-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, WCGAP7rISiv6aswfF85sotKOBAdwJD8ZXGwgGGd3E6iQxWgkKckDIMIsppVPVk7q 4Clw5V2owHFScflalyFwHQ== 0000950137-06-005681.txt : 20060510 0000950137-06-005681.hdr.sgml : 20060510 20060510112514 ACCESSION NUMBER: 0000950137-06-005681 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 20060331 FILED AS OF DATE: 20060510 DATE AS OF CHANGE: 20060510 FILER: COMPANY DATA: COMPANY CONFORMED NAME: BAYLAKE CORP CENTRAL INDEX KEY: 0000275119 STANDARD INDUSTRIAL CLASSIFICATION: STATE COMMERCIAL BANKS [6022] IRS NUMBER: 391268055 STATE OF INCORPORATION: WI FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-16339 FILM NUMBER: 06824129 BUSINESS ADDRESS: STREET 1: 217 N FOURTH AVE STREET 2: PO BOX 9 CITY: STURGEON BAY STATE: WI ZIP: 54235-0009 BUSINESS PHONE: 9207435551 10-Q 1 c05212e10vq.txt QUARTERLY REPORT UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2006 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ______________ to ___________________ Commission file number 0-8679 BAYLAKE CORP. (Exact name of registrant as specified in its charter) Wisconsin 39-1268055 (State or other jurisdiction (Identification No.) of incorporation or organization)
217 North Fourth Avenue, Sturgeon Bay, WI 54235 (Address of principal executive offices) (Zip Code)
(920)-743-5551 (Registrant's telephone number, including area code) None (Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ----- ----- Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of "accelerated filer" and "large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check one): Large accelerated filer [ ] Accelerated filer [X] Non-accelerated filer [ ] Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes No X ----- ----- Applicable Only to Corporate Issuers: Number of outstanding shares of common stock as of May 1, 2006: 7,800,427 shares BAYLAKE CORP. AND SUBSIDIARIES INDEX
PAGE NO. -------- PART I - FINANCIAL INFORMATION Item 1. Financial Statements Consolidated Balance Sheets (Unaudited) as of March 31, 2006 and December 31, 2005 3 Consolidated Statements of Income and Comprehensive Income (Unaudited) for the three months ended March 31, 2006 and 2005 4 Consolidated Statements of Changes in Stockholders' Equity (Unaudited) for the three months ended March 31, 2006 and 2005 5 Consolidated Statements of Cash Flows (Unaudited) for the three months ended March 31, 2006 and 2005 6-7 Notes to Unaudited Consolidated Financial Statements 8-10 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 11-33 Item 3. Quantitative and Qualitative Disclosures About Market Risk 33-34 Item 4. Controls and Procedures 34-35 PART II - OTHER INFORMATION Signatures 36 EXHIBIT INDEX Exhibit 31.1 Certification pursuant to Section 302 37 Exhibit 31.2 Certification pursuant to Section 302 39 Exhibit 32.1 Certification pursuant to 18 U.S.C. Section 1350 41 Exhibit 32.2 Certification pursuant to 18 U.S.C. Section 1350 42
BAYLAKE CORP. CONSOLIDATED BALANCE SHEETS (Unaudited) March 31, 2006 and December 31, 2005 (Amounts in thousands of dollars)
March 31, December 31, 2006 2005 ---------- ------------ ASSETS Cash and due from financial institutions $ 24,443 $ 32,855 Federal funds sold 117 199 ---------- ---------- Cash and cash equivalents 24,560 33,054 Securities available for sale 173,384 171,638 Loans held for sale 475 374 Loans, net of allowance after $9,738 and $9,551 822,274 802,745 Cash value of life insurance 23,623 22,814 Premises held for sale 1,168 1,167 Premises and equipment, net 24,759 24,703 Federal Home Loan Bank stock 8,081 8,081 Foreclosed assets, net 1,799 3,333 Goodwill 5,723 5,723 Accrued interest receivable 5,877 5,354 Other assets 10,445 10,422 ---------- ---------- Total assets $1,102,168 $1,089,408 ========== ========== LIABILITIES AND STOCKHOLDERS' EQUITY Deposits Non-interest-bearing $ 93,835 $ 110,641 Interest-bearing 757,251 746,070 ---------- ---------- Total deposits 851,086 856,711 Federal Home Loan Bank advances 120,184 125,185 Federal funds purchased and repurchase agreements 25,860 1,315 Subordinated debentures 16,100 16,100 Accrued expenses and other liabilities 10,432 10,310 Dividends payable -- 1,243 Total liabilities 1,023,662 1,010,864 ---------- ---------- Common stock, $5 par value, authorized 50,000,000 shares; issued- 7,823,586 shares in 2006, 7,805,586 shares in 2005; outstanding- 7,800,427 shares in 2006, 7,782,427 shares in 2005 39,118 39,028 Additional paid-in capital 9,620 9,466 Retained earnings 32,539 32,461 Treasury stock (23,159 shares in 2006 and 2005) (625) (625) Accumulated other comprehensive loss (2,146) (1,786) ---------- ---------- Total stockholders' equity 78,506 78,544 ---------- ---------- Total liabilities and stockholder equity $1,102,168 $1,089,408 ========== ==========
See accompanying notes to Unaudited Consolidated Financial Statements. 3 BAYLAKE CORP. CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (Unaudited) Three months ended March 31, 2006 and 2005 (Amounts in thousands of dollars except per share data)
2006 2005 ------- ------- Interest and dividend income Loans, including fees $14,664 $11,663 Taxable securities 1,571 1,729 Tax exempt securities 360 403 Federal funds sold and other 51 17 ------- ------- Total interest and dividend income 16,646 13,812 Interest expense Deposits 6,342 3,827 Federal funds purchased and repurchase agreements 175 173 Federal Home Loan Bank advances and other debt 1,362 737 Subordinated debentures 889 461 ------- ------- Total interest expense 8,768 5,198 ------- ------- NET INTEREST INCOME 7,878 8,614 Provision for loan losses 200 30 ------- ------- NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 7,678 8,584 Other income Fees from fiduciary activities 301 179 Fees from loan servicing 260 283 Fees for other services to customers 1,139 1,098 Gains from sales of loans 201 208 Increase in cash surrender value of life insurance 226 227 Other income 111 268 ------- ------- Total other income 2,238 2,263 Noninterest expenses Salaries and employee benefits 4,992 4,528 Occupancy expense 579 536 Equipment expense 395 307 Data processing and courier 300 278 Operation of other real estate 43 48 Other operating expenses 1,815 1,348 ------- ------- Total other expenses 8,124 7,045 ------- ------- INCOME BEFORE INCOME TAX EXPENSE 1,792 3,802 Income tax expense 468 1,218 ------- ------- NET INCOME $ 1,324 $ 2,584 ======= ======= COMPREHENSIVE INCOME $ 964 $ 592 ======= ======= Basic earnings per common share $ 0.17 $ 0.34 Diluted earnings per common share $ 0.17 $ 0.33
See accompanying notes to Unaudited Consolidated Financial Statements 4 BAYLAKE CORP. CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (Unaudited) Three months ended March 31, (Amounts in thousands of dollars except for per share data)
Accumulated Common Stock Additional Other ------------------- Paid-in Retained Treasury Comprehensive Total Shares Amount Capital Earnings Stock Income Equity --------- ------- ---------- -------- -------- ------------- ------- BALANCE, JANUARY 1, 2005 7,692,777 $38,580 $8,806 $28,275 $(625) $ 1,169 $76,205 Net income for the period -- -- -- 2,584 -- -- 2,584 Net changes in unrealized gain (loss) on securities available for sale, net of $(1,108) deferred taxes -- -- -- -- -- (1,992) (1,992) ------- Total comprehensive income 592 Stock options exercised 5,000 25 24 -- -- -- 49 Tax benefit from exercise of stock options -- -- 15 -- -- -- 15 Cash dividends declared ($0.15 per share) -- -- -- (1,155) -- -- (1,155) --------- ------- ------ ------- ----- ------- ------- BALANCE, MARCH 31, 2005 7,697,777 $38,605 $8,845 $29,704 $(625) $ (823) $75,706 ========= ======= ====== ======= ===== ======= ======= BALANCE, JANUARY 1, 2006 7,782,427 $39,028 $9,466 $32,461 $(625) $(1,786) $78,544 Net income for the period -- -- -- 1,324 -- -- 1,324 Net changes in unrealized gain (loss) on securities available for sale, net of $(201) deferred taxes -- -- -- -- -- (360) (360) ------- Total comprehensive income 964 Stock options exercised 18,000 90 71 -- -- -- 161 Stock compensation expense recognized -- -- 13 -- -- -- 13 Tax benefit from exercise of stock options -- -- 70 -- -- -- 70 Cash dividends declared ($0.16 per share) -- -- -- (1,246) -- -- (1,246) --------- ------- ------ ------- ----- ------- ------- BALANCE, MARCH 31, 2006 7,800,427 $39,118 $9,620 $32,539 $(625) $(2,146) $78,506 ========= ======= ====== ======= ===== ======= =======
See accompanying notes to Unaudited Consolidated Financial Statements 5 BAYLAKE CORP. CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) Three months ended March 31, 2006 and 2005 (Amounts in thousands of dollars)
2006 2005 -------- -------- CASH FLOWS FROM OPERATING ACTIVITIES: Reconciliation of net income to net cash provided by operating activities: Net income $ 1,324 $ 2,584 Adjustments to reconcile net income to net cash provided to operating activities: Depreciation 402 361 Amortization of debt issuance costs 475 59 Amortization of core deposit intangible 13 13 Provision for losses on loans 200 30 Net amortization of securities 44 163 Increase in cash surrender value of life insurance (226) (227) Federal Home Loan Bank stock dividend -- (106) Net gain on sale of loans (201) (208) Proceeds from sale of loans held for sale 9,003 8,499 Origination of loans held for sale (8,904) (7,754) Provision for valuation allowance on other real estate owned 47 20 Net gain from disposal of other real estate (78) (41) Net loss from disposal of premises and equipment 2 -- Stock option compensation expense recognized 13 -- Tax benefit from exercises of stock options (70) -- Changes in assets and liabilities: Accrued interest receivable and other assets (694) 260 Accrued expenses and other liabilities 122 115 -------- -------- Net cash provided by operating activities 1,473 3,768 CASH FLOWS FROM INVESTING ACTIVITIES: Principal payments on securities available-for-sale 4,195 2,938 Purchase of securities available-for-sale (6,545) (10,530) Proceeds from sale of other real estate owned 1,764 215 Proceeds from sale of premises and equipment -- 157 Loan originations and payments, net (19,928) (26,847) Additions to premises and equipment (461) (2,273) Investment in bank-owned life insurance (583) (470) -------- -------- Net cash used in investing activities (21,558) (36,810)
See accompanying notes to Unaudited Consolidated Financial Statements 6 BAYLAKE CORP. CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) Three months ended March 31, 2006 and 2005 (Amounts in thousands of dollars)
2006 2005 -------- -------- CASH FLOWS FROM FINANCING ACTIVITIES: Net change in deposits $ (5,625) $(14,583) Net change in federal funds purchased and repurchase agreements 24,545 24,210 Proceeds from Federal Home Loan Bank advances 10,000 15,000 Repayments on Federal Home Loan Bank advances (15,001) (2) Redemption of subordinated debt (16,100) -- Proceeds from issuance of subordinated debt 16,100 -- Proceeds from exercise of stock options 161 49 Cash dividends paid (2,489) (2,309) -------- -------- Net cash provided by financing activities 11,591 22,365 -------- -------- Net change in cash and cash equivalents (8,494) (10,677) Beginning cash and cash equivalents 33,054 26,172 -------- -------- ENDING CASH AND CASH EQUIVALENTS $ 24,560 $ 15,495 ======== ========
