, risks and uncertainties, many of which are beyond our control that may cause actual future results to differ materially from what may be expressed or forecasted in such forward-looking statements. Readers should not place undue expectations on any forward-looking statements. In addition to the assumptions and other factors referenced specifically in connection with such statements, the following factors could cause actual results to differ materially from the forward-looking statements: the factors described under “Risk Factors” in Item 1A. of our Annual Report on Form 10-K for the year ended December 31, 2006, which are incorporated herein by reference; 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.

Critical Accounting Policies

In the course of our 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, 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.

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 our operations and reported earnings. We believe that the tax assets and liabilities, including tax reserves, are adequate and properly recorded in the consolidated financial statements. The reserve does include specific reserves relative to our Nevada subsidiary.

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 our 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 (“Department”) issued favorable tax rulings regarding Nevada subsidiaries of Wisconsin financial institutions, the Department representatives have 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 that have formed and contributed assets to subsidiaries located in Nevada; to date, we 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.

In July 2007, the Department contacted us to begin discussions on the issue. They requested, and we complied with, an agreement to extend the 2002 income and franchise tax year to March 15, 2008.

Results of Operations

The following table sets forth our net income and related summary information for the three and six month periods ended June 30, 2007 and 2006.

TABLE 1

SUMMARY RESULTS OF OPERATIONS

(dollars in thousands, except per share data)


	Three months ended June 30,		Six months ended June 30,
	2007	2006	2007	2006
Net income (loss), as reported	$ 1,414	$ 2,370	$ (882)	$ 3,694
EPS-basic, as reported	$ 0.18	$ 0.30	$ (0.11)	$ 0.47
EPS-diluted, as reported	$ 0.18	$ 0.30	$ (0.11)	$ 0.47
Cash dividends declared	$ 0.16	$ 0.16	$ 0.32	$ 0.32
Return on average assets	0.51%	0.86%	(0.16)%	0.67%
Return on average equity	7.15%	12.12%	(2.18)%	9.47%
Efficiency ratio, as reported (1)	80.28%	67.21%	80.60%	72.46%

(1)

Non-interest expense divided by sum of taxable equivalent net interest income plus non-interest income, excluding net investment securities gains.

The decrease in net income for the three-month period is primarily due to an increase in interest expense on interest-bearing liabilities, along with an increase in non-interest expense. Refer to the “Net Interest Income” and “Non-Interest Expense” sections for additional details. The decrease in net income for the six-month period is primarily due to a significant increase in the provision for loan losses.

Net Interest Income

Net interest income is the largest component of our operating income, accounting for 76.5% of total operating income for the three months ended June 30, 2007 compared to 78.3% for the same period in 2006. 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 was $7.9 million for the three months ended June 30, 2007 and $9.0 million for the same period in 2006. This decrease resulted from both a decrease in interest income from loans and tax-exempt securities, as well as increased funding costs. The decrease in interest income on loans was primarily due to approximately $1.2 million of foregone interest on non accrual loans for the three month period ended June 30, 2007. During the six months ended June 30, 2007, net interest income on a tax equivalent basis decreased $1.0 million, or 6.1%, to $16.1 million from $17.1 million for the same period in 2006. Affecting the decrease in net interest income was a 54 basis-point (“bps”) increase in the cost of deposits from 3.51% for the first six months of 2006 to 4.05% for the comparable period in 2007. The end result was a 40 bps increase in the cost of interest bearing liabilities from 3.85% in 2006 to 4.25% in 2007. The increase was partially offset by a 14 bps increase in interest earning assets to 6.99% in 2007 from 6.85% in 2006.

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 (demand deposits and equity capital) to fund a portion of earning assets. The net interest margin for the second quarter of 2007 was 3.09%, down 44 bps from 3.53% for the comparable period in 2006.

Average interest rates were higher during the second quarter of this year versus a year ago, as the Federal Reserve Board (“FRB”) ended 24 months of rate increases with two increases of 25 bps each in the second quarter of 2006. The Federal Funds target rate was adjusted to 5.25% in June of last year and remains unchanged at that level as of June 30, 2007. Competition among financial institutions for deposits continues to drive up the cost of funds, contributing to a decrease in net interest margin in the first six months of 2007.

For the three months ended June 30, 2007, average-earning assets increased $486,000, or 0.05%, when compared to the same period last year. An increase in average tax-exempt securities of $16.6 million, or 47.2% for June 30, 2007 over the same period in 2006, comprised the majority of the volume increase. This was offset by decreases of $4.1 million, or 0.5% in loans, $2.5 million, or 1.7% in taxable securities, and $8.8 million, or 85.8% in federal funds sold. For the six months ended June 30, 2007, average-earning assets increased $10.1 million, or 1.0%, when compared to the same period a year ago. This was primarily due to an increase of $16.7 million, or 49.3% in tax-exempt securities, partially offset by a $4.2 million decrease, or 67.7% in federal funds sold.

