10-Q

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 September 30, 2011

OR

o     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 001-16339

BAYLAKE CORP.
(Exact name of registrant as specified in its charter)

Wisconsin	39-1268055
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)
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 o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes x No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o	Accelerated filer o	Non-accelerated filer o	Smaller reporting company x
	(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o No x

Number of outstanding shares of common stock, $5.00 par value per share, as of November 9, 2011 was 7,911,539 shares

BAYLAKE CORP. AND SUBSIDIARIES

INDEX

		PAGE NO.
PART I - FINANCIAL INFORMATION
ITEM 1 -	FINANCIAL STATEMENTS	3
ITEM 2 -	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	30
ITEM 3 -	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	51
ITEM 4 -	CONTROLS AND PROCEDURES	52
PART II - OTHER INFORMATION
ITEM 1 -	LEGAL PROCEEDINGS	52
ITEM 1A -	RISK FACTORS	52
ITEM 2 -	UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	53
ITEM 3 -	DEFAULTS UPON SENIOR SECURITIES	53
ITEM 5 -	OTHER INFORMATION	53
ITEM 6 -	EXHIBITS	54

2

PART I - FINANCIAL INFORMATION
Item 1. Financial Statements

BAYLAKE CORP.
CONSOLIDATED BALANCE SHEETS
September 30, 2011 (Unaudited) and December 31, 2010
(Dollar amounts in thousands)

	September 30, 2011			December 31, 2010
ASSETS
Cash and due from financial institutions	$	93,576		$	54,555
Federal funds sold		—			1
Cash and cash equivalents		93,576			54,556
Securities available for sale		239,683			266,760
Loans held for sale		2,142			6,400
Loans, net of allowance of $12,857 and $11,502 at September 30, 2011 and December 31, 2010, respectively		623,937			618,389
Cash surrender value of life insurance		22,966			24,472
Premises and equipment, net		23,088			23,604
Federal Home Loan Bank stock		6,792			6,792
Foreclosed properties, net		10,662			15,952
Goodwill		6,641			6,641
Deferred income taxes		7,096			9,202
Accrued interest receivable		3,441			4,165
Other assets		11,929			15,520
Total Assets	$	1,051,953		$	1,052,453
LIABILITIES AND STOCKHOLDERS’ EQUITY
Deposits
Noninterest-bearing	$	107,277		$	84,552
Interest-bearing		751,067			768,014
Total Deposits		858,344			852,566
Federal Home Loan Bank advances		55,000			70,000
Repurchase agreements		20,463			19,236
Subordinated debentures		16,100			16,100
Convertible promissory notes		9,450			9,450
Accrued expenses and other liabilities		9,042			8,034
Total Liabilities		968,399			975,386
Common stock, $5 par value, authorized 50,000,000 shares; Issued-8,132,552 shares at September 30, 2011 and December 31, 2010; Outstanding-7,911,539 shares at September 30, 2011 and December 31, 2010		40,662			40,662
Additional paid-in capital		12,039			11,980
Retained earnings		29,688			26,965
Treasury stock (221,013 shares at September 30, 2011 and December 31, 2010)		(3,549	)		(3,549	)
Accumulated other comprehensive income		4,714			1,009
Total Stockholders’ Equity		83,554			77,067
Total Liabilities and Stockholders’ Equity	$	1,051,953		$	1,052,453

See accompanying Notes to Unaudited Consolidated Financial Statements.

3

BAYLAKE CORP.
CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
Three and nine months ended September 30, 2011 and 2010
(Dollar amounts in thousands, except per share data)

	Three months ended September 30,						Nine months ended September 30,
	2011			2010			2011			2010
INTEREST AND DIVIDEND INCOME
Loans, including fees	$	8,278		$	8,872		$	24,998		$	26,897
Taxable securities		1,747			1,983			5,376			6,007
Tax exempt securities		375			382			1,129			1,119
Federal funds sold		51			28			90			81
Total Interest and Dividend Income		10,451			11,265			31,593			34,104
INTEREST EXPENSE
Deposits		1,749			2,248			5,577			7,567
Repurchase agreements		23			16			65			78
Federal Home Loan Bank advances and other debt		261			484			833			1,539
Subordinated debentures		66			77			200			209
Convertible promissory notes		245			245			735			615
Total Interest Expense		2,344			3,070			7,410			10,008
Net interest income		8,107			8,195			24,183			24,096
Provision for loan losses		1,200			4,550			4,450			6,850
Net interest income after provision for loan losses		6,907			3,645			19,733			17,246
NONINTEREST INCOME
Fees from fiduciary activities		217			214			720			714
Fees from loan servicing		139			123			552			397
Fees for other services to customers		1,260			1,320			3,726			3,797
Net gain on sale of loans		208			324			805			725
Net gain (loss) in mortgage servicing rights		(111	)		(12	)		(225	)		26
Net gain on sale of securities		267			973			392			1,406
Net loss on sale of premises and equipment		(1	)		(81	)		(3	)		(83	)
Increase in cash surrender value of life insurance		102			205			353			271
Income in equity of UFS subsidiary		199			185			631			423
Other income/(expense)		(174	)		16			190			75
Total Noninterest Income		2,106			3,267			7,141			7,751
NONINTEREST EXPENSE
Salaries and employee benefits		4,067			4,207			12,681			12,156
Occupancy expense		551			584			1,731			1,782
Equipment expense		304			287			891			961
Data processing and courier		210			221			621			662
FDIC insurance expense		571			697			1,861			1,938
Operation of other real estate		108			894			1,875			1,837
Provision for impairment of standby letters of credit		117			—			131			87
Loan and collection expense		139			155			470			492
Other outside services		166			208			488			541
Other operating expenses		975			985			3,028			2,987
Total Noninterest Expense		7,208			8,238			23,777			23,443
Income before provision for (benefit from)income taxes		1,805			(1,326	)		3,097			1,554
Provision for (benefit from) income taxes		508			(814	)		374			(101	)
Net Income (loss)	$	1,297		$	(512	)	$	2,723		$	1,655
Basic earnings (loss) per share	$	0.16		$	(0.06	)	$	0.34		$	0.21
Diluted earnings (loss) per share	$	0.16		$	(0.06	)	$	0.34		$	0.21

See accompanying Notes to Unaudited Consolidated Financial Statements.

4

BAYLAKE CORP.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY AND COMPREHENSIVE
INCOME (Unaudited)
Nine months ended September 30, 2011
(Dollar amounts in thousands, except share data)

					Additional Paid-in Capital		Retained Earnings		Treasury Stock			Accumulated Other Comprehensive Income			Stockholders’ Equity
	Common Stock
	Shares		Amount
Balance, January 1, 2011		7,911,539	$	40,662	$	11,980	$	26,965	$	(3,549	)	$	1,009		$	77,067
Net income for the period		—		—		—		2,723		—			—			2,723
Net changes in unrealized gain on securities available for sale		—		—		—		—		—			6,516			6,516
Reclassification adjustment for net gains realized in income		—		—		—		—		—			(392	)		(392	)
Tax effect		—		—		—		—		—			(2,419	)		(2,419	)
Total comprehensive income		—		—		—		—		—			—			6,428
Stock-based compensation expense		—		—		59		—		—			—			59
Balance, September 30, 2011		7,911,539	$	40,662	$	12,039	$	29,688	$	(3,549	)	$	4,714		$	83,554

See accompanying Notes to Unaudited Consolidated Financial Statements.

5

BAYLAKE CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
Nine months ended September 30, 2011 and 2010
(Dollar amounts in thousands)

	2011			2010
CASH FLOWS FROM OPERATING ACTIVITIES
Reconciliation of net income to net cash provided by operating activities:
Net Income	$	2,723		$	1,655
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		986			997
Amortization of debt issuance costs		26			39
Amortization of core deposit intangible		—			25
Goodwill on UFS option exercise		—			191
Provision for losses on loans		4,450			6,850
Provision for impairment of letters of credit		131			51
Net amortization of premium/discount on securities		1,754			1,056
Increase in cash surrender value of life insurance		(353	)		(271	)
Net gain on life insurance death benefit		(297	)		—
Net realized gain on sale of securities		(392	)		(1,406	)
Net gain on sale of loans		(805	)		(725	)
Proceeds from sale of loans held for sale		52,313			46,580
Origination of loans held for sale		(47,367	)		(47,817	)
Net change in valuation of mortgage servicing rights		225			(26	)
Provision for valuation allowance on foreclosed properties		1,517			1,374
Net (gain) loss on sale of premises and equipment		(7	)		83
Net loss on sale of land held for sale		10			—
Net gain on disposals of foreclosed properties		(198	)		(39	)
Benefit for deferred income tax expense		(313	)		(1,030	)
Stock-based compensation expense		59			—
Income in equity of UFS subsidiary		(631	)		(423	)
Changes in assets and liabilities:
Accrued interest receivable and other assets		5,802			2,883
Payment to reduce LOC valuation allowance		(232	)		(2,980	)
Accrued expenses and other liabilities		1,109			944
Net cash flows provided by operating activities		20,510			8,011
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from sale of securities available for sale		25,696			53,779
Principal payments on securities available for sale		46,284			58,082
Purchase of securities available for sale		(40,141	)		(155,651	)
Proceeds from sale of foreclosed properties		6,798			1,560
Proceeds from sale of premises and equipment		11			—
Proceeds from sale of land held for sale		308			—
Loan originations and payments, net		(12,825	)		11,992
Additions to premises and equipment		(474	)		(936	)

See accompanying Notes to Unaudited Consolidated Financial Statements.

6

BAYLAKE CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
Nine months ended September 30, 2011 and 2010
(Dollar amounts in thousands)

	2011			2010
CASH FLOWS FROM INVESTING ACTIVITIES (continued)
Proceeds from life insurance surrender	$	1,698		$	—
Proceeds from life insurance death benefit		457			59
Rabbi Trust initial funding		(1,626	)		—
Net change in federal funds sold		1			—
Dividend from UFS Subsidiary		319			144
Net cash provided by (used in) investing activities		26,506			(30,971	)
CASH FLOWS FROM FINANCING ACTIVITIES
Net change in deposits		5,778			13,725
Net change in federal funds purchased and repurchase agreements		1,227			1,349
Proceeds from Federal Home Loan Bank advances		—			40,000
Repayments on Federal Home Loan Bank advances		(15,000	)		(55,000	)
Debt offering costs paid		—			(6	)
Proceeds from issuance of convertible promissory notes		—			4,100
Net cash provided by (used in) financing activities		(7,995	)		4,168
Net change in cash and cash equivalents		39,021			(18,792	)
Beginning cash		54,555			86,526
Ending cash	$	93,576		$	67,734
Supplemental cash flow information:
Interest paid	$	7,363		$	10,415
Income taxes refunded, net		2,526			1,704
Supplemental noncash disclosure:
Transfers from loans to foreclosed properties	$	2,827		$	3,398
Mortgage servicing rights resulting from sale of loans		117			83

See accompanying Notes to Unaudited Consolidated Financial Statements.

7

BAYLAKE CORP.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2011

1.	The accompanying interim consolidated financial statements should be read in conjunction with our 2010 Annual Report on Form 10-K. The accompanying consolidated financial statements are unaudited. These interim consolidated 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 (“GAAP”) for complete financial statements. In the opinion of management, the unaudited consolidated financial information included in this report reflects all adjustments, consisting of normal recurring accruals of operations for the nine month periods ending September 30, 2011 and 2010. The consolidated results of operations for the three and nine months ended September 30, 2011 are not necessarily indicative of results to be expected for the entire year. We have evaluated all subsequent events through November 9, 2011, the date the interim consolidated financial statements were issued.
2.	Use of Estimates
	To prepare consolidated financial statements in conformity with GAAP, our management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the consolidated financial statements and the disclosures provided, and actual results could differ. The allowance for loan losses, foreclosed properties, mortgage servicing rights, income tax expense and fair values of financial instruments are particularly subject to change.
3.	Earnings (Loss) Per Share
	Diluted earnings (loss) 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 the weighted average number of common shares outstanding and common stock equivalents. The following table shows the computation of the basic and diluted earnings (loss) per share:

EARNINGS (LOSS) PER SHARE
(Dollar amounts in thousands, excluding per share data)

	Three months ended September 30,						Nine months ended September 30,
	2011			2010			2011			2010
(Numerator):
Net income (loss)	$	1,297		$	(512	)	$	2,723		$	1,655
(Denominator):
Weighted average number of common shares outstanding-basic		7,911,539			7,911,539			7,911,539			7,911,539
Dilutive effect of stock options		—	(1)		—	(1)		—	(1)		—	(1)
Dilutive effect of convertible promissory notes		—	(2)		—	(2)		—	(2)		—	(2)
Dilutive effect of restricted stock units		5,215			—			3,500			—
Weighted average number of common shares outstanding-diluted		7,916,754			7,911,539			7,915,039			7,911,539
Basic Earnings (Loss) Per Share	$	0.16		$	(0.06	)	$	0.34		$	0.21
Diluted Earnings (Loss) Per Share	$	0.16		$	(0.06	)	$	0.34		$	0.21

(1)

At September 30, 2011 and 2010, there were 112,400 and 49,628 outstanding stock options, respectively, which are not included in the computation of diluted earnings per share because they are considered anti-dilutive.

(2)

At September 30, 2011 and 2010, we had $9.45 million of outstanding Convertible Promissory Notes (the “Convertible Notes”). The Convertible Notes are convertible into shares of our common stock at a conversion ratio of one share of common stock for each $5.00 in aggregate principal amount held on the record date of the conversion subject to certain adjustments as described in the Convertible Notes. On October 1, 2014, one-half of the original principal amount of the Convertible Notes is mandatorily convertible at the conversion ratio if conversion has not occurred. The mandatorily convertible principal of the Convertible Notes represents 945,000 shares, which are not included in the computation of diluted earnings per share because they are considered anti-dilutive. The remaining half of the principal amount of Convertible Notes is convertible into an additional 945,000 common shares at the discretion of the respective holders. These shares have not been included because of their anti-dilutive effect, if converted.

8

BAYLAKE CORP.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2011

4.	Recent Accounting Pronouncements
	In April 2011, the FASB issued ASU No. 2011-02, Receivables (Topic 310): A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring. The ASU will improve financial reporting by creating greater consistency in the way GAAP is applied for various types of debt restructurings. The ASU clarifies which loan modifications constitute troubled debt restructurings. It is intended to assist creditors in determining whether a modification of the terms of a receivable meets the criteria to be considered a troubled debt restructuring, both for purposes of recording an impairment loss and for disclosure of troubled debt restructurings. The new guidance is effective for interim and annual periods beginning on or after June 15, 2011, and applies retrospectively to restructurings occurring on or after the beginning of the fiscal year of adoption. The provisions of this guidance are not expected to have a significant impact on our consolidated financial condition, results of operation or liquidity.
	In May 2011, the FASB issued ASU No. 2011-03, Transfers and Servicing (Topic 860): Reconsideration of Effective Control for Repurchase Agreements. The ASU is intended to improve financial reporting of repurchase agreements (“repos”) and other agreements that both entitle and obligate a transferor to repurchase or redeem financial assets before their maturity. The amendments to the codification in this ASU are intended to improve the accounting for these transactions by removing from the assessment of effective control the criterion requiring the transferor to have the ability to repurchase or redeem the financial assets. The guidance in the ASU is effective for the first interim or annual period beginning on or after December 15, 2011. The provisions of this guidance are not expected to have a significant impact on our consolidated financial condition, results of operation or liquidity.
	In June 2011, the FASB issued ASU No. 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. This ASU represents the converged guidance of the FASB and IASB (the Boards) on fair value measurement. The collective efforts of the Boards and their staffs, reflected in ASU 2011-04, have resulted in common requirements for measuring fair value and for disclosing information about fair value measurements, including a consistent meaning of the term “fair value.” The Boards have concluded the common requirements will result in greater comparability of fair value measurements presented and disclosed in financial statements prepared in accordance with U.S. GAAP and IFRSs. The amendments to the FASB Accounting Standards Codification (Codification) in this ASU are to be applied prospectively. For public entities, the amendments are effective during interim and annual periods beginning after December 15, 2011. Early application by public entities is not permitted. The provisions of this guidance are not expected to have a significant impact on our consolidated financial condition, results of operations or liquidity.

9

BAYLAKE CORP.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2011

In June 2011, the FASB issued ASU No. 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income. This ASU amends the Codification to allow an entity the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In both choices, an entity is required to present each component of net income along with total net income, each component of other comprehensive income along with a total for other comprehensive income, and a total number for comprehensive income. ASU 2011-05 eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders’ equity. The amendments to the Codification in the ASU do not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income. ASU 2011-05 should be applied retrospectively. For public entities, the amendments are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. Early adoption is permitted. In October 2011, the FASB deferred the effective date of the amendment. No effective date has been established. The provisions of this guidance are not expected to have a significant impact on our consolidated financial condition, results of operations or liquidity.

In September 2011, the FASB issued ASU No. 2011-08, Intangibles-Goodwill and Other (Topic 350): Testing Goodwill for Impairment. ASU 2011-08 is intended to simplify how entities, both public and nonpublic, test goodwill for impairment. ASU 2011-08 permits an entity to first assess qualitative factors to determine whether it is “more likely than not” that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test described in Topic 350, Intangibles-Goodwill and Other. The more-likely-than-not threshold is defined as having a likelihood of more than 50%. ASU 2011-08 is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. The provisions of this guidance are not expected to have a significant impact on our consolidated financial condition, results of operations or liquidity.

5.	Fair Value
	Accounting guidance establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The guidance describes three levels of inputs that may be used to measure fair value:

Level 1:	Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.
Level 2:	Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.
Level 3:	Significant unobservable inputs that reflect a reporting entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

The fair value of securities available for sale is determined by obtaining quoted prices on nationally recognized securities exchanges (Level 1 inputs) or matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities (Level 2 inputs).

The fair value of mortgage servicing rights is based on a valuation model that calculates the present value of estimated net servicing income. The valuation model incorporates assumptions that market participants would use in estimating future net servicing income. These assumptions include servicing costs, expected loan lives, discount rates, and the determination of whether the loan is likely to be refinanced. We compare the valuation model inputs and results to widely available published industry data for reasonableness (Level 2 inputs).

10

BAYLAKE CORP.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2011

The fair value of foreclosed properties is determined using a variety of market information including but not limited to appraisals, professional market assessments and real estate tax assessment information. Foreclosed properties are carried at the lower of amortized cost at date of transfer or fair value less estimated costs to sell (Level 3 inputs).

The fair value of loans held for sale is based on quoted market prices (Level 2 inputs).

The fair value of impaired loans 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 the estimated costs to sell. Impaired loans do not require an allowance if the fair value of the expected repayments or collateral exceeds the investments in such loans. Impaired loans are carried at the lower of amortized cost or fair value (Level 3 inputs).

ASSETS MEASURED ON A RECURRING BASIS
(Dollar amounts in thousands)

Assets measured at fair value on a recurring basis are summarized below:

	September 30, 2011		Quoted Prices in Active Markets For Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
Securities available for sale:
U.S. government-sponsored agency securities	$	20,858	$	—	$	20,858	$	—
Mortgage-backed securities		142,593		—		142,593		—
Asset-backed securities		5,125		—		5,125		—
Obligations of states and political subdivisions		56,461		—		56,461		—
Private placement and corporate bonds		12,378		—		12,378		—
Other securities		2,268		—		2,268		—
Total securities available for sale		239,683		—		239,683		—
Mortgage servicing rights		638		—		638		—
Loans held for sale		2,180		—		2,180		—
Total	$	242,501	$	—	$	242,501	$	—

11

BAYLAKE CORP.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2011

	December 31, 2010		Quoted Prices in Active Markets For Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
Securities available for sale:
U.S. government-sponsored agency securities	$	33,753	$	—	$	33,753	$	—
Mortgage-backed securities		159,646		—		159,646		—
Asset-backed securities		5,536		—		5,536		—
Obligations of states and political subdivisions		52,853		—		52,853		—
Private placement and corporate bonds		12,537		—		12,537		—
Other securities		2,435		—		2,435		—
Total securities available for sale		266,760		—		266,760		—
Mortgage servicing rights		746		—		746		—
Loans held for sale		6,488		—		6,488
Total	$	273,994	$	—	$	273,994	$	—

ASSETS MEASURED ON A NON-RECURRING BASIS
(Dollar amounts in thousands)

Assets measured at fair value on a non-recurring basis are summarized below:

	September 30, 2011		Quoted Prices in Active Markets For Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
Impaired loans	$	14,183	$	—	$	—	$	14,183
Foreclosed properties		10,662		—		—		10,662
Total	$	24,845	$	—	$	—	$	24,845

	December 31, 2010		Quoted Prices in Active Markets For Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
Impaired loans	$	7,676	$	—	$	—	$	7,676
Foreclosed properties		15,952		—		—		15,952
Total	$	23,628	$	—	$	—	$	23,628

12

BAYLAKE CORP.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2011

Required Financial Disclosures about Fair Value of Financial Instruments

The accounting guidance for financial instruments requires disclosures of estimated fair value of certain financial instruments and the methods and significant assumptions used to estimate their fair values. Certain financial instruments and all nonfinancial instruments are excluded from the scope of this guidance. Accordingly, the fair value disclosures required by this guidance are only indicative of the value of individual financial instruments as of the dates indicated and should not be considered an indication of our fair value.

	(Dollar amounts in thousands)
	September 30, 2011				December 31, 2010
	Carrying Amount		Fair Value		Carrying Amount		Fair Value
FINANCIAL ASSETS
Cash	$	93,576	$	93,576	$	54,555	$	54,555
Federal funds sold		—		—		1		1
Securities available for sale		239,683		239,683		266,760		266,760
Loans held for sale		2,142		2,180		6,400		6,488
Loans, net		623,937		627,942		618,389		622,273
Cash value of life insurance		22,966		22,966		24,472		24,472
Federal Home Loan Bank stock		6,792		6,792		6,792		6,792
Accrued interest receivable		3,441		3,441		4,165		4,165
FINANCIAL LIABILITIES
Deposits	$	858,344	$	859,703	$	852,566	$	854,598
Repurchase agreements		20,463		20,463		19,236		19,236
Federal Home Loan Bank advances		55,000		55,000		70,000		71,525
Subordinated debentures		16,100		16,100		16,100		16,100
Convertible promissory notes		9,450		9,630		9,450		9,224
Accrued interest payable		1,286		1,286		1,239		1,239
Off-balance sheet credit related items:
Letters of credit	$	635	$	635	$	737	$	737

The methods and assumptions used to estimate fair value are described as follows:

(a) Cash

Due to their short-term nature, the carrying amount approximates fair value.

(b) Securities Available for Sale

Fair values for securities available for sale are based on market prices or other inputs that are observable or can be corroborated by observable market data.

(c) Loans Held for Sale

The fair value of loans held for sale is based on actual market quotes from third party investors.

13

BAYLAKE CORP.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2011

(d) Loans, net

For variable-rate loans that reprice frequently, fair values are based on carrying value. Fair values for other loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms. Impaired loans are valued at the lower of cost or fair value. Fair value is measured based on the value of the underlying collateral securing those loans less the cost of sale. This evaluation may include obtaining supplemental market data and/or routine site visits to offer support to the valuation process.