See accompanying notes to Unaudited Consolidated Financial Statements 7 BAYLAKE CORP. NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 2006 1. The accompanying consolidated financial statements should be read in conjunction with Baylake Corp.'s 2005 annual report on Form 10-K. The accompanying consolidated financial statements are unaudited. These interim financial statements are prepared in accordance with the requirements of Form 10-Q, and accordingly do not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements. In the opinion of management, the unaudited financial information included in this report reflects all adjustments, consisting of normal recurring accruals, which are necessary for a fair statement of the financial position as of March 31, 2006 and December 31, 2005. The results of operations for the three months ended March 31, 2006 are not necessarily indicative of results to be expected for the entire year. 2. To prepare financial statements in conformity with U.S. generally accepted accounting principles, management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided, and actual results could differ. The allowance for loan losses, foreclosed assets, and fair values of financial instruments are particularly subject to change. 3. Diluted earnings per share, which reflects the potential dilution that could occur if outstanding stock options were exercised and stock awards were fully vested and resulted in the issuance of common stock that then shared in the earnings of the Company, is computed by dividing net income by weighted average number of common shares and common stock equivalents. The following table shows the computation of the basic and diluted earnings per share for the three months ended March 31 (dollars in thousands, except per share amounts):
Three months ended March 31, ---------------------------- 2006 2005 ---------- ---------- (NUMERATOR): Net income $ 1,324 $ 2,584 (DENOMINATOR): Weighted average number of common shares outstanding-basic 7,784,960 7,695,721 Dilutive effect of stock options 53,796 100,849 ---------- ---------- Weighted average of common shares outstanding and assumed conversion-diluted 7,838,756 7,796,570 BASIC EPS $ 0.17 $ 0.34 DILUTED EPS $ 0.17 $ 0.33
See accompanying notes to Unaudited Consolidated Financial Statements 8 BAYLAKE CORP. 4. Baylake Corp. declared a cash dividend of $0.16 per share payable on March 15, 2006 to shareholders of record as of March 1, 2006. 5. The Company has a non-qualified stock option plan, which is described more fully in the Company's December 31, 2005 Annual Report on Form 10-K. Beginning in 2006, the Company accounts for stock compensation expense under the provisions of FASB Statement No. 123R, "Accounting for Stock-Based Compensation" ("FAS 123R") on a modified prospective basis. FAS 123R requires all public companies to record compensation cost for stock options provided to employees in return for employee service. The cost is measured at the fair value of the options when granted, and this cost is expensed over the employment service period, which is normally the vesting period of the options. This applies to awards granted, modified or vesting in fiscal years beginning in 2006. Compensation cost is recorded for prior option grants that vest after the date of adoption. The effect on results of operations will depend on the level of future option grants and the calculation of the fair value of the options granted at such future date, as well as the vesting periods provided, and so cannot currently be predicted. The Company may no longer issue stock options under the current plan and thus there will be no further grants thereunder. Existing options that will vest after the adoption date are expected to result in an immaterial amount of compensation expense during 2006 through 2008. For the first quarter of 2006, the amount of compensation expense reflected in the financial statements is $13,000. As a matter of comparing the first quarter in 2006 with 2005, the following table illustrates the effect on net income and earnings per share if the Company had applied the fair value provisions of SFAS 123 "Accounting for Stock-Based Compensation," to stock-based employee compensation for periods prior to January 1, 2006.
Three months ended March 31, 2005 --------------------- Amounts in thousands, except per share data Net income, as reported $2,584 Less: Total stock-based employee compensation cost determined under the fair value based method, net of income taxes (14) ------ Pro forma net income $2,570 Earnings per share: Basic - as reported $ 0.34 Basic - pro forma $ 0.33 Diluted - as reported $ 0.33 Diluted - pro forma $ 0.33
See accompanying notes to Unaudited Consolidated Financial Statements 9 BAYLAKE CORP. The fair value of each option granted was estimated as of the date of grant using the Black-Scholes option pricing model. The resulting compensation cost was amortized over the vesting period. The following table indicates the options outstanding at March 31, 2006. A market price of $16.40 was used to compute intrinsic value for March 31, 2006, which was the closing market price on that date. Fully vested options include only those share options that have vested or are expected to vest at March 31, 2006 and have economic value.
Weighted-average Aggregate intrinsic Weighted average remaining Description of options Number of shares exercise price value (In thousands) life (In years) - ---------------------- ---------------- ---------------- -------------------- -------------------------- Options outstanding 408,869 $12.55 $1,575 3.3 Options exercisable 367,512 $12.43 $1,457 3.3
There were 18,000 options exercised during the three months ended March 31, 2006 amounting to $135,780 in intrinsic value. 6. The Company has redeemed on March 31, 2006 all of its 10.00% Cumulative Trust Preferred Securities (the "Trust Preferred Securities") and its 10.00% Common Securities (the "Trust Common Securities") at a redemption price equal to the $10.00 liquidation amount of each security plus all accrued and unpaid interest per security to March 31, 2006, the redemption date through Baylake Capital Trust I (the "Trust"). The Trust has taken such action in connection with the concurrent redemption by Baylake Corp. of all of its $16.6 million 10.00% debentures due March 31, 2031 (the "Debentures") which are held exclusively by the Trust. The Debentures were redeemed on March 31, 2006 at a redemption price equal to the principal outstanding of the Debentures plus interest accrued on the Debentures up to March 31, 2006. In connection with the redemption of the Debentures, the Company expensed during the first quarter $475,015, net of tax, of unamortized origination cost associated with the Debentures. The Company has funded the redemption through the issuance of $16.1 million of trust preferred securities and $498,000 of trust common securities that will adjust quarterly at a rate equal to 1.35% over the three-month LIBOR. The initial rate for the second quarter will be 6.31%. See accompanying notes to Unaudited Consolidated Financial Statements 10 PART 1 - FINANCIAL INFORMATION ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL Baylake is a full-service financial services company, providing a wide variety of loan, deposit and other banking products and services to its business, individual or retail, and municipal customers, as well as a full range of trust, investment and cash management services. The Company is the bank holding company of Baylake Bank ("Bank"), chartered as a state bank in Wisconsin and a member bank of the Federal Reserve and Federal Home Loan Bank. The following sets forth management's discussion and analysis of the consolidated financial condition and results of operations of Baylake Corp. ("Baylake" or the "Company") for the three months ended March 31, 2006 and 2005 which may not be otherwise apparent from the consolidated financial statements included in this report. Unless otherwise stated, the "Company" or "Baylake" refers to this entity and to its subsidiaries on a consolidated basis when the context indicates. For a more complete understanding, this discussion and analysis should be read in conjunction with the financial statements, related notes, the selected financial data and the statistical information presented elsewhere in this report. FORWARD-LOOKING INFORMATION This discussion and analysis of financial condition and results of operations, and other sections of this report, may contain forward-looking statements that are based on the current expectations of management. Such expressions of expectations are not historical in nature and are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Words such as "anticipates," "believes," "estimates," "expects," "forecasts," "intends," "is likely," "plans," "projects," and other such words are intended to identify in such forward-looking statements. Also, discussions of or including any periods ending after the period for which this report is filed are forward-looking statements. The statements contained herein and in such forward-looking statements involve or may involve certain assumptions, risks and uncertainties, many of which are beyond the control of the Company, that may cause actual future results to differ materially from what may be expressed or forecasted in such forward-looking statements. Readers should not place undue expectations on any forward-looking statements. In addition to the assumptions and other factors referenced specifically in connection with such statements and those discussed in Item 1A of our annual report on Form 10-K for the year ended December 31, 2005, the following factors could impact the business and financial prospects of the relationships; demand for financial products and financial services; the degree of competition by traditional and non-traditional financial services competitors; changes in banking legislation or regulations; changes in tax laws and the results of recent Wisconsin state tax developments; changes in interest rates; changes in prices; the impact of technological advances; governmental and regulatory policy changes; trends in customer behavior as well as their ability to repay loans; and changes in the general economic conditions, nationally or in the State of Wisconsin. 11 CRITICAL ACCOUNTING POLICIES In the course of the Company's normal business activity, management must select and apply many accounting policies and methodologies that lead to the financial results presented in the consolidated financial statements of the Company. Some of these policies are more critical than others. Allowance for Loan Losses: The allowance for loan losses ("ALL") is a valuation allowance for probable incurred credit losses. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. Management estimates the allowance balance required using past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and the estimated collateral values, economic conditions, and other factors. