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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES AND EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2001
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[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES AND EXCHANGE ACT OF 1934
For the transition period from to
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Commission file number 0-8679
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BAYLAKE CORP.
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(Exact name of Registrant as specified in its charter)
Wisconsin 39-1268055
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(State or other jurisdiction of (I.R.S. Employer
incorporated or organization) Identification No.)
217 North Fourth Avenue., Sturgeon Bay, WI 54235
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(Address of principal executive offices) (Zip Code)
Registrant's Telephone number, including area code: (920)-743-5551
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Securities registered pursuant to Section 12(b) of the Act: None
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Securities registered pursuant to Section 12(g) of the Act: Common Stock
$5 Par Value
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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 if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K [ ]
As of March 25, 2002, 7,471,576 shares of Common Stock were outstanding, and the
aggregate market value of the Common Stock (based upon the $13.25 reported bid
price on that date) held by non-affiliates (excludes a total of 649,628 shares
reported as beneficially owned by directors and executive officers -- does not
constitute an admission as to affiliate status) was approximately $90,542,718.
DOCUMENTS INCORPORATED BY REFERENCE
Part of Form 10-K Into Which
Document Portions of Documents are Incorporated
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Definitive Proxy Statement for 2002 Part III
Annual Meeting of Shareholders to be
Filed within 120 days of the fiscal
Year ended December 31, 2001
1
2001 FORM 10-K
TABLE OF CONTENTS
DESCRIPTION PAGE NO.
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PART I
ITEM 1. Business 3
ITEM 2. Properties 8
ITEM 3. Legal Proceedings 8
ITEM 4. Submission of Matters to a Vote of Security Holders 8
PART II
ITEM 5. Market for Registrant's Common Equity and Related
Stockholder Matters 8
ITEM 6. Selected Financial Data 9
ITEM 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 12
ITEM 7A. Quantitative and Qualitative Disclosures about Market
Risk 40
ITEM 8. Financial Statements and Supplementary Data 41
ITEM 9. Changes and Disagreements with Accountants on Accounting and
Financial Disclosure. 80
PART III
ITEM 10. Directors and Executive Officers of the Registrant 80
ITEM 11. Executive Compensation 80
ITEM 12. Security Ownership of Certain Beneficial Owners and Management 80
ITEM 13. Certain Relationships and Related Transactions 80
PART IV
ITEM 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K 81
Signatures 82
2
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
The statements contained in this report, including the discussion and analysis
of financial condition and results of operations, that are not historical facts
are "forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995 and are intended to be covered by the safe-harbor
provisions for forward-looking statements contained in that Act. For example,
all statements regarding our expected financial position, business and
strategies are forward-looking statements. The words "anticipates," "believes,"
"estimates," "seeks," "expects," "plans," "intends," and similar expressions, as
they relate to Baylake or its management, are intended to identify
forward-looking statements. Forward-looking statements are made based upon
management's current expectations and beliefs concerning future developments and
their potential effects upon Baylake or the Bank. Although we believe that the
expectations reflected in these forward-looking statements are reasonable, and
have based these expectations on our beliefs as well as assumptions we have
made, these expectations may prove to be incorrect. Actual results may differ
materially from those included in the forward-looking statements. Important
factors that could cause actual results to differ materially from our
expectations include, without limitation, the failure of a significant number of
borrowers to repay their loans, general changes in economic conditions and
interest rates, as well as restrictions imposed on us by regulations or
regulators of the banking industry. Many of these factors are not within the
control of Baylake or management. Baylake undertakes no obligation to update or
revise any forward-looking information, whether as a result of new information,
future developments or otherwise.
ITEM 1. BUSINESS
General
Baylake Corp., a Wisconsin corporation organized in 1976, ("Baylake" or the
"Company") is a registered bank holding company under the Federal Bank Holding
Company Act of 1956, as amended. Baylake's primary activities consist of holding
indirectly the stock of Baylake Bank ("Bank"), and providing a wide range of
banking and related business activities, through the Bank and its other
subsidiaries.
Kewaunee County Banc-Shares, Inc.
Kewaunee County Banc-Shares, Inc., ("KCB"), a Wisconsin corporation organized in
1983 and located in Sturgeon Bay, WI, is a registered bank holding company under
the Federal Bank Holding Company Act of 1956, as amended. It is an intermediate
tier holding company owned 100% by Baylake. KCB's only activity is to acquire
and hold all of the outstanding stock of Bank.
Baylake Bank
The Bank is a Wisconsin State Bank originally chartered in 1876. The Bank
conducts its community banking business through 25 full-service financial
centers located throughout Northeast Wisconsin, in Brown, Door, Green Lake,
Kewaunee, Manitowoc, Outagamie, Waupaca, and Waushara Counties. The Bank has
eight financial centers in Door County, which is known for its seasonal and
tourism related services. The balance of the Bank's financial centers are
located in the previously mentioned counties, with the highest concentration,
after Door County, in Brown County, which has six financial centers. Other
principal industries in Bank's market area include light industry and
manufacturing, agriculture, food related products, and to a lesser degree,
lumber and furniture.
The Bank is an independent community bank offering a full range of financial
services primarily to small businesses and individuals located in its market
area. To complement the Bank's traditional banking products, such as demand
deposit accounts, various savings account plans, certificates of deposit and
real estate, consumer, commercial/industrial and agricultural loans, the Bank
offers its customers a variety of services. These services include transfer
agency, personal and corporate trust, insurance agency, brokerage, financial
planning, cash management and electronic banking services.
3
Bank Subsidiaries
In addition to its banking operations, the Bank owns four non-bank subsidiaries:
Baylake Investments, Inc., located in Las Vegas, Nevada, which holds and manages
a portion of the Bank's investment and loan portfolio; Bank of Sturgeon Bay
Building Corporation, which owns the Bank's main office building in Sturgeon
Bay, Wisconsin and nearby conference center facilities and underlying real
property; Cornerstone Financial, Inc., which manages the conference center
facilities; and Baylake Insurance Agency, Inc., which offers various types of
insurance products to the general public as an independent agent. The Bank also
owns a minority interest (49.8% of the outstanding common stock) in United
Financial Services, Inc. ("UFS"), a data processing services company, located in
Grafton, Wisconsin, that provides data processing services to approximately 23
banks (including Bank) and ATM processing services to 50 banks. The revenues
generated by Bank's wholly-owned subsidiaries and UFS amount, in aggregate, to
less than 5% of the Bank's total income. On January 24, 2002, the Bank formed an
additional subsidiary, Arborview LLC ("Arborview") for purposes of the operation
of a community based residential facility, acquired as a result of loan
problems.
At December 31, 2001, the Company had total assets of $845.8 million. For
additional financial information, see the Consolidated Financial Statements and
Notes beginning at Item 8 of this Form 10-K.
Acquisitions
Effective October 1, 1998, Baylake acquired Evergreen Bank, N.A., ("Evergreen")
from M&I Marshall & Ilsley Bank, Milwaukee, Wisconsin ("M&I"). Pursuant to the
stock purchase agreement with M&I, Baylake is only required to pay M&I for the
Evergreen stock it purchased upon certain events set forth in the stock purchase
agreement. Although the payment period set forth in the stock purchase agreement
expired, Baylake has committed to M&I that it will treat the payment terms of
the stock purchase agreement as though they had not expired. As of December 31,
2001, none of the events that would require Baylake to pay any funds to M&I has
occurred. In connection with Baylake's acquisition of Evergreen, Baylake changed
the name of Evergreen, to Baylake Bank, N.A. ("BLBNA"). On March 15, 1999, BLBNA
merged with and into Baylake Bank.
Lending
The Company offers short-term and long-term loans on a secured and unsecured
basis for business and personal purposes. It makes real estate,
commercial/industrial, agricultural and consumer loans, in accordance with the
basic lending policies established by its board of directors. The Company
focuses lending activities on individuals and small businesses in its market
area. Lending has, historically, been exclusively within the State of Wisconsin.
The Company does not conduct any substantial business with foreign obligors. The
markets served by the Company include a wide variety of industries; therefore,
Baylake believes the broad business base of its market area limits its exposure
to the problems in any particular industry group. However, any general weakness
in the economy of Northeastern Wisconsin (as a result, for example, of a decline
in its manufacturing and tourism industries or otherwise) could have a material
adverse effect on the business and operations of Baylake.
The Company's total outstanding loans as of December 31, 2001 amounted to
approximately $605.3 million, consisting of 82.6% residential, commercial,
agricultural and construction real estate loans, 13.3% commercial and industrial
loans, 2.8% installment and 1.3% agricultural loans.
Investments
The Company maintains a portfolio of other investments, primarily consisting of
U.S. Treasury securities, U.S. Government Agency securities, mortgage-backed
securities, and obligations of states and their political subdivisions. The
Company attempts to balance its portfolio to manage interest rate risks,
maximize tax advantages and meet its liquidity needs while endeavoring to
maximize investment income.
4
Deposits
The Company offers a broad range of depository products, including non-interest
bearing demand deposits, interest-bearing demand deposits, various savings and
money market accounts and certificates of deposit. Deposits at the Company are
insured by the Bank Insurance Fund of the Federal Deposit Insurance Corporation
("FDIC") up to statutory limits. At December 31, 2001, the Company's total
deposits amounted to $669.9 million, including interest bearing deposits of
$593.8 million and non-interest bearing deposits of $76.1 million.