(e) Cash Value of Life Insurance

The fair value of life insurance approximates the carrying amount, because upon liquidation of these investments, we would receive the cash surrender value, which equals the carrying amount.

(f) Federal Home Loan Bank Stock

It is not practical to determine the fair value of Federal Home Loan Bank (“FHLB”) stock due to restrictions placed on its transferability. No secondary market exists for FHLB stock. The stock is bought and sold at par by the FHLB. Management believes that the recorded value is fair value.

(g) Accrued Interest Receivable

The carrying amount of accrued interest receivable approximates fair value.

(h) Deposits

The carrying amount of demand deposits (interest-bearing and non-interest-bearing), savings deposits, and money market deposits approximates fair value. The carrying amount of variable rate time deposits, including certificates of deposit, approximates fair value. For fixed rate time deposits, fair value is based on discounted cash flows using current market interest rates.

(i) Repurchase Agreements

The carrying amount of repurchase agreements approximates fair value.

(j) Federal Home Loan Bank Advances

The carrying amount of variable rate FHLB advances approximates fair value. For fixed rate advances, fair value is based on discounted cash flows using current market interest rates.

(k) Subordinated Debentures

The carrying amount of variable rate subordinated debentures approximates fair value.

(l) Convertible Promissory Notes

The fair value of fixed rate convertible promissory notes is based on discounted cash flows using current market interest rates.

(m) Accrued Interest Payable

The carrying amount of accrued interest payable approximates fair value.

14

BAYLAKE CORP.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2011

(n) Off Balance Sheet Credit Related Items-Letters of Credit

The carrying amount of the off balance sheet letters of credit approximates fair value based on management’s evaluation of the factors affecting the letters of credit.

6. Investments

INVESTMENT SECURITY ANALYSIS
(Dollar amounts in thousands)

The fair value of securities available for sale and the related unrealized gains and losses as of September 30, 2011 and December 31, 2010 are as follows:

	September 30, 2011
	Fair Value		Gross Unrealized Gains		Gross Unrealized Losses
U.S. government-sponsored agency securities	$	20,858	$	151	$	—
Obligations of states and political subdivisions		56,461		3,683		—
Mortgage-backed securities		142,593		5,111		(1,138	)
Asset-backed securities		5,125		135		(483	)
Private placement and corporate bonds		12,378		332		—
Other securities		2,268		—		—
Totals	$	239,683	$	9,412	$	(1,621	)

	December 31, 2010
	Fair Value		Gross Unrealized Gains		Gross Unrealized Losses
U.S. government-sponsored agency securities	$	33,753	$	80	$	(35	)
Obligations of states and political subdivisions		52,853		863		(284	)
Mortgage-backed securities		159,646		2,074		(866	)
Asset-backed securities		5,536		175		(841	)
Private placement and corporate bonds		12,537		534		(33	)
Other securities		2,435		—		—
Totals	$	266,760	$	3,726	$	(2,059	)

At September 30, 2011 and December 31, 2010, the mortgage-backed securities portfolio was $142.6 million, (59.5%) and $159.6 million, (59.8%), respectively, of the investment portfolios. Approximately 10.3%, or $14.6 million, of the mortgage-backed securities outstanding at September 30, 2011 were issued and guaranteed by the Government National Mortgage Association (GNMA) or the United States Department of Veterans Affairs (VA); agencies of the United States government. An additional 66.7%, or $94.9 million, of the mortgage-backed securities outstanding at September 30, 2011 were issued by either Federal National Mortgage Association (FNMA) or the Federal Home Loan Mortgage Corporation (FHLMC); United States government-sponsored agencies. Non-agency mortgage-backed securities present a level of credit risk that does not exist currently with agency-backed securities, but only comprised approximately 23%, or $33.0 million, of the outstanding mortgage-backed securities at September 30, 2011. We evaluate these non-agency mortgage-backed securities at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation.

15

BAYLAKE CORP.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2011

Securities with unrealized losses at September 30, 2011 and December 31, 2010, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, are as follows (dollar amounts in thousands):

	September 30, 2011
	Less than 12 Months					12 Months or More					Total
Description of Securities	Fair Value		Unrealized Loss			Fair Value		Unrealized Loss			Fair Value		Unrealized Loss
Mortgage-backed securities		29,668		(668	)		4,296		(470	)		33,964		(1,138	)
Asset-backed securities		—		—			3,788		(483	)		3,788		(483	)
Total temporarily impaired	$	29,668	$	(668	)	$	8,084	$	(953	)	$	37,752	$	(1,621	)

	December 31, 2010
	Less than 12 Months					12 Months or More					Total
Description of Securities	Fair Value		Unrealized Loss			Fair Value		Unrealized Loss			Fair Value		Unrealized Loss
U.S. government-sponsored agency securities	$	4,960	$	(35	)	$	—	$	—		$	4,960	$	(35	)
Obligations of states and political subdivisions		15,177		(284	)		—		—			15,177		(284	)
Mortgage-backed securities		53,582		(838	)		5,500		(28	)		59,082		(866	)
Asset-backed securities		3,889		(841	)		—		—			3,889		(841	)
Private placement and corporate bonds		—		—			4,967		(33	)		4,967		(33	)
Total temporarily impaired	$	77,608	$	(1,998	)	$	10,467	$	(61	)	$	88,075	$	(2,059	)

At September 30, 2011, the mortgage-backed securities category with continuous unrealized losses for twelve months or more comprises one security. The asset-backed securities category with continuous unrealized losses for twelve months or more comprises two securities.

At December 31, 2010, the mortgage-backed securities category with continuous unrealized losses for twelve months or more and the private placement and corporate bond category with continuous unrealized losses for twelve months or more each comprise one security.

We evaluate securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. As part of such monitoring, the credit quality of individual securities and their issuers is assessed. Adjustments to market value that are considered temporary are recorded as a separate component of other comprehensive income, net of tax. If an impairment of a security is identified as other-than-temporary based on information available, such as the decline in the creditworthiness of the issuer, external market ratings or the anticipated or realized elimination of associated dividends, such impairments are further analyzed to determine if a credit loss exists. If there is a credit loss, it will be recorded in the statement of operations. Unrealized losses other than credit losses will continue to be recognized in other comprehensive income. Unrealized losses reflected in the preceding tables have not been included in the results of operations because the unrealized loss was not deemed other-than-temporary. Management has determined that it is not more likely than not that we will be required to sell the debt securities before their anticipated recovery and therefore, there is no other-than-temporary impairment. The losses on these securities are expected to dissipate as they approach their maturity dates and/or if interest rates decline.

16

BAYLAKE CORP.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2011

7. Loans

            Loans held for investment are summarized as follows (dollar amounts in thousands):

	September 30, 2011			December 31, 2010
Real Estate-Commercial	$	329,253		$	344,263
Real Estate-Residential		137,085			129,449
Real Estate-Construction		54,999			55,467
Commercial Loans		91,083			73,928
Consumer Loans		8,869			10,225
Obligations of States and Political Subdivisions		15,909			16,892
Gross Loans		637,198			630,224
Less: Deferred Origination Fees, net of costs		(404	)		(333	)
Less: Allowance for Loan Losses		(12,857	)		(11,502	)
Total	$	623,937		$	618,389

Loans having a carrying value of $95,330 and $86,744 are pledged as collateral for borrowings from the Federal Home Loan Bank at September 30, 2011 and December 31, 2010, respectively.

A summary of the activity in the allowance for loan losses by class of loan is as follows (dollar amounts in thousands):

	Construction Loans			Real Estate- Mortgage			Real Estate- Commercial			Commercial			Consumer			Municipal		Not Specifically Allocated			Total
Allowance for Loan Losses:
Balance January 1, 2011	$	1,424		$	2,103		$	6,355		$	1,189		$	391		$	—	$	40		$	11,502
Charge-offs		(373	)		(1,407	)		(856	)		(476	)		(213	)		—		—			(3,325	)
Recoveries		59			9			78			38			46			—		—			230
Provision		457			1,888			1,213			363			146			—		383			4,450
Balance September 30, 2011	$	1,567		$	2,593		$	6,790		$	1,114		$	370		$	—	$	423		$	12,857
Ending balance individually evaluated for impairment	$	178		$	536		$	1,773		$	43		$	149		$	—	$	—		$	2,679
Ending balance collectively evaluated for impairment	$	1,389		$	2,057		$	5,017		$	1,071		$	221		$	—	$	423		$	10,178
Loans:
Balance September 30, 2011	$	54,999		$	137,085		$	328,868		$	91,064		$	8,869		$	15,909	$	—		$	636,794
ALL		(1,567	)		(2,593	)		(6,790	)		(1,114	)		(370	)		—		(423	)		(12,857	)
Recorded investment	$	53,432		$	134,492		$	322,078		$	89,950		$	8,499		$	15,909	$	(423	)	$	623,937
Ending balance individually evaluated for impairment	$	2,675		$	2,067		$	9,080		$	361		$	—		$	—	$	—		$	14,183
Ending balance collectively evaluated for impairment	$	50,757		$	132,425		$	312,998		$	89,589		$	8,499		$	15,909	$	(423	)	$	609,754

17

BAYLAKE CORP.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2011

	Construction Loans			Real Estate- Mortgage			Real Estate- Commercial			Commercial			Consumer			Municipal		Not Specifically Allocated			Total
Allowance for Loan Losses:
Balance January 1, 2010	$	1,184		$	1,452		$	4,558		$	1,497		$	375		$	—	$	534		$	9,600
Charge-offs		(1,837	)		(156	)		(5,443	)		(1,030	)		(123	)		—		—			(8,589	)
Recoveries		5			206			1,316			1,553			61			—		—			3,141
Provision		2,072			601			5,924			(831	)		78			—		(494	)		7,350
Balance, December 31, 2010	$	1,424		$	2,103		$	6,355		$	1,189		$	391		$	—	$	40		$	11,502
Ending balance individually evaluated for impairment	$	168		$	717		$	1,236		$	528		$	189		$	—	$	—		$	2,838
Ending balance collectively evaluated for impairment	$	1,256		$	1,386		$	5,119		$	661		$	202		$	—	$	40		$	8,664
Loans:
Balance December 31, 2010	$	55,467		$	129,448		$	343,955		$	73,904		$	10,225		$	16,892	$	—		$	629,891
ALL		(1,424	)		(2,103	)		(6,355	)		(1,189	)		(391	)		—		(40	)		(11,502	)
Recorded investment	$	54,043		$	127,345		$	337,600		$	72,715		$	9,834		$	16,892	$	(40	)	$	618,389
Ending balance individually evaluated for impairment	$	3,959		$	4,178		$	23,883		$	1,174		$	7		$	—	$	—		$	33,201
Ending balance collectively evaluated for impairment	$	50,084		$	123,167		$	313,717		$	71,541		$	9,827		$	16,892	$	(40	)	$	585,188

A summary of past due loans at September 30, 2011 and December 31, 2010 is as follows (dollar amounts in thousands):

	September 30, 2011
	30-89 Days Past Due (accruing)		90 Days & Over or on non-accrual		Total
Construction	$	833	$	5,221	$	6,054
Real estate – mortgage		941		4,252		5,193
Real estate – commercial		781		13,955		14,736
Commercial		91		722		813
Consumer		141		164		305
Municipal		—		—		—
Total	$	2,787	$	24,314	$	27,101

18

BAYLAKE CORP.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2011

	December 31, 2010
	30-89 Days Past Due (accruing)		90 Days & Over or on non-accrual		Total
Construction	$	586	$	4,066	$	4,652
Real estate – mortgage		1,311		4,845		6,156
Real estate – commercial		3,531		6,360		9,891
Commercial		289		973		1,262
Consumer		95		256		351
Municipal		—		—		—
Total	$	5,812	$	16,500	$	22,312

Credit Quality: We utilize a risk grading matrix on each of our commercial loans. Loans are graded on a scale of 1 to 7. A description of the loan grades is as follows:

0001 - Excellent Risk. Borrowers of highest quality and character. Almost no loss probability. Balance sheets are very strong with superior liquidity, excellent debt capacity and low leverage. Cash flow trends are positive and stable.

0002 - Very Good Risk. Strong ratios in all areas. High quality borrower. Normally quite liquid. Differs slightly from a one-rated customer.

0003 - Strong in most categories. Possible higher levels of debt or shorter track record. Minimal attention required.

0004 - Better than Average Risk. Adequate ratios, fair liquidity, desirable customer. Proactive management. Performance trends are positive. Any deviations are limited and temporary as a historical trend.

0005 - Satisfactory Risk. Some ratios slightly weak. Overall ability to repay is adequate. Capable and generally proactive management in all critical positions. Margins and cash flow may lack stability but trends are stable to positive. Company normally profitable year to year but may experience an occasional loss.

0006 A - Weakness detected in either management, capacity to repay or balance sheet. Erratic profitability and financial performance. Loan demands more attention. Includes loans deemed to have weaknesses and less than 90 days past due.

0006 B - Have weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or in the Bank’s collateral position at some future date. Loans rated 6B are not adversely classified as they do not expose the Bank to sufficient risk to warrant adverse classification.

0007 - Well defined weaknesses and trends that jeopardize the repayment of loans. Ranging from workout to legal. Includes loans that are 90 days and over past due.

19

BAYLAKE CORP.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2011

Below is a breakdown of loans by risk grading as of September 30, 2011 (dollar amounts in thousands):

	0001-0005		0006A		0006B		0007		Total
Commercial Loans	$	82,520	$	5,010	$	988	$	2,565	$	91,083
Real Estate - Commercial		246,463		35,502		8,454		38,834		329,253
Real Estate - Construction		38,609		6,352		3,333		6,705		54,999
		367,592		46,864		12,775		48,104		475,335
Real Estate - Residential		129,448		481		789		6,367		137,085
Consumer Loans		8,709		—		—		160		8,869
Obligations of States and Political Subdivisions		15,909		—		—		—		15,909
		154,066		481		789		6,527		161,863
	$	521,658	$	47,345	$	13,564	$	54,631		637,198
Deferred Origination Fees, net of costs										(404	)
Total									$	636,794

Below is a breakdown of loss by risk grading as of December 31, 2010 (dollar amounts in thousands):

	0001-0005		0006A			0006B	0007		Total
Commercial Loans	$	61,733	$	5,964	$	3,590	$	2,641	$	73,928
Real Estate – Commercial		240,368		33,604		35,763		34,528		344,263
Real Estate – Construction		37,990		6,587		5,308		5,582		55,467
		340,091		46,155		44,661		42,751		473,658
Real Estate - Residential		120,529		715		1,846		6,359		129,449
Consumer Loans		9,985		—		—		240		10,225
Obligations of States and Political Subdivisions		16,892		—		—		—		16,892
		147,406		715		1,846		6,599		156,566
	$	487,497	$	46,870	$	46,507	$	49,350		630,224
Deferred Origination Fees, net of costs										(333	)
Total									$	629,891

20

BAYLAKE CORP.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2011

8.	Allowance For Loan Losses (“ALL”)
	The ALL represents management’s estimate of probable and inherent credit losses in the loan portfolio. Estimating the amount of the ALL requires the exercise of significant judgment and the use of estimates related to the amount and timing of expected future cash flows on impaired loans, estimated losses on pools of homogeneous loans based on historical loss experience, and consideration of other qualitative factors such as current economic trends and conditions, all of which may be susceptible to significant change. The loan portfolio also represents the largest asset on our consolidated balance sheet. Loan losses are charged off against the ALL, while recoveries of amounts previously charged off are credited to the ALL. A provision for loan losses (“PFLL”) is charged to operations based on management’s periodic evaluation of the factors previously mentioned, as well as other pertinent factors.
	The ALL consists of specific reserves on certain impaired loans and general reserves for non-impaired loans. Specific reserves reflect estimated losses on impaired loans from analyses developed through specific credit allocations for individual loans. The specific credit allocations are based on regular analyses of all impaired non-homogenous loans. These analyses involve a high degree of judgment in estimating the amount of loss associated with specific loans, including estimating the amount and timing of future cash flows and collateral values. The general reserve is based on the Bank’s historical loss experience which is updated quarterly. The general reserve portion of the ALL also includes consideration of certain qualitative factors such as 1) changes in the nature, volume and terms of loans, 2) changes in lending personnel, 3) changes in the quality of the loan review function, 4) changes in nature and volume of past-due, nonaccrual and/or classified loans, 5) changes in concentration of credit risk, 6) changes in economic and industry conditions, 7) changes in legal and regulatory requirements, 8) unemployment and inflation statistics, and 9) changes in underlying collateral values.
	There are many factors affecting the ALL; some are quantitative while others require qualitative judgment. The process for determining the ALL (which management believes adequately considers potential factors which might possibly result in credit losses) includes subjective elements and, therefore, may be susceptible to significant change. To the extent actual outcomes differ from management estimates, additional PFLL could be required that could adversely affect our earnings or financial position in future periods. Allocations of the ALL may be made for specific loans but the entire ALL is available for any loan that, in management’s judgment, should be charged-off or for which an actual loss is realized. As an integral part of their examination process, various regulatory agencies review the ALL as well. Such agencies may require that changes in the ALL be recognized when such regulators’ credit evaluations differ from those of management based on information available to the regulators at the time of their examinations.

Changes in the ALL were as follows (dollar amounts in thousands):

ALLOWANCE FOR LOAN LOSSES

	For the three months ended September 30,						For the nine months ended September 30,
	2011			2010			2011			2010
Balance at beginning of period	$	12,660		$	11,455		$	11,502		$	9,600
Provision for loan losses		1,200			4,550			4,450			6,850
Charge-offs		(1,040	)		(3,932	)		(3,325	)		(6,170	)
Recoveries		37			1,153			230			2,946
Balance at end of period	$	12,857		$	13,226		$	12,857		$	13,226
Net charge-offs	$	(1,003	)	$	(2,779	)	$	(3,095	)	$	(3,224	)

21

BAYLAKE CORP.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2011

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

IMPAIRED LOANS AND ALLOCATED ALLOWANCE

September 30, 2011	Construction Loans		Real Estate- Mortgage		Real Estate- Commercial		Commercial		Consumer		Municipal		Not Specifically Allocated		Totals
With an allowance recorded:
Recorded investment	$	2,675	$	2,067	$	9,080	$	361	$	—	$	—	$	—	$	14,183
Unpaid principal balance		2,853		2,603		10,853		404		149		—		—		16,862
Related allowance		178		536		1,773		43		149		—		—		2,679
With no related allowance recorded:
Recorded investment	$	2,369	$	3,080	$	21,753	$	695	$	15	$	—	$	—	$	27,912
Unpaid principal balance		2,369		3,080		21,753		695		15		—		—		27,912
Related allowance		—		—		—		—		—		—		—		—
Total:
Recorded investment	$	5,044	$	5,147	$	30,833	$	1,056	$	15	$	—	$	—	$	42,095
Unpaid principal balance		5,222		5,683		32,606		1,099		164		—		—		44,774
Related allowance		178		536		1,773		43		149		—		—		2,679
Average recorded investment during quarter	$	5,123	$	4,738	$	28,901	$	1,003	$	18	$	—	$	—	$	39,783
Interest income recognized while impaired	$	—	$	27	$	631	$	24	$	—	$	—	$	—	$	682

December 31, 2010	Construction Loans		Real Estate- Mortgage		Real Estate- Commercial		Commercial		Consumer		Municipal		Not Specifically Allocated		Totals
With an allowance recorded:
Recorded investment	$	288	$	3,097	$	4,174	$	110	$	7	$	—	$	—	$	7,676
Unpaid principal balance		456		3,814		5,410		638		196		—		—		10,514
Related allowance		168		717		1,236		528		189		—		—		2,838
With no related allowance recorded:
Recorded investment	$	3,559	$	1,125	$	13,637	$	695	$	60	$	—	$	—	$	19,076
Unpaid principal balance		3,559		1,125		13,637		695		60		—		—		19,076
Related allowance		—		—		—		—		—		—		—		—
Total:
Recorded investment	$	3,847	$	4,222	$	17,811	$	805	$	67	$	—	$	—	$	26,752
Unpaid principal balance		4,015		4,939		19,047		1,333		256		—		—		29,590
Related allowance		168		717		1,236		528		189		—		—		2,838
Average recorded investment during quarter	$	4,100	$	2,885	$	7,113	$	426	$	51	$	—	$	—	$	14,575
Interest income recognized while impaired	$	3	$	—	$	2	$	—	$	—	$	—	$	—	$	5

22

BAYLAKE CORP.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2011

Management regularly monitors impaired loan relationships. In the event facts and circumstances change, an additional PFLL may be necessary.

Nonperforming loans are as follows (dollar amounts in thousands):

NONPERFORMING LOANS

	September 30, 2011		June 30,2011		March 31,2011		December 31,2010		September 30,2010
Nonaccrual loans	$	19,027	$	16,759	$	17,027	$	15,877	$	18,339
Loans restructured in a troubled debt restructuring, non-accrual		5,287		5,288		165		623		586
Total nonperforming loans (“NPLs”)	$	24,314	$	22,047	$	17,192	$	16,500	$	18,925
Restructured loans, accruing	$	20,461	$	18,559	$	22,777	$	13,090	$	11,416

9.	Foreclosed Properties, Net
	Foreclosed properties are summarized as follows (dollar amounts in thousands):

	For the nine months ended September 30,
	2011			2010
Beginning balance	$	19,934		$	17,768
Transfer of net realizable value to foreclosed properties		2,827			3,398
Sale proceeds, net		(6,798	)		(1,560	)
Net gain from sale of foreclosed properties		198			39
Valuation allowance related to properties disposed		(2,776	)		(566	)
Total foreclosed properties		13,385			19,079
Valuation allowance for losses		(2,723	)		(3,581	)
Total foreclosed properties, net	$	10,662		$	15,498

Changes in the valuation allowance for losses on foreclosed properties were as follows (dollar amounts in thousands):

	For the nine months ended September 30,
	2011			2010
Beginning balance	$	3,982		$	2,773
Provision charged to operations		1,517			1,374
Amounts related to properties disposed		(2,776	)		(566	)
Balance at end of period	$	2,723		$	3,581

23

BAYLAKE CORP.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2011

10.	Income Taxes
	In accordance with the accounting guidance for income taxes, deferred income taxes are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred income tax assets and liabilities are measured using enacted tax rates that will apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred income tax assets and liabilities of a change in tax rates is recognized as income or expense in the period that includes the enactment date.
	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. The amount recognized is the largest amount of tax benefit that has a greater than 50% chance of being realized on examination. For tax positions not meeting the “more likely than not” test, no tax benefit is recorded.
	We regularly review the carrying amount of our deferred income tax assets to determine if the establishment of a valuation allowance is necessary. If, based on the available evidence, it is more likely than not that all or a portion of our deferred income tax assets will not be realized in future periods, a deferred income tax valuation allowance would be established. Consideration is given to various positive and negative factors that could affect the realization of the deferred income tax assets. In evaluating available evidence, management considers, among other things, historical financial performance, expectation of future earnings, the ability to carry back losses to recoup taxes previously paid, length of statutory carry forward periods, experience with operating loss and tax credit carry forwards not expiring unused, tax planning strategies and timing of reversals of temporary differences. Significant judgment is required in assessing future earning trends and the timing of reversals of temporary differences. Our evaluation is based on current tax laws as well as management’s expectations of future performance. At September 30, 2011 and December 31, 2010, we determined that no valuation allowance was required to be taken against our deferred income tax asset other than a valuation allowance to reduce our state net operating loss carry forwards to an amount which we believe the benefit will more likely than not be realized. We continue to assess the amount of tax benefits we may realize.
	We are subject to the income tax laws of the U.S., its states and municipalities. These tax laws are complex and subject to different interpretations by the taxpayer and the relevant Governmental taxing authorities. Accounting guidance related to uncertainty in income taxes prescribes a comprehensive model for how companies should recognize, measure, present, and disclose in their financial statements uncertain tax positions taken or expected to be taken on a tax return. Under the guidance, tax positions shall initially be recognized in the financial statements when it is more likely than not the position will be sustained upon the examination by the tax authorities. Such tax positions shall initially and subsequently be measured as the largest amount of tax benefit that has a greater than 50% chance of being realized upon ultimate settlement with the tax authority assuming full knowledge of the position and all relevant facts. The guidance also revises disclosure requirements to include an annual tabular roll forward of unrecognized tax benefits. In establishing a provision for income tax expense, we must make judgments and interpretations about the application of these inherently complex tax laws within the framework existing under GAAP. We recognize interest and/or penalties related to income tax matters in income tax expense.
	During the second quarter of 2011, the IRS began an audit of our 2009 federal income tax return primarily due to our net operating loss carry back claim. As of September 30, 2011, the audit is on-going and we anticipate this audit may not be concluded until early 2012.

