-----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, RikPv/jKtalovj/COFkPjCZTnYyQNkv8waXWMsRJvedSYA/VbKvecMsmEFCpWaV+ 0j0LGuE+QEXVRjoxITBTJA== 0000950137-06-012128.txt : 20061109 0000950137-06-012128.hdr.sgml : 20061109 20061109112041 ACCESSION NUMBER: 0000950137-06-012128 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 20060930 FILED AS OF DATE: 20061109 DATE AS OF CHANGE: 20061109 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: 061200156 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 c09924e10vq.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 SEPTEMBER 30, 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 (State or other jurisdiction of 39-1268055 incorporation or organization) (Identification No.)
217 North Fourth Avenue, Sturgeon Bay, WI 54235 (Address of principal executive offices) (Zip Code)
(920)-743-5551 (Registrant's telephone number, including area code) None (Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- 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 November 3, 2006: 7,821,141 shares BAYLAKE CORP. AND SUBSIDIARIES INDEX
PAGE NO. -------- PART I - FINANCIAL INFORMATION Item 1. Financial Statements Consolidated Balance Sheets (Unaudited) as of September 30, 2006 and December 31, 2005 3 Consolidated Statements of Income and Comprehensive Income (Unaudited) for the three and nine months ended September 30, 2006 and 2005 4 Consolidated Statements of Changes in Stockholders' Equity (Unaudited) for the nine months ended September 30, 2006 and 2005 5 Consolidated Statements of Cash Flows (Unaudited) for the nine months ended September 30, 2006 and 2005 6-7 Notes to Consolidated Unaudited Financial Statements 8-13 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 14-38 Item 3. Quantitative and Qualitative Disclosures About Market Risk 39-40 Item 4. Controls and Procedures 40 PART II - OTHER INFORMATION 40 EXHIBIT INDEX Signatures 43 Exhibit 31.1 Certification pursuant to Section 302 44 Exhibit 31.2 Certification pursuant to Section 302 46 Exhibit 32.1 Certification pursuant to 18 U.S.C. Section 1350 48 Exhibit 32.2 Certification pursuant to 18 U.S.C. Section 1350 49
BAYLAKE CORP. CONSOLIDATED BALANCE SHEETS (Unaudited) September 30, 2006 and December 31, 2005 (Dollar amounts in thousands)
September 30, December 31, 2006 2005 ------------- ------------ ASSETS Cash and due from financial institutions $ 21,767 $ 32,855 Federal funds sold 401 199 ---------- ---------- Cash and cash equivalents 22,168 33,054 Securities available for sale 188,097 171,638 Loans held for sale 1,043 374 Loans, net of allowance after $8,220 and $9,551 797,557 802,745 Cash value of life insurance 23,968 22,814 Premises held for sale 673 1,167 Premises and equipment, net 27,979 24,703 Federal Home Loan Bank stock 7,266 8,081 Foreclosed assets, net 3,158 3,333 Goodwill 5,723 5,723 Accrued interest receivable 5,941 5,354 Other assets 10,195 10,422 ---------- ---------- Total assets $1,093,768 $1,089,408 ========== ========== LIABILITIES AND STOCKHOLDERS' EQUITY Deposits Non-interest-bearing $ 101,656 $ 110,641 Interest-bearing 766,065 746,070 ---------- ---------- Total deposits 867,721 856,711 Federal Home Loan Bank advances 115,180 125,185 Federal funds purchased and repurchase agreements 1,595 1,315 Subordinated debentures 16,100 16,100 Accrued expenses and other liabilities 12,462 10,310 Dividends payable -- 1,243 ---------- ---------- Total liabilities 1,013,058 1,010,864 Common stock, $5 par value, authorized 50,000,000; issued- 7,899,197 shares in 2006, 7,805,586 shares in 2005; outstanding- 7,807,184 shares in 2006, 7,782,427 shares in 2005 39,496 39,028 Additional paid-in capital 10,229 9,466 Retained earnings 34,299 32,461 Treasury stock (92,013 shares in 2006 and 23,159 shares in 2005) (1,726) (625) Accumulated other comprehensive loss (1,588) (1,786) ---------- ---------- Total stockholders' equity 80,710 78,544 ---------- ---------- Total liabilities and stockholder equity $1,093,768 $1,089,408 ========== ==========
See accompanying notes to Unaudited Consolidated Financial Statements. 3 BAYLAKE CORP. CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (Unaudited) Three and Nine Months ended September 30, 2006 and 2005 (Dollar amounts in thousands, except per share data)
Three months ended Sept 30 Nine months ended Sept 30 -------------------------- ------------------------- 2006 2005 2006 2005 ------- ------- ------- ------- Interest and dividend income Loans, including fees $15,905 $13,576 $45,987 $38,183 Taxable securities 1,648 1,768 4,789 5,226 Tax exempt securities 453 508 1,191 1,400 Federal funds sold and other 88 33 295 66 ------- ------- ------- ------- Total interest and dividend income 18,094 15,885 52,262 44,875 ------- ------- ------- ------- Interest expense Deposits 7,395 5,193 20,827 13,514 Federal funds purchased and repurchase agreements 142 215 406 706 Federal Home Loan Bank advances and other debt 1,469 1,224 4,230 2,975 Subordinated debentures 282 461 1,428 1,384 ------- ------- ------- ------- Total interest expense 9,288 7,093 26,891 18,579 ------- ------- ------- ------- NET INTEREST INCOME 8,806 8,792 25,371 26,296 Provision for loan losses 371 1,547 632 1,668 ------- ------- ------- ------- NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 8,435 7,245 24,739 24,628 ------- ------- ------- ------- Other income Fees from fiduciary activities 206 193 747 556 Fees from loan servicing 295 292 830 863 Fees for other services to customers 1,344 1,260 3,729 3,543 Gains from sales of loans 149 348 559 733 Net gains (loss) from sale and disposal of premises and equipment 103 (73) 288 (224) Increase in cash surrender value of life insurance 217 184 641 601 Other income 163 139 402 560 ------- ------- ------- ------- Total other income 2,477 2,343 7,196 6,632 ------- ------- ------- ------- Non-interest expenses Salaries and employee benefits 5,066 4,213 14,583 13,070 Occupancy expense 596 717 1,760 1,855 Equipment expense 430 349 1,270 996 Data processing and courier 324 285 939 861 Operation of other real estate 86 87 203 216 Provision for impairment of letter of credit 27 1,846 27 1,846 Other operating expenses 1,797 1,446 5,361 4,235 ------- ------- ------- ------- Total non-interest expenses 8,326 8,943 24,143 23,079 ------- ------- ------- ------- INCOME BEFORE INCOME TAX EXPENSE 2,586 645 7,792 8,181 Income tax expense (benefit) 703 (62) 2,215 2,330 ------- ------- ------- ------- NET INCOME $ 1,883 $ 707 $ 5,577 $ 5,851 ------- ------- ------- ------- COMPREHENSIVE INCOME $ 3,717 $ 220 $ 5,775 $ 4,424 ------- ------- ------- ------- BASIC EARNINGS PER SHARE $ 0.24 $ 0.09 $ 0.72 $ 0.76 DILUTED EARNINGS PER SHARE $ 0.24 $ 0.09 $ 0.71 $ 0.75
See accompanying notes to Unaudited Consolidated Financial Statements. 4 BAYLAKE CORP. CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (Unaudited) Nine months ended September 30, (Dollar amounts in thousands except for share and per share data)