Other Customer Services and Products
Other services and products offered by the Company include transfer agency, safe
deposit box services, personal and corporate trust services, conference center
facilities, insurance agency and brokerage services, cash management, financial
planning and electronic banking services, including eBanc, an Internet banking
product for its customers.
Competition
The financial services industry is highly competitive. The Company competes with
other financial institutions and businesses in both attracting and retaining
deposits and making loans in all of its principal markets. The primary factors
in competing for deposits are interest rates, personalized services, the quality
and range of financial services, convenience of office locations and office
hours. Competition for deposit products comes primarily from other commercial
banks, savings banks, credit unions and non-bank competitors, including
insurance companies, money market and mutual funds, and other investment
alternatives. The primary factors in competing for loans are interest rates,
loan origination fees, the quality and range of lending services and
personalized services. Competition for loans comes primarily from other
commercial banks, savings banks, mortgage banking firms, credit unions, finance
companies, leasing companies, and other financial intermediaries. The Company
also faces direct competition from members of bank holding company systems that
have greater assets and resources than those of the Company.
Regulation and Supervision
The banking industry is highly regulated by both federal and state regulatory
authorities. Regulation includes, among other things, capital and reserve
requirements, dividend limitations, limitations on products and services
offered, geographical limits, consumer credit regulations, community
reinvestment requirements and restrictions on transactions with affiliated
parties. The system of supervision and regulation applicable to Baylake and the
Bank establishes a comprehensive framework for our respective operations and is
intended primarily for the protection of the FDIC's deposit funds, the
depositors of the Bank and the public, rather than shareholders of the Bank or
Baylake. Any change in government regulation may have a material adverse effect
on the business of Baylake and the Bank.
Baylake Corp. As a bank holding company, Baylake is subject to regulation by the
Federal Reserve Board under the Bank Holding Company Act of 1956, as amended, or
BHCA. Under the BHCA, Baylake is subject to examination by the Federal Reserve
Board and is required to file reports of its operations and such additional
information as the Federal Reserve Board may require. Baylake is also subject to
supervision and examination by the Wisconsin Department of Financial
Institutions under Wisconsin law. Under Federal Reserve Board policy, Baylake is
expected to act as a source of financial strength to the Bank and to commit
resources to support the Bank in circumstances where Baylake might not do so
absent such policy.
Any loans by a bank holding company to a subsidiary bank are subordinate in
right of payment to deposits and to certain other indebtedness of such
subsidiary bank. In the event of a bank holding company's bankruptcy, any
commitment by the bank holding company to a federal bank regulatory agency to
maintain the capital of a subsidiary bank will be assumed by the bankruptcy
trustee and entitled to a priority of payment.
With certain limited exceptions, the BHCA prohibits bank holding companies from
acquiring direct or indirect ownership or control of voting shares or assets of
any company other than a bank, unless the company involved is engaged solely in
one or more activities which the Federal Reserve Board has determined to be so
closely related to banking or managing or
5
controlling banks as to be incidental to these operations. Under current Federal
Reserve Board regulations, these permissible non-bank activities include such
things as mortgage banking, equipment leasing, securities brokerage, and
consumer and commercial finance company operations. As a result of recent
amendments to the BHCA, many of these acquisitions may be effected by bank
holding companies that satisfy certain statutory criteria concerning management,
capitalization, and regulatory compliance, if written notice is given to the
Federal Reserve within 10 business days after the transaction. In other cases,
prior written notice to the Federal Reserve Board will be required.
The Federal Reserve Board uses capital adequacy guidelines in its examination
and regulation of bank holding companies. If capital falls below minimum
guidelines, a bank holding company may, among other things, be denied approval
to acquire or establish banks or non-bank businesses.
Baylake Bank. As a Wisconsin bank, the Bank is subject to supervision and
regulation by the Wisconsin Department of Financial Institutions (the "WDFI"),
the Board of Governors of the Federal Reserve System and the FDIC. Federal law
and regulations, including provisions added by the Federal Deposit Insurance
Corporation Improvement Act of 1991, or FDICIA, and regulations promulgated
thereunder, establish supervisory standards applicable to the lending activities
of the Bank, including internal controls, credit underwriting, loan
documentation and loan-to-value ratios for loans secured by real property.
The Bank is subject to certain federal and state statutory and regulatory
restrictions on any extension of credit to Baylake or its subsidiaries, on
investments in the stock or other securities of Baylake or its subsidiaries, on
the payment of dividends to Baylake, and on the acceptance of the stock or other
securities of Baylake or its subsidiaries as collateral for loans to any person.
Certain limitations and reporting requirements are also placed on extension of
credit by the Bank to its directors and officers, to directors and officers of
us and our subsidiaries, to principal shareholders of us, and to "related
interests" of such directors, officers and principal shareholders. In addition,
such legislation and regulations may affect the terms upon which any person
becoming a director or officer of us or one of our subsidiaries or a principal
shareholder of us may obtain credit from banks with which we maintain a
correspondent relationship.
The FDIC, the Office of Thrift Supervision, the Federal Reserve Board and the
Office of the Comptroller of the Currency have published guidelines implementing
the FDICIA requirement that the federal banking agencies establish operational
and managerial standards to promote the safety and soundness of federally
insured depository institutions. The guidelines establish standards for internal
controls, information systems, internal audit systems, loan documentation,
credit underwriting, interest rate exposure, asset growth, and compensation,
fees and benefits. In general, the guidelines prescribe the goals to be achieved
in each area, and each institution will be responsible for establishing its own
procedures to achieve those goals. If an institution fails to comply with any of
the standards set forth in the guidelines, the institution's primary federal
bank regulator may require the institution to submit a plan for achieving and
maintaining compliance. The preamble to the guidelines states that the agencies
expect to require a compliance plan from an institution whose failure to meet
one or more of the standards is of such severity that it could threaten the safe
and sound operation of the institution. Failure to submit an acceptable
compliance plan, or failure to adhere to a compliance plan that has been
accepted by the appropriate regulator, would constitute grounds for further
enforcement action.
The Bank's business includes making a variety of types of loans to individuals.
In making these loans, the Bank is subject to state usury and regulatory laws
and to various federal statutes, such as the Equal Credit Opportunity Act, the
Fair Credit Reporting Act, the Truth in Lending Act, the Real Estate Settlement
Procedures Act and the Home Mortgage Disclosure Act, and the regulations
promulgated thereunder, which prohibit discrimination, specify disclosures to be
made to borrowers regarding credit and settlement costs and regulate the
mortgage loan servicing activities of the Bank, including the maintenance and
operation of escrow accounts and the transfer of mortgage loan servicing. The
Riegle Act imposed new escrow requirements on depository and non-depository
mortgage lenders and services under the National Flood Insurance Program. In
receiving deposits, the Bank is subject to extensive regulation under state and
federal law and regulations, including the Truth in Savings Act, the Expedited
Funds Availability Act, the Bank Secrecy Act, the Electronic Funds Transfer Act,
and the Federal Deposit Insurance Act. Violation of these laws could result in
the imposition of significant damages and fines upon the Bank, its directors and
officers.
Under the Community Reinvestment Act, or CRA, and the implementing regulations,
the Bank has a continuing and
6
affirmative obligation to help meet the credit needs of its local community
including low and moderate-income neighborhoods, consistent with the safe and
sound operation of the institution. The CRA requires the board of directors of
financial institutions, such as the Bank, to adopt a CRA statement for each
assessment area that, among other things, describes its efforts to help meet
community credit needs and the specific types of credit that the institution is
willing to extend. The Bank's service area is designated and comprised of the
eight counties within the geographic area of Central and Northeast, Wisconsin.
The Bank's board of directors is required to review the appropriateness of this
delineation at least annually.
Financial institution regulation has been the subject of significant legislation
in recent years and may be the subject of further significant legislation in the
future. This regulation substantially affects the business and financial results
of all financial institutions and holding companies, including Baylake and its
subsidiaries. As an example, Baylake is subject to the capital and leverage
guidelines of the Board of Governors of the Federal Reserve System ("FRB"),
which requires that Baylake's capital to asset ratio meet certain minimum
standards. For a discussion of the Federal Reserve Board's guidelines and the
Company's applicable ratios, see the section entitled "Capital Resources" under
Item 7: "Management's Discussion and Analysis of Financial Condition and Results
of Operation."
In addition to general requirements that banks retain specified levels of
capital and otherwise conduct their business in a safe and sound manner,
Wisconsin law requires that dividends of Wisconsin banks declared and paid
without approval of the WDFI be paid out of current earnings or, no more than
once within the immediate preceding two years, out of undivided profits in the
event that there have been insufficient net profits. Any other dividends require
the prior written consent of the WDFI. The Bank is in compliance with all
applicable capital requirements and may pay dividends to Baylake.
Current federal law provides that adequately managed bank holding companies from
any state may acquire banks and bank holding companies located in any other
state, subject to certain conditions. Wisconsin law generally permits
establishment of full service bank branch offices statewide.
Recent Legislation. The Gramm-Leach-Bliley Act, or Gramm-Leach, was signed into
law on November 12, 1999 and authorizes bank holding companies that meet
specified conditions to elect to become "financial holding companies" and
thereby engage in a broader array of financial activities than previously
permitted. Such activities include selling and underwriting insurance (including
annuities), underwriting and dealing in securities, and merchant banking.
Gramm-Leach also authorizes banks to engage through "financial subsidiaries" in
certain of the activities permitted for financial holding companies. In February
2001, the Federal Reserve Bank of Chicago approved our election to become a
financial holding company; however, we have no current plans to pursue expanded
activities under Gramm-Leach.