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management's judgment, should be charged-off. The allowance consists of specific and general components. The specific component relates to loans that are individually classified as impaired or loans otherwise classified as substandard or doubtful. The general component covers non-classified loans and is based on historical loss experience adjusted for current factors. A loan is impaired when full payment under the loan terms is not expected. Commercial and commercial real estate loans are individually evaluated for impairment. If a loan is impaired, a portion of the allowance is allocated so that the loan is reported, net, at the present value of estimated future cash flows using the loan's existing rate or at the fair value of collateral, if repayment is expected solely from the collateral. Large groups of smaller balance homogeneous loans, such as consumer and residential real estate loans, are collectively evaluated for impairment, and accordingly, they are not separately identified for impairment disclosures. Foreclosed Assets: Foreclosed assets acquired through or instead of loan foreclosure are initially recorded at fair value when acquired, less estimated costs to sell, establishing a new cost basis. If fair value declines subsequent to foreclosure, a valuation allowance is recorded through expense. Costs after acquisition are expensed. Provision for Impairment of Standby Letter of Credit: The provision for impairment of letter of credit represents management's estimate of probable incurred losses on an off-balance sheet standby letter of credit which is used to accommodate our customer's borrowing arrangements with an unrelated third party. In the event, of further impairment, a provision for impairment of standby letter of credit is charged to operations based on management's periodic evaluation of the factors affecting this standby letter of credit. Income tax accounting: The assessment of tax assets and liabilities involves the use of estimates, assumptions, interpretations, and judgments concerning certain accounting pronouncements and federal and state tax codes. There can be no assurance that future events, such as court decisions or positions of federal and state taxing authorities, will not differ from management's current assessment, the impact of which could be significant to the consolidated results of the Company's operations and reported earnings. The Company believes that the tax assets and liabilities are adequate and properly recorded in the consolidated financial statements. The reserve does not include any specific reserves relative to any position recently taken by state taxing authorities. 12 Income tax expense may be affected by developments in the state of Wisconsin. Like many financial institutions that are located in Wisconsin, a subsidiary of the Bank located in the state of Nevada holds and manages various investment securities. Due to that fact that these subsidiaries are out of state, income from their operations has not been subject to Wisconsin state taxation. Although the Wisconsin Department of Revenue issued favorable tax rulings regarding Nevada subsidiaries of Wisconsin financial institutions, the Department representatives have recently stated that the Department intends to revoke those rulings and tax some or all these subsidiaries' income, even though there has been no intervening change in the law. The Department also implemented a program in 2003 for the audit of Wisconsin financial institutions who have formed and contributed assets to subsidiaries located in Nevada; to date, the Company and its subsidiaries have not been audited on these matters. The Department sent letters in July 2004 to financial institutions in Wisconsin, whether or not they are undergoing an audit, reporting on settlements involving 17 banks and their out-of-state investment subsidiaries. The letter provided a summary of currently available settlement parameters. For periods before 2004, they include: restrictions on the types of subsidiary income excluded from Wisconsin taxation; assessment of certain back taxes for a limited period of time; and interest (but not penalties) on any past-due taxes. For 2004 and going forward, there are similar provisions plus limits on the amount of subsidiaries' assets as to which their income will be excluded from Wisconsin tax. Settlement on the terms outlined would result in the Department's rescission of related prior letter rulings, and would purport to be binding going forward except for future legislation or change by mutual agreement. By implication, the Department appears to accept the general proposition that some out-of-state investment subsidiary income is not subject to Wisconsin taxes. The Company continues to believe that it has reported income and paid Wisconsin taxes correctly in accordance with applicable tax laws and the Department's prior longstanding interpretations thereof, including interpretations issued specifically to it. However, in view of the Department's subsequent change in position (even if that change does not have a basis in law), the aggressive stance now being taken by the Department, the settlements by some other banks, and the potential effect that decisions by other similarly situated institutions may have on the Company's alternatives going forward, the Company has determined that it would consider a settlement proposal from the Department; however, the Company has not yet received a specific proposal nor has any assessment been made against the Company or its subsidiaries. The Company will need to review any settlement proposal in more specific detail to quantify in any definitive way the Department's view of its exposure and to evaluate alternatives. Although there will likely be challenges to the Department's actions and interpretations, the Bank's net income would be reduced if the Department succeeds in its actions and interpretations. The Bank could also incur costs in the future to address any action taken against it by the Department. RESULTS OF OPERATIONS The following table sets forth the Company's net income and related summary information for the three-months periods ended March 31, 2006 and 2005, as well as comparisons between the respective periods. TABLE 1 SUMMARY RESULTS OF OPERATIONS ($ in thousands, except per share data) 13
Three months ended Three months ended % Increase March 31, 2006 March 31, 2005 or decrease ------------------ ------------------ ----------- Net income $1,324 $2,584 - 48.8% EPS-basic $ 0.17 $ 0.34 - 50.0% EPS-diluted $ 0.17 $ 0.33 - 48.5% Return on average assets 0.48% 0.98% - 51.0% Return on average equity 6.81% 13.49% - 49.5% Efficiency ratio (1) 78.24% 63.03% - 24.1%
(1) Non-interest expense divided by sum of taxable equivalent net interest income plus non-interest income, excluding investment securities gains, net The decrease in net income for the period is primarily due to decreased net interest income, an increase in the provision for loan losses, a decrease in other income and an increase in other expenses. These items were partially offset by a decrease in income tax expense. NET INTEREST INCOME Net interest income is the largest component of the Company's operating income (net interest income on a tax-equivalent basis plus other non-interest income), accounting for 78.5% of total operating income for the three months ended March 31, 2006, as compared to 79.8% for the same period in 2005. Net interest income represents the difference between interest earned on loans, investments and other interest earning assets offset by the interest expense attributable to the deposits and the borrowings that fund such assets. Interest fluctuations together with changes in the volume and types of earning assets and interest-bearing liabilities combine to affect total net interest income. This analysis discusses net interest income on a tax-equivalent basis in order to provide comparability among the various types of earned interest income. Tax-exempt interest income is adjusted to a level that reflects such income as if it were fully taxable. Net interest income on a tax equivalent basis for the three months ended March 31, 2006 decreased $770,000, or 8.6%, to $8.1 million from $8.9 million over the comparable period a year ago. The decrease results from a decrease in our net interest margin which resulted partially from an increase in the amount of non-accrual loan interest of $406,534 (due to an increase in the level of non-performing loans, which did not accrue interest) and the amortization expense of issuance costs related to the redemption of the trust preferred securities (totaling $475,015), offset partially by an increase in average loans for the period. As a result of the new basis for computing interest on these securities, we expect the interest paid on trust securities to be $145,507 lower in the second quarter than it would have been with the prior securities. See "Balance Sheet Analysis - Long Term Debt" below. Net interest margin is tax-equivalent net interest income expressed as a percentage of average earning assets. The net interest margin exceeds the interest rate spread because of the use of non-interest bearing sources of funds to fund a portion of earning assets. As a result, the level of funds available without interest cost (demand deposits and equity capital) is an important component impacting net interest margin. 14 The net interest margin for the first quarter of 2006 was 3.23%, down 43 basis points ("bps") from 3.66% for the comparable period in 2005. The 43 bps decrease in net interest margin is attributable to a 56 bps decrease in interest rate spread (the net result of a 88 bps increase in the yield on earning assets substantially offset by a 144 bps increase in the cost of interest-bearing liabilities), and a 13 bps higher contribution from net free funds. As the Federal Reserve Board ("FRB") has continued the trend of steadily increased interest rates during the latter half of 2004 thru the first quarter of 2006 in an attempt to keep inflation in control, average interest rates were higher in 2006 than in 2005. Comparatively, the Federal Funds rate at March 31, 2006 was at 4.75% compared to 2.75% at March 31, 2005, while the average Federal Funds rate for the first quarter of 2006 was 199 bps higher than for the same period in 2005. Market demand for deposit products has driven up the cost of funds and as a result, net interest margin decreased in the first quarter of 2006. Net interest margin was affected by the impact of short-term rate changes and its affect on wholesale funding costs for the first quarter of 2006. For the three months ended March 31, 2006, average-earning assets increased $36.2 million, or 3.7%, when compared to the same period last year. The Company recorded an increase in average loans of $60.0 million, or 7.8%, for the first quarter of 2006 compared to the same period a year ago. Loans have typically resulted in higher rates of interest income to the Company than have investment securities, which further positively affect interest income. Interest rate spread is the difference between the tax-equivalent rate earned on average earning assets and the rate paid on average interest-bearing liabilities. The interest rate spread decreased for the quarter ended March 31, 2006 when compared to the same period a year ago. The interest rate spread decreased 56 bps to 2.84% at March 31, 2006 from 3.40% in the same quarter in 2005. While the average yield on earning assets increased 88 bps during the period, the average rate paid on interest-bearing liabilities increased 144 bps over the same period. The increase in the rates paid on interest-bearing liabilities occurred as a result of a higher cost of funding from deposits and other wholesale funding such as federal funds purchased and loans from the Federal Home Loan Bank in addition to amortization of issuance costs from the trust preferred redemption as discussed earlier. We would expect that trend to continue in light of the recent continuing Federal Reserve Board interest rate increases. TABLE 2 NET INTEREST INCOME ANALYSIS ON A TAX -EQUIVALENT BASIS ($ In thousands)
Three months ended March 31, ----------------------------------------------------------------- 2006 2005 ------------------------------- ------------------------------- Interest Average Interest Average Average income/ yield/ Average income/ yield/ Balance expense rate Balance expense Rate ---------- -------- ------- ---------- -------- ------- ASSETS Earning assets: Loans, net $ 826,052 $14,748 7.14% $ 766,068 $11,756 6.14% Taxable securities 146,309 1,571 4.30% 169,410 1,729 4.08% Tax exempt securities 32,938 543 6.59% 35,243 611 6.95%