Accumulated Common Stock Additional Other ------------------ Paid-in Retained Treasury Comprehensive Total Shares Amount Capital Earnings Stock Income (loss) Equity --------- ------- ---------- -------- -------- ------------- ------- BALANCE, JANUARY 1, 2005 7,692,777 $38,580 $ 8,806 $28,275 $ (625) $ 1,169 $76,205 Net income for the year -- -- -- 5,851 -- -- 5,851 Net changes in unrealized gain (loss) on securities available for sale, net of $(793) deferred taxes -- -- -- -- -- (1,427) (1,427) ------- Total comprehensive income 4,424 Stock options exercised 72,950 364 299 -- -- -- 663 Tax benefit from exercise of stock options -- -- 243 -- -- -- 243 Cash dividends declared ($0.45 per share) -- -- -- (3,473) -- -- (3,473) --------- ------- ------- ------- ------- ------- ------- BALANCE, SEPTEMBER 30, 2005 7,765,727 $38,944 $ 9,348 $30,653 $ (625) $ (258) $78,062 ========= ======= ======= ======= ======= ======= ======= BALANCE, JANUARY 1, 2006 7,782,427 $39,028 $ 9,466 $32,461 $ (625) $(1,786) $78,544 Net income for the year -- -- -- 5,577 -- -- 5,577 Net changes in unrealized gain (loss) on securities available for sale, net of $106 deferred taxes -- -- -- -- -- 198 198 ------- Total comprehensive income 5,775 Stock compensation expense recognized -- -- 39 -- -- -- 39 Stock options exercised 76,587 383 323 -- -- -- 706 Common stock issued under Dividend Reinvestment Plan 17,024 85 183 -- -- -- 268 Treasury stock repurchases (68,854) -- -- -- (1,101) -- (1,101) Tax benefit from exercise of stock options -- -- 218 -- -- -- 218 Cash dividends declared ($0.48 per share) -- -- -- (3,739) -- -- (3,739) --------- ------- ------- ------- ------- ------- ------- BALANCE, SEPTEMBER 30, 2006 7,807,184 $39,496 $10,229 $34,299 $(1,726) $(1,588) $80,710 ========= ======= ======= ======= ======= ======= =======
See accompanying notes to Unaudited Consolidated Financial Statements. 5 BAYLAKE CORP. CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) Nine months ended September 30, 2006 and 2005 (Dollar amounts in thousands)
2006 2005 -------- -------- CASH FLOWS FROM OPERATING ACTIVITIES: Reconciliation of net income to net cash provided by operating activities: Net income $ 5,577 $ 5,851 Adjustments to reconcile net income to net cash provided to operating activities: Depreciation and amortization 1,209 1,353 Amortization of debt issuance costs 475 177 Amortization of core deposit intangible 39 39 Provision for losses on loans 632 1,668 Provision for impairment on letter of credit 27 1,846 Net amortization of securities 95 457 Increase in cash surrender value of life insurance (641) (601) Federal Home Loan Bank stock dividend -- (309) Net gain on sale of loans (559) (733) Proceeds from sale of loans held for sale 31,315 38,007 Origination of loans held for sale (31,426) (36,469) Provision for valuation allowance on other real estate owned 90 54 Net (gain) loss from disposal of other real estate (76) 35 Net (gain) loss from disposal of bank premises and equipment (288) 224 Stock option compensation expense recognized 39 -- Changes in assets and liabilities: Accrued interest receivable and other assets (947) (956) Accrued expenses and other liabilities 2,152 873 -------- -------- Net cash provided by operating activities 7,713 11,516 CASH FLOWS FROM INVESTING ACTIVITIES: Principal payments on securities available-for-sale 15,405 14,143 Purchase of securities available-for-sale (31,653) (30,654) Proceeds from sale of other real estate owned 2,494 908 Proceeds from sale of premises and equipment 690 316 Loan originations and payments, net 2,231 (35,141) Proceeds from redemption of FHLB Stock 815 -- Additions to premises and equipment (4,392) (5,415) Investment in bank-owned life insurance (583) (469) -------- -------- Net cash used in investing activities (14,993) (56,312)
See accompanying notes to Unaudited Consolidated Financial Statements. 6 BAYLAKE CORP. CONSOLIDATED STATEMENTS OF CASH FLOWS Nine months ended September 30, 2006 and 2005 (Dollar amounts in thousands)
2006 2005 --------- ------- CASH FLOWS FROM FINANCING ACTIVITIES: Net change in deposits $ 11,010 $22,083 Net change in federal funds purchased and repurchase agreements 280 622 Proceeds from Federal Home Loan Bank advances 100,000 25,000 Repayments on Federal Home Loan Bank advances (110,005) (5) Redemption of subordinated debt (16,100) -- Proceeds from issuance of subordinated debt 16,100 -- Proceeds from exercise of stock options 706 663 Tax benefit from exercises of stock options 218 -- Treasury stock repurchases (1,101) -- Cash dividends paid (4,714) (4,627) --------- ------- Net cash (used in) provided by financing activities (3,606) 43,736 --------- ------- Net change in cash and cash equivalents (10,886) (1,060) Beginning cash and cash equivalents 33,054 26,172 --------- ------- ENDING CASH AND CASH EQUIVALENTS $ 22,168 $25,112 ========= =======
See accompanying notes to Unaudited Consolidated Financial Statements. 7 BAYLAKE CORP. NOTES TO CONSOLIDATED UNAUDITED FINANCIAL STATEMENTS SEPTEMBER 30, 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 September 30, 2006 and December 31, 2005. The results of operations for the three and nine months ended September 30, 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 and nine months ended September 30 (dollars in thousands, except per share amounts):
Three months Nine months ended Sept 30, ended Sept 30, ----------------------- ----------------------- 2006 2005 2006 2005 ---------- ---------- ---------- ---------- (Net income in thousands) (NUMERATOR): Net income $ 1,883 $ 707 $ 5,577 $ 5,851 (DENOMINATOR): Weighted average number of common shares outstanding-basic 7,800,998 7,742,346 7,796,443 7,713,177 Dilutive effect of stock options 33,635 86,401 35,990 82,972 Weighted average number of common shares outstanding-diluted 7,834,633 7,828,747 7,832,433 7,796,149 BASIC EPS $ 0.24 $ 0.09 $ 0.72 $ 0.76 DILUTED EPS $ 0.24 $ 0.09 $ 0.71 $ 0.75
8 BAYLAKE CORP. NOTES TO CONSOLIDATED UNAUDITED FINANCIAL STATEMENTS SEPTEMBER 30, 2006 4. Baylake Corp. paid a cash dividend of $0.16 per share on September 15, 2006 to shareholders of record as of September 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 nine months of 2006, the amount of compensation expense reflected in the financial statements is $39,000, including $13,000 in the third quarter of 2006. As a matter of comparing the three and nine months ended September 30, 2006 with the same period in 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 Nine months ended September 30, 2005 September 30, 2005 ------------------ ------------------ (In thousands, except per share amounts) Net income, as reported $ 707 $5,851 Less: Total stock-based employee compensation cost determined under the fair value method, net of income taxes (14) (43) Pro forma net income 693 5,808 Earnings per share: Basic - as reported $0.09 $ 0.76 Basic - pro forma $0.09 $ 0.75 Diluted - as reported $0.09 $ 0.75 Diluted - pro forma $0.09 $ 0.74
9 BAYLAKE CORP. NOTES TO CONSOLIDATED UNAUDITED FINANCIAL STATEMENTS SEPTEMBER 30, 2006 The fair value of each option outstanding 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. A summary of the Company's stock-based compensation activity for the nine months ended September 30, 2006, is presented below.