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. For the second quarter of 2007 compared to the same period for 2006, the interest rate spread decreased 47 bps to 2.68%, the net result of a two bps decrease in the yield on earning assets and a 45 bps increase in the cost of interest-bearing liabilities. 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 advances from the Federal Home Loan Bank. Interest expense on the subordinated debentures was lower in 2007 due to the reduction in interest rates on the trust preferred securities as well as the elimination of the $475,015 of amortization expenses that were incurred in the first quarter of 2006. This was the amortization expense of issuance costs related to the redemption of our trust-preferred securities. For the six months ended June 30, 2007, the interest rate spread decreased 26 bps to 2.74% from 3.00% for the six months ended June 30, 2006. The average yield on earning assets increased 14 bps to 6.99% from 6.85%, while the average rate paid on interest-bearing liabilities increased 40 bps when comparing the six months ended June 30, 2007 with the same period in 2006.

TABLE 2

NET INTEREST INCOME ANALYSIS ON A TAX –EQUIVALENT BASIS

($ in thousands)

Three months ended June 30,


	2007			2006
	Average Balance	Interest income/ Expense	Average yield/ Rate	Average Balance	Interest income/ Expense	Average yield/ rate
ASSETS
Earning assets:
Loans, net	$ 819,842	$ 15,398	7.51%	$ 823,936	$ 15,501	7.53%
Taxable securities	142,523	1,522	4.27%	145,043	1,570	4.33%
Tax exempt securities	51,677	791	6.12%	35,104	574	6.54%
Federal funds sold and interest bearing due from banks	3,096	38	4.90%	12,569	156	4.96%
Total earning assets	1,017,138	17,749	6.98%	1,016,652	17,801	7.00%
Non-interest earning assets	88,055			84,408

Total assets	$ 1,105,193			$ 1,101,060

LIABILITIES AND STOCKHOLDERS’ EQUITY
Interest-bearing liabilities:
Total interest-bearing deposits	790,315	8,101	4.10%	775,806	7,090	3.66%

Short-term borrowings	11,726	164	5.59%	6,394	78	4.88%
Customer repurchase agreements	3,742	45	4.94%	1,086	11	4.05%
Federal Home Loan Bank advances	98,967	1,321	5.34%	118,534	1,399	4.72%
Subordinated debentures	16,100	262	6.50%	16,100	257	6.39%
Total interest-bearing liabilities	$920,850	$9,893	4.30%	$ 917,920	$ 8,835	3.85%
Demand deposits	91,453			92,205
Accrued expenses and other liabilities	13,779			12,696
Stockholders’ equity	79,111			78,239

Total liabilities and stockholders’ equity	$ 1,105,193			$ 1,101,060

Interest rate spread		$ 7,856	2.68%		$ 8,966	3.15%
Net interest margin			3.09%			3.53%

Six months ended June 30,


	2007			2006
	Average Balance	Interest income/ Expense	Average yield/ Rate	Average Balance	Interest income/ Expense	Average yield/ rate
ASSETS
Earning assets:
Loans, net	$ 825,734	$ 31,006	7.51%	$ 824,989	$ 30,249	7.33%
Taxable securities	143,415	3,119	4.35%	145,745	3,141	4.31%
Tax exempt securities	50,684	1,558	6.15%	33,955	1,117	6.58%
Federal funds sold and interest bearing due from banks	3,671	91	4.95%	8,760	207	4.73%
Total earning assets	1,023,504	35,773	6.99%	1,013,449	34,714	6.85%
Non-interest earning assets	89,504			83,374

Total assets	$ 1,113,008			$ 1,096,823

LIABILITIES AND STOCKHOLDERS’ EQUITY
Interest-bearing liabilities:
Total interest-bearing deposits	793,213	16,053	4.05%	765,228	13,432	3.51%

Short-term borrowings	8,590	238	5.54%	9,720	241	4.96%
Customer repurchase agreements	2,525	59	4.69%	1,214	23	3.79%
Federal Home Loan Bank advances	107,028	2,803	5.24%	121,537	2,761	4.54%
Subordinated debentures	16,100	546	6.78%	16,456	1,146	13.93%
Total interest-bearing liabilities	$927,456	$19,699	4.25%	$ 914,155	$ 17,603	3.85%
Demand deposits	91,333			92,730
Accrued expenses and other liabilities	13,293			11,922
Stockholders’ equity	80,926			78,016

Total liabilities and stockholders’ equity	$ 1,113,008			$ 1,096,823

Interest rate spread		$ 16,074	2.74%		$ 17,111	3.00%
Net interest margin			3.14%			3.38%

Our management’s ability to employ overall assets for the production of interest income can be measured by the ratio of average earning assets to average total assets. This ratio was 92.0% and 92.4% for the first six months of 2007 and 2006, respectively.

Provision for Loan Losses

The provision for loan losses (“PFLL”) is the cost of providing an allowance for probable incurred losses. The allowance consists of specific and general components. Our 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, and management’s evaluation of loan quality, general economic factors and collateral values.

Please refer to the Note 8 to the Consolidated Unaudited Financial Statements above for additional discussion on the PFLL and credit processes. As previously discussed in Note 8, the PFLL for the first three months of 2007 was $5,985,000 compared to $200,000 for the first three months in 2006. For the second quarter, there was no provision recorded compared to $61,000 for the second quarter of 2006.

As described more fully in Table 6, non-accrual loans increased $18.5 million during the first six months of 2007. See “Balance Sheet Analysis – Non-Performing Loans, Potential Problem Loans and Other Real Estate” below. The increase in non-accrual loans during the quarter did not result in increased provision as these loans had been previously analyzed for impairment and appropriate provisions made.