15 Federal funds sold and interest bearing due from banks 4,907 51 4.16% 3,281 17 2.07% ---------- ------- ----- ---------- ------- ----- Total earning assets 1,010,206 16,913 6.68% 974,002 14,113 5.80% Non-interest earning assets 82,334 76,598 ---------- ---------- Total assets $1,092,540 $1,050,600 ========== ========== LIABILITIES AND STOCKHOLDERSEQUITY Interest-bearing liabilities: Total interest-bearing deposits 754,535 6,342 3.36% 721,631 3,827 2.12% Short-term borrowings 13,083 163 4.98% 23,256 165 2.84% Customer repurchase agreements 1,344 12 3.57% 1,538 8 2.08% Federal Home Loan Bank advances 124,573 1,362 4.37% 102,024 737 2.89% Subordinated debentures 16,816 889 21.15% 16,100 461 11.45% ---------- ------- ----- ---------- ------- ----- Total interest-bearing liabilities $ 910,351 $ 8,768 3.84% $ 864,549 $ 5,198 2.40% ========== ======= ===== ========== ======= ===== Demand deposits 93,259 102,036 Accrued expenses and other liabilities 11,154 7,373 Stockholders' equity 77,776 76,642 ---------- ---------- Total liabilities and stockholders' equity $1,092,540 $1,050,600 ========== ========== Interest rate spread $ 8,145 2.84% $ 8,915 3.40% Net interest margin 3.23% 3.66% ===== =====
16 The ratio of average earning assets to average total assets measures management's ability to employ overall assets for the production of interest income. This ratio was 92.5% and 92.7% for the first three months of 2006 and 2005, respectively. Provision for Loan Losses The provision for loan losses ("PFLL") is the periodic cost of providing an allowance for probable incurred losses. As previously discussed, the allowance consists of specific and general components. The Company's internal risk system is used to identify loans that meet the criteria as being "impaired" under the definition of SFAS 114. The specific component relates to loans that are individually classified as impaired or loans otherwise classified as substandard or doubtful. These identified loans for potential impairment are assigned a loss allocation based upon that analysis. The general component covers non-classified loans and is based on historical loss experience adjusted for current factors. These current factors include loan growth, net charge-offs, changes in the composition of the loan portfolio, delinquencies, management's evaluation of loan quality, general economic factors and collateral values. As a result of this process, the PFLL for the first three months of 2006 was $200,000 as compared to a PFLL of $30,000 for the first three months in 2005. The calculation of the amount took into account overall asset quality in the loan portfolio during the period. Net loan charge-offs in the first three months of 2006 were $13,000 compared with net charge-offs of $196,000 for the same period in 2005. Net charge-offs as a percentage of average loans is a key measure of asset quality. Net charge-offs to average loans were 0.01% for the first three months of 2006 compared to 0.10% for the same period in 2005. For the three months ended March 31, 2006, non-performing loans increased $19.5 million; see below for further information. TABLE 3 ALLOWANCE FOR LOAN LOSSES ($ in thousands)
For the three months For the three months ended March 31, 2006 ended March 31, 2005 -------------------- -------------------- Allowance for Loan Losses ("ALL) Balance at beginning of period $9,551 $10,445 Provision for loan losses 200 30 Charge-offs 83 336 Recoveries 70 140 Balance at end of period $9,738 $10,279 Net charge-offs ("NCOs:) $ 13 $ 196
As described more fully in Table 7, non-accrual loans increased significantly during the period from December 31, 2005. However, despite the increase in non-accrual loans during the quarter ended March 31, 2006, the required allocation of the allowance for these loans only increased $110,000. These facts in addition to the net charge-offs for the three months ended March 31, 2006 were factors in the determination of a provision of $200,000 for the first quarter of 2006. Although the amount of non-performing loans increased substantially during the quarter, the 17 provision did not increase as significantly because of management's belief and expectation that collateral values on these loans and other factors will likely ultimately minimize any related loss (although there can be no assurances). See "Balance Sheet Analysis - Non-Performing Loans, Potential Problem Loans and Other Real Estate" below. Management believes that the current provision conforms to the Company's loan loss reserve policy and is adequate in view of the present condition of the Company's loan portfolio. However, a decline in the quality of our loan portfolio, as a result of general economic conditions, factors affecting particular borrowers or our market area, or otherwise, could affect the adequacy of the allowance. If there are significant charge-offs against the allowance, or we otherwise determine that the allowance is inadequate, we will need to make higher provisions in the future. See "Risk Management and the Allowance for Loan Losses" and "Non-Performing Loans, Potential Problem Loans and Other Real Estate" below for more information related to non-performing loans. Non-Interest Income Total non-interest income decreased $25,000, or 1.1% to $2.2 million for the first quarter of 2006 when compared to the first quarter of 2005. The non-interest income to average assets ratio was 0.82% for the three months ended March 31, 2006 compared to 0.86% for the same period in 2005. The decrease in non-interest income for the three-month period is mainly due to the non-recurrence of gains on the sale of bank assets in other income offset partially by increases in fiduciary fee income ("trust fees") and fees for other services to customers. Table 4 reflects the various components of non-interest income for the comparable quarters. TABLE 4 NON-INTEREST INCOME ($ in thousands)
Three months ended Three months ended % Change from March 31, 2006 March 31, 2005 prior year ------------------ ------------------ ------------- Fees from fiduciary activities 301 179 68.2% Fees from loan servicing 260 283 (8.1%) Service charges on deposit accounts 794 725 9.5% Other fee income 165 187 (11.8%) Financial services income 180 186 (3.2%) Gains from sales of loans 201 208 (3.4%) Increase in cash surrender value of life insurance 226 227 (0.4%) Gain on sale of bank assets 0 179 NM Other income 111 89 24.7% Total Other Income 2,238 2,263 (1.1%)
Service charges on deposit accounts increased $69,000 for the three-month period ended March 31, 2006 due in part to the implementation of new product offerings such as High Performance Checking ("HPC") and other price increases implemented during the latter part of 2005. 18 In the first quarter of 2006, gains from sales of loans totaling $201,000 were similar to the $208,000 recorded in the first quarter of 2005. During the first quarter of 2006, secondary mortgage loan activity improved although gains from sale of those loans decreased as a result of tighter spreads and competitive pressures with respect to pricing. Although interest rates have increased over the quarter, the Company has not seen a decrease in the number of loan applications. Secondary loan production increased 14.8% between the comparable first three-month periods ($8.9 million in the first three months of 2006 versus $7.8 million in the first three months of 2005). The increase in production was driven primarily by secondary mortgage and commercial loan production (loan production to be sold to the secondary market) and resulting sales. For the three-month period ended March 31, 2006 compared to the same period in 2005, the decrease in gain on sale of bank assets was related to a gain on sale of stock of $179,000 taken in the first quarter of 2005 in connection with a third party acquisition of Pulse (an ATM operator/provider) in which the Bank held an ownership interest. Non-Interest Expense Non-interest expense increased $1.1 million or 15.3%, to $8.1 million for the three months ended March 31, 2006 compared to the same period in 2005. The non-interest expense to average assets ratio was 2.97% for the three months ended March 31, 2006 compared to 2.68% for the same period in 2005. Net overhead expense is total non-interest expense less total non-interest income excluding securities gains. The net overhead expenses to average assets ratio was 2.15% for the three months ended March 31, 2006 compared to 1.82% for the same period in 2005. The efficiency ratio is total non-interest expense as a percentage of the sum of net-interest income on a fully taxable equivalent basis and total non-interest income. The efficiency ratio for the three months ended March 31, 2006 was 78.24% compared to 63.03% for the same period in 2005. TABLE 5 NON-INTEREST EXPENSE ($ in thousands)
Three months ended Three months ended % Change from March 31, 2006 March 31, 2005 prior year ------------------ ------------------ ------------- Salaries and employee benefits 4,992 4,528 10.2% Occupancy 579 536 8.0% Equipment 395 307 28.7% Data processing and courier 300 278 7.9% Operation of other real estate 43 48 (10.4%) Business development and advertising 234 204 14.7% Charitable contributions 76 92 (17.4%) Stationary and supplies 104 112 (7.1%) Director fees 119 82 45.1% FDIC 27 27 0.0%
19 Mortgage servicing rights amortization 55 62 (11.3%) Legal and professional 205 176 16.5% Other operating 995 593 67.8% Total non-interest expense 8,124 7,045 15.3%
Salaries and employee benefits showed an increase of $464,000, or 10.2%, to $5.0 million for the first quarter of 2006 compared to the same period in 2005. The number of full-time equivalent employees was 324 as of March 31, 2006 compared to 308 as of March 31, 2005, primarily the result of additional staffing for the remodeled downtown Green Bay branch opened in June 2005. For the three months ended March 31, 2006, salary-related expenses increased $369,000, or 13.1%, due principally to merit increases between the years and increased staffing. In the first quarter of 2005, the Company implemented the Baylake Bank Supplemental Executive Retirement Plan ("Plan"), which is intended to provide certain management and highly compensated employees of the Bank who have contributed, and are expected to continue to contribute, to the Bank's success by providing for deferred compensation in addition to that available under the Bank's other retirement programs. It amounted to approximately $335,000 in expenses related to the vested portion of the Plan contributions in the first quarter of 2006 compared to $300,000 for the same period in 2005. Benefit costs, principally for health insurance and pension costs, represent the remaining increase in personnel-related costs. The increase in health insurance costs is expected to continue for the balance of 2006. Bonus expense decreased $75,000 to $151,000 for the first quarter of 2006, as various income-related goals were not met during the period. Management will continue its efforts to control salaries and employee benefits expense, although increases in these expenses are likely to continue in future years. Occupancy and equipment expense, collectively, increased $131,000, or 15.5%, to $974,000 for the first quarter of 2006 compared to the same period in 2005. The increase in expense was attributable to additional depreciation expense resulting from the remodeled downtown Green Bay branch as mentioned previously, costs related to various equipment upgrades and increased utility costs. Expenses related to the operation of other real estate owned decreased $5,000 to $43,000 for the 2006 three-month period compared to the same period in 2005. Included in these expenses were net gains taken on the sale of other real estate owned amounting to $78,000 for the first three months of 2006 compared to net gains taken on sale of $41,000 for the same period in 2005. In addition, costs related to the holding of other real estate owned properties increased $32,000 to $121,000 for the first three months of 2006. Other operating expense increased $402,000 to $995,000. The increase was due in part to costs of $211,000 related to various employee recruitment and search expenses, including those costs related to the searches for a new bank president/chief operating officer and a market president. $103,000 of the increase was related to new product offering costs, including those for the High Performance Checking ("HPC") product introduced in the fourth quarter of 2005. Income Taxes Income tax expense for the Company for the three months ended March 31, 2006 was $468,000, a decrease of $750,000, compared to the same period in 2005. The lower tax expense in 2006 reflected the Company's decrease in income before income tax resulting in an increase proportion of non-taxable income to total income before income taxes. 