Employees
At December 31, 2001, Baylake and its subsidiaries had 286 full-time equivalent
employees. Baylake considers the relationship with its employees to be good.
7
ITEM 2. PROPERTIES
Baylake does not directly own any real property of any kind. However, the Bank
owns twenty-two branches and leases the Company's main office building in
Sturgeon Bay, Wisconsin from its subsidiary, the Bank of Sturgeon Bay Building
Corporation.
The main office building located in Sturgeon Bay serves as headquarters for
Baylake as well as the main banking office of the Bank. The main office also
accommodates the expanded business of the Bank, primarily an insurance agency
(Baylake Insurance Agency) and financial services. The twenty-five branches
owned or leased by the Bank are in good condition and considered adequate for
present and near term requirements. In addition, the Bank owns other real
property that, when considered in the aggregate, is not material to its
financial position.
ITEM 3. 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 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of security holders during the fourth
quarter of fiscal year 2001.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED SECURITY HOLDER
MATTERS
Historically, trading in shares of the Company's Common Stock has been limited.
Since mid-1993, Baylake Common Stock has been listed on the OTC Bulletin Board
(Trading symbol: bylk.ob), an electronic interdealer quotation system providing
real-time quotations on eligible securities. Trading in Baylake Common Stock has
been conducted principally by certain brokerage and investment firms with
offices in Door County, Wisconsin that have provided price quotations, and have
assisted individual holders of Baylake Common Stock who wish to purchase or sell
shares. In addition, since May 1993, prices for Baylake Common Stock have
generally been reported regularly in The Milwaukee Journal Sentinel based on
information provided by a local brokerage firm.
The following table summarizes high and low bid prices and cash dividends paid
for the Baylake Common Stock for the periods indicated. Bid prices are computed
from those obtained from two brokerage firms, and, since May 1993 from bid
prices reported in The Milwaukee Journal Sentinel. The reported high and low
prices represent interdealer bid prices, without retail mark-up, mark-downs or
commission, and may not necessarily represent actual transactions.
Calendar period High Low Cash dividends per
--------------- ---- --- ------------------
share
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2000 1st Quarter $26.00 $21.50 $0.100
2nd Quarter $23.50 $19.88 $0.100
3rd Quarter $21.00 $18.00 $0.100
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4th Quarter $18.25 $14.50 $0.110
2001 1st Quarter $16.25 $11.00 $0.110
2nd Quarter $15.00 $12.80 $0.110
3rd Quarter $16.25 $13.00 $0.110
4th Quarter $13.75 $12.75 $0.120
Baylake had approximately 1,707 shareholders of record at March 15, 2002.
Dividends on Baylake Common Stock have historically been paid in cash on a
quarterly basis in March, June, September and January, and Baylake expects to
continue this practice for the immediate future. The holders of Baylake Common
Stock are entitled to receive such dividends when and as declared by Baylake's
Board of Directors. The ability of Baylake to pay dividends is dependent upon
receipt by Baylake of dividends from the Bank, which is subject to regulatory
restrictions. Such restrictions, which govern state chartered banks, generally
limit the payment of dividends on bank stock to the bank's undivided profits
after all payments of all necessary expenses, provided that the bank's surplus
equals or exceeds its capital, as discussed further in Item 7. "Management
Discussion and Analysis of Financial Condition and Results of Operation-Capital
Resources". In determining the payment of cash dividends, the Board of Directors
of Baylake considers the earnings, capital and debt servicing requirements,
financial ratio guidelines issued by the FRB and other banking regulators,
financial conditions of Baylake and the Bank, and other relevant factors. In
addition, under the terms of Baylake's 10.00% Junior Subordinated Debentures due
2031, Baylake would be precluded from paying dividends on the Common Stock if it
was in default under the Debentures, if it exercised its right to defer payments
of interest on the Debentures, or if certain related defaults occurred. Baylake
maintains a dividend reinvestment plan enabling participating shareholders to
elect to purchase shares of Baylake Common Stock in lieu of receiving cash
dividends. Such shares may be newly issued securities or acquired in the market
and will be purchased on behalf of participating shareholders at their then fair
market value.
ITEM 6. SELECTED FINANCIAL DATA
Year Ended December 31,
2001 2000 1999 1998 1997
---- ---- ---- ---- ----
(dollars in thousands, except per share data)
RESULTS OF OPERATIONS:
Interest Income $ 59,023 $ 56,036 $ 46,467 $ 38,061 $ 31,577
Interest Expense 32,053 32,099 23,280 19,148 14,662
-------- -------- -------- -------- --------
Net Interest Income 26,970 23,937 23,187 18,913 16,915
Provision for Loan Losses 2,880 545 850 1,135 1,115
-------- -------- -------- -------- --------
Net interest income after 24,090 23,392 22,337 17,778 15,800
provision for loan losses
Non-interest income:
Gain on sale of loans 873 240 295 893 678
Loan servicing fees 1,461 837 875 846 731
Trust fees 664 517 553 451 491
Service charges on deposit 1,836 1,489 1,369 1,074 844
accounts
Securities gains (losses), net 0 0 (2) 0 292
Other 1,473 1,603 1,466 1,113 1,032
-------- -------- -------- -------- --------
Total non-interest income 6,307 4,686 4,556 4,377 4,068
Non-interest expense
Salaries and employee benefits 11,923 10,353 9,700 7,772 7,003
Occupancy expense, net 3,235 3,047 2,668 2,192 2,035
Data processing 986 932 872 699 642
9
Other non-interest expense 4,379 4,280 4,247 3,213 2,861
Operation of other real estate 248 (22) (117) 15 30
-------- -------- -------- -------- --------
Total non-interest expense 20,771 18,590 17,370 13,891 12,571
-------- -------- -------- -------- --------
Income before income tax 9,626 9,488 9,523 8,264 7,297
Income tax provision 2,091 2,778 2,600 2,247 2,027
-------- -------- -------- -------- --------
Net income $7,535 $6,710 $6,923 $6,017 $5,270
PER SHARE DATA: (1)
Net income per share (basic) $1.01 $0.90 $0.94 $0.82 $0.72
Net income per share (diluted) 0.99 0.87 0.90 0.80 0.71
Cash dividends per common share 0.45 0.41 0.37 0.47 0.40
Book value per share 7.91 7.14 6.21 6.17 5.71
SELECTED FINANCIAL CONDITION
DATA (AT END OF PERIOD):
Total assets $845,791 $772,268 $646,310 $607,438 $450,062
Investment securities (2) 167,100 153,511 145,080 128,046 114,899
Total loans 607,715 555,831 447,767 408,921 293,438
Total deposits 669,890 554,005 504,074 495,284 345,976
Short-term borrowings (3) 2,837 79,538 9,231 3,758 20,649
Other borrowings (4) 90,000 77,700 80,000 53,000 36,000
Notes payable and subordinated 158 211 264 392 383
debt
Trust preferred securities 16,100 0 0 0 0
Total shareholders' equity 59,130 53,127 46,210 45,272 41,855
PERFORMANCE RATIOS:
Return on average assets 0.93% 0.95% 1.12% 1.21% 1.29%
Return on average total 13.37% 13.76% 15.07% 13.87% 13.14%
shareholders' equity
Net interest margin (5) 3.80% 3.86% 4.35% 4.42% 4.77%
Net interest spread (5) 3.38% 3.34% 3.89% 3.85% 4.12%
Non-interest income to average 0.78% 0.66% 0.74% 0.88% 1.00%
assets
Non-interest expense to average 2.57% 2.63% 2.82% 2.79% 3.08%
assets
Net overhead ratio (6) 1.79% 1.97% 2.08% 1.91% 2.08%
Average loan-to-average deposit 95.76% 96.71% 85.54% 86.28% 83.14%
ratio
Average interest-earning assets 109.90% 110.78% 111.14% 113.63% 116.51%
to average interest-bearing
liabilities
ASSET QUALITY RATIOS: (7)(8)
Non-performing loans to total 2.42% 2.34% 2.80% 3.45% 1.58%
loans
Allowance for loan losses to:
Total loans 1.32% 1.26% 1.70% 2.71% 1.32%
Non-performing loans 54.47% 53.94% 60.67% 78.33% 83.46%
Net charge-offs to average loans 0.32% 0.23% 0.80% 0.14% 0.05%
Non-performing assets to 1.93% 1.80% 1.95% 2.41% 1.03%
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total assets
CAPITAL RATIOS: (9)
Shareholders' equity to assets 6.99% 6.88% 7.15% 7.45% 9.30%
Tier 1 risk-based capital 10.10% 7.77% 8.81% 7.97% 11.31%
Total risk-based capital 11.29% 8.92% 10.07% 9.22% 12.52%
Leverage ratio 8.22% 6.38% 6.79% 6.02% 8.86%
RATIO OF EARNINGS TO FIXED
CHARGES: (10)
Including deposit interest 1.30x 1.30x 1.41x 1.43x 1.50x
Excluding deposit interest 2.27x 2.11x 3.55x 3.44x 5.24x
(1) Earnings and dividends per share are based on the weighted average
number of shares outstanding for the period. All per share data has
been adjusted to reflect (a) a 2 for 1 stock dividend paid on November
15, 1999 and (b) a 3 for 2 stock dividend paid on May 15, 1998.
(2) Includes securities classified as held-to-maturity and available for
sale.
(3) Consists of Federal Home Loan Bank advances, federal funds purchased
and collateralized borrowings.
(4) Consists of Federal Home Loan Bank term notes and Company borrowings
from unaffiliated correspondent bank.