Weighted Weighted average Aggregate average remaining intrinsic exercise contractual value Stock options Shares price term (000's) - ------------- ------- -------- ----------- --------- Outstanding at December 31, 2005 486,869 $13.95 Granted -- -- Exercised 76,587 9.21 Forfeited -- -- Outstanding at September 30, 2006 410,282 14.83 Outstanding and in the money options at September 30, 2006 350,282 13.09 3.4 $966 Options exercisable and in the money at September 30, 2006 313,901 13.03 3.4 $884
During the first nine months of 2006, $706,000 was received for the exercise of 76,587 stock options. 6. Effect of Newly Issued But Not Yet Effective Accounting Standards: In September 2006, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 158, "Accounting for Defined Benefit Pension and Other Postretirement Plans - amendment of FASB Statements No. 87, 88, 106, and 132 (R)", ("SFAS 158"). SFAS 158 requires an employer to recognize a plan's overfunded or underfunded status in its balance sheets and recognize the changes in a plan's funded status in comprehensive income in the year in which the changes occur. In addition, SFAS No. 158 requires an employer to measure plan assets and obligations that determine its funded status as of the end of its fiscal year. The requirement to recognize the funded status of a benefit plan and the disclosure requirements are effective as of the end of the fiscal year ending after December 15, 2006. The requirement to measure plan assets and benefit obligations as of the employer's fiscal year-end is effective for fiscal years ending after December 15, 2008. We do not expect the adoption of SFAS No. 158 will have a significant impact on our financial condition or results of operations. 10 BAYLAKE CORP. NOTES TO CONSOLIDATED UNAUDITED FINANCIAL STATEMENTS SEPTEMBER 30, 2006 In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements" which clarifies the principle that fair value should be based on the assumptions market participants would use when pricing an asset or liability and establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. Under the standard, fair value measurement would be separately disclosed by level with the fair value hierarchy. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007 (January 1, 2008 for us), and interim periods within those fiscal years, with early adoption permitted. We are currently assessing the impact that SFAS 157 will have on our financial condition or results of operations. In September 2006, the Securities and Exchange Commission ("SEC") issued Staff Accounting Bulletin No. 108, "Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements", ("SAB 108"). SAB 108 requires the evaluation of prior-year misstatements using both the balance sheet approach and the income statement approach. In the initial year of adoption should either approach result in quantifying an error that is material in light of quantitative and qualitative factors, SAB 108 guidance allows for a one-time cumulative effect adjustment to beginning retained earnings. In years subsequent to adoption, previously undetected misstatements deemed material shall result in the restatement of previously issued financial statements in accordance with FAS 154. SAB 108 is effective for fiscal years ending on or after November 15, 2006. We do not expect the adoption of this standard will have a significant impact on our financial condition or results of operations. Under Emerging Issues Task Force ("EITF") 06-4: Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split Dollar Life Insurance Arrangements, the EITF reached a consensus that requires the recognition of a liability related to the postretirement benefits covered by an endorsement split-dollar life insurance arrangement. The consensus highlights that the employer who is the policy holder has a liability for the benefit it is providing to the employee. The employer has agreed to maintain the insurance policy in force for the employee's benefit during his retirement, then the liability recognized during the employee's active service period should be based on the future cost of insurance to be incurred during the employee's retirement. Also, if the employer has agreed to provide the employee with a death benefit, then the liability for the future death benefit should be recognized under SFAS 106. As of September 30, 2006, this FASB board ratified the above. It is applicable for fiscal years beginning after December 15, 2006. We do not expect the adoption of this standard will have a significant impact on our financial condition or results of operations. Under EIFT 06-5: Accounting for Purchases of Life Insurance-Determining the Amount That Could be Realized in Accordance with FASB Technical Bulletin No. 85-4, "Accounting for Purchases of Life Insurance", the task force reached a consensus that a policyholder should consider any additional amounts included in the contractual terms of the policy in determining the amount that could be realized under the insurance contract. The task forces agreed that contractual limitations should be considered when determining the realizable amounts. Those amounts that are recoverable by the policyholder at the discretion of the insurance company should be excluded from the amount that could be 11 BAYLAKE CORP. NOTES TO CONSOLIDATED UNAUDITED FINANCIAL STATEMENTS SEPTEMBER 30, 2006 realized. The task force also agreed that fixed amounts that are recoverable by the policyholder in future periods in excess of one year from the surrender of the policy should be recognized at their present value. The task force also reached a consensus that a policyholder should determine the amount that could be realized under the life insurance contract assuming the surrender of an individual-life by individual life policy. The task force also noted that any amount that is ultimately realized by the policyholder upon the assumed surrender of the final policy shall be included in the amount that could be realized under the insurance contract. The issue should be effective for fiscal years beginning after December 15, 2006, but early adoption is permitted. This was ratified at the Task Force, September 20, 2006 meeting. We do not expect the adoption of this standard will have a significant impact on our financial condition or results of operations. In June 2006, the FASB issued Interpretation No. 48, "Accounting for Uncertainty in Income Taxes-an interpretation of FASB Statement No. 109, "(FIN 48"). FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The interpretation requires the impact of a tax position to be recognized in the financial statements if that position is more-likely-than-not of being sustained upon examination, based on the technical merits of the position. A tax position meeting the more-likely-than-not threshold is then to be measured at the largest amount of benefit that is greater than 50 percent likely of being realized upon settlement. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. As discussed in the section titled "Critical Accounting Policies-Income tax accounting", the Company does have uncertain tax positions relative to Wisconsin Department of Revenue and income earned by out of state subsidiaries. For further discussion, please review that discussion. The Company will adopt FIN 48 in 2007 and is in the process of assessing the impact on its results of operations, financial position, and liquidity. In March 2006, FASB issued Statement of Financial Accounting Standards No. 156, "Accounting for Servicing of Financial Assets, an amendment of FASB Statement No. 140, " ("SFAS 156"). SFAS 156 requires an entity to recognize a servicing asset or servicing liability each time it undertakes an obligation to service a financial asset by entering into a servicing contract. All separately recognized servicing assets and servicing liabilities are to be initially measured at fair value, if practicable. SFAS 156 permits an entity to choose either the Amortization method or the Fair Value Measurement Method for subsequently measuring each class of separately recognized servicing assets or servicing liabilities. Under the amortization method, servicing assets or servicing liabilities are amortized in proportion to and over the period of estimated net servicing income or loss and servicing assets or servicing liabilities are assessed for impairment based on fair value at each reporting date with the changes in fair value recognized in earnings in the period in which the changes occur. SFAS 156 is effective for fiscal years beginning after September 15, 2006, and earlier adoption is permitted as of the beginning of an entity's fiscal year, provided the entity has not yet issued financial statements for any period of that fiscal year. Total servicing rights as of September 30, 2006, include $505,000 of mortgage servicing rights and 12 BAYLAKE CORP. NOTES TO CONSOLIDATED UNAUDITED FINANCIAL STATEMENTS SEPTEMBER 30, 2006 $695,000 of servicing rights on SBA loans. The Company will adopt SFAS 156 in 2007 and is in the process of assessing the impact on its results of operations, financial position, and liquidity. 7. The Bank owns a 49% interest in United Financial Services, Inc. ("UFS") a data processing service. The Bank's ownership interest totals $3.2 million and $2.7 million, respectively, at September 30, 2006 and 2005, respectively, and is reflected in the Other Assets in the "Consolidated Balance Sheets". In addition to the ownership interest, UFS and the Company have a common member on each respective Board of Directors. The investment in this entity is carried under the equity method of accounting, and the pro rata share of its income is included in other income. On June 27, 2006, UFS entered into an amendment to an earlier agreement for employment with a key employee of UFS allowing that individual the option to purchase up to 20%, or 240 shares, of the authorized shares of UFS. The option price shall be $1,000 per share, less dividends or distributions to owners. Current book value of UFS is approximately $6,500 per share. Any exercise of the options will have an effect of reducing the Company's interest in UFS and decrease other income as those options are exercised. 