20 The Company's effective tax rate (income tax expense divided by income before taxes) was 26.1% for the three months ended March 31, 2006 compared with 32.0% for the same period in 2005. The effective tax rate of 26.1% consisted of a federal effective tax rate of 19.9% and Wisconsin State effective tax rate of 6.2%. Taxable income decreased while tax-exempt interest income from municipal investments and income from BOLI increased proportionately, which caused the change in the effective tax rate. Income tax expense recorded in the consolidated statements of income involves interpretation and application of certain accounting pronouncements and federal and state tax codes, and is, therefore, considered a critical accounting policy. The Company undergoes examination by various taxing authorities. Such taxing authorities may require that changes in the amount of tax expense or valuation allowance be recognized when their interpretations differ from those of management, based on their judgments about information available to them at the time of their examinations. See "Critical Accounting Policies-Income Tax Accounting" above regarding Wisconsin tax matters which may affect our income tax expense. BALANCE SHEET ANALYSIS Loans At March 31, 2006, total loans increased $19.7 million, or 2.4%, to $832.0 million from $812.3 million at December 31, 2005. Growth in the Company's loan portfolio resulted primarily from an increase in real estate commercial loans to $478.7 million at March 31, 2006 compared to $468.0 million at December 31, 2005. In addition, growth in real estate construction loans increased to $93.9 million at March 31, 2006 compared to $85.7 million at December 31, 2005. Growth in commercial real estate mortgages and commercial loans occurred principally as a result of the Company's expansion efforts (primarily in the Green Bay market) and the strong economic growth in that market. The following table reflects the composition (mix) of the loan portfolio (dollars in thousands): TABLE 6 LOAN PORTFOLIO ANALYSIS ($ in thousands)
March 31, December 31, Percent 2006 2005 change --------- ------------ ------- Amount of loans by type Real estate-mortgage Commercial $478,656 $467,956 2.3% 1-4 family residential First liens 93,152 90,946 2.4% Junior liens 24,525 23,470 4.5% Home equity 31,943 34,320 (6.9%) Commercial, financial and agricultural 81,512 80,260 1.6% Real estate-construction 93,896 85,729 9.5% Installment Credit cards and related plans 2,089 2,088 0.0% Other 12,804 12,175 5.2%
21 Obligations of states and political subdivisions 13,945 15,785 (11.7%) Less: deferred origination fees, net of costs 510 433 17.8% Total $832,012 $812,296 2.4%
Risk Management and the Allowance for Loan Losses The loan portfolio is the Company's primary asset subject to credit risk. To reflect this credit risk, the Company sets aside an allowance for probable incurred credit losses through periodic charges to earnings. These charges are shown in the Company's consolidated income statement as provision for loan losses. See "Provision for Loan Losses" above. Credit risk is controlled and monitored through the use of lending standards, a thorough review of potential borrowers, and an on-going review of payment performance. Asset quality administration, including early identification of problem loans and timely resolution of problems, further enhances management of credit risk and minimization of loan losses. All specifically identifiable and quantifiable losses are charged off against the allowance. Charged-off loans are subject to periodic review, and specific efforts are taken to achieve maximum recovery of principal and interest. As indicated in Table 3 above, the ALL at March 31, 2006 was $9.7 million compared with $9.6 million at the end of 2005. This was based on management's analysis of the loan portfolio risk at March 31, 2006. As such a provision expense of $200,000 was recorded for the quarter ended March 31, 2006. The quarter to date provision has increased by $170,000 compared to the same period in 2005, as discussed previously. The provision for loan losses is predominately a function of management's evaluation of the loan portfolio, with particular emphasis directed toward non-performing and other potential problem loans. During these evaluations, consideration is also given to such factors as management's evaluation of specific loans, the level and composition of impaired loans, other non-performing loans, historical loan experience, results of examinations by regulatory agencies and various other factors. On a quarterly basis, management reviews the adequacy of the ALL. Commercial credits are graded by the loan officers and the loan review function validates the officers' grades. In the event that the loan review function downgrades the loan, it is included in the allowance analysis at the lower grade. The grading system is in compliance with the regulatory classifications and the allowance is allocated to the loans based on the regulatory grading, except in instances where there are known differences (i.e., collateral value is nominal, etc.). To establish the appropriate level of the allowance, a sample of loans (including impaired and non-performing loans) are reviewed and classified as to potential loss exposure. Based on an estimation computed pursuant to the requirements of Financial Accounting Standards Board ("FASB") Statement No. 5, "Accounting for Contingencies," and FASB Statements No. 114 and 118, "Accounting by Creditors for Impairment of a Loan," the analysis of the ALL consists of two components: (i) specific credit allocation established for expected losses resulting from analysis developed through specific credit allocations on individual loans for which the recorded investment in the loan exceeds its fair value; (ii) general portfolio allocation based on historical loan loss experience for each loan category and adjusted for economic conditions as well as specific and other factors in the markets in which the Company operates. The specific credit allocation of the ALL is based on a regular analysis of loans over a fixed-dollar amount where the internal credit rating is at or below a predetermined classification. The fair value of the loan is determined based on either the present value of expected future cash flows 22 discounted at the loan's effective interest rate, the market price of the loan, or, if the loan is collateral dependent, the fair value of the underlying collateral less cost of sale. The general portfolio allocation component of the ALL is determined statistically using a loss migration analysis that examines historical loan loss experience. The loss migration analysis is performed quarterly and loss factors are updated regularly based on actual experience. The general portfolio allocation element of the ALL also includes consideration of the amounts necessary for concentrations and changes in portfolio mix and volume. The ALL is based on estimates, and ultimate losses will vary from current estimates. These estimates are reviewed monthly, and as adjustments, either positive or negative, become necessary, a corresponding increase or decrease is made in the provision for loan losses. The composition of the loan portfolio has not significantly changed since year-end 2005. Management remains watchful of credit quality issues and believes that issues within the portfolio are reflective of the challenging economic environment experienced over the past few years. Should the economic climate deteriorate from current levels, borrowers may experience difficulty, and the level of non-performing loans, charge-offs and delinquencies could rise and require further increases in the provision. Consideration for making such allocations is consistent with the factors discussed above, and all of the factors are subject to change; thus, the allocation is not necessarily indicative of the loan categories in which future loan losses will occur. It would also be expected that the amount allocated for any particular type of loan will increase or decrease proportionately to both the changes in the loan balances and to increases or decreases in the estimated loss in loans of that type. In other words, changes in the risk profile of the various parts of the loan portfolio should be reflected in the allowance allocated. While there exists probable asset quality problems in the loan portfolio, management believes sufficient reserves have been provided in the ALL to absorb probable incurred losses in the loan portfolio at March 31, 2006. Ongoing efforts are being made to collect these loans, and the Company involves the legal process when necessary to minimize the risk of further deterioration of these loans for full collection. While management uses available information to recognize losses on loans, future adjustments to the ALL may be necessary based on changes in economic conditions and the impact of such change on the Company's borrowers. As an integral part of their examination process, various regulatory agencies also review the Company's ALL. Such agencies may require that changes in the ALL be recognized when their credit evaluations differ from those of management, based on their judgments about information available to them at the time of their examination. Non-Performing Loans, Potential Problem Loans and Other Real Estate Management encourages early identification of non-accrual and problem loans in order to minimize the risk of loss. This is accomplished by monitoring and reviewing credit policies and procedures on a regular basis. Non-performing loans are a leading indicator of future loan loss potential. Non-performing loans are defined as non-accrual loans, guaranteed loans 90 days or more past due but still accruing, and restructured loans. Additionally, whenever management becomes aware of facts or circumstances that may adversely impact on the collection of principal or interest on loans, it is 23 the practice of management to place such loans on non-accrual status immediately rather than waiting until the loans become 90 days past due. The accrual of interest income is discontinued when a loan becomes 90 days past due as to principal or interest. When interest accruals are discontinued, interest credited to income is reversed. If collection is in doubt, cash receipts on non-accrual loans are used to reduce principal rather than recorded as interest income. The process of restructuring loans involves the granting of some concession to the borrower involving a loan modification, such as payment schedule or interest rate changes. TABLE 7 NON-PERFORMING ASSETS ($ in thousands)