(5) Net interest margin represents net interest income as a percentage of
average interest-earning assets, and net interest rate spread
represents the difference between the weighted average yield on
interest-earning assets and the weighted average cost of
interest-bearing liabilities.
(6) Net overhead ratio represents the difference between noninterest
expense and noninterest income, divided by average assets.
(7) Non-performing loans consist of non-accrual loans, guaranteed loans 90
days or more past due but still accruing interest and restructured
loans.
(8) The increases in non-performing loans culminating with the period ended
December 31, 1998 were due, in part, to various troubled loans acquired
as a result of the acquisition of Evergreen. For additional
information, see in Item 7. "Management's Discussion and Analysis of
Financial Condition and Result of Operations-Non-performing Loans,
Potential Problem Loans and Other Real Estate."
(9) The capital ratios are presented on a consolidated basis. For
information on Baylake and the Bank's regulatory capital requirements,
see Item 7. "Management's Discussion and Analysis of Financial
Condition and Results of Operations-Capital Resources" and Item 1.
"Business-Regulation and Supervision".
(10) For purposes of calculating the ratio of earnings to fixed charges,
earnings consist of income before taxes plus interest and rent expense.
Fixed charges consist of interest and rent expense.
11
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
General
The following sets forth management's discussion and analysis of the
consolidated financial condition and results of operations of the Baylake Corp.
("Baylake" or the "Company"), which may not be otherwise apparent from the
consolidated financial statements included in this report at Item 8. This
discussion and analysis should be read in conjunction with those financial
statements, related notes, the selected financial data and the statistical
information presented elsewhere in this report for a more complete understanding
of the following discussion and analysis.
On October 1, 1998, the Company acquired Evergreen Bank, N.A. and changed its
name to Baylake Bank, N.A. ("BLBNA"). The acquisition was accounted for using
the purchase method of accounting. Therefore, any consideration paid to M&I
could affect future income. See the discussion of this transaction under Item 1.
"Business" and Note 13 of Notes to Consolidated Financial Statements for
additional details on this transaction.
All per share information has been restated to reflect the 2-for-1 dividend paid
on November 1999.
Results of Operations
Earnings Summary
Net income in 2001 was $7.5 million, a 12.3% increase from the $6.7 million
earned in 2000. Net income for 2000 showed a 3.1% decrease over the 1999
earnings. Basic operating earnings per share increased $0.11 to $1.01 per share
in 2001 compared with $0.90 in 2000, an increase of 12.2%. Basic operating
earnings per share in 2000 showed a 4.2% decrease from 1999 results of $0.94 per
share. On a diluted earnings per share basis, the Company recorded $0.99 per
share in 2001, compared to $0.87 and $0.90 per share in 2000 and 1999,
respectively.
Net income for 2001 and 2000 includes amortization expense of $327,000 of
goodwill related to the purchase of Four Seasons (holding company of financial
institution named "The Bank", acquired by the Company on July 1, 1996) and
$159,000 related to the acquisition of BLBNA. This expense reduced after-tax net
income in 2001 and 2000 by $486,000 or earnings per share by $0.06. Net income
for 1999 reflected amortization expense of $453,000 related to goodwill, thereby
reducing after-tax earnings per share by $0.06.
Although affected by a declining interest rate environment and increased
competition in 2001, net interest income improved. Net interest income for 2001
improved $3.0 million or 12.7% over 2000 levels. Net interest income for 2000
improved $750,000 or 3.2% over 1999 levels. For 2001, interest income increased
by 5.3% while interest expense decreased 0.1%.
Non-interest income during 2001 increased $1.6 million or 34.6% when compared to
2000. The primary factors increasing non-interest income were an increase in
gains on sales of loans, an increase in loan servicing fees, an increase in fees
for other services to customers and increased fiduciary income offset by a
decrease in other income.
Non-interest expense increased $2.2 million during 2001, or 11.7% over 2000
levels. Factors contributing to the increase were increased personnel expenses,
occupancy expense, data processing expense, other operating expenses and an
increase in operation of other real estate.
For 2001, return on average assets declined to 0.93% compared with 0.95% in 2000
and 1.12% in 1999. This ratio declined as a result of the various factors
discussed above combined with an average asset growth rate of 14.4% in 2001.
Return on average stockholders' equity in 2001 showed a decrease to 13.4%
compared to 13.8% in 2000 and 15.1% in 1999. The decrease in 2001 compared to
2000 occurred as a result of a higher level of average capital and the factors
described above offset to a lesser degree by increased net income.
12
Cash dividends declared in 2001 increased 9.8% to $0.45 per share compared with
$0.41 in 2000. This compares to an increase of 10.8% in dividends declared in
2000 as compared to 1999.
The major components of net income and changes in these components are
summarized in Table 1 for years ended December 31, 2001, 2000 and 1999 and are
discussed in more detail on the following pages.
TABLE 1: NET INCOME COMPONENTS
Years ended December 31,
2001 2000 2000 to 2001 1999 1999 to 2000
increase increase
(dollars in thousands)
Net interest $26,970 $23,937 12.7% $23,187 3.2%
Income
Provision for $ 2,880 $ 545 428.4% $ 850 (35.9%)
Loan losses
Noninterest $ 6,307 $ 4,686 34.6% $ 4,556 2.9%
Income
Noninterest $20,771 $18,590 11.7% $17,370 7.0%
Expense
Income before $ 9,626 $ 9,488 1.5% $ 9,523 (.4%)
Income taxes
Income tax $ 2,091 $ 2,778 (24.7%) $ 2,600 6.8%
Expense
Net income $ 7,535 $ 6,710 12.3% $ 6,923 (3.1%)
Net Interest Income
Net interest income (on a tax equivalent basis) is the Company's principal
source of revenue accounting for 81.8% of total income in 2001, as compared to
84.3% in 2000 and in 1999. Net interest income represents the difference between
interest earned on loans, investments and other interest earning assets offset
by the interest expense attributable to funding sources, principally deposits
and borrowings. Interest rate 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 interest income earned. Tax-exempt interest income is adjusted to a level
that reflects such income as if it were fully taxable.
Net interest income in the consolidated statements of income (which excludes the
taxable equivalent adjustment on tax exempt assets) was $27.0 million, compared
to $23.9 million in 2000 and $23.2 million in 1999. The taxable equivalent
adjustments (the adjustments to bring tax-exempt interest to a level that would
yield the same after-tax income had that income been subject to taxation, using
a 34% tax rate) of $1.3 million for 2001, 2000 and 1999, resulted in fully
taxable equivalent ("FTE") net interest income of $28.3 million, $25.2 million
and $24.5 million, respectively. Net interest income on a tax-equivalent basis
reached $28.3 million in 2001, an increase of 12.2% from $25.2 million in 2000.
Net interest income on a tax-equivalent basis was $24.5 million in 1999. The
improvement in 2001 net interest income of $3.1 million was due in part to an
increase in the volume of net average earning assets of $3.5 million. In spite
of this, average-earning assets increased 14.0% offset by an increase of 14.9%
in average interest-bearing liabilities. The benefit from an increase in earning
assets, non-interest bearing deposits and a decrease in the cost on interest
paying liabilities were offset, in part, by an increase in interest-bearing
liabilities and a decrease in the yield on interest earning assets. As a result,
interest income increased 5.3% while interest expense for 2001 decreased 0.2%.
13
Interest rate spread and net interest margin are terms utilized to measure and
explain changes in net interest income. Interest rate spread is the difference
between the yield on earning assets ("EAs") and the rate paid on
interest-bearing liabilities (IBLs") that fund those assets. The net interest
margin is expressed as the percentage of tax-equivalent net interest income as a
percentage of average EAs. The net interest margin exceeds the interest rate
spread because of the use of non-interest bearing sources of funds (net free
funds), principally composed of demand deposits and stockholders' equity, to
fund a portion of EAs. To compare tax-exempt asset yields to taxable yields, the
yield on tax-exempt loans and securities is computed on an FTE basis. As a
result, the level of funds available without interest cost is an important
factor affecting the ability to increase net interest margin.
Table 2 provides average balances of EAs and IBLs, the associated income and
expense, and the corresponding interest rates earned and paid, as well as net
interest income, interest rate spread, and net interest margin on an FTE basis
for the three years ended December 31, 2001. Tables 3 through 4 present
additional information for the discussion of FTE net interest income, interest
rate spread, and net interest margin.
As indicated in Tables 2 and 3, increases in volume and changes in the mix of
both EAs and IBLs added $3.4 million to FTE net interest income, while changes
in the rates resulted in a $362,000 decline, for a net increase of $3.1 million.
Average loans outstanding grew from $505.9 million in 2000 to $588.0 million in
2001, an increase of 16.2%. The increase in loan volume was a significant
contributing factor to the increase in interest income. Average loans
outstanding increased from $421.5 million in 1999 to $505.9 million in 2000, an
increase of 20.0%. The mix of average loans to average total assets increased
from 68.3% in 1999 to 71.6% in 2000 and to 72.7% in 2001. The relationship of a
higher volume of loans as a percentage of the asset mix has provided a source of
higher yielding assets, which has contributed to an increase in net interest
income.
The year 2001 saw a slight reduction of the interest rate spread for the Company
due to a lower interest rate environment further compressing interest spreads.