As reported in the table in Note 8 of the Notes to the Consolidated Unaudited Financial Statements, net loan charge-offs in the first six months of 2007 were $2.5 million compared with net charge-offs of $390,000 for the same period in 2006. Net charge-offs to average loans were 0.30% for the first six months of 2007 compared to 0.05% for the same period in 2006. For the three months ended June 30, 2007, non-performing loans increased $7.2 million. Refer to the “Risk Management and the Allowance for Loan Losses” and “Non-Performing Loans, Potential Problem Loans and Other Real Estate” sections below for more information related to non-performing loans.

Management believes that the current provision conforms to our allowance for loan loss policy and represents our probable incurred credit losses in view of the present condition of our loan portfolio. However, a further 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 allowance for loan losses. Also, negative developments relating to our non-performing loans, including diminution of value of the collateral or increased costs of collection, could affect the allowance for loan losses. If there are significant unanticipated charge-offs against the allowance, or we otherwise determine that the allowance is inadequate, we will need to make higher provisions in the future, which would negatively affect our earnings.

Non-Interest Income

Total non-interest income remained relatively stable at $2.4 million with a decrease of $68,000 or 2.7% for the three months ended June 30, 2007 compared to the same period in 2006. For the six months ended June 30, 2007, total non-interest income was $4.7 million, a decrease of $61,000 or 1.3%. The non-interest income to average assets ratio was 0.87% for the six months ended June 30, 2007 compared to 0.90% for the same period in 2006, a decrease of 0.03%. For the six months ended June 30, 2007, the non-interest income to average assets ratio was 0.84% compared to 0.86% for the same period in 2006. Contributing to the decrease was a decline in the gain on sale of loans of $121,000 or 29.5%, and a decline in gain realized

on the sale of fixed assets of $189,000. In 2006, a gain of $185,000 was recognized on the sale of land located near our I43 branch.

Table 3 reflects the various components of non-interest income for the comparable quarters.

TABLE 3

NON-INTEREST INCOME

($ in thousands)


	Three months ended			Six months ended
	June 30, 2007	June 30, 2006	% Change	June 30, 2007	June 30, 2006	% Change
Fees from fiduciary services	256	$ 240	6.7%	523	$ 541	-3.3%
Fees from loan servicing	237	275	-13.8%	508	535	-5.0%
Service charges on deposit accounts	916	851	7.6%	1,743	1,645	6.0%
Other fee income	158	165	-4.2%	331	330	0.3%
Financial services income	216	230	-6.1%	429	410	4.6%
Gains from sales of loans	183	209	-12.4%	289	410	-29.5%
Net gains (loss) from sale of premises and equipment	(4)	185	-102.2%	(4)	185	-102.2%
Increase in cash surrender value of life insurance	312	175	78.3%	536	401	33.7%
Death benefits realized	-	23	-100.00%	-	23	-100.0%
Other income	139	128	8.6%	303	239	26.8%

Total Non-Interest Income	$ 2,413	$ 2,481	-2.7%	$ 4,658	$ 4,719	-1.3%

Gains on sales of loans decreased $121,000 for the first six months of 2007 compared to the same period in 2006. This was primarily due to adoption of FASB Statement No. 156 as discussed in Note 5 to the consolidated unaudited financial statements, along with a decrease in gain on commercial loan sales offset by an increase in mortgage loan sales gains.

Other income increased $64,000 for the six month periods compared above. This is primarily due to a $43,000 increase in UFS income for the six months ended June 30, 2007 over the same period in 2006.

Non-Interest Expense

Non-interest expense increased $551,000 or 7.2%, to $8.2 million for the three months ended June 30, 2007 compared to the same period in 2006. This was primarily attributable to increases in the operation of other real estate, FDIC insurance assessments, and loan and collection expenses. This was partially offset by a reduction in business development and advertising expenses. For the six months ended June 30, 2007, total non-interest expense increased $892,000 or 5.7%, to $16.7 million compared to the same period in 2006. The non-interest expense to average assets ratio was 2.99% for the three months ended June 30, 2007 compared to 2.79% for the same period in 2006. For the six months ended June 30, 2007, the non-interest expense ratio to average assets was 3.00% compared to 2.88% for the six months ended June 30, 2006.

Net overhead expense is total non-interest expense less total non-interest income excluding securities gains. The net overhead expenses to average assets ratio increased to 2.11% for the three months ended June 30, 2007 compared to 1.89% for the same period in 2006. For the six months ended June 30, 2007, the net overhead expenses to average assets ratio was 2.17% compared to 2.02% for the six months ended June 30, 2006. 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 increased to 80.3% for the three months ended June 30, 2007 from 67.2% for the comparable period last year. For the six months ended June 30, 2007, the efficiency ratio was 80.6% compared to 72.5% for the same period in 2006.