24

BAYLAKE CORP.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2011

Changes in the deferred income tax balances were as follows (dollar amounts in thousands):

Deferred income taxes – Available for sale securities

	For the nine months ended September 30,
	2011			2010
Balances at beginning of period	$	(659	)	$	333
Net change during period		(2,419	)		(2,415	)
Balances at end of period	$	(3,078	)	$	(2,082	)

Deferred income taxes – Other than available for sale securities

	For the nine months ended September 30,
	2011		2010
Balances at beginning of period	$	9,861	$	8,523
Net change during period		313		1,030
Balances at end of period	$	10,174	$	9,553

25

BAYLAKE CORP.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2011

11.	Equity Investment
	Baylake Bank owns a 49.8% interest (500 shares) in United Financial Services, Inc. (“UFS”), a data processing service. In addition to the ownership interest, we and UFS have a common member on each of our respective 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 amended an earlier employment agreement with one of its key employees that provided the individual the option to purchase up to 20%, or 240 shares, of the authorized UFS common stock. The option price was $1,000 per share, less dividends or distributions to owners. During 2007, options for 120 shares were exercised by the key employee. The remaining options were exercised in 2010. The carrying value of our investment in UFS was $4.2 million and $3.9 million at September 30, 2011 and December 31, 2010, respectively. The current book value of UFS is approximately $8,478 per share.
12.	Mortgage Servicing Rights
	We have obligations to service residential first mortgage loans and commercial loans that have been sold in the secondary market. Mortgage servicing rights (“MSRs”) are recorded when loans are sold in the secondary market with servicing retained. On a quarterly basis MSRs are valued based on a valuation model that calculates the present value of estimated servicing income. The valuation model incorporates assumptions that market participants would use in estimating future net servicing income.
	Changes in the carrying value of MSRs are as follows (dollar amounts in thousands):

MORTGAGE SERVICING RIGHTS

	For the three months ended September 30,						For the nine months ended September 30,
	2011			2010			2011			2010
Balance at beginning of period	$	722		$	679		$	746		$	609
Additions from loans sold with servicing retained		28			51			117			83
Changes in valuation		(74	)		32			(73	)		127
Loan payments and payoffs		(38	)		(44	)		(152	)		(101	)
Fair value of MSRs at the end of period	$	638		$	718		$	638		$	718

Unpaid principal balance of loans serviced for others were $81,457 and $75,923 at September 30, 2011 and September 30, 2010, respectively.

During 2009 and 2010, we issued 10% Convertible Notes due June 30, 2017 (the “Convertible Notes”) totaling $9.45 million. The Convertible Notes were offered and sold in reliance on the exemption from registration under Section 4(2) of the Securities Act of 1933 and Rule 506 promulgated there under.

13.	Promissory Notes
	During 2009 and 2010, we issued 10% Convertible Notes due June 30, 2017 (the “Convertible Notes”) totaling $9.45 million. The Convertible Notes were offered and sold in reliance on the exemption from registration under Section 4(2) of the Securities Act of 1933 and Rule 506 promulgated there under.
	The Convertible Notes accrue interest at a fixed rate of 10% per annum upon issuance and until maturity or earlier conversion or redemption. Interest is payable quarterly, in arrears, on January 1, April 1, July 1, and October 1 of each year. The Convertible Notes are convertible into shares of our common stock at a conversion ratio of one share of common stock for each $5.00 in aggregate principal amount held on the record date of the conversion, subject to certain adjustments as described in the Convertible Notes. Prior to October 1, 2014, each holder of the Convertible Notes may convert up to 100% (at the discretion of the holder) of the original principal amount into shares of our common stock at the conversion ratio. On October 1, 2014, one-half of the original principal amounts are mandatorily convertible into common stock at the conversion ratio if voluntary conversion has not occurred. The principal amount, along with accrued but unpaid interest, of any Convertible Note that has not been converted will be payable at maturity on June 30, 2017. We are not obligated to register the common stock issued on the conversion of the Convertible Notes.

26

BAYLAKE CORP.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2011

	During 2009 and 2010 the Company incurred debt issuance costs of $0.2 million. These costs were capitalized and are being amortized to interest expense using the effective interest method over the initial conversion term, which ends October 1, 2014.
14.	Troubled Debt Restructuring
	A troubled debt restructuring (“TDR”) includes a loan modification where a borrower is experiencing financial difficulty and we grant a concession to that borrower that we would not otherwise consider except for the borrower’s financial difficulties. A TDR may be either accrual or nonaccrual status based upon the performance of the borrower and management’s assessment of collectability. If a TDR is placed on nonaccrual status, it remains there until a sufficient period of performance under the restructured terms has occurred at which time it is returned to accrual status, generally six months.
	(Dollar amounts in thousands)

	Construction Loans		Real Estate- Mortgage			Real Estate- Commercial			Commercial			Consumer		Municipal		Total
Accruing
December 31, 2010	$	—	$	44		$	12,661		$	386		$	—	$	—	$	13,091
Principal payments		—		(2	)		(246	)		(9	)		—		—		(257	)
Charge-offs		—		—			(174	)		(160	)		—		—		(334	)
Advances		—		—			40			—			—		—		40
New restructured		—		1,391			11,653			—			—		—		13,044
Class transfers		—		—			(160	)		160			—		—		—
Transfers between nonaccrual		—		—			(5,123	)		—			—		—		(5,123	)
September 30, 2011	$	—	$	1,433		$	18,651		$	377		$	—	$	—	$	20,461
Nonaccrual
December 31, 2010	$	—	$	—		$	586		$	18		$	20	$	—	$	624
Principal payments		—		—			(295	)		(2	)		—		—		(297	)
Charge-offs		—		—			(172	)		—			—		—		(172	)
Advances		—		—			9			—			—		—		9
New Restructured		—		—			—			—			—		—		—
Class transfers		—		—			—			—			—		—		—
Transfers between accruing		—		—			5,123			—			—		—		5,123
September 30, 2011	$	—	$	—		$	5,251		$	16		$	20	$	—	$	5,287
Totals
December 31, 2010	$	—	$	44		$	13,247		$	404		$	20	$	—	$	13,715
Principal payments		—		(2	)		(541	)		(11	)		—		—		(554	)
Charge-offs		—		—			(346	)		(160	)		—		—		(506	)
Advances		—		—			49			—			—		—		49
New Restructured		—		1,391			11,653			—			—		—		13,044
Class transfers		—		—			(160	)		160			—		—		—
Transfers between accruing		—		—			—			—			—		—		—
September 30, 2011	$	—	$	1,433		$	23,902		$	393		$	20	$	—	$	25,748

27

BAYLAKE CORP.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2011

A summary of troubled debt restructurings as of September 30, 2011 and December 31, 2010 is as follows (dollar amounts in thousands):

	September 30, 2011				December 31, 2010
	Number of Modifications		Recorded Investment		Number of Modifications		Recorded Investment
Construction		—	$	—		—	$	—
Real estate – mortgage		3		1,433		1		44
Real estate – commercial		22		23,902		19		13,247
Commercial		2		393		2		404
Consumer		1		20		1		20
Municipal		—		—		—		—
Total		28	$	25,748		23	$	13,715

15.

Supervisory Agreement

On December 23, 2010, we and the Bank entered into a Written Agreement (the “Written Agreement”) with the Federal Reserve Bank and the Wisconsin Department of Financial Institutions (“WDFI”). Under the terms of the Written Agreement, the Bank has agreed to develop and submit for approval within the time periods specified therein written plans to: (i) further reduce the Bank’s concentration of commercial real estate loans; (ii) improve the Bank’s position with respect to loans, relationships, or other assets in excess of $0.5 million which are now or in the future become past due more than 90 days, are on the Bank’s problem loan list, or are adversely classified in any report of examination of the Bank; (iii) review and revise, as appropriate, the Bank’s current policy for determining, documenting and recording an adequate allowance for loan losses and maintain sound processes for compliance with the same; and (iv) improve the Bank’s earnings and overall condition.

28

BAYLAKE CORP.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2011

In addition, the Bank has agreed that it will: (i) not extend, renew or restructure any credit that has been criticized by the Federal Reserve Bank or the WDFI absent prior board of directors’ approval in accordance with the restrictions in the Written Agreement; and (ii) eliminate all assets or portions of assets classified as “loss” and thereafter charge off all assets classified as “loss” in a federal or state report of examination, unless otherwise approved by the Federal Reserve Bank. In addition, the Bank has agreed that it will: (a) not take any other form of payment representing a reduction in the Bank’s capital or make any distributions of interest, principal or other sums on subordinated debentures or trust preferred securities absent prior regulatory approval; (b) refrain from incurring or guaranteeing any debt without the prior written approval of the Federal Reserve Bank; and (c) refrain from purchasing or redeeming any shares of our stock without the prior written consent of the Federal Reserve Bank.

Under the terms of the Written Agreement, both we and the Bank have agreed to: (i) submit for approval plans to maintain sufficient capital on a consolidated basis, and the Bank, on a stand-alone basis; (ii) comply with applicable notice provisions with respect to the appointment of new directors and senior executive officers and legal and regulatory limitations on indemnification payments and severance payments; and (iii) refrain from declaring or paying dividends absent prior regulatory approval. Failure to comply with the provisions of the Written Agreement could result in the imposition of additional restrictions and/or sanctions by the Federal Reserve Bank and WDFI and could have a material adverse effect on our consolidated financial condition and results of operations.

As of the date of this filing, we and the Bank have complied with all terms of the Written Agreement.

29

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

General

We are a Wisconsin corporation that is registered with the Board of Governors of the Federal Reserve (the “Federal Reserve”) as a bank holding company under the Bank Holding Company Act of 1956, as amended. Our wholly-owned banking subsidiary, Baylake Bank, is a Wisconsin state-chartered bank that provides a wide variety of loan, deposit and other banking products and services to its business, retail, and municipal customers, as well as a full range of trust, investment and cash management services. The Bank is a member of the Federal Reserve and the Federal Home Loan Bank of Chicago.

The following sets forth management’s discussion and analysis of our consolidated financial condition at September 30, 2011 and December 31, 2010 and our consolidated results of operations for the three and nine months ended September 30, 2011 and 2010. This discussion and analysis should be read together with the consolidated financial statements and accompanying notes contained in Part I of this Form 10-Q, as well as our Annual Report on Form 10-K for the year ended December 31, 2010.

Forward-Looking Information

This discussion and analysis of consolidated 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 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 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 this Quarterly Report on Form 10-Q and of our Annual Report on Form 10-K for the year ended December 31, 2010, which are incorporated herein by reference, and other risks that may be identified or discussed in this Form 10-Q.

The Dodd-Frank Wall Street Reform and Consumer Protection Act

On July 21, 2010, President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”) into law. This legislation makes extensive changes to the laws regulating financial services firms and requires significant rule-making. In addition, the legislation mandates multiple studies, which could result in additional legislative or regulatory action. While the full effects of the legislation on us and Baylake Bank cannot yet be determined, this legislation is generally perceived as negatively impacting the banking industry. This legislation may result in higher compliance and other costs, reduced revenues and higher capital and liquidity requirements, among other things, which could adversely affect our business and the business of the Bank.

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 our consolidated financial statements. The following is a summary of what management believes are our critical accounting policies.

Allowance for Loan Losses: The ALL represents management’s estimate of probable and inherent credit losses in the loan portfolio. Estimating the amount of the ALL requires the exercise of significant judgment and the use of estimates related to the amount and timing of expected future cash flows on impaired loans, estimated losses on pools of homogeneous loans based on historical loss experience, and consideration of other qualitative factors such as current economic trends and conditions, all of which may be susceptible to significant change. The loan portfolio also represents the largest asset on our consolidated balance sheet. Loan losses are charged off against the ALL while recoveries of amounts previously charged off are credited to the ALL. A PFLL is charged to operations based on management’s periodic evaluation of the factors previously mentioned, as well as other pertinent factors.

30

The ALL consists of specific reserves on certain impaired loans and general reserves for non-impaired loans. Specific reserves reflect estimated losses on impaired loans from analyses developed through specific credit allocations for individual loans. The specific credit allocations are based on regular analyses of all impaired non-homogenous loans. These analyses involve a high degree of judgment in estimating the amount of loss associated with specific loans, including estimating the amount and timing of future cash flows and collateral values. The general reserve is based on our historical loss experience which is updated quarterly. The general reserve portion of the ALL also includes consideration of certain qualitative factors such as (i) changes in the nature, volume and terms of loans, (ii) changes in lending personnel, (iii) changes in the quality of the loan review function, (iv) changes in nature and volume of past-due, nonaccrual and/or classified loans, (v) changes in concentration of credit risk, (vi) changes in economic and industry conditions, (vii) changes in legal and regulatory requirements, (viii) unemployment and inflation statistics, and (ix) changes in underlying collateral values.

There are many factors affecting the ALL, some are quantitative while others require qualitative judgment. The process for determining the ALL (which management believes adequately considers potential factors which might possibly result in credit losses) includes subjective elements and, therefore, may be susceptible to significant change. To the extent actual outcomes differ from management estimates, additional PFLL could be required that could adversely affect our earnings or financial position in future periods. Allocations of the ALL may be made for specific loans but the entire ALL is available for any loan that, in management’s judgment, should be charged-off or for which an actual loss is realized.

As an integral part of their examination process, various regulatory agencies review the ALL as well. Such agencies may require that changes in the ALL be recognized when such regulatory credit evaluations differ from those of management based on information available to the regulators at the time of their examinations.

Provision for Impairment of Standby Letters of Credit: The provision for losses on standby letters of credit represents management’s estimate of probable incurred losses with respect to off-balance sheet standby letters of credit which are used to support our customers’ business arrangements with an unrelated third party. In the event of further impairment, a provision for impairment of standby letters of credit is charged to operations based on management’s periodic evaluation of the factors affecting the standby letters of credit.

Foreclosed Properties: Foreclosed properties acquired through or in lieu of loan foreclosure are initially recorded at the lower of carrying cost or fair value less estimated costs to sell, establishing a new cost basis. Fair value is determined using a variety of market information including but not limited to appraisals, professional market assessments and real estate tax assessment information. If fair value declines subsequent to foreclosure, a valuation allowance is recorded through expense. Costs incurred after acquisition are expensed.

Income Taxes: The assessment of income 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 deferred income tax assets on our September 30, 2011 balance sheet are recoverable, and the deferred income tax liabilities are adequate and fairly stated in the consolidated financial statements.

Goodwill: Goodwill represents the excess of the cost of businesses acquired over fair value of net identifiable assets at the date of acquisition. Goodwill is not amortized but is subject to impairment tests on an annual basis or more frequently if deemed appropriate. Goodwill is subject to a periodic assessment by applying a fair value test based upon a two-step method. The first step of the process compares the fair value of the reporting unit with its carrying value, including any goodwill. During 2010, we, with the assistance of a third party valuation firm determined an estimated cash fair value of our common stock. Consideration was given to our nature and history, the competitive and economic outlook for our trade area and for the banking industry in general, our book value and financial condition, our future earnings and dividend paying capacity, the size of the block valued, and the prevailing market prices of bank stocks. The following valuation methodologies were considered: (i) net asset value – defined as our net worth, (ii) market value – defined as the price at which knowledgeable buyers and sellers would agree to buy and sell our common stock, and (iii) investment value – defined as an estimate of the present value of the future benefits, usually earnings, cash flow, or dividends, that will accrue to our common stock. When consideration was given to the three valuation methodologies, as well as all other relevant valuation variables and factors, the fully-diluted cash fair value range of our common shares was considered to be in excess of the book value. Since the valuation range obtained from that firm exceeded our carrying value including goodwill, we did not fail step one of the impairment test established under generally accepted accounting principles and, therefore, no goodwill impairment was recognized. If the carrying amount would have exceeded fair value, we would have performed the second step to measure the amount of impairment loss. Based on the valuation obtained as of September 30, 2010, our valuation exceeded our carrying value by a range of 22% to 33%. As of September 30, 2011, there are no conditions that would require us to reevaluate goodwill impairment.

31

Results of Operations

The following table sets forth our results of operations and related summary information for the three and nine month periods ended September 30, 2011 and 2010.

SUMMARY RESULTS OF OPERATIONS
(Dollar amounts in thousands, except per share data)

	Three months ended September 30,						Nine months ended September 30,
	2011			2010			2011			2010
Net income (loss), as reported	$	1,297		$	(512	)	$	2,723		$	1,655
Earnings (loss) per share-basic, as reported	$	0.16		$	(0.06	)	$	0.34		$	0.21
Earnings (loss) per share-diluted, as reported	$	0.16		$	(0.06	)	$	0.34		$	0.21
Cash dividends declared	$	—		$	—		$	—		$	—
Return on average assets		0.49	%		(0.19	%)		0.35	%		0.21	%
Return on average equity		6.25	%		(2.54	%)		4.55	%		2.85	%
Efficiency ratio (1)		70.60	%		75.96	%		74.94	%		74.88	%

⁽¹⁾ Noninterest expense divided by the sum of taxable equivalent net interest income plus noninterest income, excluding net investment securities gains and net gains on the sale of fixed assets. A lower ratio indicates greater efficiency.

Net income of $1.3 million for the three months ended September 30, 2011 increased from a net loss of $0.5 million for the comparable period in 2010. Net interest income decreased $0.1 million for the quarter ended September 30, 2011 versus the comparable quarter last year, resulting from a $0.8 million reduction in interest income partially offset by a $0.7 million reduction in interest expense. A PFLL of $1.2 million was charged to operations for the third quarter of 2011, which is $3.4 million lower than the $4.6 million PFLL taken during the comparable quarter of 2010. Noninterest income decreased by $1.2 million in the third quarter of 2011 versus the comparable quarter of 2010, which was partially offset by a $1.0 million decrease in noninterest expense between the periods.

Net Interest Income:

Net interest income is the largest component of our operating income and represents the difference between interest earned on loans, investments and other interest-earning assets offset by the interest expense attributable to the deposits and borrowings that fund such assets. Interest rate fluctuations, together with changes in the volume and types of interest-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 $8.4 million for the three months ended September 30, 2011 compared to $8.5 million for the same period in 2010. The decrease for the third quarter of 2011 resulted primarily from a decrease in interest income on loans attributable to both a decline in interest rates and a reduction in average loan balances, partially offset by a decrease in funding costs on interest-bearing liabilities. Positively impacting net interest income was an $11.0 million increase in average noninterest-bearing demand deposits, from $92.3 million during the third quarter of 2010 to $103.3 million for the comparable period in 2011.

Interest rate spread is the difference between the interest rate earned on average interest-earning assets and the rate paid on average interest-bearing liabilities. Interest rate spread decreased 7 bps to 3.36% for the third quarter of 2011 compared to the same period in 2010, resulting primarily from a 38 bps decrease in the yield on earning assets from 4.83% to 4.45%, partially offset by a 31 bps decrease in the cost of interest-bearing liabilities from 1.40% to 1.09%. We continue to be positively impacted by the interest rate floors on a large number of loans on our balance sheet, which has resulted in the recognition of a greater amount of interest income than would have been recognized had the floors not existed.

32

Net interest margin represents net interest income expressed as an annualized percentage of average interest-earning assets. Net interest margin exceeds the interest rate spread because of the use of noninterest-bearing sources of funds (demand deposits and equity capital) to fund a portion of earning assets. Net interest margin for the third quarter of 2011 was 3.48%, down 7 bps from 3.55% for the comparable period in 2010.

For the three months ended September 30, 2011, average interest-earning assets increased $7.3 million from the same period in 2010. Increases in average federal funds sold and interest bearing due from financial institutions balances of $43.8 million (116.2%) and in tax exempt securities of $1.9 million (4.5%) were partially offset by a $10.4 million (1.6%) decrease in loans and a $28.0 million decrease (12.0%) in taxable securities.

NET INTEREST INCOME ANALYSIS ON A TAX-EQUIVALENT BASIS
(Dollar amounts in thousands)

	Three months ended September 30, 2011							Three months ended September 30, 2010
	Average Balance		Interest Income/ Expense		Average Yield/ Rate			Average Balance		Interest Income/ Expense		Average Yield/ Rate
ASSETS
Average Earning Assets:
Loans, net 1,2	$	625,684	$	8,348		5.29	%	$	636,067	$	8,949		5.58	%
Taxable securities		205,932		1,747		3.39	%		233,941		1,983		3.39	%
Tax exempt securities 1		42,765		568		5.31	%		40,909		579		5.66	%
Federal funds sold and interest-bearing due from financial institutions		81,582		51		0.25	%		37,742		28		0.30	%
Total earning assets		955,963		10,714		4.45	%		948,659		11,539		4.83	%
Noninterest earning assets		93,758							102,880
Total Assets	$	1,049,721						$	1,051,539
LIABILITIES AND STOCKHOLDERS’ EQUITY
Average Interest-bearing liabilities:
Total interest-bearing deposits	$	745,786	$	1,749		0.93	%	$	744,803	$	2,248		1.20	%
Customer repurchase agreements		28,499		23		0.32	%		25,462		16		0.25	%
Federal Home Loan Bank advances		55,000		261		1.88	%		74,565		484		2.57	%
Convertible promissory notes		9,450		245		10.37	%		9,450		245		10.29	%
Subordinated debentures		16,100		66		1.63	%		16,100		77		1.90	%
Total interest-bearing liabilities		854,835		2,344		1.09	%		870,380		3,070		1.40	%
Demand deposits		103,330							92,273
Accrued expenses and other liabilities		9,158							8,753
Stockholders’ equity		82,398							80,133
Total liabilities and stockholders’ equity	$	1,049,721						$	1,051,539
Net Interest Income			$	8,370						$	8,469
Interest rate spread (3)						3.36	%						3.43	%
Net interest margin (4)						3.48	%						3.55	%

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(1)	The interest income on tax exempt securities and loans is computed on a tax-equivalent basis using a tax rate of 34% for all periods presented.
(2)	The average loan balances and rates include nonaccrual loans.
(3)	Interest rate spread is the difference between the annualized average yield earned on average interest-earning assets for the period and the annualized average rate of interest accrued on average interest-bearing liabilities for the period.
(4)	Net interest margin is the annualized effect of net interest income for a period divided by average interest-earning assets for the period.