The interest rate spread decreased 3 basis points in 2001 to 3.34% from 3.37% in
2000, as the average yield on earning assets decreased 73 basis points while the
average rate paid on interest-bearing liabilities decreased 70 basis points over
the same period. In contrast, interest rate spread decreased 51 basis points in
2000 compared to 1999 results. The decrease in the Company's earning assets
yield reflects a decreasing rate environment impacting rates on the variable
priced loans for the year 2001. Increased investment interest income, which
resulted from an increased investment portfolio, offset by lower yields on the
investment portfolio, have contributed to some of the decrease in the yields on
interest earning assets. Yields on interest-paying liabilities decreased 71
basis points. A decreased rate environment also affected the funding side of the
balance sheet. Decreased interest costs resulted from a lower rate environment
offset to a lesser extent by increased competition for retail deposits;
increased balances in indexed accounts and additional reliance on wholesale
funding. Yields on interest bearing deposits decreased 64 basis points from
5.11% in 2000 to 4.47% in 2001.
Average short-term borrowings decreased $22.4 million as deposit growth from
core and non-core funding exceeded loan demand, decreasing reliance on other
short-term wholesale funding sources. Short-term borrowings consist of federal
funds purchased and overnight borrowings from the Federal Home Loan Bank
("FHLB") of Chicago. These funding sources decreased the percentage of average
short-term borrowings as a percentage of average interest-bearing liabilities to
2.4% in 2001 compared to 5.9% in 2000. Yields on these borrowings decreased 121
basis points in 2001 compared to 2000 contributing to an overall decrease in the
yields paid on interest-bearing liabilities.
Additional sources of funds consisted of other borrowings. Other borrowings
consist of term loans with the FHLB and other term loans taken out by the
Company during the year 2001. Other borrowings on average increased $11.0
million to $94.5 million. As a percentage of interest-bearing liabilities, other
borrowings decreased to 11.7% from 11.8% in 2000. Yields on these borrowings
decreased 135 basis points to 5.26% from 6.61% in 2000.
An additional source of funds generated in 2001 were proceeds from the trust
preferred securities offering. These resulted in an average of $14.0 million
generated for 2001 at a cost of 10.2%.
The net interest margin for 2001 was 3.79% compared to 3.88% in 2000. The
decline in net interest margin was in part related to a decline in the free
funds ratio, a decrease in the interest rate spread and an increase in
non-accrual
14
loans. The impact from competition as it relates to the commercial
loan portfolio and costs related to new product offerings had a negative effect
on the change in net interest margin. A declining interest rate environment
further compressed the net interest margin for the year 2001. The free funds
ratio, or the level of non-interest bearing funds that support earning assets,
declined to 16.2% from 16.5% in 2000.
The net interest margin for 2000 was 3.88% compared to 4.35% in 1999 as interest
rate spread declined during that period. The decrease in 2000 during a rising
interest rate environment occurred primarily as the result of a decrease in
non-accrual loans and a decline in the free funds ratio offset to a greater
extent by a 51 basis point decrease in the interest rate spread. Increased
competition, especially as it relates to the commercial loan portfolio,
negatively affected net interest margin.
The ratio of average earning assets to average total assets measures
management's ability to employ overall assets for the production of interest
income. This ratio was 92.5% in 2001 compared with 92.1% in 2000 and 91.5% in
1999. The ratio increased in 2001 as a result of an increase in net free funds
offset to a lesser degree by an increase in non-accrual loans.
Competition in the financial services industry will also affect net interest
margin. Spreads will be a focus of management's attention, as the Company
constantly seeks to attract lower cost core deposits, service the needs of
customers, and provide attractively priced products. Competition for high
quality assets will also affect asset yields.
Growth in net interest income primarily is the result of growth in the level of
earning asset volumes and changes in asset mix. Interest rate spread management
through asset and liability pricing and increased levels of non-interest-bearing
sources of funds also aid in improving net interest income. Management will
continue its focus on maintaining an appropriate mix of quality earning assets
as well as seeking to achieve appropriate growth in volumes.
Changes in the levels of market interest rates also affect net income, but are
less directly under the control of the Company. Although a stable rate
environment has been experienced, management believes that a gradual increase in
interest rates will not adversely affect the earning capacity of the Company.
Past experience has shown that, although the Company remains in a short-term
negative interest rate sensitivity gap, deposits tend not to be repriced as
quickly as loans in a rising rate scenario and are repriced more frequently in a
falling interest rate environment. More discussion on this subject is referenced
in the section titled "Interest Rate Risk"below.
TABLE 2: AVERAGE BALANCES AND INTEREST RATES (INTEREST AND RATES ON A
TAX-EQUIVALENT BASIS)
Year ended December 31,
2001 2000 1999
---- ---- ----
Average Interest Average Average Interest Average Average Interest Average
Balance Rate Balance Rate Balance Rate
(dollars in thousands)
ASSETS:
Earning Assets
Loans (1)(2)(3) $ 587,995 $ 505,892 421,541
Less: non-accruals (10,613) (8,396) (10,364)
--------- --------- -------
Net loans 577,382 $ 49,313 8.54% 497,496 $ 46,685 9.38% 411,177 $ 37,586 9.14%
U.S. Treasuries 1,229 8 6.35% 1,164 79 6.79% 1,156 79 6.83%
Agencies 99,972 6,202 6.20% 94,882 6,127 6.46% 90,249 5,579 6.18%
State and Municipal 53,158 4,051 7.62% 49,363 3,912 7.92% 50,954 3,989 7.83%
obligations (1)
Other Securities 7,671 483 6.30% 6,457 467 7.23% 4,036 265 6.57%
Federal funds sold 5,347 174 3.25% 14 1 7.14% 5,361 245 4.57%
Other money market
instruments 2,963 78 2.63% 1,188 69 5.81% 1,251 5 4.64%
--------- -------- ----- --------- -------- ----- ------- -------- ------
15
Total earning assets $ 747,722 $ 60,379 8.08% $ 650,564 $ 57,340 8.81% $ 564,184 $ 47,801 8.47%
--------- --------- --------- --------- ------ --------- ---------
Allowance for loan (7,349) (7,999) (8,924)
Losses
Non-accrual loans 10,613 8,396 10,364
Cash and due from 16,288 14,937 15,710
Banks
Other assets 41,162 40,548 35,505
Total assets $ 808,436 $ 706,446 616,839
LIABILITIES AND
STOCKHOLDERS'
EQUITY
Interest bearing
liabilities
NOW accounts $ 44,015 $ 514 1.17% $ 44,965 $ 837 1.86% $ 47,313 $ 837 1.77%
Savings accounts 197,993 6,940 3.51% 164,858 7,890 4.79% 141,972 5,325 3.75%
Time deposits 305,012 17,001 5.57% 252,086 14,855 5.89% 246,782 13,379 5.42%
--------- --------- ----- --------- --------- ------ --------- --------- ------
Total interest-bearing 547,020 24,455 4.47% 461,909 23,582 5.11% 436,067 19,541 4.48%
Deposits
Short-term borrowings 19,351 1,084 5.60% 41,798 2,847 6.81% 10,812 605 5.60%
Securities sold under 2,403 94 3.91% 2,213 123 5.56% 3,657 163 4.46%
agreement to
repurchase
Other borrowings 94,589 4,975 5.26% 83,269 5,529 6.61% 56,466 2,950 5.22%
Trust preferred 14,031 1,430 10.19%
Long term debt 159 15 9.43% 211 18 8.53% 265 21 7.92%
--------- --------- ----- --------- --------- ------ --------- --------- ------
Total interest-bearing $ 677,553 $ 32,053 4.73% $ 589,760 $ 32,099 5.44% $ 507,267 $ 23,280 4.59%
Liabilities
Demand deposits 67,012 61,214 56,755
Accrued expenses and 7,519 6,718 6,882
other liabilities
Stockholders' equity 56,352 48,754 45,935
--------- --------- ---------
Total liabilities and $ 808,436 $ 706,446 $ 616,839
--------- --------- ---------
stockholders' equity
Net interest income $ 28,326 3.34% $ 25,241 3.37% $ 24,521 3.88%
And rate spread
Net interest margin 3.79% 3.88% 4.35%
(1) The yield on tax exempt loans and securities is computed on a
tax-equivalent basis using a tax rate of 34% for all periods presented.
(2) Nonaccrual loans and loans held for sale have been included in the
average balances.
(3) Interest income includes net loan fees.
TABLE 3: RATE/VOLUME ANALYSIS (1)
2001 compared to 2000 2000 compared to 1999
Increase (Decrease) due to Increase (Decrease) due to
Volume Rate Net Volume Rate Net
(dollars in thousands)
Interest income:
Loans (2) $ 7,160 $ (4,532) $ 2,628 $ 7,995 $ 1,104 $ 9,099
16
U.S. treasuries 1 (2) (1) 1 (1) 0
Agencies 81 (6) 75 432 116 548
State and municipal
obligations (2) 142 (3) 139 (54) (23) (77)
Other securities 82 (66) 16 167 35 202
Federal funds sold 277 (104) 173 (313) 69 (244)
Other money market
instruments 75 (66) 9 (3) 14 11
------- ------- ------- ------- ------- -------
Total earning assets $ 7,817 $(4,778) $ 3,039 $ 8,225 $ 1,314 $ 9,539
======= ======= ======= ======= ======= =======
Interest expense:
NOW accounts $ (14) $ (309) $ (323) $ (43) $ 43 $ 0
Savings accounts 1,374 (2,324) (950) 977 1,588 2,565
Time deposits 3,034 (888) 2,146 300 1,176 1,476
Short term borrowings (1,393) (370) (1,763) 1,922 320 2,242
Securities sold 9 (38) (29) (72) 32 (40)
under agreement to
repurchase
Other borrowings 651 (1,205) (554) 1,607 972 2,579
Trust preferred 715 715 1,430
Long term debt (5) 2 (3) (4) 1 (3)
------- ------- ------- ------- ------- -------
Total
interest-bearing
liabilities $ 4,370 $(4,416) $ (46) $ 4,687 $ 4,132 $ 8,819
Net interest income $ 3,447 $ (362) $ 3,085 $ 3,538 $(2,818) $ 720
======= ======= ======= ======= ======= =======
(1) The change in interest due to both rate and volume has been allocated
proportional to the relationship to the dollar amounts of the change in
each.