TABLE 4

NON-INTEREST EXPENSE

($ in thousands)


	Three months ended			Six months ended
	June 30, 2007	June 30, 2006	% Change	June 30, 2007	June 30, 2006	% Change
Salaries and employee benefits	4,711	$ 4,525	4.1%	9,862	$ 9,517	3.6%
Occupancy	621	585	6.2%	1,230	1,164	5.7%
Equipment	394	445	-11.5%	766	840	-8.8%
Data processing and courier	320	315	1.6%	633	615	2.9%
Operation of other real estate owned	265	74	258.1%	545	117	365.8%
Business development & advertising	36	243	-85.2%	263	477	-44.9%
Charitable contributions	(19)	30	-163.3%	73	106	-31.1%
Stationary and supplies	159	158	0.6%	289	262	10.3%
Director fees	116	152	-23.7%	226	271	-16.6%
FDIC	125	26	380.8%	151	53	184.9%
Legal and professional	195	45	333.3%	453	250	81.2%
Loan and collection	494	263	87.8%	494	307	60.9%
Other operating	827	832	-0.4%	1,724	1,838	-6.2%

Total Non-Interest Expense	$ 8,244	$ 7,693	7.2%	$ 16,709	$ 15,817	5.6%

Salaries and employee benefits showed an increase of $186,000, or 4.1%, to $4.7 million for the three month period ended June 30, 2007, compared to the same period in 2006. The number of full-time equivalent employees was 326 as of June 30, 2007 compared to 326 at June 30, 2006.

Expenses related to the operation of other real estate owned increased $191,000 or 258.1% to $265,000 for the three-month period ended June 30, 2007 compared to $74,000 for the same period in 2006. Real estate property taxes and insurance premiums for parcels comprised approximately $91,000 of the amount. In addition, $194,000 of expenses was incurred for the operation of a large commercial property located in Green Bay, and $69,000 of valuation write-downs was taken on various real estate properties. This was partially offset by net gains on sale of other real estate properties of $98,000 for the quarter. The number of properties in other real estate totaled eighteen and ten at June 30, 2007 and June 30, 2006, respectively.

For the three-month period ended June 30, 2007, FDIC insurance expense increased $99,000, or 380.8% from the same period a year ago. During the period, our assessment included an FDIC charge of $217,000 in addition to the Financing Corporation (FICO) assessment of approximately $25,000. The FDIC charge was partially offset by a portion of our share of the one-time assessment credit pool, thus reducing the charge to $99,000 for the quarter. Our remaining share of the pool of $427,000 will be used to offset future FDIC assessments. We anticipate our future assessments for FDIC premiums will continue at the same level as the second quarter of 2007 until the one-time credit pool is fully absorbed. At that point, we expect our premiums to significantly increase.

Loan and collection expenses increased $231,000 for the three months ended June 30, 2007 to $494,000 compared to the same period in 2006. The increase is partly attributable to legal fees of $85,000 on various properties in the legal process, $87,000 in property tax expense on a property that is in the foreclosure process, and $44,000 of expenses related to a borrower that is experiencing cash flow problems. These expenses are expected to continue in the future, as our level of non-performing loans

remains high. Legal fees from outside law firms will continue to rise since we have outsourced a majority of our legal process.

Income Taxes

Our income tax expense for the three months ended June 30, 2007 was $229,000, versus an expense of $1.0 million for the same period in 2006. For the six months ended June 30, 2007, our income tax benefit was $1.8 million compared to an expense of $1.5 million for the same period in 2006. The tax benefit for the current year reflects our year-to-date loss recognized before income tax for the six-month period.

Our effective tax rate (income expense divided by income before taxes) was 13.9% for the three months ended June 30, 2007 compared with 30.6% for the same period in 2006. The effective tax rate of 13.9% consisted of a federal effective tax rate of 13.5% and Wisconsin State effective tax rate of 0.4%. Taxable income decreased while tax-exempt interest income from investments increased, 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. We undergo examinations 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 in future periods.

Balance Sheet Analysis

Loans

At June 30, 2007, total loans decreased $4.8 million, or 0.6%, to $815 million from $820 million at December 31, 2006. This was primarily due to a decrease of $10.0 million, or 11.3%, in first lien residential real estate loan totals from December 31, 2006 to June 30, 2007. This decrease was partially offset by a $5.4 million increase in real estate construction loans during the period.

The following table reflects the composition (mix) of the loan portfolio:

TABLE 5

LOAN PORTFOLIO ANALYSIS

($ in thousands)


	June 30, 2007	December 31, 2006	Percent change
Amount of loans by type
Real estate-mortgage
Commercial	$463,383	$464,843	(0.3%)
1-4 family residential
First liens	78,370	88,397	(11.3%)
Junior liens	24,619	23,829	3.3%
Home equity	31,614	31,647	(0.1%)
Commercial, financial and agricultural	84,321	82,619	2.1%
Real estate-construction	99,512	94,082	5.8%
Installment
Credit cards and related plans	2,191	2,143	2.2%
Other	12,115	12,750	(5.0%)
Obligations of states and political subdivisions	19,032	19,633	(3.1%)
Less: deferred origination fees, net of costs	(407)	(375)	8.5%
Total	$814,750	$819,568	(0.6%)

Risk Management and the Allowance for Loan Losses

The loan portfolio is our primary asset subject to credit risk. To reflect this credit risk, we set aside an allowance for probable incurred credit losses through periodic charges to earnings. These charges are shown in our 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. With the creation of the Chief Credit Officer, an updated credit procedure has been implemented. The procedures include additional detail in the loan presentations and due diligence in the background research of both companies and guarantors. New credits entering the bank, along with existing credits requesting new money, may require additional verification procedures over past practices. The level of detail for the verification procedures will be determined by the risks associated with the request. 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 when collectability is considered unlikely. Charged-off loans are subject to periodic review and specific efforts are taken to achieve maximum recovery of principal and interest.