Net income of $2.7 million for the nine months ended September 30, 2011 increased from net income of $1.7 million for the comparable period in 2010. Net interest income increased $0.1 million for the nine months ended September 30, 2011 versus the comparable period last year resulting from a $2.6 million reduction in interest expense partially offset by a $2.5 million reduction in interest income. A PFLL of $4.5 million was charged to operations for the nine months ended September 30, 2011, which is $2.4 million lower than the $6.9 million PFLL taken during the comparable period of 2010. Noninterest income decreased $0.6 million, and noninterest expense increased $0.3 million in the nine months of 2011 compared to the similar period in 2010. Income tax expense increased $0.5 million. Refer to the “Net Interest Income,” “Provision for Loan Losses,” “Noninterest Expense” and “Noninterest Income” sections below for additional details.

Interest rate spread decreased 1 bps to 3.45% for the nine months ended September 30, 2011 compared to the same period in 2010, resulting primarily from a 38 bps decrease in the cost of interest-bearing liabilities from 1.54% to 1.16%, offset by a 39 bps decrease in the yield on interest-bearing assets from 5.00% to 4.61%.

Net interest income on a tax-equivalent basis was $25.0 million for the nine months ended September 30, 2011 compared to $24.9 million for the same period in 2010. The increase in 2011 resulted primarily from a decrease in funding costs on liabilities attributable to both a decline in interest rates and a reduction in average interest-bearing liabilities, partially offset by a decrease in interest income on loans, due to both a decline in yields and a reduction in average loans. Contributing to the improved net interest income was a $13.0 million increase in average noninterest-bearing demand deposits, from $79.9 million during the third quarter of 2010 to $92.9 million for the comparable period in 2011.

For the nine months ended September 30, 2011, average interest-earning assets increased $6.3 million (0.7%) from the same period in 2010. Increases in average taxable securities of $17.8 million (8.8%), in tax exempt securities of $2.4 million (6.2%), and a $2.6 million (5.4%) increase in federal funds sold and interest-bearing due from bank balances were partially offset by a $16.5 million (2.6%) decrease in loans.

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NET INTEREST INCOME ANALYSIS ON A TAX-EQUIVALENT BASIS
(Dollar amounts in thousands)

	Nine months ended September 30, 2011							Nine months ended September 30, 2010
	Average Balance		Interest Income/ Expense		Average Yield/ Rate			Average Balance		Interest Income/ Expense		Average Yield/ Rate
ASSETS
Average Earning Assets:
Loans, net 1,2	$	626,735	$	25,210		5.38	%	$	643,197	$	27,105		5.63	%
Taxable securities		220,686		5,376		3.25	%		202,879		6,007		3.95	%
Tax exempt securities 1		41,298		1,710		5.52	%		38,891		1,695		5.81	%
Federal funds sold and interest-bearing due from financial institutions		50,606		90		0.24	%		48,034		81		0.23	%
Total earning assets		939,325		32,386		4.61	%		933,001		34,888		5.00	%
Noninterest earning assets		96,793							104,213
Total Assets	$	1,036,118						$	1,037,214
LIABILITIES AND STOCKHOLDERS’ EQUITY
Average Interest-bearing liabilities:
Total interest-bearing deposits	$	742,163	$	5,577		1.00	%	$	743,500	$	7,567		1.36	%
Short-term borrowings		—		—		—	%		17		—		0.92	%
Customer repurchase agreements		27,198		65		0.32	%		25,433		78		0.41	%
Federal Home Loan Bank advances		59,487		833		1.87	%		77,857		1,539		2.64	%
Convertible promissory notes	$	9,450	$	735		10.37	%	$	7,863	$	615		10.31	%
Subordinated debentures		16,100		200		1.65	%		16,100		209		1.71	%
Total interest-bearing liabilities		854,398		7,410		1.16	%		870,770		10,008		1.54	%
Demand deposits		92,890							79,944
Accrued expenses and other liabilities		8,860							8,902
Stockholders’ equity		79,970							77,598
Total liabilities and stockholders’ equity	$	1,036,118						$	1,037,214
Net Interest Income			$	24,976						$	24,880
Interest rate spread (3)						3.45	%						3.46	%
Net interest margin (4)						3.55	%						3.56	%

(1)	The interest income on tax exempt securities and loans is computed on a tax-equivalent basis using a tax rate of 34% for all periods presented.
(2)	The average loan balances and rates include nonaccrual loans.
(3)	Interest rate spread is the difference between the annualized average yield earned on average interest-earning assets for the period and the annualized average rate of interest accrued on average interest-bearing liabilities for the period.
(4)	Net interest margin is the annualized effect of net interest income for a period divided by average interest-earning assets for the period.

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RATE/VOLUME ANALYSIS ⁽¹⁾
(Dollar amounts in thousands)

Three months ended September 30, 2011 compared to the three months ended September 30, 2010:

	Increase (Decrease) due to (1)
	Volume			Rate			Net
Interest income:
Loans	$	(617	)	$	16		$	(601	)
Taxable securities		(882	)		646			(236	)
Tax exempt securities		102			(113	)		(11	)
Federal funds sold and interest-bearing due from financial institutions		112			(89	)		23
Total interest-earning assets	$	(1,285	)	$	460		$	(825	)
Interest expense:
Total interest-bearing deposits	$	40		$	(540	)	$	(500	)
Short term borrowings		—			—			—
Repurchase agreements		8			(1	)		7
FHLB advances		(437	)		214			(223	)
Subordinated debentures		—			(10	)		(10	)
Long term debt		—			—			—
Total interest-bearing liabilities	$	(389	)	$	(337	)	$	(726	)
Net interest income	$	(896	)	$	797		$	(99	)

⁽¹⁾ The change in interest due to both rate and volume has been allocated in proportion to the relationship to the dollar amounts of the change in each.

Our management’s ability to employ overall assets for the production of interest income can be measured by the ratio of average interest-earning assets to average total assets. This ratio was 91.1% and 90.2% for the third quarter of 2011 and 2010, respectively.

36

RATE/VOLUME ANALYSIS ⁽¹⁾
(Dollar amounts in thousands)

Nine months ended September 30, 2011 compared to the nine months ended September 30, 2010:

	Increase (Decrease) due to (1)
	Volume			Rate			Net
Interest income:
Loans	$	(724	)	$	(1,171	)	$	(1,895	)
Taxable securities		371			(1,002	)		(631	)
Tax exempt securities		102			(87	)		15
Federal funds sold and interest-bearing due from financial institutions		4			5			9
Total interest-earning assets	$	(247	)	$	(2,255	)	$	(2,502	)
Interest expense:
Total interest-bearing deposits	$	(151	)	$	(1,839	)	$	(1,990	)
Short term borrowings		—			—			—
Repurchase agreements		5			(18	)		(13	)
FHLB advances		(316	)		(390	)		(706	)
Subordinated debentures		—			(9	)		(9	)
Long term debt		120			—			120
Total interest-bearing liabilities	$	(342	)	$	(2,256	)	$	(2,598	)
Net interest income	$	95		$	1		$	96

⁽¹⁾ The change in interest due to both rate and volume has been allocated in proportion to the relationship to the dollar amounts of the change in each.

Our management’s ability to employ overall assets for the production of interest income can be measured by the ratio of average interest-earning assets to average total assets. This ratio was 90.7% and 90.0% for the first nine months of 2011 and 2010, respectively.

Provision for Loan Losses:

The ALL consists of specific and general reserves. The PFLL is the cost of providing an allowance for probable and inherent losses in our loan portfolio. Our internal risk system is used to identify loans that meet the criteria for being “impaired” as defined by accounting guidance. Specific reserves are computed on non-homogeneous loans that are individually classified as impaired. Loans identified as impaired are evaluated for impairment using either the discounted expected cash flows or collateral value less estimated costs to sell. When the fair value of the collateral is less than amortized cost, a specific reserve is required. In addition to the specific reserves, a general reserve is computed on non-impaired loans and is based on historical loss experience adjusted for qualitative factors. These qualitative factors include: (i) changes in the nature, volume and terms of loans, (ii) changes in lending personnel, (iii) changes in the quality of the loan review function, (iv) changes in nature and volume of past-due, nonaccrual and/or classified loans, (v) changes in concentration of credit risk, (vi) changes in economic and industry conditions, (vii) changes in legal and regulatory requirements, (viii) unemployment and inflation statistics, and (ix) changes in underlying collateral values. Allocations of the ALL may be made for specific loans but the entire ALL is available for any loan that, in management’s judgment, should be charged-off or for which an actual loss is realized.

The PFLL for the quarter ended September 30, 2011 was $1.2 million compared to $4.6 million for the third quarter of 2010. New impairments of $0.4 million on loans not previously identified, with associated loan balances of $3.6 million, were recorded during the third quarter of 2011. Included in those amounts is an impairment of $0.2 million on a loan balance of $2.5 million for which we obtained updated collateral valuations during the quarter.

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Net loan charge-offs for the third quarter of 2011 were $1.0 million. Net annualized charge-offs to average loans were 0.63% for the third quarter of 2011 compared to 1.73% for the same period in 2010. For the three months ended September 30, 2011, nonperforming loans increased by $2.3 million (10.3%) to $24.3 million from $22.0 million at June 30, 2011.

Net loan charge-offs for the first nine months of 2011 and 2010 were $3.1 million and $3.2 million, respectively. Net annualized charge-offs to average loans were 0.66% for the first nine months of 2011 compared to 0.67% for the same period in 2010. For the nine months ended September 30, 2011, nonperforming loans increased by $7.8 million (47.3%) to $24.3 million from $16.5 million at December 31, 2010. Refer to the “Financial Condition - Risk Management and the Allowance for Loan Losses” and “Financial Condition - Nonperforming Loans, Potential Problem Loans and Foreclosed Properties” sections below for more information related to nonperforming loans. Our management believes that the ALL at September 30, 2011 and the related PFLL charged to earnings for the quarter and nine months ended September 30, 2011 are appropriate in light of the present condition of the loan portfolio and the amount and quality of the collateral supporting nonperforming loans. We continue to monitor nonperforming loan relationships and will make additional PFLLs, as necessary, if the facts and circumstances change. In addition, a decline in the quality of our loan portfolio as a result of general economic conditions, factors affecting particular borrowers or our market area, or otherwise, could affect the adequacy of the ALL. If there are significant charge-offs against the ALL, or we otherwise determine that the ALL is inadequate or our estimates are different than our regulators’ estimates, we will need to make additional PFLLs in the future.

Noninterest Income:

The following table reflects the various components of noninterest income for the three and nine month periods ended September 30, 2011 and 2010, respectively.

NONINTEREST INCOME
(Dollar amounts in thousands)

	Three months ended									Nine months ended
	September 30, 2011			September 30, 2010			% Change			September 30, 2011			September 30, 2010			% Change
Fees from fiduciary services	$	217		$	214			1.4	%	$	720		$	714			0.8	%
Fees from loan servicing		139			123			12.8	%		552			397			39.2	%
Service charges on deposit accounts		906			935			(3.1	)%		2,549			2,615			(2.5	)%
Other fee income		178			183			(2.6	)%		511			553			(7.6	)%
Financial services income		176			202			(12.7	)%		666			629			5.8	%
Net gains from sales of loans		208			324			(35.8	)%		805			725			11.1	%
Net gain (loss) in valuation of mortgage servicing rights		(111	)		(12	)		(819.9	)%		(225	)		26			(975.5	)%
Net gains from sale of securities		267			973			(72.5	)%		392			1,406			(72.1	)%
Losses from sale of fixed assets		(1	)		(81	)		99.0	%		(3	)		(83	)		96.0	%
Increase in cash surrender value of life insurance		102			205			(50.4	)%		353			271			30.6	%
Equity in income of UFS subsidiary		199			185			7.6	%		631			423			49.1	%
Other income		(174	)		16			(1179.0	)%		190			75			153.9	%
Total Noninterest Income	$	2,106		$	3,267			(35.5	)%	$	7,141		$	7,751			(7.9	)%

Noninterest income decreased $1.2 million (35.5%) for the three months ended September 30, 2011 versus the comparable period in 2010. This was primarily due to a decrease of $0.7 million on gains from the sale of securities, a $0.1 million reduction in gains on sale of loans due to reduced mortgage loan activity, a $0.1 million reduction in the valuation of mortgage servicing rights, an increase in the cash surrender value of life insurance that was $0.1 million lower in the third quarter of 2011 versus the comparable quarter of 2010, and a $0.2 million decrease due to reduced earnings on the investments maintained in the SERP.

Noninterest income decreased $0.6 million (7.9%) for the nine months ended September 30, 2011 versus the comparable period in 2010. This was primarily due to $1.0 million decrease in net gains from the sale of securities and a $0.2 million reduction in the valuation of mortgage servicing rights. This was partially offset by a $0.3 million increase in death benefit claims on an insurance policy in which the Bank was the beneficiary and a $0.2 million increase in the equity in income of our subsidiary, UFS.

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Noninterest Expense:

The following table reflects the various components of noninterest expense for the three and nine months ended September 30, 2011 and 2010, respectively.

NONINTEREST EXPENSE
(Dollar amounts in thousands)

	Three months ended							Nine months ended
	September 30, 2011		September 30, 2010		% Change			September 30, 2011		September 30, 2010		% Change
Salaries and employee benefits	$	4,067	$	4,207		(3.3	)%	$	12,681	$	12,156		4.3	%
Occupancy		551		584		(5.6	)%		1,731		1,782		(2.9	)%
Equipment		304		287		5.9	%		891		961		(7.2	)%
Data processing and courier		210		221		(5.0	)%		621		662		(6.3	)%
Operation of foreclosed properties		108		894		(87.9	)%		1,875		1,837		2.1	%
Business development & advertising		113		115		(2.3	)%		420		446		(5.9	)%
Charitable contributions		4		6		(32.6	)%		40		52		(21.9	)%
Stationery and supplies		112		129		(13.4	)%		374		381		(1.8	)%
Director fees		89		94		(6.0	)%		287		279		3.0	%
FDIC insurance expense		571		697		(18.1	)%		1,861		1,938		(4.0	)%
Legal and professional		219		178		22.8	%		602		523		15.0	%
Loan and collection		139		155		(10.0	)%		470		492		(4.4	)%
Other outside services		166		208		(20.6	)%		488		541		(9.8	)%
Provision for impairment of letter of credit		117		—		NM	%		131		87		50.6	%
Other operating		438		463		(5.1	)%		1,305		1,306		(0.1	)%
Total Noninterest Expense	$	7,208	$	8,238		(12.5	)%	$	23,777	$	23,443		1.4	%

Total noninterest expense decreased $1.0 million (12.5%) for the three months ended September 30, 2011 compared to the same period in 2010. The noninterest expense to average assets ratio was 2.7% for the three months ended September 30, 2011 compared to 3.1% for the same period in 2010.

Net overhead expense is total noninterest expense less total noninterest income. The net overhead expense to average assets ratio was at 1.9% for the three months ended September 30, 2011 and September 30, 2010. The efficiency ratio represents total noninterest expense as a percentage of the sum of net interest income on a fully taxable equivalent basis and total noninterest income (excluding net gains on the sale of securities and premises and equipment). A lower efficiency ratio indicates a more efficient operation. The efficiency ratio improved to 70.6% for the three months ended September 30, 2011 from 76.0% for the comparable period last year. This is primarily due to a decrease of $1.0 million in noninterest expense, of which $0.8 million was related to the operation of foreclosed properties, a decrease of $0.1 million (3.3%) in salaries and benefits and a $0.1 million decrease in FDIC expense. Partially offsetting those decreases was a $0.1 million increase in impairment on a letter of credit.

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Included in noninterest expense are FDIC insurance premiums of $0.6 million for the three months ended September 30, 2011 compared to $0.7 million for the same period a year ago. FDIC insurance premiums consist of two components, deposit insurance premiums and payments for servicing obligations of the Financing Corporation (“FICO”) that were issued in connection with the resolution of savings and loan associations. With the enactment in early 2006 of the Federal Deposit Insurance Reform Act of 2005, major changes were introduced in the calculation of FDIC deposit insurance premiums. Such changes were effective January 1, 2007 and included establishment by the FDIC of a target reserve ratio range for the Deposit Insurance Fund (“DIF”) of between 1.15% and 1.50%, as opposed to the prior fixed reserve ratio of 1.25%. At the same time, the FDIC adopted a new risk-based system for assessment of deposit insurance premiums under which all such institutions are required to pay minimum annual premiums. The system categorizes institutions in one of four risk categories, depending on capitalization and supervisory rating criteria. Baylake Bank’s assessment rate, like that of other financial institutions, is confidential and may not be directly disclosed, except to the extent required by law. Payments for the FICO portion will continue as long as FICO obligations remain outstanding. In February 2009, the FDIC adopted a final rule modifying the risk-based assessment system and setting initial base assessment rates beginning April 1, 2009 at between 12 bps and 45 bps. On November 12, 2009, the Board of Directors of the FDIC adopted a rule that required insured institutions to prepay their estimated quarterly risk-based assessments for the fourth quarter of 2009 and for all of 2010, 2011 and 2012. In October 2010, the FDIC Board voted to eliminate a uniform 3 bps increase in assessment rates that was to be effective January 1, 2011. We were required to prepay approximately $6.7 million in premiums in December 2009, which premiums are being taken as a charge against our operations in the period for which they apply.

On February 7, 2011, the FDIC finalized the rule to change its assessment base from total domestic deposits to average total assets minus average tangible equity, as required in the Dodd-Frank Act. The new assessment base began in the second quarter of 2011, with the premium payable in September 2011. The result of the change has been a reduction in FDIC assessments.

Expenses related to the operation of foreclosed properties held for sale by the Bank increased $0.1 million to $1.9 million for the nine-month period ended September 30, 2011 compared to $1.8 million for the same period in 2010. The increase consists of a $0.1 million increase in write-downs due to the revaluation of properties held and a $0.1 million increase in net operating expenses, offset by a $0.1 million increase in the net gain on sale of foreclosed properties. We continue to evaluate all foreclosed property values and attempt to reduce the holding periods of these properties and, as a result, the related holding costs, to the extent possible. Such expenses include but are not limited to insurance, maintenance, real estate taxes, management fees, utilities and legal fees. A majority of the properties have been revalued within the last nine months.

Salaries and employee benefits increased $0.5 million (4.3%) to $12.7 million for the nine months ended September 30, 2011 compared to $12.2 million for the nine months ended September 30, 2010. The number of full-time equivalent employees (FTEs) increased from 303 at September 30, 2010 to 305 at September 30, 2011. Contributing to the increase in salary expense of $0.5 million was the increase in FTEs, as well as cost of living adjustments to employee salaries and wages. Commission expense for commissioned salespersons, including financial advisors and mortgage originators, increased $0.1 million due to increased activity and expenses related to deferred compensation plans increased $0.1 million due to increases in the returns on the investments within the plans.

Income Taxes:

We recorded an income tax expense of $0.5 million for the three months ended September 30, 2011 versus a tax benefit of $0.8 million for the same period in 2010. The increase in tax expense is primarily attributable to a $3.1 million year-over-year increase in pre-tax income.

We recorded an income tax expense of $0.4 million for the nine months ended September 30, 2011 versus a tax benefit of $0.1 million for the same period in 2010. The increase in tax expense is primarily attributable to a $1.5 million increase in pre-tax income.

We maintain significant net deferred income tax assets for deductible temporary tax differences, such as allowance for loan losses, nonaccrual loan interest, and foreclosed property valuations as well as net operating loss carry forwards. Our determination of the amount of our deferred income tax assets to be realized is highly subjective and is based on several factors, including projected future income, income tax planning strategies, and federal and state income tax rules and regulations. At September 30, 2011, we determined that no valuation allowance was required to be taken against our deferred income tax assets other than a valuation allowance to reduce our state net operating loss carry forwards to an amount which we believe the benefit will more likely than not be realized. We continue to assess the amount of tax benefits we may realize.

During the second quarter of 2011, the IRS began an audit of our 2009 federal income tax return primarily due to our net operating loss carry back claim. As of September 30, 2011, the audit is on-going and we anticipate this audit may not be concluded until early 2012.

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Financial Condition

Loans:

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

LOAN PORTFOLIO ANALYSIS
(Dollar amounts in thousands)

	September 30, 2011			December 31, 2010			Percent Change
Amount of Loans by Type:
Real estate-mortgage:
Commercial	$	329,253		$	344,263			(4.4	)%
1-4 Family residential
First liens		85,152			76,874			10.8	%
Junior liens		8,680			11,143			(22.1	)%
Home equity		43,253			41,432			4.4	%
Commercial, financial and agricultural		91,083			73,928			23.2	%
Real estate-construction		54,999			55,467			(0.8	)%
Installment
Credit cards and related plans		1,633			1,662			(1.7	)%
Other		7,236			8,563			(15.5	)%
Obligations of states and political subdivisions		15,909			16,892			(5.8	)%
Less: Deferred origination fees, net of costs		(404	)		(333	)		21.3	%
Less: Allowance for loan losses		(12,857	)		(11,502	)		11.8	%
Total	$	623,937		$	618,389			0.9	%

Net loans at September 30, 2011 increased $5.5 million (0.9%) from $618.4 million at December 31, 2010 to $623.9 million at September 30, 2011. The increase is primarily due to an increase of $17.2 million (23.2%) in commercial, financial, and agricultural loans, and an increase of $8.3 million (10.8%) in first lien 1-4 family residential loans, partially offset by reductions in commercial real estate loans of $15.0 million (4.4%), a decrease of $0.5 million (0.8%) in construction loans and a decrease of $2.5 million (22.1%) in junior liens on 1-4 family residential loans. We continue to reduce our exposure in the commercial real estate sector.

Risk Management and the Allowance for Loan Losses:

The loan portfolio is our primary asset subject to credit risk. To address this credit risk, we maintain an ALL for probable and inherent credit losses through periodic charges to our earnings. These charges are shown in our consolidated statements of operations as PFLL. See “Provision for Loan Losses” earlier in this Report. We attempt to control, monitor and minimize credit risk through the use of prudent lending standards, a thorough review of potential borrowers prior to lending and ongoing and timely review of payment performance. Asset quality administration, including early identification of loans performing in a substandard manner, as well as timely and active resolution of problems, further enhances management of credit risk and minimization of loan losses. Any losses that occur and that are charged off against the ALL are periodically reviewed with specific efforts focused on achieving maximum recovery of both principal and interest.

The ALL at September 30, 2011 was $12.9 million, compared to $11.5 million at December 31, 2010. On a quarterly basis, management reviews the adequacy of the ALL. The analysis of the ALL consists of three components: (i) specific reserves established for expected losses relating to impaired loans for which the recorded investment in the loans exceeds its fair value; (ii) general reserves based on historical loan loss experience for significant loan classes; and (iii) general reserves based on qualitative factors such as concentrations and changes in portfolio mix and volume. Allocations of the ALL may be made for specific loans but the entire ALL is available for any loan that, in management’s judgment, should be charged off or for which an actual loss is realized.