8. In its previous report, the Company indicated that one loan of about $8.1 million might be repaid upon sale of collateral real estate under an accepted full price offer to purchase, but that closing was subject to settlement of liens and claims against the property. However, despite negotiations, the lien claims were not resolved and the offer has been withdrawn. The Company then filed and has completed a foreclosure on a portion of the loans in the amount of $4.0 million. Upon withdrawal of the offer to purchase, the Company is initiating additional foreclosure proceedings on the remaining loans of about $4.1 million. 13 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 and nine months ended September 30, 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. 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, 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. 14 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. 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. 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 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 15 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 Department made contact with the Company's outside counsel in June 2006 with the intention of gathering various financial data from the Company for the purpose of preparing a formal settlement proposal for the Company. To this point, the Department has not provided counsel with any formal request. The Company will respond to the Department's request once a formal request is provided. 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 and nine-month periods ended September 30, 2006 and 2005, as well as comparisons between the respective periods. TABLE 1 SUMMARY RESULTS OF OPERATIONS ($ in thousands, except per share data)
Three months Three months Nine months Nine months ended Sept 30, ended Sept 30, ended Sept 30, ended Sept 30, 2006 2005 2006 2005 -------------- -------------- -------------- -------------- Net income, as reported $1,883 $ 707 $5,577 $5,851 EPS-basic, as reported $ 0.24 $ 0.09 $ 0.72 $ 0.76
16 EPS-diluted, as reported $ 0.24 $ 0.09 $ 0.71 $ 0.75 Cash dividends declared $ 0.16 $ 0.15 $ 0.48 $ 0.45 Return on average assets, as reported 0.69% 0.26% 0.68% 0.72% Return on average equity, as reported 9.54% 3.60% 9.49% 10.09% Efficiency ratio, as reported (1) 71.76% 77.97% 72.21% 68.09%
(1) Non-interest expense divided by sum of taxable equivalent net interest income plus non-interest income, excluding investment securities gains, net The increase in net income for the three-month period is primarily due to a decrease in the provision for loan losses and a decrease in non-interest expense. These were partially offset by an increase in income tax expense. The decrease in net income for the nine-month period is primarily due to decreased net interest income and an increase in non-interest expense. These were partially offset by an increase in other income, a decrease in the provision for loan losses and 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 78.7% of total operating income for the three months ended September 30, 2006, as compared to 79.6% 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 was $9.1 million for the three months ended September 30, 2006 and 2005. This resulted from an increase in our net interest margin which occurred partially from an increase in average loans for the period. Net interest income for the period was offset partially by an increase in interest foregone on non-accrual loans (due to an increase in the level of non-performing loans, which do not accrue interest). See "Balance Sheet-'"Non-Performing Loans, Potential Problem Loans and Other Real Estate" below. During the nine months ended September 30, 2006, net interest income on a tax equivalent basis decreased $1.0 million, or 3.8%, to $26.2 million from $27.3 million for the comparable period in 2005. The decrease resulted from a decrease in our net interest margin which resulted partially from an increase in interest foregone on non-accrual loans, offset partially by an increase in average loans for the period. In addition, amortization expense of issuance costs related to the redemption of trust preferred securities (totaling $475,015 in the first quarter) affected results for the nine months ended September 30, 2006. 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 17 funds available without interest cost (demand deposits and equity capital) is an important component increasing net interest margin. The net interest margin for the third quarter of 2006 was 3.61%, up 3 basis points ("bps") from 3.58% for the comparable period in 2005. For the third quarter of 2006, interest rate spread decreased 3 bps to 3.18% (the net result of a 93 bps increase in the yield on earning assets more than offset by a 96 bps increase in the cost of interest-bearing liabilities. During the nine months ended September 30, 2006, the net interest margin was 3.46% compared to 3.64% for the comparable period in 2005. Net interest margin decreased as a result of a decrease in earning assets relative to interest-bearing liabilities and a 26 bps decrease in interest rate spread (the net result of a 88 bps increase in the yield on earning assets more than offset by a 114 bps increase in the cost of interest-bearing liabilities). As the Federal Reserve Board ("FRB") has steadily increased short-term interest rates during the latter half of 2004 thru the second 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 September 30, 2006 was at 5.25% compared to 3.75% at September 30, 2005, while the average Federal Funds rate for the first nine months of 2006 was 191 bps higher than for the same period in 2005. Financial institutions' competition for deposits has driven up the cost of funds and, as a result, net interest margin decreased in the first nine months 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 nine months of 2006. For the three months ended September 30, 2006, average-earning assets decreased $9.9 million, or 1.0%, when compared to the same period last year. The Company recorded an increase in average loans of $12.8 million, or 1.6%, for the third quarter of 2006 compared to the same period a year ago. For the nine months ended September 30, 2006, average-earning assets increased $12.7 million, or 1.3%, when compared to the same period last year. The Company recorded an increase in average loans of $35.2 million, or 4.5%, for the first nine months of 2006 compared to the same period a year ago. Loans have typically resulted in higher rates of interest income to the Company than have investment securities, which positively affected income in the period. Interest rate spread is the difference between the tax-equivalent rate earned on average earning assets and the rate paid on average interest-bearing liabilities. The interest rate spread decreased for the quarter ended September 30, 2006 when compared to the same period a year ago. The interest rate spread decreased 3 bps to 3.18% at September 30, 2006 from 3.21% in the same quarter in 2005. While the average yield on earning assets increased 93 bps during the period, the average rate paid on interest-bearing liabilities increased 96 bps over the same period. For the nine months ended September 30, 2006, the interest rate spread decreased 26 bps to 3.06% from 3.32% when compared to the same period a year earlier. The average yield on earning assets increased 88 bps to 7.00% from 6.12% during the nine-month period, while the average rate paid on interest-bearing liabilities increased 114 bps. The increase in the rates paid on interest-bearing liabilities occurred as a result of a higher cost of funding from deposits and other wholesale funding such as federal funds purchased and loans from the Federal Home Loan Bank. We would expect that trend to be tempered in light of the recent Federal Reserve Board interest rate actions to hold short-term interest rates. 18 TABLE 2 NET INTEREST INCOME ANALYSIS ON A TAX -EQUIVALENT BASIS ($ in thousands) Three months ended September 30,
2006 2005 ---------------------------------------- ---------------------------------------- Average Interest Average Average Interest Average Balance income/expense yield/Rate Balance income/Expense yield/rate ---------- -------------- ---------- ---------- -------------- ---------- ASSETS Earning assets: Loans, net $ 811,119 $15,992 7.89% $ 798,321 $13,653 6.84% Taxable securities 149,508 1,648 4.41% 172,055 1,768 4.11% Tax exempt securities 42,544 686 6.45% 45,630 766 6.71% Federal funds sold and interest bearing due from banks 6,682 88 5.27% 3,786 33 3.49% ---------- ------- ---- ---------- ------- ---- Total earning assets 1,009,853 18,414 7.29% 1,019,792 16,220 6.36% ---------- ------- ---- ---------- ------- ---- Non-interest earning assets 86,984 82,507 Total assets $1,096,837 $1,102,299 ---------- ---------- LIABILITIES AND STOCKHOLDERS' EQUITY Interest-bearing liabilities: Total interest-bearing deposits 765,970 7,395 3.86% 736,925 5,193 2.82% Short-term borrowings 8,915 129 5.79% 21,948 204 3.72% Customer repurchase agreements 1,303 13 3.99% 1,553 11 2.83% Federal Home Loan Bank advances 112,681 1,469 5.21% 122,904 1,224 3.98% Subordinated debentures 16,100 282 7.01% 16,100 461 11.45% ---------- ------- ---- ---------- ------- ----- Total interest-bearing liabilities $ 904,969 9,288 4.11% $ 899,430 $ 7,093 3.15% ---------- ------- ---- ---------- ------- ---- Demand deposits 99,928 115,807 Accrued expenses and other liabilities 12,949 8,573 Stockholders' equity 78,991 78,489 ---------- ---------- Total liabilities and stockholders' equity $1,096,837 $1,102,299 ---------- ---------- Interest rate spread $ 9,126 3.18% $ 9,127 3.21% Net interest margin 3.61% 3.58% ---- ----
19 TABLE 3 NET INTEREST INCOME ANALYSIS ON A TAX -EQUIVALENT BASIS ($ in thousands) Nine months ended September 30,