The ALL at June 30, 2007 was $11.5 million compared with $8.1 million at the end of 2006. This increase was based on management's analysis of the loan portfolio risk at June 30, 2007 as discussed above. As such, a provision expense of $5,985,000 was recorded for the six months ended June 30, 2007 as compared to the $261,000 provision recorded for the same period in 2006.

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. The loan officers grade commercial credits 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 an analysis developed through specific credit allocations on individual loans for which the recorded investment in the loan exceeds its fair value; and (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 we operate.

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 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 quarterly and as either positive or negative adjustments 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 2006.

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 further deteriorate, borrowers may experience difficulty and the level of non-performing loans, charge-offs and delinquencies could rise and require further increases in the provision. In addition, declines in real estate values in our market areas may affect collateral values of loans secured by commercial or residential mortgages, which may require further re-evaluation of allowance levels.

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 probable asset quality problems exist in the loan portfolio in view of collateral values, management believes sufficient ALL allocations have been provided in the ALL to absorb probable incurred losses in the loan portfolio at June 30, 2007. Ongoing efforts are being made to collect these loans, and we involve the legal process for collection when necessary to minimize the risk of further deterioration of these loans.

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 our borrowers. As an integral part of their examination process, various regulatory agencies also review our 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. Monitoring and reviewing credit policies and procedures on a regular basis, as well as reviewing specific credits periodically accomplish this.

Non-performing loans are a leading indicator of future loan loss potential. Non-performing loans are defined as non-accrual loans, 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

the collection of principal or interest on loans, it is 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. Restructuring loans involve the granting of some concession to the borrower involving a loan modification, such as payment schedule or interest rate changes. Restructured loans involve loans that have had a charge-off taken against the loan to reduce the carrying amount of the loan to fair market value as determined using a SFAS 114 analysis.

TABLE 6

NON-PERFORMING ASSETS

($ in thousands)


	June 30, 2007	December 31, 2006	June 30, 2006
Nonperforming Assets:
Nonaccrual loans	$ 45,873	$27,352	$ 28,677
Loans restructured in a troubled debt restructuring	475	496	-
Accruing loans past due 90 days or more	-	-	-

Total nonperforming loans ("NPLs")	$ 46,348	$ 27,848	$ 28,677
Other real estate owned	5,919	5,760	1,374

Total nonperforming assets ("NPAs")	$ 52,267	$ 33,608	$ 30,051
Ratios:
ALL to NCO's (annualized)	2.31	3.36	12.18
NCO's to average loans (annualized)	0.60%	0.29%	0.09%
ALL to total loans	1.42%	0.98%	1.15%
NPL's to total loans	5.69%	3.39%	3.49%
NPA's to total assets	4.74%	3.02%	2.72%
ALL to NPL's	24.92%	28.94%	32.87%

Non-accrual loans increased during the six months ended June 30, 2007 by $18.5 million from December 31, 2006. The increase is primarily attributable to six commercial relationships totaling $16 million for businesses that are experiencing difficulties in sales, cash flow, fiscal operations, and/or general management issues. Five of these six non-performing relationships are secured primarily by commercial or residential real estate, and secondarily, by personal guarantees from principals of the respective borrowers. As previously mentioned in the “Provision for Loan Losses” section above, the other relationship has a significant collateral shortfall. This relationship totals $3.2 million and is secured by personal property and a contract assignment. Management has allocated $2.2 million in the ALL on the basis of a SFAS 114 analysis for any loss estimated with respect to this relationship.

Other real estate owned, which represents property that we have acquired through foreclosure, deed in lieu of foreclosure or in satisfaction of debt, consisted of eighteen properties at June 30, 2007 compared to seventeen properties at December 31, 2006.

Information regarding other real estate owned is as follows:

TABLE 7

OTHER REAL ESTATE OWNED

($ in thousands)


	June 30, 2007	December 31, 2006	June 30, 2006
Beginning Balance	$ 5,760	$ 3,333	$3,333
Transfer of net realizable value to ORE	2,611	6,399	391
Sales Proceeds, net	(2,430)	(3,958)	(2,356)
Net gain from sale of ORE	111	76	53
Provision for ORE	(133)	(90)	(47)

Total Other Real Estate	$ 5,919	$ 5,760	$1,374

Changes in the valuation allowance for losses on other real estate owned were as follows:


	June 30, 2007	December 31, 2006
Beginning Balance	$ 108	$ 267
Provision charged to operations	133	90
Amounts related to properties disposed	(9)	(249)

Balance at end of period	$ 232	$ 108

Investment Portfolio

The investment portfolio is intended to provide us with adequate liquidity, flexibility in asset/liability management and, lastly, an increase in its earning potential.

At June 30, 2007, the investment portfolio (which includes investment securities available for sale) decreased $2.3 million to $186.0 million as compared to $188.3 million at December 31, 2006. At June 30, 2007, the investment portfolio represented 16.88% of total assets compared with 16.94% at December 31, 2006.