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On a regular basis, loan officers review all commercial credit relationships. The loan officers grade commercial credits and the loan review function validates the grades assigned. In the event that the loan review function downgrades a loan, it is included in the ALL analysis process at the lower grade. This grading system is in compliance with regulatory classifications. At least quarterly, all commercial loans that have been deemed impaired are evaluated. In compliance with accounting guidance for impaired loans, 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 the estimated costs to sell. This evaluation may include obtaining supplemental market data and/or routine site visits to offer support to the evaluation process. A specific reserve is then allocated to the loans based on this assessment. Specific reserves are reviewed by the Chief Credit Officer (“CCO”) and management familiar with the credits.

During the second quarter of 2011, a loan review engagement was performed by an external third party. The objective of the review was to assist management with proactively identifying and quantifying the credit risk in the loan portfolio. The engagement included an assessment of our control and methodology for identifying, monitoring, and addressing credit quality issues, as well as our methodology for determining the adequacy of our ALL. The sample consisted of approximately 30% of our non-classified risk rated loan portfolio. Results of the review concluded that our credit approval and credit administration processes are satisfactory, including but not limited to the following: (1) detailed and accurate credit presentations are on file, (2) loans were closed as approved, (3) collateral was perfected in a timely manner, (4) compliance with loan covenants existed, and (5) appropriate loan file documentation is maintained in the credit files.

We have two other major components of the ALL that do not pertain to specific loans: “General Reserves – Historical” and “General Reserves – Other.” We determine General Reserves – Historical based on our historical recorded charge-offs of loans in particular classes, analyzed as a group. As it relates to the historical loss component, in December 2009 we reduced the historical loss look-back period from sixteen quarters to between eight and twelve quarters. This was primarily done to enable the model to provide a better reflection of the recent economic times. This resulted in increased allocations that we determined were appropriate. We determine General Reserves – Other by taking into account other factors, such as the concentration of loans in a particular industry or geographic area and adjustments for economic indicators. By nature, our general reserve changes with our fluid lending environment and the overall economic environment in which we lend. As such, we are continually attempting to enhance this portion of the allocation process to reflect anticipated losses in our portfolio driven by these changing factors. Economic statistics, specifically unemployment and inflation rates for national, state and local markets are monitored and factored into the allocation to address repayment risk. Further identification and management of portfolio concentration risks, both by loan class and by specific markets is reflected in the general allocation component. In the fourth quarter of 2009 the model was enhanced to include more specific qualitative factors, as mentioned previously, by loan type.

Nonperforming Loans, Potential Problem Loans and Foreclosed Properties:

Management encourages early identification of nonaccrual and problem loans in order to minimize the risk of loss. Nonperforming loans are defined as nonaccrual loans, loans 90 days or more past due but still accruing, and loans restructured in a troubled debt restructuring that haven’t shown a sufficient period of performance with the restructured terms. 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 nonaccrual 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 or earlier as deemed appropriate. When interest accruals are discontinued, interest credited to income is reversed. If collection is in doubt, cash receipts on nonaccrual loans are used to reduce principal rather than recorded as interest income. Restructuring a loan typically involves the granting of some concession to the borrower involving a loan modification, such as payment schedule or interest rate changes. Restructured loans may 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 pursuant to accounting guidance for troubled debt restructurings.

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NONPERFORMING ASSETS
(Dollar amounts in thousands)

	September 30, 2011			June 30, 2011			December 31, 2010			September 30, 2010
Nonperforming Assets:
Nonaccrual loans	$	19,027		$	16,759		$	15,877		$	18,339
Nonaccrual loans, restructured		5,287			5,288			623			586
Accruing loans past due 90 days or more		—			—			—			—
Total nonperforming loans (“NPLs”)	$	24,314		$	22,047		$	16,500		$	18,925
Foreclosed assets, net		10,662			11,946			15,952			15,498
Total nonperforming assets (“NPAs”)	$	34,976		$	33,993		$	32,452		$	34,423
Restructured loans, accruing(1)	$	20,461		$	18,559		$	13,090		$	11,416
Ratios:
ALL to Net Charge-offs (“NCOs”) (annualized)		3.11	x		3.00	x		2.11	x		3.07	x
NCOs to average loans (annualized)		0.66	%		0.67	%		0.85	%		0.67	%
ALL to total loans		2.01	%		2.04	%		1.83	%		2.09	%
NPLs to total loans		3.81	%		3.55	%		2.62	%		2.99	%
NPAs to total assets		3.33	%		3.34	%		3.08	%		3.27	%
ALL to NPLs		52.88	%		57.42	%		69.71	%		69.89	%

⁽¹⁾ Restructured loans on nonaccrual status are returned to accruing when a sufficient period of performance in accordance with the restructured terms, generally six months, has passed.

Restructured nonaccrual loans at December 31, 2010 were $0.6 million. During the second quarter of 2011, a $5.1 million restructured loan was transferred from the accruing category to the nonaccruing category. For the first nine months of 2011, principal payments of $0.3 million were received on those loans and $0.1 million was charged-off. As of September 30, 2011, principal balances of $5.3 million remain, which is consistent with June 30, 2011.

Restructured loans accruing at December 31, 2010 were $13.1 million. New restructured loans of $13.0 million were recorded during the first nine months of 2011. Of that amount $1.9 million was recorded in the third quarter of 2011 consisting of one credit. This credit relates to a commercial property where an interest rate concession was made due to reduced lease income from a tenant. Principal payments of $0.3 million were received on these loans and $0.3 million was charged off. As of September 30, 2011, $20.5 million of principal balances continue to be reported as restructured loans accruing, which is $1.9 million higher than June 30, 2011.

Nonperforming loans increased $7.8 million (47.3%) from December 31, 2010 to September 30, 2011 primarily due to the transfer of the $5.1 million restructured loan from the accruing category to the nonaccruing category during the second quarter of 2011. During the third quarter of 2011, nonperforming loans increased $2.3 million. The increase primarily related to two credits. One credit in the amount of $1.3 million related to a commercial real estate property in which the borrower was making payments in accordance with a payment plan, but has since discontinued making payments. The other credit in the amount of $0.6 million related to a commercial real estate development project that repayment was anticipated from the sale of an asset. The asset did not sell and the borrower does not have the capacity to make payments. The nonperforming loan relationships are secured primarily by commercial or residential real estate and, secondarily, by personal guarantees from principals of the respective borrowers.

Loan balances with a risk grading of 0006B or 0007 have decreased by $27.7 million since December 31, 2010. Loans in these categories are existing or potential problem loans that require management’s close attention. The significant decline in these troubled assets is a strong indication of improvement in the quality of the loan portfolio. As additional evidence of the continued improvement in the overall quality of the loan portfolio, loan balances with a risk grading of 0005 or better have risen to $521.7 million as of September 30, 2011, representing 81.9% of the total loan portfolio. Loan balances with a risk grading of 0005 or better totaled $487.5 million as of December 31, 2010, representing 77.4% of the total loan portfolio.

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The following table presents an analysis of our past due loans excluding nonaccrual loans:

PAST DUE LOANS (EXCLUDING NONACCRUALS)
30-89 DAYS PAST DUE
(Dollar amounts in thousands)

	September 30, 2011			June 30, 2011			March 31, 2011			December 31, 2010			September 30, 2010
Secured by Real Estate	$	2,555		$	3,355		$	7,615		$	5,428		$	6,877
Commercial and industrial loans		91			249			1,877			280			140
Loans to individuals		141			44			54			95			80
All other loans		—			—			60			9			1
Total	$	2,787		$	3,648		$	9,606		$	5,812		$	7,098
Percentage of total loans		0.44	%		0.59	%		1.55	%		0.92	%		1.12	%

As indicated above, loan balances 30 to 89 days past due have decreased by $3.0 million since December 31, 2010. During the quarter ended September 30, 2011, loan balances 30 to 89 days past due have decreased by $0.9 million. Payments of $2.0 million were made to bring certain loans in this category current, including through a modification of loan terms, and $0.8 million of loan balances moved to nonaccrual status. Partially offsetting the decrease was a net increase of $2.0 million of other loans that reached 30 day past due status.

Information regarding foreclosed properties is as follows:

FORECLOSED PROPERTIES
(Dollar amounts in thousands)

	Nine months ended September 30, 2011			Twelve months ended December 31, 2010			Nine months ended September 30, 2010
Beginning Balance	$	15,952		$	14,995		$	14,995
Transfer of loans to foreclosed properties		2,827			5,587			3,398
Sales proceeds, net		(6,798	)		(2,520	)		(1,560	)
Net gain from sale of foreclosed properties		198			39			39
Provision for foreclosed properties		(1,517	)		(2,149	)		(1,374	)
Total Foreclosed Properties	$	10,662		$	15,952		$	15,498

Changes in the valuation allowance for losses on foreclosed properties were as follows:

	Nine months ended September 30, 2011			Twelve months ended December 31, 2010			Nine months ended September 30, 2010
Beginning Balance	$	3,982		$	2,773		$	2,773
Provision charged to operations		1,517			2,149			1,374
Allowance recovered on properties disposed		(2,776	)		(940	)		(566	)
Ending Balance	$	2,723		$	3,982		$	3,581

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Investment Portfolio:

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

At September 30, 2011, the investment portfolio (comprising investment securities available for sale) decreased $27.1 million (10.2%) to $239.7 million compared to $266.7 million at December 31, 2010. At September 30, 2011, the investment portfolio represented 22.8% of total assets compared to 25.3% at December 31, 2010. For the nine months ended September 30, 2011, principal payments of $46.3 million were received on maturing investments and $25.7 million from the sale of investments. We purchased $40.1 million of securities for a net cash increase of $31.9 million.

We closely monitor securities we hold in our investment portfolio that remain in an unrealized loss position for greater than twelve months. During the third quarter of 2011, $3.9 million of securities were sold and a $0.3 million gain was recognized. Total gross unrealized losses on these securities are $1.0 million at September 30, 2011, representing 62.5% of total gross unrealized securities losses and 0.4% of total investment portfolio. Based on an in-depth analysis, which may include ratings from external rating agencies and/or brokers, of the specific instruments and the creditworthiness of the related issuers, including their ability to continue payments under the terms of the security agreements, no unrealized losses were deemed to be other-than-temporary. Additionally, we do not have the intent to sell the securities and it is not more likely than not that we will be required to sell these securities before their anticipated recovery. If at any point in time any losses are considered other-than-temporary, we would be required to recognize other-than-temporary impairment. This would require us to assess the cash flows expected to be collected from the security. The difference between the present value of the cash flows expected to be collected and the amortized cost basis would result in a credit loss for the amount of the impairment. This amount would reduce our earnings. The remaining portion of the impairment related to factors other than credit loss would be recognized through other comprehensive income (loss). At September 30, 2011 and December 31, 2010, we did not hold securities of any one issuer, other than one of the following agencies or corporations of the United States government: the Federal National Mortgage Association (FNMA), Government National Mortgage Association (GNMA), Federal Home Loan Mortgage Corporation (FHLMC), or United States Department of Veterans Affairs (VA), in an amount greater than 10% of stockholders’ equity. As of September 30, 2011, the highest concentration of loans underlying mortgage-backed securities issued in any state was issued in California, representing approximately 21.2% of the total amount invested in mortgage-backed securities.

Deposits:

Total deposits at September 30, 2011 increased $5.7 million (0.7%) to $858.3 million from $852.6 million at December 31, 2010. This increase was a result of a $4.4 million (9.6%) increase in our brokered deposits from $46.0 million at December 31, 2010 to $50.4 million at September 30, 2011 and a $24.2 million (8.7%) increase in our savings deposits from $277.2 million at December 31, 2010 to $301.3 million at September 30, 2011, partially offset by a decrease of $3.9 million (1.6%) in our demand deposits from $242.1 million at December 31, 2010 to $238.2 million at September 30, 2011, and a decrease in our time deposits (excluding brokered time deposits) of $18.9 million (6.6%) from $287.3 million at December 31, 2010 to $268.4 million at September 30, 2011. Total interest-bearing deposits decreased $16.9 million (2.2%) while non-interest-bearing deposits increased $22.7 million (26.8%) from December 31, 2010 to September 30, 2011. The increase in deposits is primarily due to seasonal deposit fluctuations during the third quarter and not as a result of an aggressive pricing strategy.

Emphasis has been, and will continue to be, placed on generating additional core deposits in 2011 through competitive pricing of deposit products and through our existing branch delivery systems. We will also attempt to attract and retain core deposit accounts through new product offerings and quality customer service. If liquidity concerns arise, we have alternative sources of funds such as lines of credit with correspondent banks and borrowing arrangements with the Federal Home Loan Bank and through the discount window at the Federal Reserve.

Other Funding Sources:

Securities sold under agreements to repurchase increased $1.2 million (6.4%) from $19.2 million at December 31, 2010 to $20.4 million at September 30, 2011. We did not have any federal funds purchased at either September 30, 2011 or December 31, 2010.

FHLB advances were $55.0 million at September 30, 2011, compared to $70.0 million at December 31, 2010. During the first quarter of 2011, $15.0 million of borrowings matured and were paid in full. The availability of deposits also determines the amount of funds we need to borrow in order to fund loan demand.

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Long Term Debt:

In March 2006, we issued $16.1 million of variable rate, trust preferred securities (“TruPS”) and $0.5 million of trust common securities through Baylake Capital Trust II (the “Trust”) that adjust quarterly at a rate equal to 1.35% over the three month LIBOR. At September 30, 2011, the interest rate on these securities was 1.72%. These securities were issued to replace trust preferred securities issued in 2001 through Baylake Capital Trust I. For bank regulatory purposes, these securities are considered Tier 1 capital.

The Trust’s ability to pay amounts due on the TruPS is solely dependent upon us making payment on the related subordinated debentures (“Debentures”) to the Trust. Under the terms of the Debentures, we would be precluded from paying dividends on our common stock if we were in default under the Debentures, if we exercised our right to defer payment of interest on the Debentures or if certain related defaults occurred. After discussion with our regulators during the first quarter of 2011, we exercised our right to defer payment of interest on the Debentures beginning with the March 30, 2011 interest payment, even though we had sufficient cash to make the interest payment. Our payments due June 29, 2011 and September 29, 2011 were also deferred. The expense related to the interest payment was recorded with a corresponding liability for the interest payment amount. We will reevaluate with our regulators the continued deferral of interest payments on the TruPS quarterly as future payments come due.

During 2009 and 2010, we completed several separate closings of a private placement of Convertible Notes. The Convertible Notes were offered and sold in reliance on the exemption from registration under Section 4(2) of the Securities Act of 1933 and Rule 506 promulgated there under. The total amount of the Convertible Notes outstanding as of the date of this report is $9.45 million.

The Convertible Notes accrue interest at a fixed rate of 10% per annum upon issuance and until maturity or earlier conversion or redemption. Interest is payable quarterly, in arrears, on January 1, April 1, July 1, and October 1, of each year. The Convertible Notes are convertible into shares of our common stock at a conversion ratio of one share of common stock for each $5.00 in aggregate principal amount held on the record date of the conversion subject to certain adjustments as described in the Convertible Notes. Prior to October 1, 2014, each holder of the Convertible Notes may convert up to 100% (at the discretion of the holder) of the original principal amount into shares of our common stock at the conversion ratio. On October 1, 2014, one-half of the original principal amounts are mandatorily convertible into common stock at the conversion ratio if voluntary conversion has not occurred. The principal amount of any Convertible Note that has not been converted will be payable at maturity on June 30, 2017. To date, none of the notes have been converted.

Contractual Obligations:

We use 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, 2010 for quantitative and qualitative disclosures about our fixed and determinable contractual obligations. Contractual obligations disclosed in the 2010 Annual Report on Form 10-K have not materially changed since that Report was filed.

The following table summarizes our significant contractual obligations and commitments at September 30, 2011:

CONTRACTUAL OBLIGATIONS
(Dollar amounts in thousands)

	Within 1 Year		1-3 Years		3-5 Years		After 5 Years		Total
Certificates of deposit and other time deposit obligations	$	188,314	$	109,101	$	17,991	$	—	$	315,406
Repurchase agreements		20,463		—		—		—		20,463
Federal Home Loan Bank advances		15,000		28,000		12,000		—		55,000
Subordinated debentures		—		—		—		16,100		16,100
Convertible promissory notes (1)		—		—		9,450		—		9,450
Total	$	223,777	$	137,101	$	39,441	$	16,100	$	416,419

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⁽¹⁾ One-half of the Convertible Notes are mandatorily converted to shares of our common stock by October 1, 2014. The principal amount of any Convertible Note that has not been converted or redeemed will be payable at maturity on June 30, 2017.

Off- Balance Sheet Arrangements:

The following is a summary of our off-balance sheet commitments, all of which were lending-related commitments:

LENDING RELATED COMMITMENTS
(Dollar amounts in thousands)

	September 30, 2011		December 31, 2010
Commitments to fund home equity line loans	$	56,502	$	51,195
Commitments to fund 1-4 family loans		5,474		1,394
Commitments to fund residential real estate construction loans		1,798		777
Commitments unused on various other lines of credit loans		158,651		133,457
Total commitments to extend credit	$	222,425	$	186,823
Financial standby letters of credit	$	10,917	$	12,448

Liquidity:

Liquidity management refers to our ability to ensure that cash is available on a timely basis 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. We and the Bank have different liquidity considerations.

Our primary sources of funds are dividends from the Bank, investment income, and net proceeds from borrowings. We may also undertake offerings of debt and issue our common stock if and when we deem it prudent to do so, subject to regulatory approval. We generally manage our liquidity position in order to provide funds necessary to meet interest obligations of our trust preferred securities and convertible notes, pay dividends to our shareholders, subject to regulatory restrictions, and repurchase shares. Such restrictions, which govern all state chartered banks, preclude the payment of dividends without the prior written consent of the WDFI if dividends declared and paid by such bank in either of the two immediately preceding years exceeded that bank’s net income for those years. In consultation with our federal and state regulators, our Board of Directors elected to forego the dividend to our shareholders beginning in the first quarter of 2008. In addition, in order to pay dividends in the future, we will need to seek prior approval from WDFI as well as the Federal Reserve Board pursuant to the Written Agreement. There is no assurance that we would receive such approval if sought.

The Bank meets its cash flow needs by having funding sources available to satisfy the credit needs of customers as well as having available funds to satisfy deposit withdrawal requests. Liquidity is derived from deposit growth, payments on and maturities of loans, payments on and maturities of the investment portfolio, access to other funding sources, marketability of certain assets, the ability to use loan and investment portfolios as collateral for secured borrowings and a strong capital position.

Maturing investments have historically been a primary source of liquidity. For the nine months ended September 30, 2011, principal payments totaling $46.3 million were received on maturing investments. In addition, we received proceeds of $25.7 million from the sale of investments and we purchased $40.1 million in investments in the same period. Approximately 10.3%, or $14.6 million, of the mortgage-backed securities outstanding at September 30, 2011 were issued and guaranteed by the Government National Mortgage Association (GNMA) or the United States Department of Veterans Affairs (VA); agencies of the United States government. An additional 66.7%, or $94.9 million, of the mortgage-backed securities outstanding at September 30, 2011 were issued by either Federal National Mortgage Association (FNMA) or the Federal Home Loan Mortgage Corporation (FHLMC); United States government-sponsored agencies. These securities tend to be highly marketable.

Deposit increases, reflected as a financing activity in the September 30, 2011 Unaudited Consolidated Statements of Cash Flows, resulted in $5.8 million of cash inflow during the first nine months of 2011. Deposit growth is normally 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 brokered deposits increased $4.4 million from $46.0 million at December 31, 2010 to $50.4 million at September 30, 2011. If at any point in the future we fall below the “well capitalized” regulatory capital threshold, it will become more difficult for us to obtain brokered deposits. Also 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.

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The scheduled payments and maturities of loans can provide a source of additional liquidity. There are $223.9 million, or 35.0% of total loans, maturing within one year of September 30, 2011. 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 creates a need for liquidity that may cause us to acquire other sources of funding, some of which could be more difficult to find and more costly to secure.

Within the classification of short-term borrowings at September 30, 2011, securities sold under agreements to repurchase totaled $20.5 million compared to $19.2 million at the end of 2010. Securities sold under agreements to repurchase are obtained from a base of business customers. Short-term and long-term borrowings from the FHLB are another source of funds, totaling $55.0 million at September 30, 2011 and $70.0 million at December 31, 2010. During the first quarter of 2011, we reduced our FHLB borrowings by $15.0 million.

We expect that deposit growth will be our primary 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. We expect deposit growth to be a reliable funding source in the future as a result of marketing efforts to attract and retain core deposits. In addition, we may acquire additional brokered deposits as funding for short-term liquidity needs. Short-term liquidity needs will also be addressed by growth in short-term borrowings, maturing federal funds sold and portfolio investments, and loan maturities and prepayments.

In assessing liquidity, historical information such as seasonality, local economic cycles and the economy in general are considered along with our current financial position and projections. We believe that in the current economic environment our 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 liquidity.

Capital Resources:

Stockholders’ equity at September 30, 2011 and December 31, 2010 was $83.6 million and $77.1 million, respectively, reflecting an increase of $6.5 million (8.4%) during the first nine months of 2011. The increase in stockholders’ equity was primarily related to our net income of $2.7 million and an increase in comprehensive income of $3.7 million (as a result of an increase in unrealized gains on available for sale securities). The ratio of stockholders’ equity to assets was 7.9% and 7.3% at September 30, 2011 and December 31, 2010, respectively.

No cash dividends were declared during the first nine months of 2011 or during all of 2010. Beginning in February 2008, our Board of Directors, in consultation with our federal and state bank regulators, elected to forego the payment of cash dividends on our common stock. We continue to monitor the payment of dividends in relationship to our financial position on a quarterly basis and our intention is to reinstate payment of dividends at the earliest appropriate opportunity, however there is no assurance if or when we will be able to do so or if we do, in what amounts. Our ability to pay dividends is subject to various factors including, among other things, sufficient earnings, available capital, board discretion and regulatory compliance. In order to pay dividends, pursuant to the Written Agreement, advance approval from the WDFI as well as the Federal Reserve Board will need to be obtained. There is no assurance that we would receive such approval if sought.

We regularly review the adequacy of our capital to ensure that sufficient capital is available for our current and future needs and it 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.

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The Federal Reserve 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 which at least half must comprise core capital elements defined as Tier 1 capital. The federal banking agencies also have adopted leverage capital guidelines which banks and bank holding companies 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 minimum ratio of 4% or 5%, depending on their rating. 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 our consolidated financial statements. At September 30, 2011, we were in excess of the minimum capital ratios established for “well capitalized” under the regulatory framework for the prompt corrective action categorization. There are no conditions or events since that date 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%.

Effective December 29, 2010, we and the Bank entered into the Written Agreement with the Federal Reserve Bank and WDFI. Under the terms of the Written Agreement, both we and the Bank have agreed to, among other things: (i) submit for approval plans to maintain sufficient capital; (ii) comply with applicable notice provisions with respect to the appointment of new directors and senior executive officers and legal and regulatory limitations on indemnification payments and severance payments; and (iii) refrain from declaring or paying dividends absent prior regulatory approval. Our directors and senior management and the directors and senior management of the Bank continue to comply with all requirements specified in the Written Agreement.