2006 2005 ---------------------------------------- ---------------------------------------- Average Interest Average Average Interest Average Balance income/Expense yield/Rate Balance income/expense yield/Rate ---------- -------------- ---------- ---------- -------------- ---------- ASSETS Earning assets: Loans, net $ 820,315 $46,241 7.52% $ 785,124 $38,433 6.53% Taxable securities 147,013 4,789 4.34% 169,714 5,226 4.11% Tax exempt securities 36,850 1,803 6.52% 41,473 2,117 6.81% Federal funds sold and interest bearing due from banks 8,059 295 4.88% 3,206 66 2.74% ---------- ------- ----- ---------- ------- ----- Total earning assets 1,012,237 53,128 7.00% 999,517 45,842 6.12% ---------- ------- ----- ---------- ------- ----- Non-interest earning assets 84,591 80,157 ---------- ---------- Total assets $1,096,828 $1,079,674 ---------- ---------- LIABILITIES AND STOCKHOLDERS' EQUITY Interest-bearing liabilities: Total interest-bearing deposits 765,478 20,827 3.63% 727,383 13,514 2.48% Short-term borrowings 9,449 370 5.22% 27,636 679 3.28% Customer repurchase agreements 1,244 36 3.86% 1,421 27 2.53% Federal Home Loan Bank advances 118,552 4,230 4.76% 113,449 2,975 3.50% Subordinated debentures 16,336 1,428 11.66% 16,100 1,384 11.46% ---------- ------- ----- ---------- ------- ----- Total interest-bearing liabilities $ 911,059 $26,891 3.94% $ 885,989 $18,579 2.80% ---------- ------- ----- ---------- ------- ----- Demand deposits 95,155 107,965 Accrued expenses and other liabilities 12,270 8,367 Stockholders' equity 78,344 77,353 ---------- ----------
20 Total liabilities and stockholders' equity $1,096,828 $1,079,674 ---------- ---------- Interest rate spread $26,237 3.06% $27,263 3.32% Net interest margin 3.46% 3.64% ===== =====
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 92.3% and 92.6%, respectively, for the first nine months of 2006 and 2005, respectively. Provision for Loan Losses The provision for loan losses ("PFLL") is the cost of providing an allowance for probable incurred losses. The allowance consists of specific and general components. 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 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 nine months of 2006 was $632,000 as compared to a PFLL of $1.7 million for the first nine months in 2005. The calculation of the amount during the period took into account overall asset quality in the loan portfolio, including an increase in non-performing assets. See the discussion below following Table 4. Net loan charge-offs in the first nine months of 2006 were $2.0 million compared with net charge-offs of $1.6 million for the same period in 2005. The loans charged-off in the first nine months of 2006 had a specific reserve in the aggregate of $1.8 million which approximated the amount charged-off. Net charge-offs as a percentage of average loans is a key measure of asset quality. Net charge-offs to average loans were 0.32% for the first nine months of 2006 compared to 0.28% for the same period in 2005. For the nine months ended September 30, 2006, non-performing loans increased $15.4 million, although for the three months ended September 30, 2006 non-performing loans decreased $6.4 million; see below for further information. TABLE 4 ALLOWANCE FOR LOAN LOSSES ($ in thousands)
For the nine months For the nine months ended Sept 30, 2006 ended Sept 30, 2005 ------------------- ------------------- Allowance for Loan Losses ("ALL) Balance at beginning of period $9,551 $10,445 Provision for loan losses 632 1,668 Charge-offs 2,447 1,913 Recoveries 484 292 Balance at end of period $8,220 $10,492 Net charge-offs ("NCOs:) $1,963 $ 1,621
21 As described more fully in Table 8 below, non-accrual loans increased significantly during the period from December 31, 2005. However, despite the increase in non-accrual loans during the nine months ended September 30, 2006, the required allocation of the allowance for these loans only increased $90,000, as these loans had previously been assessed for impairment under the requirements of SFAS 114. The amount of non-performing loans increased substantially during the nine-month period ended September 2006. The provision did not increase as significantly because of management's belief and expectations 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. Also, negative developments relating to our non-performing loans, including diminution of value of the collateral or increased costs of collection, 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 which would negatively affect our earnings taken. 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 increased $134,000, or 5.7% to $2.5 million for the third quarter of 2006 when compared to the third quarter of 2005. For the nine months ended September 30, 2006, total non-interest income was $7.2 million, an increase of $564,000, or 8.5%, when compared to the same period in 2005. The non-interest income to average assets ratio was 0.90% for the three months ended September 30, 2006 compared to 0.85% for the same period in 2005. For the nine months ended September 30, 2006, the non-interest income to average assets ratio was 0.87% compared to 0.82% for the same period in 2005. The increase in non-interest income for the three-month and nine-month periods is due primarily to increases in net gains from sales and disposals of premises and equipment. Table 5 reflects the various components of non-interest income for the comparable quarters. 22 TABLE 5 NON-INTEREST INCOME ($ in thousands)
Third Third Percent YTD YTD Percent quarter 2006 quarter 2005 change 2006 2005 change ------------ ------------ ------- ------ ------ ------- Fees from fiduciary services $ 206 $ 193 6.7% $ 747 $ 556 34.4% Fees from loan servicing 295 292 1.0% 830 863 (3.8%) Service charges on deposit accounts 885 877 0.9% 2,530 2,447 3.4% Other fee income 200 199 0.5% 530 549 (3.5%) Financial services income 259 184 40.8% 669 547 22.3% Gains from sales of loans 149 348 (57.2%) 559 733 (23.7%) Net gains (loss) from sale and disposal of premises and equipment 103 (73) NM 288 (224) NM Increase in cash surrender value of life insurance 217 184 17.9% 618 601 2.8% Death benefits realized -- -- NM 23 -- NM Gain on sale of bank assets -- -- NM -- 200 NM Other income 163 139 17.3% 402 360 11.7% ------ ------ ------ ------ Total Other Income $2,477 $2,343 5.7% $7,196 $6,632 8.5%
Service charges on deposit accounts increased $83,000 for the nine-month period ended September 30, 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. In the first nine months of 2006, gains from sales of loans totaling $559,000 compared to $733,000 in the first nine months of 2005. During the first nine months of 2006, secondary mortgage loan activity decreased. Additionally gains from sale of these loans decreased proportionally more as changes in the mix of commercial/mortgage loans sold, tighter spreads and competitive pressures with respect to pricing resulted during the period. The Company has seen a decrease in the number of loan applications, as interest rates have increased over the nine-month period. Secondary loan production decreased $5.0 million between the comparable nine-month periods ($31.4 million in the first nine months of 2006 versus $36.5 million in the first nine months of 2005). The decrease in loan 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 and nine-month periods ended September 30, 2006, net gains (loss) from the sale of bank premises and equipment were related to gains of $188,000 on the sale of bank land located in the Green Bay market area. In addition, gains totaling $103,000 taken in the third quarter of 2006 for space related to the Baylake City Center project which was sold by the Company to an unrelated third party. The net loss on disposal of bank premises of $224,000 for 23 the nine-month period ended September 30, 2005 related to the sale of two buildings and land formerly used as branch offices in addition to write-downs of leasehold improvements which occurred in the third quarter of 2005. For the three-month and nine-month periods ended September 30, 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 $200,000 ($21,000 recognized in the second 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 decreased $617,000 or 6.9%, to $8.3 million for the three months ended September 30, 2006 compared to the same period in 2005. For the nine months ended September 30, 2006, total non-interest expense increased $1.1 million or 4.6%, to $24.1 million compared to the same period in 2005. Impacting the three-month and nine-month period results for 2005 was a $1.8 million charge for impairment related to an-off balance sheet letter of credit. The non-interest expense to average assets ratio was 3.04% for the three months ended September 30, 2006 compared to 3.25% for the same period in 2005. For the nine months ended September 30, 2006, the non-interest expense ratio to average assets was 2.93% compared to 2.85% for the same period in 2005. Net overhead expense is total non-interest expense less total non-interest income excluding securities gains. The net overhead expenses to average assets ratio was 2.13% for the three months ended September 30, 2006 compared to 2.39% for the same period in 2005. For the nine months ended September 30, 2006, the net overhead expenses to average assets ratio was 2.06% compared to 2.03% for the same period in 2005. The efficiency ratio is total non-interest expense as a percentage of the sum of net-interest income on a fully taxable equivalent basis and total non-interest income. The efficiency ratio for the three months ended September 30, 2006 was 71.76% compared to 77.97% for the same period in 2005. For the nine months ended September 30, 2006, the efficiency ratio was 72.21% compared to 68.09% for the same period in 2005. TABLE 6 NON-INTEREST EXPENSE ($ in thousands)
Third Third Percent YTD YTD Percent quarter 2006 quarter 2005 change 2006 2005 change ------------ ------------ ------- ------- ------- ------- Salaries and employee benefits $5,066 $4,213 20.2% $14,583 $13,070 11.6% Occupancy 596 717 (16.9%) 1,760 1,855 (5.1%) Equipment 430 349 23.2% 1,270 996 27.5% Data processing and courier 324 285 13.7% 939 861 9.1% Operation of other real estate owned 86 87 (1.1%) 203 216 (6.0%) Business development and advertising 253 276 (8.3%) 730 764 (4.5%) Charitable contributions 52 36 44.4% 158 183 (13.7%)