Securities available for sale consist of the following:

TABLE 8

INVESTMENT SECURITY ANALYSIS

At June 30, 2007

($ in thousands)


	Gross Unrealized Gains	Gross Unrealized Losses	Fair Value

Securities available for sale
U.S. Treasury & other U.S. agencies	15	(1,241)	57,154
Mortgage-backed securities	10	(1,791)	74,055
Obligations of states & political subdivisions	143	(1,010)	52,016
Other securities	-	-	2,764

Total securities available for sale	$ 168	$ (4,042)	$ 185,989

At December 31, 2006

($ in thousands)


	Gross Unrealized Gains	Gross Unrealized Losses	Fair Value

Securities available for sale
U.S. Treasury & other U.S. agencies	$ 69	$ (953)	$ 57,528
Mortgage-backed securities	154	(1,583)	78,226
Obligations of states & political subdivisions	512	(148)	50,059
Private placement	16	-	1,015
Other securities	-	-	1,487

Total securities available for sale	$ 751	$ (2,684)	$ 188,315

The decreases in unrealized losses are related principally to changes in interest rates. As we have the intent and ability to hold these securities until forecasted recovery, which may be maturity in some instances, no declines were deemed to be other than temporary.

Deposits

Total deposits at June 30, 2007 increased $19.6 million, or 2.2%, to $898.5 million from $878.9 million at December 31, 2006. Non-interest bearing deposits at June 30, 2007 increased to $98.4 million as compared

to $96.9 million at December 31, 2006. Interest-bearing deposits at June 30, 2007 increased $18.2 million, or 2.32%, to $800.2 million from $782.0 million at December 31, 2006. Brokered CDs were relatively stable and totaled $105.8 million at June 30, 2007 compared to $104 million at December 31, 2006. If liquidity concerns arise, we have 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 continues to limit our 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 our customer base as customers draw down deposits during the first half of the year in anticipation of the summer tourist season. Then, in the later half of the year, deposits tend to increase as a result of cash receipts during the tourist season.

Emphasis has been, and will continue to be, placed on generating additional core deposits in 2007 through competitive pricing of deposit products and through the branch delivery systems that have already been established and a new branch located in the Green Bay market that opened in the third quarter of 2006. We will also attempt to attract and retain core deposit accounts through new product offerings and quality customer service. We also may increase brokered time deposits during the remainder of the year 2007 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, we 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

Securities under agreements to repurchase and federal funds purchased at June 30, 2007 increased $26.0 million to $30.5 million from $4.5 million at December 31, 2006. Federal funds purchased accounted for $18.4 million of the increase while repurchase agreements accounted for the remaining $7.6 million. In the second quarter, efforts were made to sweep commercial deposits for our larger depositors to internal Baylake Bank accounts rather than to sweep to external accounts. This provides us with an additional source of funds.

Federal Home Loan Bank Advances decreased $50 million at June 30, 2007 to $65.2 million. Part of this decrease was a result of the increase in balances in repurchase agreements and federal funds purchased already described. The remaining decrease was because customer deposits grew faster than loans during the first six months of the year, reducing our reliance on outside funds to support loan growth. We 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 we need to borrow in order to fund loan demand. We anticipate we will continue to use wholesale funding sources of this nature, if these borrowings add incrementally to overall profitability.

Long-term Debt

In March 2006, we issued $16.1 million of trust preferred securities and $498,000 of trust common securities under the name Baylake Capital Trust II that will adjust quarterly at a rate equal to 1.35% over the three month LIBOR. This was issued to replace the trust-preferred securities issued in 2001 under the Baylake Capital Trust I. For banking regulatory purposes, these securities are considered Tier 1 capital.

The trust’s ability to pay amounts due on the trust preferred securities are solely dependent upon us making payment on the related subordinated debentures to the trust. Our obligations under the subordinated debentures constitute a full and unconditional guarantee by us of the trust’s obligation under the trust securities issued by the trust.

Contractual Obligations, Commitments, Off-Balance Sheet Risk, and Contingent Liabilities

We utilize a variety of financial instruments in the normal course of business to meet the financial needs of our 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 our Annual Report on Form 10-K for the year ended December 31, 2006 for discussion with respect to our quantitative and qualitative disclosures about our 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)


	June 30, 2007	December 31, 2006
Commitments to fund home equity line loans	$ 49,376	$ 50,702
Commitments to fund residential real estate construction loans	3,375	2,195
Commitments unused on various other lines of credit loans	142,016	174,975
Total commitments to extend credit	$ 194,767	$ 227,872
Financial standby letters of credit	$ 19,756	$ 21,327

The following table summarizes our significant contractual obligations and commitments at June 30, 2007:

TABLE 10

CONTRACTUAL OBLIGATIONS

($ in thousands)


	Within 1 year	1-3 years	3-5 years	After 5 years	Total
Certificates of deposit and other time deposit obligations	$ 349,648	$ 70,308	$ 4,239	$ -	$ 424,195
Federal funds purchased and repurchase agreements	30,496	-	-	-	30,496
Federal Home Loan Bank advances	65,000	175	-	-	65,175
Subordinated debentures	-	-	-	16,100	16,100
Operating leases	3	-	-	-	3
Total	$445,147	$ 70,483	$ 4,239	$ 16,100	$ 535,969

Liquidity

Liquidity management refers to our ability 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. Our subsidiary and we have different liquidity considerations.

Our primary sources of funds are dividends from our subsidiary, investment income, and net proceeds from borrowings and the offerings of junior subordinated obligations, in addition to the issuance of our common stock securities. We manage our liquidity position in order to provide funds necessary to pay dividends to our shareholders and repurchase shares. Dividends received from our subsidiary totaled $1.7 million for the first six months of 2007 and will continue to be our main source of long-term liquidity. The dividends from our subsidiary along with existing cash were sufficient to pay cash dividends to our shareholders of $3.8 million in the first six months of 2007.