At or for the period At or for the period At or for the period ended March 31, 2006 ended March 31, 2005 ended December 31, 2005 -------------------- -------------------- ----------------------- Nonperforming Assets: Nonaccrual loans $26,385 $ 8,288 $ 6,942 Accruing loans past due 90 days or more 0 0 0 Restructured loans 0 0 0 ------- ------- ------- Total nonperforming loans ("NPLs") $26,385 $ 8,288 $ 6,942 Other real estate owned 1,799 2,378 3,333 ------- ------- ------- Total nonperforming assets ("NPAs") $28,184 $10,666 $10,275 Ratios: ALL to NCO's (annualized) 184.70 12.93 2.32 NCO's to average loans (annualized) 0.01% 0.10% 0.52% ALL to total loans 1.17% 1.31% 1.18% NPL's to total loans 3.17% 1.06% 0.85% NPA's to total assets 2.56% 1.00% 0.94% ALL to NPL's 36.91% 124.02% 137.58%
As indicated in Table 7, non-performing loans at March 31, 2006 were $26.4 million compared to $6.9 million at December 31, 2005. Non-accrual loans represented $26.4 million of the total non-performing loans. Real estate non-accrual loans accounted for $25.9 million of the total, of which $2.8 million was residential real estate, $5.5 million was real estate construction and $17.6 million was commercial real estate, while commercial and industrial non-accrual loans total $514,000. Non-accrual loans increased during this quarter by $19.4 million and is primarily attributable to six commercial loans for businesses that are experiencing difficulties in sales, cash flow, fiscal operations, and/or general management issues. Of these, two loans totaling $2.9 million are commercial real estate development loans, two loans totaling $11.4 million are recreational real 24 estate golf course properties, one loan totaling $898,223 is a restaurant and one loan totaling $4.3 million is a retail shopping mall. Each of these six non-performing loans is secured primarily by commercial or residential real estate, and secondarily, by personal guarantees from principals of the respective borrowers. The Company has initiated foreclosure actions on three of these loans totaling $7.1 million and it anticipates protracted litigation of at least twelve months in duration in each case. Management has provided $1.1 million (including $231,006 in the current period) in the ALL for any loss estimated with respect to these loans. The other loans totaling $12.3 million are subject to voluntary liquidation plans that propose to sell underlying real estate assets in amounts sufficient to repay the outstanding loan balances. Of these, two loans, totaling $9.0 million, have full purchase price offers currently pending for the underlying collateral. However, the Company cannot identify a time line for final disposition of those loans because of the necessity for settlement of liens and claims against the properties, nor can the Company provide assurances that there will not be any further losses relating to these or other credits. Current impairments have been established for each of these credits and the Company does not anticipate any further loss at this time, in part due to expected collateral values. As a result the ratio of non-performing loans to total loans at March 31, 2006 was 3.17% compared to 0.85% at end of year 2005. The Company's ALL was 36.9% of total non-performing loans at March 31, 2006 compared to 137.6% at end of year 2005. Non-performing assets (non-performing loans plus other real estate owned assets) at March 31, 2006 were $28.2 million compared to $10.3 million at December 31, 2005. Other real estate owned, which represents property that the Company acquired through foreclosure or in satisfaction of debt, consisted of twelve commercial properties totaling $1.8 million. Other real estate owned at December 31, 2005 totaled $3.3 million and consisted of seventeen properties. Potential problem loans are currently performing loans that management believes may incur difficulties in complying with loan repayment terms. Management's decision to place loans in this category does not necessarily mean that the Company expects to take losses on such loans, but that management needs to be more vigilant in its efforts to oversee the loans and recognize that a higher degree of risk is associated with these potential problem loans. At March 31, 2006, potential problem loans amounted to $5.8 million compared to a total of $10.0 million at December 31, 2005. A portion of this decrease results from a transfer during the period to non-accrual (non-performing) status of $4.3 million of these problem loans which were identified at year end. Investment Portfolio The investment portfolio is intended to provide the Company with adequate liquidity, flexibility in asset/liability management and, lastly, an increase in its earning potential. At March 31, 2006, the investment portfolio (which includes investment securities available for sale) increased $1.7 million, or 1.0%, to $173.4 million from $171.6 million at December 31, 2005. At March 31, 2006 and December 31, 2005, the investment portfolio represented 15.7% and 15.8%, respectively, of total assets. Securities available for sale consist of the following: 25 TABLE 8 INVESTMENT SECURITY ANALYSIS At March 31, 2006 ($ in thousands)
Gross Gross Unrealized Unrealized Gains Losses Fair Value ---------- ---------- ---------- Securities available for sale Obligations of U.S. Treasury & other U.S. agencies $ 91 $1,445 $ 64,148 Mortgage-backed securities 1 2,236 71,189 Obligations of states & political subdivisions 379 199 32,929 Private placement 43 0 1,040 Other securities 0 0 4,078 ---- ------ -------- Total securities available for sale $514 $3,880 $173,384 ==== ====== ========
At December 31, 2005 ($ in thousands)
Gross Gross Unrealized Unrealized Gains Losses Fair Value ---------- ---------- ---------- Securities available for sale Obligations of U.S. Treasury & other U.S. Agencies $179 $1,153 $ 59,819 Mortgage-backed securities 2 2,015 72,531 Obligations of states & political subdivisions 407 269 33,827 Private placement 44 0 1,040 Other securities 0 0 4,421 ---- ------ -------- Total investment securities $632 $3,437 $171,638 ==== ====== ========
26 Deposits Total deposits at March 31, 2006 decreased $5.6 million, or 0.7%, to $851.1 million from $856.7 million at December 31, 2005. Non-interest bearing deposits at March 31, 2006 decreased $16.8 million, or 15.2%, to $93.8 million from $110.6 million at December 31, 2005. Interest-bearing deposits at March 31, 2006 increased $11.2 million, or 1.5%, to $757.3 million from $746.1 million at December 31, 2005. Brokered CD's totaled $152.1 million at March 31, 2006 compared to $155.1 million at December 31, 2005. Time deposits greater than $100,000 and brokered time deposits were priced within the framework of the Company's rate structure and did not materially increase the average rates on deposit liabilities. If liquidity concerns arose, the Company has alternative sources of funds such as lines with correspondent banks and borrowing arrangements with FHLB should the need present itself. Increased competition for consumer deposits and customer awareness of interest rates continue to limit the Company's core deposit growth in these types of deposits. Typically, overall deposits for the first six months tend to decline slightly as a result of the seasonality of the Company's customer base as customers draw down deposits during the first half of the year in anticipation of the summer tourist season. Emphasis has been, and will continue to be, placed on generating additional core deposits in 2006 through competitive pricing of deposit products and through the branch delivery systems that have already been established. The Company will also attempt to attract and retain core deposit accounts through new product offerings and quality customer service. The Company also may increase brokered time deposits during the remainder of the year 2006 as an additional source of funds to provide for loan growth in the event that core deposit growth goals would not be accomplished. Under that scenario, the Company will continue to look at other wholesale sources of funds, if the brokered CD market became illiquid or more costly in terms of interest rate. Other Funding Sources Federal funds purchased and securities under agreements to repurchase at March 31, 2006 increased $24.5 million to $25.9 million from $1.3 million at December 31, 2005. Federal funds purchased increased from no funds purchased at December 31, 2005 to $24.5 million at March 31, 2006 accounting for the majority of the increase. These have increased to fund the growth in the loan portfolio which was coupled with a decrease in core deposits during the quarter ended March 31, 2006. Federal Home Loan Bank Advances totaled $120.2 million at March 31, 2006 compared to $125.2 million at December 31, 2005. Typically, borrowings increase in order to fund growth in the loan portfolio in periods when borrowings increase more rapidly than deposits. The Company will borrow monies if borrowing is a less costly form of funding loans compared to the cost of acquiring deposits or if deposit growth is not sufficient. Additionally, the availability of deposits also determines the amount of funds the Company needs to borrow in order to fund loan demand. The Company anticipates it will continue to use wholesale funding sources of this nature, if these borrowings add incrementally to overall profitability. Long-term Debt In connection with the issuance of Trust Preferred Securities in 2001 (see "Capital Resources"), the Company issued long-term subordinated debentures to Baylake Capital Trust I, a Delaware Business Trust, formed by the Company. The aggregate principal amount of the debentures due 27 2031, to the trust was $16,597,940. These securities were redeemed on March 31, 2006, as noted in our press release dated February 28, 2006. The redemption of these securities were funded through the issuance of $16.1 million of trust preferred securities and $498,000 of trust common securities, and underlying debt securities, that will adjust quarterly at a rate equal to 1.35% over the three month LIBOR. The rate on this financing for the second quarter is 6.31%. This lower interest rate will provide interest savings in the second quarter of 2006, and thereafter depending upon changes in the interest rate environment. Management believes that the new financing should provide a better match for the overall interest rate sensitivity position of the Company going forward. For additional details, please make reference to the Consolidated Financial Statements and the accompanying footnotes on the Company's Form 10-Q for the period ended March 31, 2006. CONTRACTUAL OBLIGATIONS, COMMITMENTS, OFF-BALANCE SHEET RISK, AND CONTINGENT LIABILITIES The Company utilizes a variety of financial instruments in the normal course of business to meet the financial needs of its customers. These financial instruments include commitments to extend credit, commitments to originate residential mortgage loans held for sale, commercial letters of credit, standby letters of credit, and forward commitments to sell residential mortgage loans. Please refer to the Company's Annual Report on Form 10-K for the year ended December 31, 2005 for discussion with respect to the Company's quantitative and qualitative disclosures about its fixed and determinable contractual obligations. Items disclosed in Form 10-K have not materially changed since that report was filed. The following is a summary of our off-balance sheet commitments, all of which were lending-related commitments: TABLE 9 LENDING RELATED COMMITMENTS ($ in thousands)
March 31, 2006 December 31, 2005 -------------- ----------------- Commitments to fund home equity line loans $ 47,253 $ 45,435 Commitments to fund commercial real estate loans 2,192 3,409 Commitments unused on various other lines of credit loans 159,313 164,112 -------- -------- Total commitments to extend credit $208,758 $212,956 Financial standby letters of credit $ 22,146 $ 22,160
The following table summarizes the Company's significant contractual obligations and commitments at March 31, 2006: 28 TABLE 10 CONTRACTUAL OBLIGATIONS ($ in thousands)