As of the date of this filing, Baylake Corp and the Bank have complied with all terms of the Written Agreement. Specific steps taken include, but are not limited to:

1.	Continuing to reduce the Bank’s concentration in Commercial Real Estate loans and placing a greater emphasis on Commercial and Industrial loans.
2.	Delegating primary responsibility to the Bank’s Directors’ Loan Committee for the following:
	a.	Monitoring loan relationships and other assets, including Other Real Estate Owned, in excess of $0.5 million with an emphasis on improving the Bank’s position.
	b.	Overseeing the Bank’s current policy for determining, documenting and recording an adequate allowance for loan losses and monitoring the Bank’s compliance with such policy.
	c.	Charging-off all assets classified as “loss” in a federal or state report of examination.
	d.	Pre-approving any extension, renewal, or restructure of any asset criticized by the Federal Reserve Bank or WDFI.
3.	Delegating primary responsibility to the full Board of Directors for the following:
	a.	Obtaining prior regulatory approval on any form of payment resulting in a reduction in Baylake Corp’s or the Bank’s capital, including interest payments on our debentures and trust preferred securities.
	b.	Obtaining Federal Reserve Bank approval prior to purchasing or redeeming any shares of our stock.
	c.	Submitting required capital plans to the Federal Reserve Bank and WDFI.
	d.	Complying with notice provisions with respect to new directors and senior executive officers.
	e.	Complying with legal and regulatory limitations on indemnification payments and severance payments.
	f.	Obtaining prior regulatory approval for the declaration and payment of dividends.

Our senior management, primarily through our Chief Executive Officer, has established a regular dialogue with our lead examiner. These open communication lines provide timely feedback to us and the Bank on proposed action plans and keep our regulators updated on progress we have made.

Total capital to Risk-weighted Asset ratios for the previous four quarters are as follows:

	September 30, 2011			June 30, 2011			March 31, 2011			December 31, 2010
Company		13.35	%		13.43	%		13.14	%		12.76	%
Bank		13.16	%		13.20	%		12.87	%		12.48	%

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. We believe 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.

49

The following tables present our and the Bank’s capital ratios as of September 30, 2011 and December 31, 2010:

CAPITAL RATIOS
(Dollar amounts 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 September 30, 2011
Total Capital (to Risk-Weighted Assets)
Company	$	99,101		13.35	%	$	59,389		8.00	%	$	N/A		N/A
Bank		97,746		13.16	%		59,427		8.00	%		74,284		10.00	%
Tier 1 Capital (to Risk-Weighted Assets)
Company	$	80,327		10.82	%	$	29,694		4.00	%	$	N/A		N/A
Bank		88,417		11.90	%		29,714		4.00	%		44,570		6.00	%
Tier 1 Capital (to Average Assets)
Company	$	80,327		7.76	%	$	41,404		4.00	%	$	N/A		N/A
Bank		88,417		8.53	%		41,466		4.00	%		51,833		5.00	%

	Actual					Required For Capital Adequacy Purposes					Required To Be Well Capitalized Under Prompt Corrective Action Provisions
	Amount		Ratio			Amount		Ratio			Amount		Ratio
As of December 31, 2010
Total Capital (to Risk-Weighted Assets)
Company`	$	96,245		12.76	%	$	60,364		8.00	%	$	N/A		N/A
Bank		94,194		12.48	%		60,394		8.00	%		75,493		10.00	%
Tier 1 Capital (to Risk-Weighted Assets)
Company	$	77,338		10.25	%	$	30,182		4.00	%	$	N/A		N/A
Bank		84,732		11.22	%		30,197		4.00	%		45,296		6.00	%
Tier 1 Capital (to Average Assets)
Company	$	77,338		7.41	%	$	41,720		4.00	%	$	N/A		N/A
Bank		84,732		8.12	%		41,237		4.00	%		52,171		5.00	%

50

Item 3. Quantitative and Qualitative Disclosures 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. Historically, we have not used 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 subordinated debentures. 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 Federal Reserve. Changes in the economic environment may influence, among other matters, the growth rate of loans and deposits, the quality of the loan portfolio and loan and deposit pricing. Fluctuations in interest rates are not predictable or controllable.

As of September 30, 2011, 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, 2010, as described in our 2010 Annual Report on Form 10-K.

Our overall interest rate sensitivity is demonstrated by net interest income shock analysis which 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 100 bp to 200 bp 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 September 30, 2011.

INTEREST SENSITIVITY
(Dollar amounts in thousands)

	Change in Net Interest Income Over One Year Horizon
	At September 30, 2011						At December 31, 2010
Change in levels of interest rates	Dollar change			Percentage change			Dollar change			Percentage change
+200 bp	$	(314	)		(1.0)	%	$	191			0.6	%
+100 bp		(184	)		(0.6)	%		(118	)		(0.4)	%
Base		—			__			—			__
-100 bp		(536	)		(1.8)	%		(1,468	)		(4.4)	%
-200 bp		(910	)		(2.9)	%		(2,622	)		(7.9)	%

As shown above, at September 30, 2011, the effect of an immediate 200 bp increase in interest rates would have decreased our net interest income by $0.3 million or 1.0%. The effect of an immediate 200 bp reduction in rates would have decreased our net interest income by $0.9 million or 2.9%. However, a 200 bp reduction in rates is not realistic given the low interest rate environment that currently exists. An interest rate floor of zero is used rather than assuming a negative interest rate.

During the first nine months of 2011, Baylake Bank lengthened slightly the duration of its liabilities by issuing longer term brokered deposits. This effort has contributed to moderation of the liability sensitivity that was present at December 31, 2010.

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.

51

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 September 30, 2011. 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.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Internal Control Over Financial Reporting

There have not been any 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

We and our subsidiaries may be involved from time to time in various routine legal proceedings incidental to our respective businesses. Neither we nor any of our subsidiaries are currently engaged in any legal proceedings that are expected to have a material adverse effect on our results of operations or financial position.

Item 1A. Risk Factors

The mortgage-backed securities in which we invest are subject to several types of risk.

Mortgage-backed securities are securities that evidence interests in, or are secured by, a single mortgage loan or a pool of mortgage loans. Accordingly, these securities are subject to all of the risks of the underlying mortgage loans. In a rising interest rate environment, the value of mortgage-backed securities may be adversely affected when payments on underlying mortgages do not occur as anticipated, resulting in the extension of the security’s effective maturity and the related increase in interest rate sensitivity of a longer-term instrument. The value of mortgage-backed securities may also change due to shifts in the market’s perception of issuers and regulatory or tax changes adversely affecting the mortgage securities’ market as a whole. Most mortgage-backed securities are issued by agencies of the United States government, however some mortgage-backed securities are issued by investment banks, and while the loans that are pooled to create the security carry government agency guarantees, the securities themselves are not insured or guaranteed by the United States government. Approximately 10.3%, or $14.6 million, of the mortgage-backed securities outstanding at September 30, 2011 were issued and guaranteed by the Government National Mortgage Association (GNMA) or the United States Department of Veterans Affairs (VA); agencies of the United States government. An additional 66.7%, or $94.9 million, of the mortgage-backed securities outstanding at September 30, 2011 were issued by either Federal National Mortgage Association (FNMA) or the Federal Home Loan Mortgage Corporation (FHLMC); United States government-sponsored agencies. Non-agency mortgage-backed securities comprised approximately 23% or $33.0 million of the outstanding mortgage-backed securities at September 30, 2011. Finally, mortgage-backed securities are also subject to geographic risk, when the mortgages underlying the securities are concentrated in one or more geographic areas. This risk is managed by monitoring the geographic dispersion of the underlying loans in each security. As of September 30, 2011, the highest concentration of loans issued in any state underlying mortgage-backed securities was issued in California, representing approximately 21.2% of the total amount invested in mortgage-backed securities.

Although we generally invest only in mortgage-backed securities collateralized by residential loans, the value of such securities can be negatively impacted by any dislocation in the mortgage-backed securities market in general. The mortgage-backed securities market has recently suffered from a severe dislocation created by mortgage pools that included sub-prime mortgages secured by residential real estate.

52

See “Risk Factors” in Item 1A of our annual report on Form 10-K for the year ended December 31, 2010. Other than as described above, there have been no material changes to the risk factors since then.

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

During the quarter ended September 30, 2011, we did not sell any equity securities which were not registered under the Securities Act of 1933, as amended, or repurchase any of our equity securities.

We have several limitations on our ability to pay dividends. The Federal Reserve has adopted regulations that deal with the measure of capitalization for bank holding companies. The Federal Reserve has also issued a policy statement on the payment of cash dividends by bank holding companies, wherein the Federal Reserve has stated that a bank holding company experiencing earnings weaknesses should not pay cash dividends exceeding its net income or which could only be funded in ways that weaken the bank holding company’s financial health, such as by borrowing.

Our ability to pay dividends on our common stock is largely dependent upon the Bank’s ability to pay dividends on its stock held by us. The Bank’s ability to pay dividends is restricted by both state and federal laws and regulations. The Bank is subject to policies and regulations issued by the Federal Reserve, as the Bank’s primary federal regulator, and the Division of Banking of the WDFI, which, in part, establish minimum acceptable capital requirements for banks, thereby limiting the ability of such banks to pay dividends. In addition, Wisconsin law provides that state chartered banks may declare and pay dividends out of undivided profits but only after provision has been made for all expenses, losses, required reserves, taxes and interest accrued or due from the bank.

Our and the Bank’s payment of dividends in some circumstances may require the written consent of the Federal Reserve or the WDFI. Currently, the terms of the Written Agreement prohibit us and the Bank from declaring or paying any dividends without the prior written approval of the Federal Reserve Bank and, as to the Bank, the WDFI. We anticipate that this prior approval requirement will remain in place until the Written Agreement is lifted by the Federal Reserve Bank and the WDFI. However, our and the Bank’s ability to pay future dividends may become subject to the prior written consent of our respective regulators at any time in the future.

Item 3. Defaults Upon Senior Securities

Not applicable.

Item 5. Other Information

Not applicable.

53

Item 6. Exhibits

The following exhibits are furnished herewith:

Exhibit Number	Description
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.
101	Interactive data files pursuant to Rule 405 of Regulation S-T: (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Operations, (iii) Consolidated Statement of Changes in Stockholders’ Equity, (iv) Consolidated Statements of Cash Flows, and (v) Notes to Consolidated Financial Statements tagged as blocks of text.

54

SIGNATURES

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

		BAYLAKE CORP.
Date:	November 9, 2011	/s/ Robert J. Cera
		Robert J. Cera
		President and Chief Executive Officer
Date:	November 9, 2011	/s/ Kevin L. LaLuzerne
		Kevin L. LaLuzerne
		Treasurer and Chief Financial Officer

55

EX-31.1

EXHIBIT 31.1
CERTIFICATION PURSUANT TO 18 U.S.C.
SECTION 1350, AS ADOPTED PURSUANT TO
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002

	I, Robert J. Cera, President and Chief Executive Officer of Baylake Corp., certify that:
1.	I have reviewed this quarterly report on Form 10-Q of Baylake Corp;
2.	Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3.	Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4.	The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
	a)	Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
	b)	Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
	c)	Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
	d)	Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
5.	The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
	a)	All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
	b)	Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date:	November 9, 2011
/s/ Robert J. Cera
Robert J. Cera
President and Chief Executive Officer

56

EX-31.2

EXHIBIT 31.2
CERTIFICATION PURSUANT TO 18 U.S.C.
SECTION 1350, AS ADOPTED PURSUANT TO
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002

	I, Kevin L. LaLuzerne, Chief Financial Officer, certify that:
1.	I have reviewed this quarterly report on Form 10-Q of Baylake Corp;
2.	Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3.	Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4.	The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) an 15d-15(e) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
	a)	Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
	b)	Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
	c)	Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
	d)	Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
5.	The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
	a)	All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
	b)	Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date:	November 9, 2011
/s/Kevin L. LaLuzerne
Kevin L. LaLuzerne
Treasurer and Chief Financial Officer

57

EX-32.1

EXHIBIT 32.1
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with this Quarterly Report of Baylake Corp. (the “Company”) on Form 10-Q as filed with the Securities and Exchange Commission on or about the date hereof (the “Report”), I, Robert J. Cera, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. §1350, as adopted pursuant to §906 of the Sarbanes-Oxley Act of 2002, that to the best of my knowledge:

(1)	The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
(2)	The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

Date:	November 9, 2011
/s/ Robert J. Cera
Robert J. Cera
President and Chief Executive Officer

A signed original of this written statement required by Section 906, or other document authenticating, acknowledging, or otherwise adopting the signature that appears in typed form within the electronic version of this written statement required by Section 906, has been provided to Baylake Corp. and will be retained by Baylake Corp. and furnished to the Securities and Exchange Commission or its staff upon request.

58

EX-32.2

EXHIBIT 32.2
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with this Quarterly Report of Baylake Corp. (the “Company”) on Form 10-Q as filed with the Securities and Exchange Commission on or about the date hereof (the “Report”), I, Kevin L. LaLuzerne, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. §1350, as adopted pursuant to §906 of the Sarbanes-Oxley Act of 2002, that to the best of my knowledge:

(1)	The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
(2)	The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

Date:	November 9, 2011
/s/ Kevin L. LaLuzerne
Kevin L. LaLuzerne
Treasurer and Chief Financial Officer

A signed original of this written statement required by Section 906, or other document authenticating, acknowledging, or otherwise adopting the signature that appears in typed form within the electronic version of this written statement required by Section 906, has been provided to Baylake Corp. and will be retained by Baylake Corp. and furnished to the Securities and Exchange Commission or its staff upon request.

59

XML

Consolidated Balance Sheets (Parenthetical) (USD $) In Thousands, except Share data	Sep. 30, 2011	Dec. 31, 2010
Consolidated Balance Sheets [Abstract]
Loans, allowance	$ 12,857	$ 11,502
Common stock, par value	$ 5	$ 5
Common stock, shares authorized	50,000,000	50,000,000
Common stock, shares issued	8,132,552	8,132,552
Common stock, shares outstanding	7,911,539	7,911,539
Treasury stock, shares	221,013	221,013

XML

Consolidated Statements Of Operations (USD $) In Thousands, except Per Share data	3 Months Ended		9 Months Ended
	Sep. 30, 2011	Sep. 30, 2010	Sep. 30, 2011	Sep. 30, 2010
INTEREST AND DIVIDEND INCOME
Loans, including fees	$ 8,278	$ 8,872	$ 24,998	$ 26,897
Taxable securities	1,747	1,983	5,376	6,007
Tax exempt securities	375	382	1,129	1,119
Federal funds sold	51	28	90	81
Total Interest and Dividend Income	10,451	11,265	31,593	34,104
INTEREST EXPENSE
Deposits	1,749	2,248	5,577	7,567
Repurchase agreements	23	16	65	78
Federal Home Loan Bank advances and other debt	261	484	833	1,539
Subordinated debentures	66	77	200	209
Convertible promissory notes	245	245	735	615
Total Interest Expense	2,344	3,070	7,410	10,008
Net interest income	8,107	8,195	24,183	24,096
Provision for loan losses	1,200	4,550	4,450	6,850
Net interest income after provision for loan losses	6,907	3,645	19,733	17,246
NONINTEREST INCOME
Fees from fiduciary activities	217	214	720	714
Fees from loan servicing	139	123	552	397
Fees for other services to customers	1,260	1,320	3,726	3,797
Net gain on sale of loans	208	324	805	725
Net gain (loss) in mortgage servicing rights	(111)	(12)	(225)	26
Net gain on sale of securities	267	973	392	1,406
Net loss on sale of premises and equipment	(1)	(81)	(3)	(83)
Increase in cash surrender value of life insurance	102	205	353	271
Income in equity of UFS subsidiary	199	185	631	423
Other income/(expense)	(174)	16	190	75
Total Noninterest Income	2,106	3,267	7,141	7,751
NONINTEREST EXPENSE
Salaries and employee benefits	4,067	4,207	12,681	12,156
Occupancy expense	551	584	1,731	1,782
Equipment expense	304	287	891	961
Data processing and courier	210	221	621	662
FDIC insurance expense	571	697	1,861	1,938
Operation of other real estate	108	894	1,875	1,837
Provision for impairment of standby letters of credit	117		131	87
Loan and collection expense	139	155	470	492
Other outside services	166	208	488	541
Other operating expenses	975	985	3,028	2,987
Total Noninterest Expense	7,208	8,238	23,777	23,443
Income before provision for/(benefit from) income taxes	1,805	(1,326)	3,097	1,554
Provision for (benefit from) income taxes	508	(814)	374	(101)
Net Income (loss)	$ 1,297	$ (512)	$ 2,723	$ 1,655
Basic earnings (loss) per share	$ 0.16	$ (0.06)	$ 0.34	$ 0.21
Diluted earnings (loss) per share	$ 0.16	$ (0.06)	$ 0.34	$ 0.21

XML

Document And Entity Information	9 Months Ended
	Sep. 30, 2011	Nov. 09, 2011
Document And Entity Information [Abstract]
Document Type	10-Q
Amendment Flag	false
Document Period End Date	Sep. 30, 2011
Document Fiscal Period Focus	Q3
Document Fiscal Year Focus	2011
Entity Registrant Name	BAYLAKE CORP
Entity Central Index Key	0000275119
Current Fiscal Year End Date	--12-31
Entity Filer Category	Smaller Reporting Company
Entity Common Stock, Shares Outstanding		7,911,539

XML

Investments

9 Months Ended

Sep. 30, 2011

Investments [Abstract]

Investments

6.             Investments

INVESTMENT SECURITY ANALYSIS

(Dollar amounts in thousands)

The fair value of securities available for sale and the related unrealized gains and losses as of September 30, 2011 and December 31, 2010 are as follows:

		September 30, 2011
			Fair Value		Gross Unrealized Gains		Gross Unrealized Losses
U.S. government-sponsored agency securities	$		20,858	$	151	$	-
Obligations of states and political subdivisions			56,461		3,683		-
Mortgage-backed securities			142,593		5,111		(1,138)
Asset-backed securities			5,125		135		(483)
Private placement and corporate bonds			12,378		332		-
Other securities			2,268		-		-
Totals	$		239,683	$	9,412	$	(1,621)

		December 31, 2010
		Fair Value		Gross Unrealized Gains		Gross Unrealized Losses
U.S. government-sponsored agency securities	$	33,753	$	80	$	(35)
Obligations of states and political subdivisions		52,853		863		(284)
Mortgage-backed securities		159,646		2,074		(866)
Asset-backed securities		5,536		175		(841)
Private placement and corporate bonds		12,537		534		(33)
Other securities		2,435		-		-
Totals	$	266,760	$	3,726	$	(2,059)

At September 30, 2011 and December 31, 2010, the mortgage-backed securities portfolio was $142.6 million, (59.5%) and $159.6 million, (59.8%), respectively, of the investment portfolios. Approximately 10.3%, or $14.6 million, of the mortgage-backed securities outstanding at September 30, 2011 were issued and guaranteed by the Government National Mortgage Association (GNMA) or the United States Department of Veterans Affairs (VA): agencies of the United States government. An additional 66.7%, or $94.9 million, of the mortgage-backed securities outstanding at September 30, 2011 were issued by either the Federal National Mortgage Association (FNMA) or the Federal Home Loan Mortgage Corporation (FHLMC); United States government-sponsored-agencies. Non-agency mortgage-backed securities present a level of credit risk that does not exist currently with agency-backed securities, but only comprised approximately 23%, or $33.0 million, of the outstanding mortgage-backed securities at September 30, 2011. We evaluate these non-agency mortgage-backed securities at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation.

Securities with unrealized losses at September 30, 2011 and December 31, 2010, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, are as follows (dollar amounts in thousands):

	September 30, 2011
	Less than 12 Months				12 Months or More						Total
Description of Securities		Fair Value		Unrealized Loss			Fair Value		Unrealized Loss			Fair Value			Unrealized Loss
Mortgage-backed securities		29,668		(668)			4,296		(470)			33,964		(1,138)
Asset-backed securities		-		-			3,788		(483)			3,788		(483)
Total temporarily impaired	$	29,668	$	(668)		$	8,084	$	(953)	$		37,752	$	(1,621)

	December 31, 2010
	Less than 12 Months					12 Months or More				Total
Description of Securities		Fair Value		Unrealized Loss		Fair Value		Unrealized Loss			Fair Value		Unrealized Loss
U.S. government-sponsored agency securities	$	4,960	$	(35)	$	-	$	-	$		4,960	$	(35)
Obligations of states and political subdivisions		15,177		(284)		-		-			15,177		(284)
Mortgage-backed securities		53,582		(838)		5,500		(28)			59,082		(866)
Asset-backed securities		3,889		(841)		-		-			3,889		(841)
Private placement and corporate bonds		-		-		4,967		(33)			4,967		(33)
Total temporarily impaired	$	77,608	$	(1,998)	$	10,467	$	(61)	$		88,075	$	(2,059)

At September 30, 2011, the mortgage-backed securities category with continuous unrealized losses for twelve months or more comprises one security. The asset-backed securities category with continuous unrealized losses for twelve months or more comprises two securities.

At December 31, 2010, the mortgage-backed securities category with continuous unrealized losses for twelve months or more and the private placement and corporate bond category with continuous unrealized losses for twelve months or more each comprise one security.

We evaluate securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. As part of such monitoring, the credit quality of individual securities and their issuers is assessed. Adjustments to market value that are considered temporary are recorded as a separate component of other comprehensive income, net of tax. If an impairment of a security is identified as other-than-temporary based on information available, such as the decline in the creditworthiness of the issuer, external market ratings or the anticipated or realized elimination of associated dividends, such impairments are further analyzed to determine if a credit loss exists. If there is a credit loss, it will be recorded in the statement of operations. Unrealized losses other than credit losses will continue to be recognized in other comprehensive income. Unrealized losses reflected in the preceding tables have not been included in the results of operations because the unrealized loss was not deemed other-than-temporary. Management has determined that it is not more likely than not that we will be required to sell the debt securities before their anticipated recovery and therefore, there is no other-than-temporary impairment. The losses on these securities are expected to dissipate as they approach their maturity dates and/or if interest rates decline.

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Equity Investment

9 Months Ended

Sep. 30, 2011

Equity Investment [Abstract]

Equity Investment

11.          Equity Investment

Baylake Bank owns a 49.8% interest (500 shares) in United Financial Services, Inc. ("UFS"), a data processing service. In addition to the ownership interest, we and UFS have a common member on each of our respective 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 amended an earlier employment agreement with one of its key employees that provided the individual the option to purchase up to 20%, or 240 shares, of the authorized UFS common stock. The option price was $1,000 per share, less dividends or distributions to owners. During 2007, options for 120 shares were exercised by the key employee.  The remaining options were exercised in 2010.  The carrying value of our investment in UFS was $4.2 million and $3.9 million at September 30, 2011 and December 31, 2010, respectively.  The current book value of UFS is approximately $8,478 per share.

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Use Of Estimates

9 Months Ended

Sep. 30, 2011

Use Of Estimates [Abstract]

Use Of Estimates

2.             Use of Estimates

To prepare consolidated financial statements in conformity with GAAP, our management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the consolidated financial statements and the disclosures provided, and actual results could differ. The allowance for loan losses, foreclosed properties, mortgage servicing rights, income tax expense and fair values of financial instruments are particularly subject to change.