Our subsidiary meets its cash flow needs by having funding sources available to satisfy the credit needs of customers as well as having available funds to satisfy deposit withdrawal requests. Liquidity is derived from deposit growth, maturing loans, the maturity of the 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. For the six months ended June 30, 2007, principal payments totaling $7.9 million were received on investments. We purchased $7.5 million in investments in the first six months of 2007. At June 30, 2007 the investment portfolio contained $131.2 million of U.S. Treasury and federal agency backed securities, representing 70.6% of the total investment portfolio. These securities tend to be highly marketable.

Deposit growth is typically another source of liquidity in the latter half of each year, although deposits typically shrink in the first half resulting in a use of cash. The seasonal pattern results from the tourism-oriented businesses in our market area. As a financing activity reflected in the June 30, 2007 Consolidated Statements of Cash Flows, deposits increased and resulted in $19.6 million of cash flow during the first six months of 2007. Our overall deposit base increased 2.2% for the six months ended June 30, 2007. Deposit growth is generally the most stable source of liquidity, although brokered deposits, which are inherently less stable than locally generated core deposits, are sometimes used. Our reliance on these deposits remained constant during the six-month period. 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 a need 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. There are $271.9 million, or 33.8%, 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 liquidity position is influenced by changes in interest rates, economic conditions and competition. Conversely, loan demand as a need for liquidity will cause us 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 June 30, 2007, federal funds purchased and securities sold under agreements to repurchase totaled $30.5 million compared to $4.5 million at the end of 2006. Federal funds are purchased from various upstream correspondent banks while securities sold under

agreements to repurchase are obtained from a base of business customers. Short-term and long-term borrowings from FHLB are another source of funds, and were $65.2 million for June 30, 2007 and $115.2 million at December 31, 2006.

The liquidity resources were sufficient in the first six months of 2007 to reduce our Federal Home Loan Bank advances and meet other cash needs as necessary.

We expect that deposit growth will continue to be the primary funding source of 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 six months of 2007, we expect 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, we 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, 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, our goals and our unique characteristics. We believe that, in the current economic environment, our and our subsidiary’s liquidity position is adequate. To our knowledge, there are no known trends nor any known demands, commitments, events or uncertainties that will result or are reasonably likely to result in material increases or decreases in our and our subsidiary’s liquidity.

Capital Resources

Stockholders’ equity at June 30, 2007 and December 31, 2006 was $79.2 million and $82.2 million, respectively. In total, stockholders’ equity decreased $3.0 million or 3.6%. The decrease in stockholders’ equity in 2007 was primarily related to the declaration of dividends of $2.5 million, the repurchase of 50,000 shares of treasury stock in the amount of $768,000, our net loss of $882,000, and a $1.3 million change in accumulated other comprehensive loss (as a result of an increase in unrealized losses on available for sale securities), offset by $522,000 in proceeds from the exercise of stock options, and adjustment of $980,000 related to the adoption of FIN 48. Stockholders’ equity to assets at June 30, 2007 was 7.2% compared to 7.4% at the end of 2006.

Cash dividends declared in the first six months of 2007 were $0.32 per share, which was the same as those declared in 2006. Total funds utilized in the payment of dividends were stable at $3.8 million and $3.7 million for the first six months of 2007 and 2006, respectively.

We regularly review the adequacy of our capital 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. We believe that because of current capital levels and projected earnings levels, capital levels are adequate to meet our ongoing and future concerns.

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, as well as possible additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the consolidated financial statements.

At June 30, 2007 and December 31, 2006, we were categorized as “well capitalized” under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that we believe have changed our 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%. There are no material commitments for capital expenditures.

The following table presents our and our subsidiary’s capital ratios as of June 30, 2007 and December 31, 2006:

TABLE 11

CAPITAL RATIOS

($ in thousands)


	Actual		Required For Capital Adequacy Purposes		Required To Be Well Capitalized under Prompt Corrective Action Provisions
	Amount	Ratio	Amount	Ratio	Amount	Ratio
As of June 30, 2007
Total Capital (to Risk Weighted Assets)
Company	$103,148	11.15%	$73,978	8.00%	N/A	N/A
Bank	$101,457	10.96%	$74,025	8.00%	$92,531	10.00%
Tier 1 Capital (to Risk Weighted Assets)
Company	$91,600	9.91%	$36,989	4.00%	N/A	N/A
Bank	$89,891	9.71%	$37,012	4.00%	$55,519	6.00%
Tier 1 Capital (to Average Assets)
Company	$91,600	8.33%	$43,960	4.00%	N/A	N/A
Bank	$89,891	8.19%	$43,929	4.00%	$54,912	5.00%

As of December 31, 2006
Total Capital (to Risk Weighted Assets)
Company	$101,489	10.87%	$74,721	8.00%	N/A	N/A
Bank	$99,249	10.63%	$74,685	8.00%	$93,356	10.00%
Tier 1 Capital (to Risk Weighted Assets)
Company	$93,430	10.00%	$37,360	4.00%	N/A	N/A
Bank	$91,191	9.77%	$37,342	4.00%	$56,014	6.00%
Tier 1 Capital (to Average Assets)
Company	$93,430	8.53%	$43,826	4.00%	N/A	N/A
Bank	$91,191	8.33%	$43,789	4.00%	$54,736	5.00%

We believe 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. Our 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. We actively review our capital strategies 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.