(2) The yield on tax-exempt loans and securities is computed on an FTE
basis using a tax rate of 34% for all periods presented.
17
TABLE 4: SELECTED AVERAGE BALANCES
Percent 2001 as % of 2000 as % of
2001 2000 Change Total Assets Total Assets
---- ---- ------- ------------ ------------
(dollars in thousands)
ASSETS
Loans, net of
non-accrual loans $577,382 $497,496 16.1% 71.4% 70.4%
Investment securities
Taxable 108,872 102,503 6.2% 13.5 14.5
Tax-exempt 53,158 49,363 7.7% 6.6 7.0
Short-term investments 8,310 1,202 NM 1.0 0.2
-------- -------- ---- ------- -----
Total earning assets 747,722 650,564 14.9% 92.5 92.1
Other assets 60,714 55,882 8.6% 7.5 7.9
-------- -------- ---- ------- -----
Total assets $808,436 $706,446 14.4% 100.0% 100.0%
======== ======== ======= =====
LIABILITIES AND
STOCKHOLDERS' EQUITY
Interest-bearing deposits $547,020 $461,909 18.4% 67.7% 65.4%
Short-term borrowings 116,343 127,640 (8.9%) 14.4 18.1
Trust preferred 14,031 0 NM 1.7 0.0
Long-term debt 159 211 (24.6%) 0.0 0.0
Total interest-bearing 677,553 589,760 14.9% 83.8 83.5
Liabilities
Demand deposits 67,012 61,214 9.5% 8.3 8.7
Accrued expenses 7,519 6,718 11.9% 0.9 1.0
Stockholders' equity 56,352 48,754 15.6% 7.0 6.9
-------- -------- ---- ----- -----
Total liabilities and
Stockholders' equity $808,436 $706,446 14.4% 100.0% 100.0%
======== ======== ==== ===== =====
TABLE 5: DISTRIBUTION OF ASSETS, LIABILITIES AND STOCKHOLDERS' EQUITY
For the years
2001 2000 1999 1998 1997
---- ---- ---- ---- ----
(dollars in thousands)
ASSETS
Cash and due from banks $ 16,896 $ 15,142 $ 15,978 $ 11,917 $ 10,162
Investment securities
U.S. Treasuries 1,173 1,164 1,156 2,102 2,691
Agencies 98,040 96,757 89,893 67,824 58,687
State and municipal
obligations 52,082 50,263 50,954 44,614 32,858
Other securities 10,026 7,440 5,019 5,629 4,475
Market adjustment on
AFS securities 3,064 (2,775) 386 2,298 927
--------- --------- --------- --------- ---------
Total investments $ 164,385 $ 152,849 $ 147,378 $ 122,467 $ 99,638
--------- --------- --------- --------- ---------
Federal funds sold 5,347 14 5,361 6,657 17
Loans, net of
unearned income 587,995 505,892 421,541 333,484 276,639
18
Reserve for loan losses (7,349) (7,999) (8,924) (5,833) (3,203)
--------- --------- --------- --------- ---------
Net loans 580,646 497,893 412,617 327,651 273,436
Bank premises and 21,033 20,128 16,795 14,434 12,521
equipment
Other real estate owned 1,501 562 287 93 38
Other assets 18,628 19,858 18,423 14,139 12,441
--------- --------- --------- --------- ---------
Total assets $ 808,436 $ 706,446 $ 616,839 $ 497,358 $ 408,253
========= ========= ========= ========= =========
LIABILITIES AND
STOCKHOLDER'S EQUITY
Demand deposits $ 67,012 $ 61,214 $ 56,755 $ 46,586 $ 41,521
NOW accounts 44,015 44,965 47,313 41,734 38,898
Savings deposits 197,993 164,858 141,972 109,778 88,544
Time deposits 305,012 252,086 246,782 188,412 163,755
--------- --------- --------- --------- ---------
Total deposits $ 614,032 $ 523,123 $ 492,822 $ 386,510 $ 332,718
Short term borrowings $ 19,351 $ 41,798 $ 10,812 $ 15,106 $ 27,701
Securities sold under 2,403 2,213 3,657 3,637 1,800
agreement to repurchase
Other borrowings 94,589 83,629 56,466 42,099 --
Long term debt 159 211 265 387 377
Trust preferred 14,031 -- -- -- --
securities
Other liabilities 7,519 6,718 6,882 6,247 5,562
--------- --------- --------- --------- ---------
Total liabilities $ 752,084 $ 657,692 $ 570,904 $ 453,986 $ 368,158
Common stock $ 37,456 $ 37,333 $ 20,996 $ 18,475 $ 12,302
Additional paid in 7,625 7,125 6,560 8,718 6,038
capital
Retained earnings 9,902 7,234 18,743 15,305 21,347
Net unrealized gains 1,994 (2,313) 261 1,496 609
(losses) on AFS
securities
Treasury stock (625) (625) (625) (622) (201)
--------- --------- --------- --------- ---------
Total equity $ 56,352 $ 48,754 $ 45,935 $ 43,372 $ 40,095
--------- --------- --------- --------- ---------
Total liabilities and
stockholders' equity $ 808,436 $ 706,446 $ 616,839 $ 497,358 $ 408,253
========= ========= ========= ========= =========
Provision for Loan Losses
The provision for loan losses ("PFLL") is the periodic cost, not less than
quarterly, of providing an allowance for anticipated future loan losses. In any
accounting period, the PFLL is based on a function of the methodology used and
management's evaluation of the loan portfolio, especially nonperforming and
other potential problem loans, taking into consideration many factors, including
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.
The PFLL in 2001 at $2.9 million compares to a PFLL of $545,000 for 2000 and
$850,000 for 1999. Net charge-offs in 2001 were $1.9 million compared with net
charge-offs of $1.2 million in 2000 and $3.4 million in 1999. Net charge-offs as
a percentage of average loans is a key measure of asset quality. Net charge-offs
to average loans
19
were 0.32% in 2001 compared with 0.23% in 2000 and 0.80% in 1999. Management
believes that the current provision conforms with the Company's loan loss
reserve policy and is adequate in view of the present condition of the Company's
loan portfolio. See "Risk Management and the Allowance for Loan Losses" below.
Non-Interest Income
Total non-interest income for 2001, excluding securities transactions, was $6.3
million, a $1.6 million increase from 2000, or 34.6%. In 2000, total
non-interest income was $130,000 more than 1999, a 2.9% increase. Trust service
fees, loan servicing fees, gains from sales of loans and service charges
continue to be the primary components of non-interest income as evidenced in
Table 6.
TABLE 6: NONINTEREST INCOME
Years ended December 31, % Change from prior year
------------------------------------------------------------------------
2001 2000 1999 2001 2000
---- ---- ---- ---- ----
(dollars in thousands)
Trust service fees $ 664 $ 517 $ 553 28.4% (6.5%)
Loan servicing income $ 1,461 $ 837 $ 875 74.6% (4.3%)
Service charges on $ 1,836 $ 1,489 $ 1,369 23.3% 8.8%
Deposit accounts
Other fee income $ 608 $ 564 $ 521 7.8% 8.3%
Financial service income $ 300 $ 459 $ 393 (34.6%) 16.8%
Gains from sale of loans $ 873 $ 240 $ 295 263.8% (18.6%)
Other $ 565 $ 580 $ 550 (2.6%) 5.5%
------- ------- -------- ------- -----
Total noninterest income $ 6,307 $ 4,686 $ 4,556 34.6% 2.9%
======= ======= ======== ======= ======
Trust fees increased $147,000 or 28.4% to $664,000 in 2001 compared to 2000,
primarily as a result of an increase in trust estate business and by an increase
in additional assets under management. This compared to a decrease of $36,000 or
6.5% in 2000 compared to 1999, primarily the result of reduced trust estate
business.
Loan servicing fees increased $624,000, or 74.6%, to $1.5 million in 2001. This
followed a decrease of $38,000, or 4.3%, to $837,000 in 2000. The increase in
2001 occurred as a result of increased servicing income due to an increase in
the portfolio of mortgage loan business sold in the secondary market and an
increase in the commercial loan business sold in the secondary market and
serviced by the Company, primarily the result of a falling interest rate
environment in 2001 compared to 2000.
Gains on sales on loans in the secondary market increased $633,000, or 263.8%,
to $873,000 in 2001 primarily as a result of increased gains from sales of
mortgage loans. Premiums increased in the secondary market for mortgage loans
contributing to an increase in $534,000 in gains from the sale of mortgage
loans. In addition, gains from commercial loans increased $99,000 in 2001. An
increase in mortgage loan business sold during 2001 amounted to $78.7 million of
loans sold compared to $17.1 million of mortgage loans sold in 2000. Total loans
sold during 2001 were $86.5 million compared to $23.6 million in 2000.