24 Stationary and supplies 135 139 (2.9%) 397 406 (2.2%) Director fees 124 134 (7.5%) 395 326 21.2% FDIC 26 28 (7.1%) 79 84 (6.0%) Mortgage servicing rights amortization 86 54 59.3% 182 170 7.1% Legal and professional 77 115 (33.0%) 327 419 (22.0%) Loan and collection 308 76 305.3% 615 229 168.6% Impairment of off-balance sheet letter of credit 27 1,846 NM 27 1,846 NM Other operating 736 588 25.2% 2,478 1,654 49.8% ------ ------ ------- ------- Total non-interest expense $8,326 $8,943 (6.9%) $24,143 $23,079 4.6%
Salaries and employee benefits showed an increase of $853,000, or 20.2%, to $5.1 million for the third quarter of 2006 compared to the same period in 2005. The number of full-time equivalent employees was 334 as of September 30, 2006 compared to 311 at September 30, 2005, primarily the result of additional staffing for the remodeled downtown Green Bay branch opened in June 2005 and a new branch in Suamico that opened for business in August 2006. For the three months ended September 30, 2006, salary-related expenses increased $520,000, or 17.7%, due principally to merit increases between the years, related staff increases and additional management personnel added during the period. For the nine months ended September 30, 2006, salary-related expenses increased $1.3 million or 14.7% compared to the same period in 2005 for the reasons listed previously. 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 $243,000 in expenses related to the Plan in the third quarter of 2006 compared to $121,000 in the third quarter of 2005 and $623,000 for the nine months ended September 30, 2006 compared to $519,000 for the same period a year earlier. The fluctuation in Plan expenses are driven from the timing of determining the discretionary contribution in addition to the change in market prices on a periodic basis. 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. 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, decreased $40,000, or 3.8%, to $1.0 million for the third quarter of 2006 compared to the same period in 2005, primarily the result of a reduction in lease expense for the period. For the nine months ended September 30, 2006, occupancy and equipment expense, collectively, increased $179,000, or 6.3%, to $3.0 million compared to the same period in 2005. The increase for the nine-month period for 2006 were attributable to additional depreciation resulting from the downtown Green Bay branch as mentioned previously, costs related to various equipment upgrades and increased utility costs. 25 Expenses related to the operation of other real estate owned were flat at $86,000 for the 2006 three-month period ended September 30 compared to $87,000 for the same period in 2005. For the nine-month period ended September 30, 2006, other real estate owned expenses decreased $13,000 to $203,000 compared to the same period in 2005. Included in these results for the nine-month period ended September 30, 2006 were net gains taken on the sale of other real estate owned amounting to $75,000 compared to net losses of $35,000 for the same period in 2005. In addition, costs related to the holding of other real estate owned properties increased $97,000 to $278,000 for the nine months ended September 30, 2006. Loan and collection expense increased $232,000 to $308,000 for the three months ended September 30, 2006 compared to the same period in 2005. For the nine months ended September 30, 2006, loan and collection expense increased $386,000 to $615,000 compared to the same period in 2005. $467,000 of the increase for the nine months ended September 30, 2006 relates to legal and operating costs on two commercial loan credits, one of which is a non-performing loan and the other related to a previously disclosed impaired letter of credit for a commercial credit in the third quarter of 2005. Both properties are listed for sale through an independent third party. Costs on these properties are expected to continue through the balance of 2006 and into at least early 2007. Other operating expense increased $148,000 for the three months ended September 30, 2006 and $824,000 to $2.5 million for the nine-month period ended September 30, 2006 compared to the same periods in 2005. The increase was due in part to costs of $216,000 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. $332,000 (including $105,000 in the third quarter of 2006) of the increase was related to new product offering costs and service delivery enhancements, including those for the HPC product introduced in the fourth quarter of 2005. Income Taxes Income tax expense for the Company for the three months ended September 30, 2006 was $703,000, an increase of $765,000 compared to the same period in 2005. For the nine months ended September 30, 2006, income tax expense resulted in a decrease of $115,000 to $2.2 million compared to an income tax expense of $2.3 million for the same period in 2005. The higher tax expense for the three-month period ended September 30 reflected the Company's increase in income before income tax. The lower tax expense for the nine-month period ended September 30 reflected the Company's decrease in income before income tax resulting in an increased proportion of non-taxable income to total income before income taxes. The Company's effective tax rate (income tax expense divided by income before taxes) was 28.4% for the nine months ended September 30, 2006 compared with 28.5% for the same period in 2005. The effective tax rate of 28.4% consisted of a federal effective tax rate of 23.4% and Wisconsin state effective tax rate of 5.0%. For the nine-month period ended September 30, 2006, 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 26 examinations. See "Critical Accounting Policies-Income Tax Accounting" above regarding Wisconsin tax matters which may affect our income tax expense in future periods. BALANCE SHEET ANALYSIS Loans At September 30, 2006, total loans decreased $6.5 million, or 0.8%, to $805.8 million from $812.3 million at December 31, 2005. A decrease of $16.8 million or 3.6% occurred in the commercial real estate loan totals from December 31, 2005 to September 30, 2006 as a result of competitive pricing pressures and principal paydowns on several large commercial credits during the period. Growth in the remaining portion of the Company's loan portfolio resulted primarily from an increase in real estate construction loans to $96.9 million at September 30, 2006 compared to $85.7 million at December 31, 2005. The following table reflects the composition (mix) of the loan portfolio: TABLE 7 LOAN PORTFOLIO ANALYSIS ($ in thousands)
September December Percent 30, 2006 31, 2005 change --------- -------- ------- Amount of loans by type Real estate-mortgage Commercial $451,199 $467,956 (3.6%) 1-4 family residential First liens 91,323 90,946 0.4% Junior liens 23,778 23,470 1.3% Home equity 32,095 34,320 (6.5%) Commercial, financial and agricultural 82,035 80,260 2.2% Real estate-construction 96,925 85,729 13.1% Installment Credit cards and related plans 2,039 2,088 (2.3%) Other 12,600 12,175 3.5% Obligations of states and political subdivisions 14,209 15,785 (10.0%) Less: deferred origination fees, net of costs 426 433 (1.6%) -------- -------- ----- Total $805,777 $812,296 (0.8%)
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 27 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. The ALL at September 30, 2006 was $8.2 million compared with $9.6 million at the end of 2005. This was based on management's analysis of the loan portfolio risk at September 30, 2006. As such, a provision expense of $632,000 was recorded for the nine months ended September 30, 2006. The year to date provision has decreased by $1.0 million 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 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. 28 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. In addition, declines in real estate values in our market areas may affect collateral values of loans secured by commercial or residential mortgages, which may require further re-evaluation of allowance levels. Consideration for making such allocations is consistent with the factors discussed above, and all of the factors are subject to change; thus, the allocation is not necessarily indicative of the loan categories in which future loan losses will occur. It would also be expected that the amount allocated for any particular type of loan will increase or decrease proportionately to both the changes in the loan balances and to increases or decreases in the estimated loss in loans of that type. In other words, changes in the risk profile of the various parts of the loan portfolio should be reflected in the allowance allocated. While there exists probable asset quality problems in the loan portfolio, in view of collateral values, management believes sufficient reserves have been provided in the ALL to absorb probable incurred losses in the loan portfolio at September 30, 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 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. 29 TABLE 8 NON-PERFORMING ASSETS ($ in thousands)
At or for At or for At or for the period the period the period ended ended ended Sept 30, 2006 Sept 30, 2005 December 31, 2005 ------------- ------------- ----------------- Nonperforming Assets: Nonaccrual loans $22,368 $ 7,299 $ 6,942 Accruing loans past due 90 days or more 0 0 0 ------- ------- ------- Total nonperforming loans ("NPLs") $22,368 $ 7,299 $ 6,942 Other real estate owned 3,158 2,629 3,333 ------- ------- ------- Total nonperforming assets ("NPAs") $25,526 $ 9,928 $10,275 Ratios: ALL to NCO's (annualized) 3.14 4.85 2.32 NCO's to average loans (annualized) 0.32% 0.28% 0.52% ALL to total loans 1.02% 1.33% 1.18% NPL's to total loans 2.78% 0.92% 0.85% NPA's to total assets 2.33% 0.90% 0.94% ALL to NPL's 36.75% 143.75% 137.58%