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Allowance For Loan Losses ("ALL")

9 Months Ended

Sep. 30, 2011

Allowance For Loan Losses ("ALL") [Abstract]

Allowance For Loan Losses ("ALL")

8.             Allowance For Loan Losses ("ALL")

The ALL represents management's estimate of probable and inherent credit losses in the loan portfolio. Estimating the amount of the ALL requires the exercise of significant judgment and the use of estimates related to the amount and timing of expected future cash flows on impaired loans, estimated losses on pools of homogeneous loans based on historical loss experience, and consideration of other qualitative factors such as current economic trends and conditions, all of which may be susceptible to significant change. The loan portfolio also represents the largest asset on our consolidated balance sheet. Loan losses are charged off against the ALL, while recoveries of amounts previously charged off are credited to the ALL. A provision for loan losses ("PFLL") is charged to operations based on management's periodic evaluation of the factors previously mentioned, as well as other pertinent factors.

The ALL consists of specific reserves on certain impaired loans and general reserves for non-impaired loans. Specific reserves reflect estimated losses on impaired loans from analyses developed through specific credit allocations for individual loans. The specific credit allocations are based on regular analyses of all impaired non-homogenous loans. These analyses

involve a high degree of judgment in estimating the amount of loss associated with specific loans, including estimating the amount and timing of future cash flows and collateral values. The general reserve is based on the Bank's historical loss experience which is updated quarterly. The general reserve portion of the ALL also includes consideration of certain qualitative factors such as 1) changes in the nature, volume and terms of loans, 2) changes in lending personnel, 3) changes in the quality of the loan review function, 4) changes in nature and volume of past-due, nonaccrual and/or classified loans, 5) changes in concentration of credit risk, 6) changes in economic and industry conditions, 7) changes in legal and regulatory requirements, 8) unemployment and inflation statistics, and 9) changes in underlying collateral values.

There are many factors affecting the ALL; some are quantitative while others require qualitative judgment. The process for determining the ALL (which management believes adequately considers potential factors which might possibly result in credit losses) includes subjective elements and, therefore, may be susceptible to significant change. To the extent actual outcomes differ from management estimates, additional PFLL could be required that could adversely affect our earnings or financial position in future periods. Allocations of the ALL may be made for specific loans but the entire ALL is available for any loan that, in management's judgment, should be charged-off or for which an actual loss is realized. As an integral part of their examination process, various regulatory agencies review the ALL as well. Such agencies may require that changes in the ALL be recognized when such regulators' credit evaluations differ from those of management based on information available to the regulators at the time of their examinations.

Changes in the ALL were as follows (dollar amounts in thousands):

ALLOWANCE FOR LOAN LOSSES

		For the three months ended September 30,				For the nine months ended September 30,
		2011		2010		2011		2010
Balance at beginning of period	$	12,660	$	11,455	$	11,502	$	9,600
Provision for loan losses		1,200		4,550		4,450		6,850
Charge-offs		(1,040)		(3,932)		(3,325)		(6,170)
Recoveries		37		1,153		230		2,946
Balance at end of period	$	12,857	$	13,226	$	12,857	$	13,226
Net charge-offs	$	(1,003)	$	(2,779)	$	(3,095)	$	(3,224)

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

IMPAIRED LOANS AND ALLOCATED ALLOWANCE

September 30, 2011				Construction Loans				Real Estate- Mortgage				Real Estate- Commercial			Commercial		Consumer		Municipal				Not Specifically Allocated				Totals
With an allowance recorded:
Recorded investment		$		2,675		$		2,067		$		9,080	$		361	$	-	$	-		$		-		$		14,183
Unpaid principal balance				2,853				2,603				10,853			404		149		-				-				16,862
Related allowance				178				536				1,773			43		149		-				-				2,679
With no related allowance recorded:
Recorded investment		$		2,369		$		3,080		$		21,753	$		695	$	15	$	-		$		-		$		27,912
Unpaid principal balance				2,369				3,080				21,753			695		15		-				-				27,912
Related allowance				-				-				-			-		-		-				-				-
Total:
Recorded investment	$		5,044		$		5,147		$		30,833		$	1,056		$	15	$		-		$		-		$		42,095
Unpaid principal balance			5,222				5,683				32,606			1,099			164			-				-				44,774
Related allowance			178				536				1,773			43			149			-				-				2,679
Average recorded investment during quarter	$		5,123		$		4,738		$		28,901		$	1,003		$	18	$		-		$		-		$		39,783
Interest income recognized while impaired	$		-		$		27		$		631		$	24		$	-	$		-		$		-		$		682

December 31, 2010		Construction Loans		Real Estate- Mortgage		Real Estate- Commercial		Commercial		Consumer		Municipal		Not Specifically Allocated		Totals
With an allowance recorded:
Recorded investment	$	288	$	3,097	$	4,174	$	110	$	7	$	-	$	-	$	7,676
Unpaid principal balance		456		3,814		5,410		638		196		-		-		10,514
Related allowance		168		717		1,236		528		189		-		-		2,838
With no related allowance recorded:
Recorded investment	$	3,559	$	1,125	$	13,637	$	695	$	60	$	-	$	-	$	19,076
Unpaid principal balance		3,559		1,125		13,637		695		60		-		-		19,076
Related allowance		-		-		-		-		-		-		-		-
Total:
Recorded investment	$	3,847	$	4,222	$	17,811	$	805	$	67	$	-	$	-	$	26,752
Unpaid principal balance		4,015		4,939		19,047		1,333		256		-		-		29,590
Related allowance		168		717		1,236		528		189		-		-		2,838
Average recorded investment during quarter	$	4,100	$	2,885	$	7,113	$	426	$	51	$	-	$	-	$	14,575
Interest income recognized while impaired	$	3	$	-	$	2	$	-	$	-	$	-	$	-	$	5

Management regularly monitors impaired loan relationships. In the event facts and circumstances change, an additional PFLL may be necessary.

Nonperforming loans are as follows (dollar amounts in thousands):

NONPERFORMING LOANS

		September 30, 2011		June  30, 2011		March 31, 2011		December 31, 2010		September 30, 2010
Nonaccrual loans	$	19,027	$	16,759	$	17,027	$	15,877	$	18,339
Loans restructured in a troubled debt restructuring, non-accrual		5,287		5,288		165		623		586
Total nonperforming loans ("NPLs")	$	24,314	$	22,047	$	17,192	$	16,500	$	18,925

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Promissory Notes

9 Months Ended

Sep. 30, 2011

Promissory Notes [Abstract]

Promissory Notes

13.Promissory Notes

During 2009 and 2010, we issued 10% Convertible Notes due June 30, 2017 (the "Convertible Notes") totaling $9.45 million. The Convertible Notes were offered and sold in reliance on the exemption from registration under Section 4(2) of the Securities Act of 1933 and Rule 506 promulgated there under.

The Convertible Notes accrue interest at a fixed rate of 10% per annum upon issuance and until maturity or earlier conversion or redemption. Interest is payable quarterly, in arrears, on January 1, April 1, July 1, and October 1 of each year. The Convertible Notes are convertible into shares of our common stock at a conversion ratio of one share of common stock for each $5.00 in aggregate principal amount held on the record date of the conversion, subject to certain adjustments as described in the Convertible Notes. Prior to October 1, 2014, each holder of the Convertible Notes may convert up to 100% (at the discretion of the holder) of the original principal amount into shares of our common stock at the conversion ratio. On October 1, 2014, one-half of the original principal amounts are mandatorily convertible into common stock at the conversion ratio if voluntary conversion has not occurred. The principal amount, along with accrued but unpaid interest, of any Convertible Note that has not been converted will be payable at maturity on June 30, 2017. We are not obligated to register the common stock issued on the conversion of the Convertible Notes.

During 2009 and 2010 the Company incurred debt issuance costs of $0.2 million.These costs were capitalized and are being amortized to interest expense using the effective interest method over the initial conversion term, which ends October 1, 2014.

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Foreclosed Properties, Net

9 Months Ended

Sep. 30, 2011

Foreclosed Properties, Net [Abstract]

Foreclosed Properties, Net

9.             Foreclosed Properties, Net

Foreclosed properties are summarized as follows (dollar amounts in thousands):

		For the nine months ended September 30,
		2011		2010
Beginning balance	$	19,934	$	17,768
Transfer of net realizable value to foreclosed properties		2,827		3,398
Sale proceeds, net		(6,798)		(1,560)
Net gain from sale of foreclosed properties		198		39
Valuation allowance related to properties disposed		(2,776)		(566)
Total foreclosed properties		13,385		19,079
Valuation allowance for losses		(2,723)		(3,581)
Total foreclosed properties, net	$	10,662	$	15,498

Changes in the valuation allowance for losses on foreclosed properties were as follows (dollar amounts in thousands):

			For the nine months ended September 30,
		2011			2010
Beginning balance	$	3,982		$	2,773
Provision charged to operations		1,517			1,374
Amounts related to properties disposed		(2,776)			(566)
Balance at end of period	$	2,723		$	3,581

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Loans

9 Months Ended

Sep. 30, 2011

Loans [Abstract]

Loans

7.             Loans

Loans held for investment are summarized as follows (dollar amounts in thousands):

	September 30, 2011			December 31, 2010
Real Estate-Commercial	$	329,253	$		344,263
Real Estate-Residential		137,085			129,449
Real Estate-Construction		54,999			55,467
Commercial Loans		91,083			73,928
Consumer Loans		8,869			10,225
Obligations of States and Political Subdivisions		15,909			16,892
Gross Loans		637,198			630,224
Less: Deferred Origination Fees, net of costs		(404)			(333)
Less: Allowance for Loan Losses		(12,857)			(11,502)
Total	$	623,937	$		618,389

Loans having a carrying value of $95,330 and $86,744 are pledged as collateral for borrowings from the Federal Home Loan Bank at September 30, 2011 and December 31, 2010, respectively.

A summary of the activity in the allowance for loan losses by class of loan is as follows (dollar amounts in thousands):

		Construction Loans				Real Estate-Mortgage					Real Estate-Commercial				Commercial				Consumer				Municipal					Not Specifically Allocated				Total
Allowance for Loan Losses:
Balance January 1, 2011	$		1,424	$			2,103		$		6,355		$		1,189		$		391		$	-		$		40				$		11,502
Charge-offs			(373)				(1,407)				(856)				(476)				(213)			-				-						(3,325)
Recoveries			59				9				78				38				46			-				-						230
Provision			457				1,888				1,213				363				146			-				383						4,450
Balance September 30, 2011	$		1,567	$			2,593		$		6,790		$		1,114		$		370		$	-		$		423				$		12,857
Ending balance individually evaluated for impairment	$		178	$			536		$		1,773		$		43		$		149		$	-		$		-				$		2,679
Ending balance collectively evaluated for impairment	$		1,389	$			2,057		$		5,017		$		1,071		$		221		$	-		$		423				$		10,178
Loans:
Balance September 30, 2011	$		54,999		$			137,085		$		328,868		$		91,064		$		8,869	$	15,909			$		-		$		636,794
ALL			(1,567)					(2,593)				(6,790)				(1,114)				(370)		-					(423)				(12,857)
Recorded investment	$		53,432		$			134,492		$		322,078		$		89,950		$		8,499	$	15,909			$		(423)		$		623,937
Ending balance individually evaluated for impairment	$		2,675		$			2,067		$		9,080		$		361		$		-	$	-			$		-		$		14,183
Ending balance collectively evaluated for impairment	$		50,757		$			132,425		$		312,998		$		89,589		$		8,499	$	15,909			$		(423)		$		609,754

		Construction Loans			Real Estate-Mortgage		Real Estate-Commercial		Commercial		Consumer		Municipal		Not Specifically Allocated			Total
Allowance for Loan Losses:
Balance January 1, 2010	$		1,184	$	1,452	$	4,558	$	1,497	$	375	$	-	$		534	$	9,600
Charge-offs			(1,837)		(156)		(5,443)		(1,030)		(123)		-			-		(8,589)
Recoveries			5		206		1,316		1,553		61		-			-		3,141
Provision			2,072		601		5,924		(831)		78		-			(494)		7,350
Balance, December 31, 2010	$		1,424	$	2,103	$	6,355	$	1,189	$	391	$	-	$		40	$	11,502
Ending balance individually evaluated for impairment	$		168	$	717	$	1,236	$	528	$	189	$	-	$		-	$	2,838
Ending balance collectively evaluated for impairment	$		1,256	$	1,386	$	5,119	$	661	$	202	$	-	$		40	$	8,664
Loans:
Balance December 31, 2010	$		55,467	$	129,448	$	343,955	$	73,904	$	10,225	$	16,892	$		-	$	629,891
ALL			(1,424)		(2,103)		(6,355)		(1,189)		(391)		-			(40)		(11,502)
Recorded investment	$		54,043	$	127,345	$	337,600	$	72,715	$	9,834	$	16,892	$		(40)	$	618,389
Ending balance individually evaluated for impairment	$		3,959	$	4,178	$	23,883	$	1,174	$	7	$	-	$		-	$	33,201
Ending balance collectively evaluated for impairment	$		50,084	$	123,167	$	313,717	$	71,541	$	9,827	$	16,892	$		(40)	$	585,188

A summary of past due loans at September 30, 2011 and December 31, 2010 is as follows (dollar amounts in thousands):

	September 30, 2011
		30-89 Days Past Due (accruing)		90 Days & Over or            on non-accrual		Total
Construction	$	833	$	5,221	$	6,054
Real estate – mortgage		941		4,252		5,193
Real estate – commercial		781		13,955		14,736
Commercial		91		722		813
Consumer		141		164		305
Municipal		--		--		--
Total	$	2,787	$	24,314	$	27,101

	December 31, 2010
		30-89 Days Past Due (accruing)		90 Days & Over or on non-accrual		Total
Construction	$	586	$	4,066	$	4,652
Real estate – mortgage		1,311		4,845		6,156
Real estate – commercial		3,531		6,360		9,891
Commercial		289		973		1,262
Consumer		95		256		351
Municipal		--		--		--
Total	$	5,812	$	16,500	$	22,312

Credit Quality: We utilize a risk grading matrix on each of our commercial loans. Loans are graded on a scale of 1 to 7. A description of the loan grades is as follows:

0001 - Excellent Risk. Borrowers of highest quality and character. Almost no loss probability. Balance sheets are very strong with superior liquidity, excellent debt capacity and low leverage. Cash flow trends are positive and stable.

0002 - Very Good Risk. Strong ratios in all areas. High quality borrower. Normally quite liquid. Differs slightly from a one-rated customer.

0003 - Strong in most categories. Possible higher levels of debt or shorter track record. Minimal attention required.

0004 - Better than Average Risk. Adequate ratios, fair liquidity, desirable customer. Proactive management. Performance trends

are positive. Any deviations are limited and temporary as a historical trend.

0005 - Satisfactory Risk. Some ratios slightly weak. Overall ability to repay is adequate. Capable and generally proactive management in all critical positions. Margins and cash flow may lack stability but trends are stable to positive. Company normally profitable year to year but may experience an occasional loss.

0006 A - Weakness detected in either management, capacity to repay or balance sheet. Erratic profitability and financial performance. Loan demands more attention. Includes loans deemed to have weaknesses and less than 90 days past due.

0006 B - Have weaknesses that deserve management's close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or in the Bank's collateral position at some future date. Loans rated 6B are not adversely classified as they do not expose the Bank to sufficient risk to warrant adverse classification.

0007 - Well defined weaknesses and trends that jeopardize the repayment of loans. Ranging from workout to legal. Includes loans that are 90 days and over past due.

Below is a breakdown of loans by risk grading as of September 30, 2011 (dollar amounts in thousands):

		0001-0005		0006A		0006B		0007		Total
Commercial Loans	$	82,520	$	5,010	$	988	$	2,565	$	91,083
Real Estate - Commercial		246,463		35,502		8,454		38,834		329,253
Real Estate - Construction		38,609		6,352		3,333		6,705		54,999
		367,592		46,864		12,775		48,104		475,335
Real Estate - Residential		129,448		481		789		6,367		137,085
Consumer Loans		8,709		--		--		160		8,869
Obligations of States and                   Political Subdivisions		15,909		--		--		--		15,909
		154,066		481		789		6,527		161,863
	$	521,658	$	47,345	$	13,564	$	54,631		637,198
Deferred Origination Fees, net of costs										(404)
Total									$	636,794

Below is a breakdown of loss by risk grading as of December 31, 2010 (dollar amounts in thousands):

		0001-0005		0006A		0006B		0007		Total
Commercial Loans	$	61,733	$	5,964	$	3,590	$	2,641	$	73,928
Real Estate – Commercial		240,368		33,604		35,763		34,528		344,263
Real Estate – Construction		37,990		6,587		5,308		5,582		55,467
		340,091		46,155		44,661		42,751		473,658
Real Estate - Residential		120,529		715		1,846		6,359		129,449
Consumer Loans		9,985		--		--		240		10,225
Obligations of States and Political Subdivisions		16,892		--		--		--		16,892
		147,406		715		1,846		6,599		156,566
	$	487,497	$	46,870	$	46,507	$	49,350		630,224
Deferred Origination Fees, net of costs									$	(333)
Total										629,891

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Consolidated Statements Of Cash Flows (USD $) In Thousands	9 Months Ended
	Sep. 30, 2011	Sep. 30, 2010
CASH FLOWS FROM OPERATING ACTIVITIES
Net Income	$ 2,723	$ 1,655
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization	986	997
Amortization of debt issuance costs	26	39
Amortization of core deposit intangible		25
Goodwill on UFS option exercise		191
Provision for losses on loans	4,450	6,850
Provision for impairment of letters of credit	131	51
Net amortization of premium/discount on securities	1,754	1,056
Increase in cash surrender value of life insurance	(353)	(271)
Net gain on life insurance death benefit	(297)
Net realized gain on sale of securities	(392)	(1,406)
Net gain on sale of loans	(805)	(725)
Proceeds from sale of loans held for sale	52,313	46,580
Origination of loans held for sale	(47,367)	(47,817)
Net change in valuation of mortgage servicing rights	225	(26)
Provision for valuation allowance on foreclosed properties	1,517	1,374
Net (gain) loss on sale of premises and equipment	(7)	83
Net loss on sale of land held for sale	10
Net gain on disposals of foreclosed properties	(198)	(39)
Benefit for deferred income tax expense	(313)	(1,030)
Stock-based compensation expense	59
Income in equity of UFS subsidiary	(631)	(423)
Changes in assets and liabilities:
Accrued interest receivable and other assets	5,802	2,883
Payment to reduce LOC valuation allowance	(232)	(2,980)
Accrued expenses and other liabilities	1,109	944
Net cash flows provided by operating activities	20,510	8,011
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from sale of securities available for sale	25,696	53,779
Principal payments on securities available for sale	46,284	58,082
Purchase of securities available for sale	(40,141)	(155,651)
Proceeds from sale of foreclosed properties	6,798	1,560
Proceeds from sale of premises and equipment	11
Proceeds from sale of land held for sale	308
Loan originations and payments, net	(12,825)	11,992
Additions to premises and equipment	(474)	(936)
Proceeds from life insurance surrender	1,698
Proceeds from life insurance death benefit	457	59
Rabbi Trust initial funding	(1,626)
Net change in federal funds sold	1
Dividend from UFS Subsidiary	319	144
Net cash provided by (used in) investing activities	26,506	(30,971)
CASH FLOWS FROM FINANCING ACTIVITIES
Net change in deposits	5,778	13,725
Net change in federal funds purchased and repurchase agreements	1,227	1,349
Proceeds from Federal Home Loan Bank advances		40,000
Repayments on Federal Home Loan Bank advances	(15,000)	(55,000)
Debt offering costs paid		(6)
Proceeds from issuance of convertible promissory notes		4,100
Net cash provided by (used in) financing activities	(7,995)	4,168
Net change in cash and cash equivalents	39,021	(18,792)
Beginning cash	54,555	86,526
Ending cash	93,576	67,734
Supplemental cash flow information:
Interest paid	7,363	10,415
Income taxes refunded, net	2,526	1,704
Supplemental noncash disclosure:
Transfers from loans to foreclosed properties	2,827	3,398
Mortgage servicing rights resulting from sale of loans	$ 117	$ 83

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Earnings (Loss) Per Share

9 Months Ended

Sep. 30, 2011

Earnings (Loss) Per Share [Abstract]

Earnings (Loss) Per Share

3.             Earnings (Loss) Per Share

Diluted earnings (loss) 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 the weighted average number of common shares outstanding and common stock equivalents. The following table shows the computation of the basic and diluted earnings (loss) per share:

EARNINGS (LOSS) PER SHARE

(Dollar amounts in thousands, excluding per share data)

		Three months ended       September 30,			Nine months ended       September 30,
		2011		2010	2011		2010
(Numerator):
Net income (loss)	$	1,297	$	(512)	$	2,723	$	1,655
(Denominator):
Weighted average number of common shares outstanding-basic		7,911,539		7,911,539		7,911,539		7,911,539
Dilutive effect of stock options		-(1)		-(1)		-(1)		-(1)
Dilutive effect of convertible promissory notes		-(2)		-(2)		-(2)		-(2)
Dilutive effect of restricted stock units		5,215		-		3,500		-
Weighted average number of common shares outstanding-diluted		7,916,754		7,911,539		7,915,039		7,911,539
Basic Earnings (Loss) Per Share	$	0.16	$	(0.06)	$	0.34	$	0.21
Diluted Earnings (Loss) Per Share	$	0.16	$	(0.06)	$	0.34	$	0.21

(1)           At September 30, 2011 and 2010, there were 112,400 and 49,628 outstanding stock options, respectively, which are not included in the computation of diluted earnings per share because they are considered anti-dilutive.

(2)           At September 30, 2011 and 2010, we had $9.45 million of outstanding Convertible Promissory Notes (the "Convertible Notes").  The Convertible Notes are convertible into shares of our common stock at a conversion ratio of one share of common stock for each $5.00 in aggregate principal amount held on the record date of the conversion subject to certain adjustments as described in the Convertible Notes.  On October 1, 2014, one-half of the original principal amount of the Convertible Notes is mandatorily convertible at the conversion ratio if conversion has not occurred.  The mandatorily convertible principal of the Convertible Notes represents 945,000 shares, which are not included in the computation of diluted earnings per share because they are considered anti-dilutive.  The remaining half of the principal amount of Convertible Notes is convertible into an additional 945,000 common shares at the discretion of the respective holders.  These shares have not been included because of their anti-dilutive effect, if converted.

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Recent Accounting Pronouncements

9 Months Ended

Sep. 30, 2011

Recent Accounting Pronouncements [Abstract]

Recent Accounting Pronouncements

4.             Recent Accounting Pronouncements

In April 2011, the FASB issued ASU No. 2011-02, Receivables (Topic 310): A Creditor's Determination of Whether a Restructuring Is a Troubled Debt Restructuring. The ASU will improve financial reporting by creating greater consistency in the way GAAP is applied for various types of debt restructurings. The ASU clarifies which loan modifications constitute troubled debt restructurings. It is intended to assist creditors in determining whether a modification of the terms of a receivable meets the criteria to be considered a troubled debt restructuring, both for purposes of recording an impairment loss and for disclosure of troubled debt restructurings. The new guidance is effective for interim and annual periods beginning on or after June 15, 2011, and applies retrospectively to restructurings occurring on or after the beginning of the fiscal year of adoption. The provisions of this guidance are not expected to have a significant impact on our consolidated financial condition, results of operation or liquidity.