Service charges on deposit accounts showed an increase of $347,000, or 23.3%,
over 2000 results accounting for the improvement in fee income generated for
other services provided to customers. In addition, a lower rate environment
reduced earnings credits on transaction accounts providing for additional fee
income.
Other income decreased $15,000, or 2.6%, to $565,000 in 2001. Undistributed
income from United Financial Services, Inc., the Bank's data servicing
subsidiary increased $44,000 as a result of increased earnings to $295,000, from
the data processing subsidiary.
20
Non-Interest Expense
Non-interest expense in 2001 increased to $20.8 million, a $2.2 million, or
11.7% increase compared to 2000 results, primarily as a result of increased
personnel, equipment, data processing, and other operating expense. This
followed a $1.2 million or 7.0% increase in 2000 as compared to 1999. Primary
categories impacting the change between 2001 and 2000 are noted in Table 7
below.
TABLE 7: NONINTEREST EXPENSE
Years ended December 31, % Change from prior year
-------------------------------------------------------------------------------
(dollars in thousands)
-------------------------------------------------------------------------------
2001 2000 1999 2001 2000
---- ---- ---- ---- ----
Personnel $ 11,923 $ 10,353 $ 9,700 15.2% 6.7%
Occupancy $ 1,834 $ 1,643 $ 1,430 11.6% 14.9%
Equipment $ 1,401 $ 1,404 $ 1,238 (0.2%) 13.4%
Data processing $ 893 $ 844 $ 797 5.8% 5.9%
Business development $ 594 $ 628 $ 493 (5.4%) 27.4%
and advertising
Stationery and supplies $ 482 $ 536 $ 442 (10.1%) 21.3%
Director fees $ 285 $ 262 $ 247 8.8% 6.1%
FDIC insurance $ 110 $ 140 $ 181 (21.4%) (22.7%)
Goodwill amortization $ 486 $ 486 $ 453 0.0% 7.3%
Legal and professional $ 256 $ 199 $ 373 28.6% (46.6%)
Operation of other real $ 248 $ (22) $ (117) NM (81.2%)
Estate
Other $ 2,259 $ 2,117 $ 2,133 6.7% (0.8%)
-------- -------- -------- ------ -------
Total noninterest expense 20,771 $ 18,590 $ 17,370 11.7% 7.0%
======== ======== ======== ====== ====
Salaries and employee benefits expense is the largest component of non-interest
expense and totaled $11.9 million in 2001, an increase of $1.6 million, or
15.2%, as compared to 2000 results. The increase in 2001 primarily resulted from
staffing increases, bonus expense, increased benefit costs, and normal salary
increases. Salary and employee benefits expense in 2000 totaled $10.4 million,
an increase of $653,000, or 6.7%, as compared to 1999 results. The 1999 increase
resulted primarily from staffing increases, increased benefit costs, and normal
salary increases.
Bonus expense in 2001 was $405,000 compared to $134,000 in 2000. The increase
occurred as a result of bonus expense arising from the Company's
Pay-for-Performance Program in 2001. This program is designed to reward various
divisions upon achievement of certain goals related to improvement in income and
on return on equity. The Company did achieve its return on equity goals and,
accordingly, a bonus payment was made.
The Company's 401(k) profit sharing plan, including a money purchase plan
initiated in 1999, covering all employees who qualify as to age and length of
service increased to $713,000, an increase of $87,000, or 13.9%, over 2000
levels. Expenses in the same category in 2000 were up $54,000, or 9.4%, over
1999 levels.
The number of full-time equivalent employees increased to 286 in 2001 from 272
in 2000, an increase of 5.1%. Employee levels in 2000 increased to 272 from 252
in 1999, an increase of 7.9%. The increases occurred primarily at the Company's
Green Bay locations with emphasis on additional personnel for sales and calling
programs. Management will continue its efforts to control salaries and employee
benefits expense, although increases in these expenses are likely to continue to
occur in future years.
Net occupancy expense for 2001 showed an increase of $191,000, or 11.6%, as
compared to 2000 for a total of $1.8 million. Additional depreciation expense,
real estate tax expense, and other occupancy costs resulted in 2001. This
increase followed an increase of $213,000, or 14.9%, in 2000. Additions of two
facilities in the Green Bay region
21
plus two additional branches built on existing sites accounted for the balance
of the increase in occupancy expense for 2000.
Equipment expense was flat for 2001 decreasing $3,000, or 0.2%, compared to
2000. This followed an increase of $166,000, or 13.4%, in 2000. The increase in
2000 resulted from depreciation expense from past capital expenditures for
equipment that were made to enhance the Company's technological capabilities.
The addition of branches in 2000 also accounted for an increase in equipment
expense in 2000.
Data processing expense in 2001 increased $49,000, or 5.8%, due to an increase
in the volume of transaction activity processed and technology enhancements.
This followed an increase of $47,000, or 5.9%, in 2000 compared to 1999.
Management estimates that data processing expense should show minimal increases
in the next several years with adjustments related only to any volume increases
incurred by the Company.
Business development and advertising expense in 2001 decreased $34,000, or 5.4%
compared to 2000. This compared to an increase of $135,000, or 27.4% in 2000
compared to 1999 as television advertising production costs accounted for much
of the increase.
Supplies expense shows a decrease of $54,000, or 10.1%, in 2001 as compared to
2000. This compared to an increase of $94,000, or 21.3% in 2000 compared to
1999. This increase occurred as a result of additional branches coming online
during the year 2000.
Payments to regulatory agencies decreased $30,000 to $110,000 for 2001
reflecting the net rate reduction in deposit insurance effective for 2001 on a
higher deposit base for the year. For 2000, payments to regulatory agencies
decreased $41,000 to $140,000 when compared to 1999. For the Bank, these charges
related to a debt service assessment related to Financing Corporation ("FICO")
for 2000 and a Federal Deposit Insurance Corporation ("FDIC") assessment for the
first quarter of 2000. As a result of a change in rating assigned of 2A, rating
for adequately capitalized institutions, the Bank experienced higher assessment
costs for the last quarter of 1999 and first quarter of 2000. The higher
assessment occurred as a result of the "Total Risk-Based Capital Ratio"
decreasing to a level below 10%. Prior to the merger of the Bank and BLBNA,
BLBNA had been assigned a risk classification rating of 3B, rating assigned to
troubled and critically under capitalized institutions, therefore in addition to
a FICO assessment, BLBNA also received a FDIC assessment for its Bank Insurance
Fund. The Bank's risk classification changed to 1A, rating assigned to
well-capitalized institutions, on May 31, 2000, thereby enabling Bank to reduce
FDIC premiums accordingly for the remainder of 2000. For additional information
regarding the Company's capital adequacy, see "Capital Resources" below.
Legal and professional expense for 2001 increased $57,000 or 28.6% as various
costs were incurred as a result of legal and collection actions that occurred
during the year. Legal expenses decreased $174,000 during 2000, primarily the
result of the completion of various legal actions stemming from the operations
of the former BLBNA.
Other real estate expenses are netted against income received in the
determination of net other real estate owned expense (income). As a result, the
Company has shown varied results. Other real estate owned showed net expense of
$248,000 in 2001 as a result of various gains taken on property sales. Gains of
$23,000 were taken from lot sales of Idlewild Valley, Inc., a former subsidiary
of the Bank whose value was written off in 1988. In addition, gains of $177,000
from eight commercial property sales and $9,000 from five residential property
sales were realized in 2001. These were offset by losses of $22,000 from the
sale of two commercial properties and two residential properties. Various
operating expenses, net of income, of other real estate totaling $435,000
occurred in 2001. Other real estate owned expenses resulted in net income of
$22,000 in 2000. Gains of $73,000 were realized from lot sales of Idlewild
Valley, Inc., in 2000. In addition, gains of $110,000 from three commercial
property sales and $72,000 from seven residential property sales were realized
in 2000. These were offset by losses of $2,000 from the sale of one commercial
property and two residential properties. Various operating expenses, net of
income, of other real estate totaling $231,000 occurred in 2000.
Amortization of goodwill related to the Four Seasons acquisition and BLBNA
acquisition were unchanged for 2001 as compared to 2000. Amortization expense of
$327,000 for Four Seasons and $159,000 for BLBNA were recorded for each of those
years. Amortization of goodwill in 1999 was $453,000 which amounted to $327,000
for Four Seasons and $126,000 for BLBNA.
22
Other operating expenses in 2001 increased $142,000 or 6.7%, primarily the
result of an increase of $108,000 related to other outside service expense, such
as consulting fees and payroll service expenses. Other operating expenses in
2000 decreased $16,000 or 0.8% compared to 1999.
The overhead ratio, which is computed by subtracting non-interest income from
non-interest expense and dividing by average total assets was 1.79% for 2001
compared to 1.97% for 2000 and 2.08% for 1999.
Income Taxes
Income tax expense for the Company in 2001 was $2.1 million, a decrease of
$687,000 or 24.7% compared to 2000. The major part of the decrease was
attributable to $516,000 of net federal tax refunds booked based on an IRS audit
of BLBNA completed in December 2001. This amount was net of $151,000 of tax
assessed and $340,000 of refund claims not booked pending IRS approval. This
followed an increase of $178,000 or 6.8% in 2000 compared to 1999. The higher
tax expense in 2000 reflected the Company's increase in before tax earnings
offset by an increase in tax-exempt interest income.
The Company's effective tax rate, income tax expense divided by income before
taxes, was 21.7% in 2001 compared with 29.3% in 2000 and 27.3% in 1999. Of the
21.7% effective tax rate for 2001, the federal effective tax rate was 20.5%
while the Wisconsin State effective tax rate was 1.2%.