As indicated in Table 8, non-performing loans at September 30, 2006 were $22.4 million compared to $6.9 million at December 31, 2005. Real estate non-accrual loans accounted for $21.7 million of the total, of which $2.6 million was residential real estate, $5.5 million was real estate construction and $13.6 million was commercial real estate. Commercial and industrial non-accrual loans totaled $487,000. Non-accrual loans increased during the nine months ended September 30, 2006 by $15.4 million. The increase is primarily attributable to four commercial loans, previously disclosed, totaling $15.0 million for businesses that are experiencing difficulties in sales, cash flow, fiscal operations, and/or general management issues. Two previously disclosed non-performing loans from the first quarter of 2006 totaling $6.2 million were brought current during the third quarter. Each of these four 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 or is in the process of initiating foreclosure actions on three of these loans involving $13.6 million and it anticipates protracted litigation of at least twelve months in duration in each case. Management has allocated $311,000 in the ALL on the basis of a SFAS 114 analysis for any loss estimated with respect to these loans. One loan totaling $1.4 million is subject to voluntary liquidation plans that propose to sell underlying real estate assets in amounts sufficient to repay the outstanding loan balances. In spite of an increase in non-performing loans for the nine months ended September 30, 2006, the balance of impaired loans for which an ALL is allocated has increased minimally. As indicated the ALL allocated for impaired loans at September 30, 2006 has decreased $1.1 million compared to December 31, 2005 as indicated in Table 9. Information regarding impaired loans is as follows: 30 TABLE 9 IMPAIRED LOANS ($ in thousands)
September 30, December 31, 2006 2005 ------------- ------------ Impaired loans with no allocated allowance for loan loss -- -- Impaired loans with allocated allowance for loan loss 14,830 14,637 Allowance allocated to impaired loans 2,175 3,233
As a result the ratio of non-performing loans to total loans at September 30, 2006 was 2.78% compared to 0.85% at end of year 2005. The Company's ALL was 36.8% of total non-performing loans at September 30, 2006 compared to 137.6% at end of year 2005. Non-performing assets (non-performing loans plus other real estate owned assets) at September 30, 2006 were $25.5 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 ten commercial properties totaling $3.0 million and two residential real estate properties totaling $185,000. Other real estate owned at December 31, 2005 totaled $3.3 million and consisted of seventeen properties. 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 September 30, 2006, the investment portfolio (which includes investment securities available for sale) increased $16.5 million, or 9.6%, to $188.1 million from $171.6 million at December 31, 2005. At September 30, 2006, the investment portfolio represented 17.2% of total assets compared with 15.8% at December 31, 2005. Securities available for sale consist of the following: TABLE 10 INVESTMENT SECURITY ANALYSIS At September 30, 2006 ($ in thousands)
Gross Gross Unrealized Unrealized Gains Losses Fair Value ---------- ---------- ---------- Securities available for sale Obligations of U.S. Treasury & other U.S. agencies 42 1,311 58,159
31 Mortgage-backed securities 103 1,999 79,462 Obligations of states & political subdivisions 707 60 46,584 Private placement 17 0 1,015 Other securities 0 0 2,877 ---- ------ -------- Total securities available for sale $869 $3,370 $188,097
At December 31, 2005 ($ 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
The decreases in unrealized losses are related principally to changes in interest rates. As the Company has the ability to hold these securities for the foreseeable future, no declines were deemed to be other than temporary. Deposits Total deposits at September 30, 2006 increased $11.0 million, or 1.3%, to $867.7 million from $856.7 million at December 31, 2005. Non-interest bearing deposits at September 30, 2006 decreased $9.0 million, or 8.1%, to $101.7 million from $110.6 million at December 31, 2005. Interest-bearing deposits at September 30, 2006 increased $20.0 million, or 2.7%, to $766.1 million from $746.1 million at December 31, 2005. Brokered CD's and other brokered deposits totaled $137.8 million at September 30, 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 32 itself. Increased competition for consumer deposits and customer awareness of interest rates continues to limit the Company's core deposit growth in these types of deposits. Typically, overall deposits for the first six months tend to decline slightly as a result of the seasonality of the Company's customer base as customers draw down deposits during the first half of the year in anticipation of the summer tourist season. Then, in the later half of the year, deposits tend to increase as a result of receipts during the tourist season. Emphasis has been, and will continue to be, placed on generating additional core deposits in the remainder of 2006 and 2007 through competitive pricing of deposit products and through the branch delivery systems that have already been established and a new branch located in the Green Bay market that opened in the third quarter of 2006. 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 and in 2007 as an additional source of funds to provide for loan growth in the event that core deposit growth goals would not be accomplished. Under that scenario, 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 Securities under agreements to repurchase at September 30, 2006 increased $280,000 to $1.6 million from $1.3 million at December 31, 2005. There were no federal funds purchased at September 30, 2006 and December 31, 2005. Federal Home Loan Bank Advances totaled $115.2 million at September 30, 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 2031, to the trust is $16,597,940. These securities were redeemed on March 31, 2006. The redemption of these securities were funded through the issuance of $16.1 million of trust preferred securities and $498,000 of trust common securities, and underlying debt securities, that will adjust quarterly at a rate equal to 1.35% over the three month LIBOR. The rate on this financing for the second and third quarters of 2006, respectively, was 6.31% and 6.85%, respectively, compared to a fixed rate of 10% for the trust-preferred securities issued under Baylake Capital Trust I. This lower interest rate has provided interest savings in the second and third quarters of 2006 and thereafter depending upon the changes in the interest rate environment. The interest rate for the fourth quarter of 2006 will be 6.72%. Management believes that this new financing should provide a better match for the overall interest rate sensitivity position of the Company going forward. 33 For additional details, please make reference to the Consolidated Financial Statements and the accompanying footnotes on the Company's Form 10-Q for the period ended September 30, 2006. CONTRACTUAL OBLIGATIONS, COMMITMENTS, OFF-BALANCE SHEET RISK, AND CONTINGENT LIABILITIES The Company utilizes a variety of financial instruments in the normal course of business to meet the financial needs of its customers. These financial instruments include commitments to extend credit, commitments to originate residential mortgage loans held for sale, commercial letters of credit, standby letters of credit, and forward commitments to sell residential mortgage loans. Please refer to the Company's Annual Report on Form 10-K for the year ended December 31, 2005 for discussion with respect to the Company's quantitative and qualitative disclosures about its fixed and determinable contractual obligations. Items disclosed in Form 10-K have not materially changed since that report was filed. The following is a summary of our off-balance sheet commitments, all of which were lending-related commitments: TABLE 11 LENDING RELATED COMMITMENTS ($ in thousands)
September December 30, 2006 31, 2005 --------- -------- Commitments to fund home equity line loans $ 49,600 $ 45,435 Commitments to fund residential real estate construction loans 2,485 3,409 Commitments unused on various other lines of credit loans 173,050 164,112 -------- -------- Total commitments to extend credit $225,135 $212,956 Financial standby letters of credit $ 21,452 $ 22,160
The following table summarizes the Company's significant contractual obligations and commitments at September 30, 2006: TABLE 12 CONTRACTUAL OBLIGATIONS ($ in thousands)
WITHIN 1 YEAR 1-3 YEARS 3-5 YEARS AFTER 5 YEARS TOTAL ------------- --------- --------- ------------- -------- Certificates of deposit and other time deposit obligations $277,509 $101,762 $4,863 $ 0 $384,134
34 Federal funds purchased and repurchase agreements 1,595 $ 0 $ 0 $ 0 1,595 Federal Home Loan Bank advances 75,000 40,080 100 0 115,180 Subordinated debentures 0 0 0 16,100 16,100 Operating leases 37 0 0 0 37 -------- -------- ------ ------- -------- Total $354,141 $141,842 $4,963 $16,100 $517,046 ======== ======== ====== ======= ========
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 and repurchase shares. Dividends received from Bank totaled $4.2 million for the first nine 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 $4.7 million in the first nine 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 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 nine months ended September 30, 2006, principal payments totaling $15.4 million were received on investments. The Company purchased $31.7 million in investments in the first nine months of 2006. This resulted in net cash of $16.3 million used in investing activities for the first nine months of 2006. At September 30, 2006 the investment portfolio contained $137.6 million of U.S. Treasury and federal agency backed securities representing 73.2% 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. The seasonal pattern results from the tourism-oriented businesses in our market area. As a financing activity reflected in the September 30, 2006 Consolidated Statements of Cash Flows, deposits increased and resulted in $11.0 million of cash flow during the first nine months of 2006. The Company's 35 overall deposit base increased 1.3% for the nine months ended September 30, 2006. Deposit growth is generally the most stable source of liquidity for the Bank, although brokered deposits, which are inherently less stable than locally generated core deposits, are sometimes used. The Company's reliance on these deposits remained constant during the nine-month period. Affecting liquidity are core deposit growth levels, certificate of deposit maturity structure and retention, and characteristics and diversification of wholesale funding sources affecting the channels by which brokered deposits are acquired. Conversely, deposit outflow will cause 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 $255.8 million, or 31.7%, 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 September 30, 2006, federal funds purchased and securities sold under agreements to repurchase totaled $1.6 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 total $115.2 million at September 30, 2006 and $125.2 million at December 31, 2005. The Bank's liquidity resources were sufficient in the first nine 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 nine 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, the 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, 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. 