(IN THOUSANDS) WITHIN 1 YEAR 1-3 YEARS 3-5 YEARS AFTER 5 YEARS TOTAL ------------- --------- --------- ------------- -------- Certificates of deposit and other time deposit obligations $251,259 $161,498 $4,795 $ 0 $417,552 Federal funds purchased and repurchase agreements 25,860 0 0 0 25,860 Federal Home Loan Bank advances 70,000 25,083 101 25,000 120,184 Purchase of land 1,580 0 0 0 1,580 Construction of branch facility 582 0 0 0 582 Subordinated debentures 0 0 0 16,100 16,100 Operating leases 41 17 0 0 58 -------- -------- ------ ------- -------- Total $349,322 $186,598 $4,896 $41,100 $581,916 ======== ======== ====== ======= ========
LIQUIDITY Liquidity management refers to the ability of the Company to ensure that cash is available in a timely manner to meet loan demand and depositors' needs, and to service other liabilities as they become due, without undue cost or risk, and without causing a disruption to normal operating activities. The Company and the Bank have different liquidity considerations. The Company's primary sources of funds are dividends from the Bank, investment income, and net proceeds from borrowings and the offerings of junior subordinated obligations, in addition to the issuance of its common stock securities. The Company manages its liquidity position in order to provide funds necessary to pay dividends to its shareholders. Dividends received from Bank totaled $1.5 million for the first three months of 2006 and will continue to be the Company's main source of long-term liquidity. The dividends from the Bank along with existing cash were sufficient to pay cash dividends to the Company's shareholders of $2.5 million in the first three months of 2006. The Bank meets its cash flow needs by having funding sources available to it to satisfy the credit needs of customers as well as having available funds to satisfy deposit withdrawal requests. Liquidity at the Bank is derived from deposit growth, maturing loans, the maturity of the 29 investment portfolio, access to other funding sources, marketability of certain of its assets; the ability to use its loan and investment portfolios as collateral for secured borrowings and strong capital positions. Maturing investments have been a primary source of liquidity at the Bank. For the three months ended March 31, 2006, principal payments totaling $4.2 million were received on investments. $6.5 million in investments were purchased in the first three months of 2006. This resulted in net cash of $2.3 million used in investing activities for the first three months of 2006. At March 31, 2006 the investment portfolio contained $135.4 million of U.S. Treasury and federal agency backed securities representing 78.1% of the total investment portfolio. These securities tend to be highly marketable. Deposit growth is typically another source of liquidity for the Bank in the latter half of each year, although deposits typically shrink in the first half resulting in a use of cash. As a financing activity reflected in the March 31, 2006 Consolidated Statements of Cash Flows, deposits decreased and resulted in $5.6 million of cash outflow during the first three months of 2006. The Company's overall deposit base decreased 0.7% for the three months ended March 31, 2006. Deposit growth is generally the most stable source of liquidity for the Bank, although brokered deposits are inherently less stable than locally generated core deposits. Affecting liquidity are core deposit growth levels, certificate of deposit maturity structure and retention, and characteristics and diversification of wholesale funding sources affecting the channels by which brokered deposits are acquired. Conversely, deposit outflow will cause the Bank to develop alternative sources of funds which may not be as liquid and potentially a more costly alternative. The scheduled maturity of loans can provide a source of additional liquidity. The Bank has $258.5 million, or 31.1%, of loans maturing within one year. Factors affecting liquidity relative to loans are loan origination volumes, loan prepayment rates and the maturity structure of existing loans. The Bank's liquidity position is influenced by changes in interest rates, economic conditions and competition. Conversely, loan demand as a need for liquidity will cause the Company to acquire other sources of funding which could be harder to find; therefore more costly to acquire. Within the classification of short-term borrowings at March 31, 2006, federal funds purchased and securities sold under agreements to repurchase totaled $25.9 million compared to $1.3 million at the end of 2005. Federal funds are purchased from various upstream correspondent banks while securities sold under agreements to repurchase are obtained from a base of business customers. Borrowings from FHLB, short-term or long-term, are another source of funds. They totaled $120.2 million at March 31, 2006 and $125.2 million at December 31, 2005. The Bank's liquidity resources were sufficient in the first three months of 2006 to fund the growth in loans and investments, increase the volume of interest earning assets and meet other cash needs when necessary. Management expects that deposit growth will continue to be the primary funding source of the Bank's liquidity on a long-term basis, along with a stable earnings base, the resulting cash generated by operating activities, and a strong capital position. Although federal funds purchased and borrowings from the FHLB provided funds in the first three months of 2006, management expects deposit growth to be a reliable funding source in the future as a result of branch expansion efforts and marketing efforts to attract and retain core deposits. In addition, Bank may acquire additional brokered deposits as funding for short-term liquidity needs. Shorter-term liquidity needs will mainly be derived from growth in short-term borrowings, 30 maturing federal funds sold and portfolio investments, loan maturities and access to other funding sources. In assessing liquidity, historical information such as seasonality (loan demand's affect on liquidity which starts before and during the tourist season and deposit draw down which affects liquidity shortly before and during the early part of the tourist season), local economic cycles and the economy in general are considered along with the current ratios, management goals and the unique characteristics of the Company. Management believes that, in the current economic environment, the Company's and the Bank's liquidity position is adequate. To management's knowledge, there are no known trends nor any known demands, commitments, events or uncertainties that will result or are reasonably likely to result in a material increase or decrease in the Bank's or the Company's liquidity. Capital Resources Stockholders' equity at March 31, 2006 and December 31, 2005 was $78.5 million. In total, stockholders' equity decreased $38,000 or 0.1%. The decrease in stockholders' equity in 2006 was primarily composed of the change in unrealized losses on available for sale securities and the payment of dividends, almost completely offset by net income and proceeds from the exercise of stock options. The change in unrealized losses on available for sale securities amounted to $360,000 for the first three months of 2006; this change resulted from the effects of the increasing interest rate environment. Total dividends paid increased to $2.5 million in the quarter from $2.3 million in 2005, primarily as a result of an increase in the per share dividends rate to $0.16 from $0.15. Stockholders' equity to assets at March 31, 2006 was 7.12% compared to 7.21% at the end of 2005. On March 31, 2006, the Company redeemed its outstanding junior subordinated indentures and trust preferred securities for a total of $16.6 million which constitutes the $16.1 million stated principal values of those amounts plus $510,389 in accrued interest. See "Management's Discussion of Analysis of Financial Condition and Results of Operations - Balance Sheet Analysis - Long Term Debt" above. The redemption of these securities were funded through the issuance of $16.1 million of trust preferred securities and $498,000 of trust common securities issued under the name Baylake Capital Trust II ("Trust II") that will adjust quarterly at a rate equal to 1.35% over the three month LIBOR. The initial rate on this financing for the second quarter is 6.31%. This lower rate will provide savings beginning in the second quarter of 2006 and management believes that the new financing should provide a better match for the overall interest rate sensitivity position of the Company going forward. For banking regulatory purposes, these securities are considered Tier 1 capital. Cash dividends declared in the first three months of 2006 were $0.16 per share compared with $0.15 in 2005. The Company provided a 6.7% increase in normal dividends per share in 2006 over 2005 as a result of earnings for 2006. Total funds utilized in the payment of dividends were $2.5 million in the first three months of 2006, as compared to $2.3 million in the corresponding period of 2005. In 1997, the Company's Board of Directors authorized management, in its discretion, to repurchase up to 7,000 shares of the Company's common stock each calendar quarter in the market. The shares repurchased would be used to fill its needs for the dividend reinvestment program, any future benefit plans, and the Company's stock purchase plan. Shares repurchased are held as treasury stock and accordingly, are accounted for as a reduction of stockholders' equity. The Company repurchased none of its common shares in the first three months of 2006. 31 The adequacy of the Company's capital is regularly reviewed to ensure that sufficient capital is available for current and future needs and is in compliance with regulatory guidelines. The assessment of overall capital adequacy depends upon a variety of factors, including asset quality, liquidity, stability of earnings, changing competitive forces, economic conditions in markets served and strength of management. Management is confident that because of current capital levels and projected earnings levels, capital levels are more than adequate to meet the ongoing and future concerns of the Company. The Federal Reserve Board has established capital adequacy rules which take into account risk attributable to balance sheet assets and off-balance sheet activities. All banks and bank holding companies must meet a minimum total risk-based capital ratio of 8%. Of the 8% required, at least half must be comprised of core capital elements defined as Tier 1 capital. The federal banking agencies also have adopted leverage capital guidelines which banking organizations must meet. Under these guidelines, the most highly rated banking organizations must meet a leverage ratio of at least 3% Tier 1 capital to assets, while lower rated banking organizations must maintain a ratio of at least 4% to 5%. Failure to meet minimum capital requirements can initiate certain mandatory -and possible additional discretionary- actions by regulators that, if undertaken, could have a direct material effect on the consolidated financial statements. At March 31, 2006 and December 31, 2005, the Company was categorized as "well capitalized" under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed the Company's category. To be "well capitalized" under the regulatory framework, the Tier 1 capital ratio must meet or exceed 6%, the total capital ratio must meet or exceed 10% and the leverage ratio must meet or exceed 5%. The following table presents the Company's and the Bank's capital ratios as of March 31, 2006 and December 31, 2005: TABLE 11 CAPITAL RATIOS ($ in thousands)