Our primary market risk exposure is interest rate risk. Interest rate risk is the risk that our earnings and capital will be adversely affected by changes in interest rates. We do not use derivatives to mitigate our interest rate risk.

Our earnings are derived from the operations of our 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, our interest income and interest expense are affected by general economic conditions and by the policies of regulatory authorities, including the monetary policies of the Board of Governors of the Federal Reserve System. Changes in the economic environment may influence, among other matters, the growth rate of loans and deposits, the quality of the loan portfolio and loan and deposit pricing. Fluctuations in interest rates are not predictable or controllable.

As of June 30, 2007, we were in compliance with our management policies with respect to interest rate risk. We have not experienced any material changes to our market risk position since December 31, 2006, as described in our 2006 Form 10-K Annual Report.

Our 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 income in the event of sudden and sustained 1.0% to 2.0% increases and decreases in market interest rates. The table below presents our projected changes in net interest income for the various rate shock levels at June 30, 2007.

TABLE 12

INTEREST SENSITIVITY

($ in thousands)


Change in Net Interest Income over One Year Horizon
	At June 30, 2007		At December 31, 2006
Change in levels of interest rates	Dollar change	Percentage change	Dollar change	Percentage change
+200 bp	$ (1,857)	(6.1%)	$164	0.5%
+100 bp	(850)	(2.8%)	87	0.3%
Base	-	-	-	-
-100 bp	628	2.1%	(1,064)	(3.1%)
-200 bp	1,091	3.6%	(2,522)	(7.3%)

As shown above, at June 30, 2007, the effect of an immediate 200 basis point increase in interest rates would decrease our net interest income by $1.9 million or 6.1%. The effect of an immediate 200 basis point reduction in rates would increase our net interest income by $1.1 million or 3.6%.

During the first six months of 2007, the bank shortened the duration of their liabilities by replacing fixed rate wholesale borrowings with either variable rate or short term borrowings and by offering rate incentives in the form of a short term CD special to attract retail customers to shorter term deposits. This effort has contributed to the shift from a position of slight asset sensitivity to one of liability sensitivity.

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 we may undertake in response to changes in interest rates.

Item 4. Controls and Procedures

Disclosures Controls and Procedures: Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our 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 June 30, 2007. Based on such evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, our disclosure controls and procedures are effective in timely alerting them to material information relating to our disclosure controls and procedures required to be included in this quarterly report on Form 10-Q.

Internal Control Over Financial Reporting: During the quarter, we continued with the enhancements to the credit process that were implemented in the first quarter of 2007. The updated credit process included: (1) additional detail in loan presentations, (2) due diligence in the background research of both companies and guarantors, (3) additional verification procedures to new credits as well as existing credits requesting new money, (4) a more aggressive approach to remove the problem credits and improve asset quality, and (5) require supplemental market data and support along with routine site visits in an effort to identify any changes in collateral positions.

There have not been any other changes in our 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, our internal controls over financial reporting.

Part II - Other Information

Item 1. Legal Proceedings

Baylake and its subsidiaries may be involved from time to time in various routine legal proceedings incidental to its business. Neither Baylake nor any of its subsidiaries is currently engaged in any legal proceedings that are expected to have a material adverse effect on the results of operations or financial position of Baylake.

Item 1A. Risk Factors

See “Risk Factors” in Item 1A of our annual report on Form 10-K for the year ended December 31, 2006. There have been no material changes to the risk factors since then.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

On June 5, 2006, our Board of Directors authorized management, in its discretion, to repurchase up to 300,000 shares of our common stock, representing approximately 3.8% of our common stock in a timeframe not to extend beyond June 30, 2007. Shares repurchased are held as treasury stock and, accordingly, are accounted for as a reduction of stockholders’ equity.

During the second quarter of 2007, there were no repurchases of shares and the repurchase program expired on June 30, 2007.

On July 17, 2007, our Board of Directors authorized management, in its discretion, to repurchase up to 300,000 shares of our common stock, representing approximately 3.8% of our common stock in a timeframe not to extend beyond June 30, 2008. Shares repurchased will be held as treasury stock and, accordingly, will be accounted for as a reduction of stockholder’s equity.

During the second quarter of 2007, we did not sell any equity securities that were not registered under the Securities Act of 1933, as amended.

Item 3. Defaults Upon Senior Securities

None

Item 4. Submission of Matters to a Vote of Security Holders

None

Item 5. Other Information

None

Item 6. Exhibits

The following exhibits are furnished herewith:

Exhibit Number Description

3.1

Articles of Amendment to Articles of Incorporation

3.2

Composite Articles of Incorporation

10.1

Amendments to Deferred Compensation Arrangements with Mr. Thomas Herlache and Summary of Benefits for serving as Chairman

31.1

Certification under Section 302 of Sarbanes-Oxley by Robert J.Cera, Chief Executive Officer, is attached hereto.

31.2

Certification under Section 302 of Sarbanes-Oxley by Kevin L. LaLuzerne, 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.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

BAYLAKE CORP.

Date: August 08, 2007 /s/ Robert J. Cera

Robert J. Cera

President (CEO)

Date: August 08, 2007 /s/ Kevin L. LaLuzerne

Kevin L. LaLuzerne

Treasurer (CFO)