36 Capital Resources Stockholders' equity at September 30, 2006 and December 31, 2005, respectively, was $80.7 million and $78.5 million, respectively. In total, stockholders' equity increased $2.2 million or 2.8%. The increase in stockholders' equity in 2006 was primarily composed of net income; proceeds from the exercise of stock options and the change in accumulated other comprehensive loss (as a result of unrealized losses on available for sale securities), offset by the payment of dividends and repurchase of treasury stock. The change in unrealized losses on available for sale securities amounted to $198,000 (net of tax) for the first nine months of 2006; this change resulted from the effects of the increasing interest rate environment. Total dividends paid increased to $4.7 million in the nine-month period from $4.6 million in 2005, primarily as a result of an increase in the per share dividends rate to $0.48 from $0.45. In the three months ended September 30, 2006, the Company used $1.1 million to repurchase shares. Stockholders' equity to assets at September 30, 2006 was 7.38% compared to 7.21% at the end of 2005. Cash dividends declared in the first nine months of 2006 were $0.48 per share compared with $0.45 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 $4.7 million in the first nine months of 2006, as compared to $4.6 million in the corresponding period of 2005. On June 5, 2006, the Company's Board of Directors authorized management, in its discretion, to repurchase up to 300,000 shares, representing approximately 3.8% of the Company's common stock in a timeframe not to exceed June 30, 2007. Although the Company may not repurchase all 300,000 within the allotted time period, the program will allow the Company to repurchase its shares as opportunities arise at prevailing market prices in open market or privately negotiated transactions. Shares repurchased are held as treasury stock and accordingly, are accounted for as a reduction of stockholders' equity. The Company repurchased 68,854 of its common shares in the third quarter of 2006 with a cash outlay of $1.1 million, or an average of $16.00 per share. 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 was 6.31% and 6.85% for the third quarter. This lower rate has provided 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. Management regularly reviews the adequacy of the Company's capital to ensure that sufficient capital is available for current and future needs and is in compliance with regulatory guidelines. The assessment of overall capital adequacy depends upon a variety of factors, including asset quality, liquidity, stability of earnings, changing competitive forces, economic conditions in markets served and strength of management. Management believes 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. 37 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 September 30, 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 September 30, 2006 and December 31, 2005: TABLE 13 CAPITAL RATIOS ($ in thousands)
Required To Be Well Required For Capitalized under Capital Adequacy Prompt Corrective Actual Purposes Action Provisions --------------- ---------------- ------------------- Amount Ratio Amount Ratio Amount Ratio ------- ----- ------ ----- ------ ----- As of September 30, 2006 Total Capital (to Risk Weighted Assets) Company 100,559 10.88% 73,962 8.00% N/A N/A Bank 98,378 10.65% 73,924 8.00% 92,405 10.00% Tier 1 Capital (to Risk Weighted Assets) Company 92,339 9.99% 36,981 4.00% N/A N/A Bank 90,158 9.76% 36,962 4.00% 55,443 6.00% Tier 1 Capital (to Average Assets) Company 92,339 8.47% 43,631 4.00% N/A N/A Bank 90,158 8.27% 43.631 4.00% 54,539 5.00% As of December 31, 2005
38 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 primary market risk exposure is interest rate risk. Interest rate risk is the risk that the Company's earnings and capital will be adversely affected by changes in interest rates. The Company does not use derivatives to mitigate its interest rate risk. The Company's earnings are derived from the operations of its direct and indirect subsidiaries with particular reliance on net interest income, calculated as the difference between interest earned on loans and investments and the interest expense paid on deposits and other interest bearing liabilities, including advances from FHLB and other borrowings. Like other financial institutions, the Company's interest income and interest expense are affected by general economic conditions and by the policies of regulatory authorities, including the monetary policies of the Board of Governors of the Federal Reserve System. Changes in the economic environment may influence, among other matters, the growth rate of loans and deposits, the quality of the loan portfolio and loan and deposit pricing. Fluctuations in interest rates are not predictable or controllable. As of September 30, 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 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 September 30, 2006. TABLE 14 39 INTEREST SENSITIVITY ($ in thousands) Change in Net Interest Income over One Year Horizon
At September 30, 2006 At December 31, 2005 Change in levels of --------------------------------- --------------------------------- interest rates Dollar change Percentage change Dollar change Percentage change - ------------------- ------------- ----------------- ------------- ----------------- +200 bp $ 851 2.3% $ 2,572 6.8% +100 bp 88 0.2% 1,842 4.9% Base 0 0% 0 0% - -100 bp (1,684) (4.5%) (2,351) (6.2%) - -200 bp (3,634) (9.7%) (4,905) (13.0%)
As shown above, at September 30, 2006, the effect of an immediate 200 basis point increase in interest rates would increase the Company's net interest income by $851,000 or 2.3%. The effect of an immediate 200 basis point reduction in rates would decrease the Company's net interest income by $3.6 million or 9.7%. Changes in the mix of earning assets and interest-bearing liabilities decreased 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 September 30, 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. 40 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 On June 5, 2006, the Company's Board of Directors authorized management, in its discretion, to repurchase up to 300,000 shares, representing approximately 3.8% of the Company's common stock in a timeframe not to exceed June 30, 2007. Although the Company may not repurchase all 300,000 within the allotted time period, the program will allow the Company to repurchase its shares as opportunities arise at prevailing market prices in open market or privately negotiated transactions. Shares repurchased are held as treasury stock and, accordingly, are accounted for as a reduction of stockholders' equity. The following table provides the specified information about the repurchases of shares by the Company during the third quarter of 2006.
Total number of Maximum number of shares purchased as shares that may be part of publicly purchased under Total number of Average price announced plans or the recent plans Period shares purchased paid per share programs or programs* - ------ ---------------- -------------- ------------------- ------------------ July 1 to 31, 2006 -- -- -- 300,000 August 1, to 31, 2006 68,854 $16.00 68,854 231,146 September 1 to 30, 2006 -- -- -- 231,146
* At period end. The "price" used for these purposes is the fair market value of those shares on the date of purchase. ITEM 3. DEFAULTS UPON SENIOR SECURITIES None ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None ITEM 5. OTHER INFORMATION None 41 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. 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." 42 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. BAYLAKE CORP. Date: November 3, 2006 /s/ Thomas L. Herlache ---------------------------------------- Thomas L. Herlache President (CEO) Date: November 3, 2006 /s/ Steven D. Jennerjohn ---------------------------------------- Steven D. Jennerjohn Treasurer (CFO) 43 EX-31.1 2 c09924exv31w1.txt 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 September 30, 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 44 b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. DATE: NOVEMBER 3, 2006 /S/ THOMAS L. HERLACHE - ------------------------------------- THOMAS L. HERLACHE CHAIRMAN AND CEO 45 EX-31.2 3 c09924exv31w2.txt 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 September 30, 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 46 b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. DATE: NOVEMBER 3, 2006 /S/ STEVEN D. JENNERJOHN - ------------------------------------- STEVEN D. JENNERJOHN SENIOR VICE PRESIDENT AND CHIEF FINANCIAL OFFICER 47 EX-32.1 4 c09924exv32w1.txt 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 and nine months ended September 30, 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 and nine months ended September 30, 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 NOVEMBER 3, 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. 48 EX-32.2 5 c09924exv32w2.txt 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 and nine months ended September 30, 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 and nine months ended September 30, 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 NOVEMBER 3, 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. 49 -----END PRIVACY-ENHANCED MESSAGE-----