In May 2011, the FASB issued ASU No. 2011-03, Transfers and Servicing (Topic 860): Reconsideration of Effective Control for Repurchase Agreements. The ASU is intended to improve financial reporting of repurchase agreements ("repos") and other agreements that both entitle and obligate a transferor to repurchase or redeem financial assets before their maturity. The amendments to the codification in this ASU are intended to improve the accounting for these transactions by removing from the assessment of effective control the criterion requiring the transferor to have the ability to repurchase or redeem the financial assets. The guidance in the ASU is effective for the first interim or annual period beginning on or after December 15, 2011. The provisions of this guidance are not expected to have a significant impact on our consolidated financial condition, results of operation or liquidity.

In June 2011, the FASB issued ASU No. 2011-04, Fair Value Measurement (Topic 820):  Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs.  This ASU represents the converged guidance of the FASB and IASB (the Boards) on fair value measurement.  The collective efforts of the Boards and their staffs, reflected in ASU 2011-04, have resulted in common requirements for measuring fair value and for disclosing information about fair value measurements, including a consistent meaning of the term "fair value."  The Boards have concluded the common requirements will result in greater comparability of fair value measurements presented and disclosed in financial statements prepared in accordance with U.S. GAAP and IFRSs.  The amendments to the FASB Accounting Standards Codification (Codification) in this ASU are to be applied prospectively.  For public entities, the amendments are effective during interim and annual periods beginning after December 15, 2011.  Early application by public entities is not permitted.  The provisions of this guidance are not expected to have a significant impact on our consolidated financial condition, results of operations or liquidity.

In June 2011, the FASB issued ASU No. 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income. This ASU amends the Codification to allow an entity the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In both choices, an entity is required to present each component of net income along with total net income, each component of other comprehensive income along with a total for other comprehensive income, and a total number for comprehensive income. ASU 2011-05 eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders' equity. The amendments to the Codification in the ASU do not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income. ASU 2011-05 should be applied retrospectively. For public entities, the amendments are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. Early adoption is permitted. In October 2011, the FASB deferred the effective date of the amendment. No effective date has been established. The provisions of this guidance are not expected to have a significant impact on our consolidated financial condition, results of operations or liquidity.

In September 2011, the FASB issued ASU No. 2011-08, Intangibles-Goodwill and Other (Topic 350):  Testing Goodwill for Impairment.  ASU 2011-08 is intended to simplify how entities, both public and nonpublic, test goodwill for impairment.  ASU 2011-08 permits an entity to first assess qualitative factors to determine whether it is "more likely than not" that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test described in Topic 350, Intangibles-Goodwill and Other.  The more-likely-than-not threshold is defined as having a likelihood of more than 50%.  ASU 2011-08 is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011.  The provisions of this guidance are not expected to have a significant impact on our consolidated financial condition, results of operations or liquidity.

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Mortgage Servicing Rights

9 Months Ended

Sep. 30, 2011

Mortgage Servicing Rights [Abstract]

Mortgage Servicing Rights

12.          Mortgage Servicing Rights

We have obligations to service residential first mortgage loans and commercial loans that have been sold in the secondary market. Mortgage servicing rights ("MSRs") are recorded when loans are sold in the secondary market with servicing retained. On a quarterly basis MSRs are valued based on a valuation model that calculates the present value of estimated servicing income. The valuation model incorporates assumptions that market participants would use in estimating future net servicing income.

Changes in the carrying value of MSRs are as follows (dollar amounts in thousands):

MORTGAGE SERVICING RIGHTS

		For the three months ended September 30,					For the nine months ended September 30,
		2011		2010		2011			2010
Balance at beginning of period	$	722	$	679	$	746		$	609
Additions from loans sold with servicing retained		28		51		117			83
Changes in valuation		(74)		32		(73)			127
Loan payments and payoffs		(38)		(44)		(152)			(101)
Fair value of MSRs at the end of period	$	638	$	718	$	638		$	718

Unpaid principal balance of loans serviced for others were $81,457 and $75,923 at September 30, 2011 and September 30, 2010, respectively.

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Fair Value

9 Months Ended

Sep. 30, 2011

Fair Value [Abstract]

Fair Value

5.             Fair Value

Accounting guidance establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The guidance describes three levels of inputs that may be used to measure fair value:

Level 1:	Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.
Level 2:	Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.
Level 3:	Significant unobservable inputs that reflect a reporting entity's own assumptions about the assumptions that market participants would use in pricing an asset or liability.

The fair value of securities available for sale is determined by obtaining quoted prices on nationally recognized securities exchanges (Level 1 inputs) or matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities' relationship to other benchmark quoted securities (Level 2 inputs).

The fair value of mortgage servicing rights is based on a valuation model that calculates the present value of estimated net servicing income. The valuation model incorporates assumptions that market participants would use in estimating future net servicing income. These assumptions include servicing costs, expected loan lives, discount rates, and the determination of whether the loan is likely to be refinanced. We compare the valuation model inputs and results to widely available published industry data for reasonableness (Level 2 inputs).

The fair value of foreclosed properties is determined using a variety of market information including but not limited to appraisals, professional market assessments and real estate tax assessment information. Foreclosed properties are carried at the lower of amortized cost at date of transfer or fair value less estimated costs to sell (Level 3 inputs).

The fair value of loans held for sale is based on quoted market prices (Level 2 inputs).

The fair value of impaired loans 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 the estimated costs to sell.  Impaired loans do not require an allowance if the fair value of the expected repayments or collateral exceeds the investments in such loans.  Impaired loans are carried at the lower of amortized cost or fair value (Level 3 inputs). 

Assets measured at fair value on a recurring basis are summarized below:

		September 30, 2011		Quoted Prices in Active Markets For Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
Securities available for sale:
U.S. government-sponsored agency securities	$	20,858	$	-	$	20,858	$	-
Mortgage-backed securities		142,593		-		142,593		-
Asset-backed securities		5,125		-		5,125		-
Obligations of states and political subdivisions		56,461		-		56,461		-
Private placement and corporate bonds		12,378		-		12,378		-
Other securities		2,268		-		2,268		-
Total securities available for sale		239,683		-		239,683		-
Mortgage servicing rights		638		-		638		-
Loans held for sale		2,180		-		2,180		-
Total	$	242,501	$	-	$	242,501	$	-

		December 31, 2010		Quoted Prices in Active Markets For Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
Securities available for sale:
U.S. government-sponsored agency securities	$	33,753	$	-	$	33,753	$	-
Mortgage-backed securities		159,646		-		159,646		-
Asset-backed securities		5,536		-		5,536		-
Obligations of states and political subdivisions		52,853		-		52,853		-
Private placement and corporate bonds		12,537		-		12,537		-
Other securities		2,435		-		2,435		-
Total securities available for sale		266,760		-		266,760		-
Mortgage servicing rights		746		-		746		-
Loans held for sale		6,488		-		6,488
Total	$	273,994	$	-	$	273,994	$	-

       

Assets measured at fair value on a non-recurring basis are summarized below:

		September 30, 2011		Quoted Prices in Active Markets For Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
Impaired loans	$	14,183	$	-	$	-	$	14,183
Foreclosed properties		10,662		-		-		10,662
Total	$	24,845	$	-	$	-	$	24,845

		December 31, 2010		Quoted Prices in Active Markets For Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
Impaired loans	$	7,676	$	-	$	-	$	7,676
Foreclosed properties		15,952		-		-		15,952
Total	$	23,628	$	-	$	-	$	23,628

Required Financial Disclosures about Fair Value of Financial Instruments

The accounting guidance for financial instruments requires disclosures of estimated fair value of certain financial instruments and the methods and significant assumptions used to estimate their fair values. Certain financial instruments and all nonfinancial instruments are excluded from the scope of this guidance. Accordingly, the fair value disclosures required by this guidance are only indicative of the value of individual financial instruments as of the dates indicated and should not be considered an indication of our fair value.

	(Dollar amounts in thousands)
	September 30, 2011					December 31, 2010
		Carrying Amount		Fair Value			Carrying Amount		Fair Value
FINANCIAL ASSETS
Cash	$	93,576	$	93,576	$		54,555	$	54,555
Federal funds sold		-		-			1		1
Securities available for sale		239,683		239,683			266,760		266,760
Loans held for sale		2,142		2,180			6,400		6,488
Loans, net		623,937		627,942			618,389		622,273
Cash value of life insurance		22,966		22,966			24,472		24,472
Federal Home Loan Bank stock		6,792		6,792			6,792		6,792
Accrued interest receivable		3,441		3,441			4,165		4,165
FINANCIAL LIABILITIES
Deposits	$	858,344	$	859,703	$		852,566	$	854,598
Repurchase agreements		20,463		20,463			19,236		19,236
Federal Home Loan Bank advances		55,000		55,000			70,000		71,525
Subordinated debentures		16,100		16,100			16,100		16,100
Convertible promissory notes		9,450		9,630			9,450		9,224
Accrued interest payable		1,286		1,286			1,239		1,239
Off-balance sheet credit related items:
Letters of credit	$	635	$	635	$		737	$	737

The methods and assumptions used to estimate fair value are described as follows:

(a)           Cash

Due to their short-term nature, the carrying amount approximates fair value.

(b)           Securities Available for Sale

Fair values for securities available for sale are based on market prices or other inputs that are observable or can be corroborated by observable market data.

(c)           Loans Held for Sale

The fair value of loans held for sale is based on actual market quotes from third party investors.

(d)           Loans, net

For variable-rate loans that reprice frequently, fair values are based on carrying value. Fair values for other loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms. Impaired loans are valued at the lower of cost or fair value. Fair value is measured based on the value of the underlying collateral securing those loans less the cost of sale. This evaluation may include obtaining supplemental market data and/or routine site visits to offer support to the valuation process.

(e)           Cash Value of Life Insurance

The fair value of life insurance approximates the carrying amount, because upon liquidation of these investments, we would receive the cash surrender value, which equals the carrying amount.

(f)            Federal Home Loan Bank Stock

It is not practical to determine the fair value of Federal Home Loan Bank ("FHLB") stock due to restrictions placed on its transferability. No secondary market exists for FHLB stock. The stock is bought and sold at par by the FHLB. Management believes that the recorded value is fair value.

(g)           Accrued Interest Receivable

The carrying amount of accrued interest receivable approximates fair value.

(h)           Deposits

The carrying amount of demand deposits (interest-bearing and non-interest-bearing), savings deposits, and money market deposits approximates fair value. The carrying amount of variable rate time deposits, including certificates of deposit, approximates fair value. For fixed rate time deposits, fair value is based on discounted cash flows using current market interest rates.

(i)            Repurchase Agreements

The carrying amount of repurchase agreements approximates fair value.

(j)            Federal Home Loan Bank Advances

The carrying amount of variable rate FHLB advances approximates fair value. For fixed rate advances, fair value is based on discounted cash flows using current market interest rates.

(k)           Subordinated Debentures

The carrying amount of variable rate subordinated debentures approximates fair value.

(l)            Convertible Promissory Notes

The fair value of fixed rate convertible promissory notes is based on discounted cash flows using current market interest rates.

(m)          Accrued Interest Payable

The carrying amount of accrued interest payable approximates fair value.

(n)           Off Balance Sheet Credit Related Items-Letters of Credit

The carrying amount of the off balance sheet letters of credit approximates fair value based on management's evaluation of the factors affecting the letters of credit.

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Supervisory Agreement

9 Months Ended

Sep. 30, 2011

Supervisory Agreement [Abstract]

Supervisory Agreement

15.Supervisory Agreement

On December 23, 2010, we and the Bank entered into a Written Agreement (the "Written Agreement") with the Federal Reserve Bank and the Wisconsin Department of Financial Institutions ("WDFI").Under the terms of the Written Agreement, the Bank has agreed to develop and submit for approval within the time periods specified therein written plans to: (i) further reduce the Bank's concentration of commercial real estate loans; (ii) improve the Bank's position with respect to loans, relationships, or other assets in excess of $0.5 million which are now or in the future become past due more than 90 days, are on the Bank's problem loan list, or are adversely classified in any report of examination of the Bank; (iii) review and revise, as appropriate, the Bank's current policy for determining, documenting and recording an adequate allowance for loan losses and maintain sound processes for compliance with the same; and (iv) improve the Bank's earnings and overall condition. 

In addition, the Bank has agreed that it will: (i) not extend, renew or restructure any credit that has been criticized by the Federal Reserve Bank or the WDFI absent prior board of directors' approval in accordance with the restrictions in the Written Agreement; and (ii) eliminate all assets or portions of assets classified as "loss" and thereafter charge off all assets classified as "loss" in a federal or state report of examination, unless otherwise approved by the Federal Reserve Bank. In addition, the Bank has agreed that it will: (a) not take any other form of payment representing a reduction in the Bank's capital or make any distributions of interest, principal or other sums on subordinated debentures or trust preferred securities absent prior regulatory approval; (b) refrain from incurring or guaranteeing any debt without the prior written approval of the Federal Reserve Bank; and (c) refrain from purchasing or redeeming any shares of our stock without the prior written consent of the Federal Reserve Bank.

Under the terms of the Written Agreement, both we and the Bankhave agreed to: (i) submit for approval plans to maintain sufficient capital on a consolidated basis, and the Bank, on a stand-alone basis; (ii) comply with applicable notice provisions with respect to the appointment of new directors and senior executive officers and legal and regulatory limitations on indemnification payments and severance payments; and (iii) refrain from declaring or paying dividends absent prior regulatory approval. Failure to comply with the provisions of the Written Agreement could result in the imposition of additional restrictions and/or sanctions by the Federal Reserve Bank and WDFI and could have a material adverse effect on our consolidated financial condition and results of operations.

                As of the date of this filing, we and the Bank have complied with all terms of the Written Agreement.

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Consolidated Statement Of Changes In Stockholders' Equity And Comprehensive Income (USD $) In Thousands, except Share data	Common Stock [Member]	Additional Paid-In Capital [Member]	Retained Earnings [Member]	Treasury Stock [Member]	Accumulated Other Comprehensive Income [Member]	Total
Balance at Dec. 31, 2010	$ 40,662	$ 11,980	$ 26,965	$ (3,549)	$ 1,009	$ 77,067
Balance, shares at Dec. 31, 2010	7,911,539
Net income for the period			2,723			2,723
Net changes in unrealized gain on securities available for sale					6,516	6,516
Reclassification adjustment for net gains realized in income					(392)	(392)
Tax effect					(2,419)	(2,419)
Total comprehensive income						6,428
Stock-based compensation expense		59				59
Balance at Sep. 30, 2011	$ 40,662	$ 12,039	$ 29,688	$ (3,549)	$ 4,714	$ 83,554
Balance, shares at Sep. 30, 2011	7,911,539

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Basis Of Presentation	9 Months Ended
	Sep. 30, 2011
Basis of Presentation [Abstract]
Basis Of Presentation	1.The accompanying interim consolidated financial statements should be read in conjunction with our 2010 Annual Report on Form 10-K. The accompanying consolidated financial statements are unaudited. These interim consolidated 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 ("GAAP") for complete financial statements. In the opinion of management, the unaudited consolidated financial information included in this report reflects all adjustments, consisting of normal recurring accruals of operations for the nine month periods ending September 30, 2011 and 2010. The consolidated results of operations for the three and nine months ended September 30, 2011 are not necessarily indicative of results to be expected for the entire year. We have evaluated all subsequent events through November 9, 2011, the date the interim consolidated financial statements were issued.

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Income Taxes

9 Months Ended

Sep. 30, 2011

Income Taxes [Abstract]

Income Taxes

10.          Income Taxes

In accordance with the accounting guidance for income taxes, deferred income taxes are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred income tax assets and liabilities are measured using enacted tax rates that will apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred income tax assets and liabilities of a change in tax rates is recognized as income or expense in the period that includes the enactment date.

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. The amount recognized is the largest amount of tax benefit that has a greater than 50% chance of being realized on examination. For tax positions not meeting the "more likely than not" test, no tax benefit is recorded.

We regularly review the carrying amount of our deferred income tax assets to determine if the establishment of a valuation allowance is necessary. If, based on the available evidence, it is more likely than not that all or a portion of our deferred income tax assets will not be realized in future periods, a deferred income tax valuation allowance would be established. Consideration is given to various positive and negative factors that could affect the realization of the deferred income tax assets. In evaluating available evidence, management considers, among other things, historical financial performance, expectation of future earnings, the ability to carry back losses to recoup taxes previously paid, length of statutory carry forward periods, experience with operating loss and tax credit carry forwards not expiring unused, tax planning strategies and timing of reversals of temporary differences. Significant judgment is required in assessing future earning trends and the timing of reversals of temporary differences. Our evaluation is based on current tax laws as well as management's expectations of future performance. At September 30, 2011 and December 31, 2010, we determined that no valuation allowance was required to be taken against our deferred income tax asset other than a valuation allowance to reduce our state net operating loss carry forwards to an amount which we believe the benefit will more likely than not be realized. We continue to assess the amount of tax benefits we may realize.

We are subject to the income tax laws of the U.S., its states and municipalities.  These tax laws are complex and subject to different interpretations by the taxpayer and the relevant Governmental taxing authorities.   Accounting guidance related to uncertainty in income taxes prescribes a comprehensive model for how companies should recognize, measure, present, and disclose in their financial statements uncertain tax positions taken or expected to be taken on a tax return.  Under the guidance, tax positions shall initially be recognized in the financial statements when it is more likely than not the position will be sustained upon the examination by the tax authorities.  Such tax positions shall initially and subsequently be measured as the largest amount of tax benefit that has a greater than 50% chance of being realized upon ultimate settlement with the tax authority assuming full knowledge of the position and all relevant facts.  The guidance also revises disclosure requirements to include an annual tabular roll forward of unrecognized tax benefits.  In establishing a provision for income tax expense, we must make judgments and interpretations about the application of these inherently complex tax laws within the framework existing under GAAP.  We recognize interest and/or penalties related to income tax matters in income tax expense.

During the second quarter of 2011, the IRS began an audit of our 2009 federal income tax return primarily due to our net operating loss carry back claim. As of September 30, 2011, the audit is on-going and we anticipate this audit may not be concluded until early 2012.

Changes in the deferred income tax balances were as follows (dollar amounts in thousands):

Deferred income taxes – Available for sale securities

		For the nine months ended September 30,
		2011		2010
Balances at beginning of period	$	(659)	$	333
Net change during period		(2,419)		(2,415)
Balances at end of period	$	(3,078)	$	(2,082)

Deferred income taxes – Other than available for sale securities

		For the nine months ended September 30,
		2011		2010
Balances at beginning of period	$	9,861	$	8,523
Net change during period		313		1,030
Balances at end of period	$	10,174	$	9,553

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Troubled Debt Restructuring

9 Months Ended

Sep. 30, 2011

Troubled Debt Restructuring [Abstract]

Troubled Debt Restructuring

14.          Troubled Debt Restructuring

A troubled debt restructuring ("TDR") includes a loan modification where a borrower is experiencing financial difficulty and we grant a concession to that borrower that we would not otherwise consider except for the borrower's financial difficulties. A TDR may be either accrual or nonaccrual status based upon the performance of the borrower and management's assessment of collectability. If a TDR is placed on nonaccrual status, it remains there until a sufficient period of performance under the restructured terms has occurred at which time it is returned to accrual status, generally six months.

(Dollar amounts in thousands)

			Construction Loans				Real Estate-Mortgage					Real Estate-Commercial					Commercial					Consumer					Municipal					Total
Accruing
December 31, 2010	$	--			$			44		$			12,661		$			386			$			--		$			--	$			13,091
Principal payments		--						(2)					(246)					(9)						--					--				(257)
Charge-offs		--						--					(174)					(160)						--					--				(334)
Advances		--						--					40					--						--					--				40
New restructured		--						1,391					11,653					--						--					--				13,044
Class transfers		--						--					(160)					160						--					--				--
Transfers between nonaccrual		--						--					(5,123)					--						--					--				(5,123)
September 30, 2011	$	--			$			1,433		$			18,651		$			377			$			--		$			--	$			20,461
Nonaccrual
December 31, 2010	$			--		$			--		$			586		$			18	$			20		$			--			$			624
Principal payments				--					--					(295)					(2)				--					--						(297)
Charge-offs				--					--					(172)					--				--					--						(172)
Advances				--					--					9					--				--					--						9
New Restructured				--					--					--					--				--					--						--
Class transfers				--					--					--					--				--					--						--
Transfers between accruing				--					--					5,123					--				--					--						5,123
September 30, 2011	$			--		$			--		$			5,251		$			16	$			20		$			--			$			5,287

A summary of troubled debt restructurings as of September 30, 2011 and December 31, 2010 is as follows (dollar amounts in thousands):

	September 30, 2011				December 31, 2010
		Number of Modifications		Recorded Investment		Number of Modifications		Recorded Investment
Construction		--	$	--		--	$	--
Real estate – mortgage		3		1,433		1		44
Real estate – commercial		22		23,902		19		13,247
Commercial		2		393		2		404
Consumer		1		20		1		20
Municipal		--		--		--		--
Total		28	$	25,748		23	$	13,715

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Consolidated Balance Sheets (USD $) In Thousands	Sep. 30, 2011	Dec. 31, 2010
ASSETS
Cash and due from financial institutions	$ 93,576	$ 54,555
Federal funds sold		1
Cash and cash equivalents	93,576	54,556
Securities available for sale	239,683	266,760
Loans held for sale	2,142	6,400
Loans, net of allowance of $12,857 and $11,502 at September 30, 2011 and December 31, 2010, respectively	623,937	618,389
Cash surrender value of life insurance	22,966	24,472
Premises and equipment, net	23,088	23,604
Federal Home Loan Bank stock	6,792	6,792
Foreclosed properties, net	10,662	15,952
Goodwill	6,641	6,641
Deferred income taxes	7,096	9,202
Accrued interest receivable	3,441	4,165
Other assets	11,929	15,520
Total Assets	1,051,953	1,052,453
LIABILITIES AND STOCKHOLDERS' EQUITY
Noninterest-bearing	107,277	84,552
Interest-bearing	751,067	768,014
Total Deposits	858,344	852,566
Federal Home Loan Bank advances	55,000	70,000
Repurchase agreements	20,463	19,236
Subordinated debentures	16,100	16,100
Convertible promissory notes	9,450	9,450
Accrued expenses and other liabilities	9,042	8,034
Total Liabilities	968,399	975,386
Common stock, $5 par value, authorized 50,000,000 shares; Issued-8,132,552 shares at September 30, 2011 and December 31, 2010; Outstanding-7,911,539 shares at September 30, 2011 and December 31, 2010	40,662	40,662
Additional paid-in capital	12,039	11,980
Retained earnings	29,688	26,965
Treasury stock (221,013 shares at September 30, 2011 and December 31, 2010)	(3,549)	(3,549)
Accumulated other comprehensive income	4,714	1,009
Total Stockholders' Equity	83,554	77,067
Total Liabilities and Stockholders' Equity	$ 1,051,953	$ 1,052,453