To Be Well Capitalized For Capital under Prompt Corrective Actual Adequacy Purposes Action Provisions --------------- ----------------- ----------------------- Amount Ratio Amount Ratio Amount Ratio ------- ----- ------ ----- ------ ------ As of March 31, 2006 Total Capital (to Risk Weighted Assets) Company 100,402 10.60% 75,796 8.00% N/A N/A Bank 97,931 10.34% 75,757 8.00% 94,696 10.00% Tier 1 Capital (to Risk Weighted Assets) Company 90,664 9.57% 37,898 4.00% N/A N/A Bank 88,193 9.31% 37,879 4.00% 56,818 6.00% Tier 1 Capital (to
32 Average Assets) Company 90,664 8.34% 43,458 4.00% N/A N/A Bank 88,193 8.13% 43,412 4.00% 54,265 5.00% As of December 31, 2005 Total Capital (to Risk Weighted Assets) Company 99,882 10.73% 74,472 8.00% N/A N/A Bank 97,327 10.51% 74,404 8.00% 93,005 10.00% Tier 1 Capital (to Risk Weighted Assets) Company 90,332 9.70% 37,236 4.00% N/A N/A Bank 87,778 9.44% 37,202 4.00% 55,803 6.00% Tier 1 Capital (to Average Assets) Company 90,332 8.27% 43,692 4.00% N/A N/A Bank 87,778 8.11% 43,590 4.00% 54,488 5.00%
Management believes that a strong capital position is necessary to take advantage of opportunities for profitable expansion of product and market share, and to provide depositor and investor confidence. The Company's capital level is strong, but also must be maintained at an appropriate level to provide the opportunity for an adequate return on the capital employed. Management actively reviews capital strategies for the Company to ensure that capital levels are appropriate based on the perceived business risks, further growth opportunities, industry standards, and regulatory requirements. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK. The Company's financial performance is affected by, among other factors, credit risk and interest rate risk. The Company does not use derivatives to mitigate its interest rate risk or credit risk, relying instead on loan review and its loan loss reserve. The Company's earnings are derived from the operations of its direct and indirect subsidiaries with particular reliance on net interest income, calculated as the difference between interest earned on loans and investments and the interest expense paid on deposits and other interest bearing liabilities, including advances from FHLB and other borrowings. Like other financial institutions, the Company's interest income and interest expense are affected by general economic conditions and by the policies of regulatory authorities, including the monetary policies of the Board of Governors of the Federal Reserve System. Changes in the economic environment may influence, among other matters, the growth rate of loans and deposits, the quality of the loan portfolio and loan and deposit pricing. Fluctuations in interest rates are not predictable or controllable. As of March 31, 2006, the Company was in compliance with its management policies with respect to interest rate risk. The Company has not experienced any material changes to its market risk position since December 31, 2005, as described in the Company's 2005 Form 10-K Annual Report. The Company's overall interest rate sensitivity is demonstrated by net interest income analysis. Net interest income analysis measures the change in net interest income in the event of hypothetical changes in interest rates. This analysis assesses the risk of change in net interest 33 income in the event of sudden and sustained 1.0% to 2.0% increases and decreases in market interest rates. The table below presents the Company's projected changes in net interest income for the various rate shock levels at March 31, 2006. TABLE 12 INTEREST SENSITIVITY ($ in thousands)
Change in Net Interest Income over One Year Horizon ------------------------------------------------------- At March 31, 2006 At December 31, 2005 -------------------------- -------------------------- Change in levels Percentage Percentage of interest rates Dollar change change Dollar change change - ----------------- ------------- ---------- ------------- ---------- +200 bp $ 335 3.6% $ 2,572 6.8% +100 bp 200 2.2% 1,842 4.9% Base 0 0% 0 0% - -100 bp (1,853) (4.9%) (2,351) (6.2%) - -200 bp (4,023) (17.2%) (4,905) (13.0%)
As shown above, at March 31, 2006, the effect of an immediate 200 basis point increase in interest rates would increase the Company`s net interest income by $335,000 or 3.6%. The effect of an immediate 200 basis point reduction in rates would decrease the Company's net interest income by $4.0 million or 17.2%. Changes in the mix of earning assets and interest-bearing liabilities increased the Company's asset sensitivity during the past twelve months. Computations of the prospective effects of hypothetical interest rate changes are based on numerous assumptions, including the relative levels of market interest rates and loan prepayments, and should not be relied upon as indicative of actual results. Actual values may differ from those projections set forth above, should market conditions vary from the assumptions used in preparing the analyses. Further, the computations do not contemplate any actions the Company may undertake in response to changes in interest rates. ITEM 4. CONTROLS AND PROCEDURES DISCLOSURES CONTROLS AND PROCEDURES: The Company's management, with the participation of the Company's Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company's disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act") as of March 31, 2006. Based on such evaluation, the Company's Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, the Company's disclosure controls and procedures are effective in timely alerting them to material information relating to the Company's disclosure controls and procedures to the Company required to be included in this quarterly report on Form 10-Q. INTERNAL CONTROL OVER FINANCIAL REPORTING: There have not been any changes in the Company's internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the fiscal quarter to which this report relates that have materially affected, or are reasonably likely to materially affect, the Company's internal controls subsequent to the date of such evaluation with the exception of enhancements made during the quarter to the calculation of the allowance for loan loss reserve. Such enhancement is explained in Item 2, 34 Management's Discussion and Analysis found in the sections entitled "Provision for Loan Losses" and "Balance Sheet Analysis-Risk Management and the Allowance for Loan Losses" which discussions are incorporated by reference in this item. PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS Baylake and its subsidiaries may be involved from time to time in various routine legal proceedings incidental to its business. Neither Baylake nor any of its subsidiaries is currently engaged in any legal proceedings that are expected to have a material adverse effect on the results of operations or financial position of Baylake. ITEM 1A. RISK FACTORS See "Risk Factors" in Item 1A of the Company's annual report on Form 10-K for the year ended December 31, 2005. ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS None ITEM 3. DEFAULTS UPON SENIOR SECURITIES None ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None ITEM 5. OTHER INFORMATION On March 31, 2006, the Company called its then outstanding trust preferred securities. Simultaneously, the Company entered into arrangements for new trust preferred securities. See "Management's Discussion and Analysis - Long Term Debt" above. Although the transaction involved the termination of the old arrangements and entry into new ones, the Company does not believe these changes had an overall material on it, other than to extend the arrangement and to change the basis on which the interest is determined going forward. ITEM 6. EXHIBITS The following exhibits are furnished herewith:
EXHIBIT NUMBER DESCRIPTION - -------------- ----------- 31.1 Certification under Section 302 of Sarbanes-Oxley by Thomas L. Herlache, Chief Executive Officer, is attached hereto.
35 31.2 Certification under Section 302 of Sarbanes-Oxley by Steven D. Jennerjohn, Chief Financial Officer, is attached hereto. 32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of Sarbanes-Oxley is attached hereto. 32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of Sarbanes-Oxley is attached hereto.
"Management agrees to furnish to the Securities and Exchange Commission, upon request, a copy of any other agreements or instruments of Baylake Corp. and its subsidiaries defining the rights of holders of any long-term debt whose authorization does not exceed 10% of total assets." SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. BAYLAKE CORP. Date: May 9, 2006 /s/ Thomas L. Herlache ---------------------------------------- Thomas L. Herlache President (CEO) Date: May 9, 2006 /s/ Steven D. Jennerjohn ---------------------------------------- Steven D. Jennerjohn Treasurer (CFO) 36 EX-31.1 2 c05212exv31w1.txt SECTION 302 CERTIFICATION 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, Thomas L. Herlache, certify that: 1. I have reviewed this quarterly report on Form 10-Q for the quarter ended March 31, 2006 of Baylake Corp (the "Registrant"); 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 officers 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 officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of 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: MAY 9, 2006 /S/ THOMAS L. HERLACHE - ------------------------------------- THOMAS L. HERLACHE CHAIRMAN AND CEO EX-31.2 3 c05212exv31w2.txt SECTION 302 CERTIFICATION 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, Steven D. Jennerjohn, certify that: 1. I have reviewed this quarterly report on Form 10-Q for the quarter ended March 31, 2006 of Baylake Corp (the "Registrant"); 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 quarterly 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 officers 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-a5(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 officers 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 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: MAY 9, 2006 /S/ STEVEN D. JENNERJOHN - ------------------------------------- STEVEN D. JENNERJOHN SENIOR VICE PRESIDENT AND CHIEF FINANCIAL OFFICER EX-32.1 4 c05212exv32w1.txt SECTION 1350 CERTIFICATION 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 the Quarterly Report of Baylake Corp. (the "Company") on Form 10-Q for the three months ended March 31, 2006 as filed with the Securities and Exchange Commission on or about the date hereof (the "Report"), I, Thomas L. Herlache, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that to the best of my knowledge: (1) The Quarterly Report on Form 10-Q of the Company for the three months ended March 31, 2006 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. /S/ THOMAS L. HERLACHE - ------------------------------------- THOMAS L. HERLACHE PRESIDENT AND CHIEF EXECUTIVE OFFICER MAY 9, 2006 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. EX-32.2 5 c05212exv32w2.txt SECTION 1350 CERTIFICATION 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 the Quarterly Report of Baylake Corp. (the "Company") on Form 10-Q for the three months ended March 31, 2006 as filed with the Securities and Exchange Commission on or about the date hereof (the "Report"), I, Steven D. Jennerjohn, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that to the best of my knowledge: (1) The Quarterly Report on Form 10-Q of the Company for the three months ended March 31, 2006 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. /S/ STEVEN D. JENNERJOHN - ------------------------------------- STEVEN D. JENNERJOHN SENIOR VICE PRESIDENT AND CHIEF FINANCIAL OFFICER MAY 9, 2006 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. -----END PRIVACY-ENHANCED MESSAGE-----