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. A valuation allowance has
been recognized to offset the related deferred tax assets due to the uncertainty
of realizing tax benefits of a portion of loan loss and mortgage servicing
differences.
Income taxes are provided for the tax effects of transactions reported in the
financial statements and consists of taxes currently due plus deferred taxes
related primarily to differences between the basis of the allowance for loan
losses, deferred loan origination fees, deferred compensation, mortgage loan
servicing, market value adjustments of securities, and depreciation for
financial and income tax reporting in accordance with SFAS 109. The deferred tax
assets and liabilities represent the future tax return consequences of those
differences, which will either be taxable or deductible when the assets and
liabilities are recovered or settled.
Balance Sheet Analysis
Loans
Total loans outstanding grew to $605.3 million at December 31, 2001, a 9.0%
increase from the end of 2000. This follows a 24.2% increase at December 31,
2000 over 1999 year end.
The commercial, financial, and agricultural loan classification primarily
consists of commercial loans to small businesses. Loans of this type are in a
broad range of industries and include service, retail, wholesale, and
manufacturing concerns. Agricultural loans are made principally to farmers
engaged in dairy, cherry and apple production. Borrowers are primarily
concentrated in Door, Brown, Outagamie, Waupaca, Waushara and Kewaunee counties,
Wisconsin. The credit risk related to commercial loans made is largely
influenced by general economic conditions, especially those applicable to the
Northeast Wisconsin market area, and the resulting impact on a borrower's
operations.
Commercial loans and commercial real estate loans (including construction loans)
totaled $445.0 million at year end 2001 and comprised 73.5% of the loan
portfolio compared with 68.0% of the portfolio at the end of 2000. Loans in
these classifications grew $67.6 million or 17.9% during 2001. Loans of this
type are in a broad range of industries. The credit risk related to these type
of loans is greatly influenced by general economic conditions and the resulting
impact on the borrower's operations.
Table 8 reflects composition (mix) of the loan portfolio at December 31:
23
TABLE 8: LOAN COMPOSITION
(dollars in thousands)
2001 2000 1999
---- ---- ----
Amount % of Total Amount % of Total Amount % of Total
Amount of loans by type
Real estate-
mortgage
Commercial $288,385 47.6% $251,971 45.4% $201,301 45.0%
1-4 Family residential
First liens 96,626 16.0 109,173 19.7 95,255 21.3%
Junior liens 24,748 4.1 26,513 4.8 23,811 5.3%
Home equity 22,374 3.7 24,464 4.4 18,963 4.3%
Commercial, financial 88,649 14.6 83,897 15.1 66,159 14.8%
and agricultural
Real estate-construction 67,939 11.2 41,524 7.5 26,535 5.9%
Installment
Credit cards and related 2,145 0.4 2,140 0.4 1,810 0.4%
Plans
Other 14,745 2.4 15,785 2.8 13,636 3.1%
Less: deferred fees, net 324 0.1 360 0.1 451 0.1%
of costs
Total loans (net of $605,287 100.0% $555,107 100.0% $447,019 100.0%
unearned income) ======== ======== ========
1998 1997
---- ----
Amount % of Total Amount % of Total
Amount of loans by type
Real estate-
mortgage
Commercial $178,846 43.9% $118,103 40.2%
1-4 Family residential
First liens 101,391 24.9 67,270 22.9
Junior liens 17,122 4.2 16,571 5.7
Home equity 18,051 4.4 16,714 5.7
Commercial,financial 67,550 16.6 47,078 16.1
and agricultural
Real estate-construction 9,553 2.3 14,760 5.0
Installment
Credit cards and related 1,809 0.4 1,790 0.6
Plans
Other 14,105 3.5 11,690 4.0
Less: deferred fees, net 779 0.2 538 0.2
of costs
Total loans (net of $407,648 100.0% $293,438 100.0%
unearned income) ======== ========
Real estate loans (including construction loans) secured by non-residential real
estate properties involve borrower characteristics similar to those for
commercial loans. Because of their similarities, they are combined with
commercial loans for purposes of analysis and discussion.
Management uses an active credit risk management process for commercial loans to
ensure that sound and consistent credit decisions are made. Management attempts
to control credit risk by adhering to detailed
24
underwriting procedures, performing comprehensive loan administration, and
undertaking periodic review of borrowers' outstanding loans and commitments.
Borrower relationships are formally reviewed periodically during the life of the
loan. Further analyses by customer, industry, and location are performed to
monitor trends, financial performance and concentrations.
The Company's loan portfolio is diversified by types of borrowers and industry
groups within the market areas that it serves. Significant loan concentrations
are considered to exist for a financial entity when such amounts are loans to a
multiple of borrowers engaged in similar activities that cause them to be
similarly impacted by economic or other conditions. The Company has identified
certain industry groups within its market area, including lodging, restaurants,
retail shops, small manufacturing, real estate rental properties and real estate
development. At December 31, 2001, there existed one industry group
concentration in the Company's loans that exceeded 10% of total loans. Loans
related to the lodging industry amounted to $62.4 million or 10.3% of total
loans at year end December 31, 2001.
Although management does not believe significant industry group loan
concentrations exist in the Company's loan portfolio, it is aware that its
market area is heavily reliant on seasonal tourism. As a result, a decrease in
tourism could adversely affect one or more industry groups in the Company's loan
portfolio, which could have a corresponding adverse effect on the Company's
earnings.
At the end of 2001, residential real estate mortgage loans totaled $143.7
million and comprised 23.8% of the loan portfolio. These loans decreased $16.4
million or 10.2% during 2001. A lower interest rate environment provided
opportunities for the Company to refinance existing mortgage loans into fixed
rates and sell them into the secondary market. Residential real estate loans
consist of conventional home mortgages, adjustable indexed interest rate
mortgage loans, home equity loans, and secondary home mortgages. Loans are
primarily for properties within the market areas served by the Company.
Residential real estate loans generally contain a limit for the maximum loan to
collateral value of 75% to 80%. Private mortgage insurance may be required when
the loan to value exceeds these limits. Residential real estate loans are
written normally with a one or three year adjustment rate feature.
In 1997, the Company offered adjustable indexed interest rate mortgage loans
based upon market demands. At year end 2001, those loans totaled $43.8 million
dollars. Adjustable indexed interest rate mortgage loans contain an interest
rate adjustment provision tied to the weekly average yield on U.S. Treasury
securities adjusted to a constant maturity of one year, plus an additional
mark-up of 2.75% (the "index") which varies with the mortgage loan product.
Interest rates on indexed mortgage loans are adjusted, up or down, on
predetermined dates fixed by contract, in relation to and based on the index or
market interest rates as of a predetermined time prior to the adjustment date.
Adjustable indexed interest rate mortgage loans have an initial period, ranging
from one or three years, during which the interest rate is fixed, with
adjustments permitted thereafter, subject to annual and lifetime interest rate
caps which vary with the product. Annual limits on interest rate changes are 2%
while aggregate lifetime interest rate increases over the term of the loan are
currently at 6% above the original mortgage loan interest rate. The Company also
participates in a secondary fixed rate mortgage program under the Federal Home
Loan Mortgage Corporation ("FHLMC") guidelines. These loans are sold in the
secondary market and the Company retains servicing rights. At December 31, 2001,
these loans totaled $51.1 million.
Additionally in the last quarter of 1997, the Company began to offer fixed rate
mortgages through participation in secondary fixed rate mortgage programs under
private investors. These loans are sold in the secondary market with servicing
rights sold retained by buyer. In 2001, the Company sold $78.7 million mortgage
loans through the secondary programs.
25
TABLE 9: LOAN MATURITY AND INTEREST RATE SENSITIVITY (1)
Maturity (2)
- ---------------------------------------------------------------------------------------
December 31, 2001 Within 1 Year 1-5 Years After 5 Years Total
- ---------------------------------------------------------------------------------------
(dollars in thousands)
Loans secured
primarily by real estate:
Secured by 1 to 4 $ 33,907 $ 54,049 $ 55,792 $143,748
family residential
properties
Construction 37,525 29,333 1,081 67,939
Other real estate 76,399 154,358 57,628 288,385
Loans to farmers 2,015 5,273 626 7,914
Commercial and 18,745 26,032 34,713 79,490
industrial
Loans to consumers 5,535 10,952 403 16,890
All other loans 607 638 -- 1,245
-------- -------- -------- --------
Total $174,733 $280,635 $150,243 $605,611
- --------------------------------------------------------------------------------------
Interest sensitivity
- --------------------------------------------------------------------------------------
Fixed rate Variable rate
------------- ---------------
Due after one year $213,052 $217,826
----------- ------------
Installment loans to individuals totaled $16.9 million, or 2.8%, of the total
loan portfolio at December 31, 2001 compared to $17.9 million, or 3.2%, at end
of 2000. Installment loans include short-term installment loans, direct and
indirect automobile loans, recreational vehicle loans, credit card loans, and
other personal loans. Individual borrowers may be required to provide collateral
or a satisfactory endorsement or guaranty from another party, depending upon the
specific type of loan and the creditworthiness of the borrower. Loans are made
to individual borrowers located in the market areas served by the Company.
Credit risks for loans of this type are generally influenced by general economic
conditions (especially in the market areas served), the characteristics of
individual borrowers and the nature of the loan collateral. Credit risk is
primarily controlled by reviewing the creditworthiness of the borrowers as well
as taking the appropriate collateral and guaranty positions on such loans.
Critical factors in the overall management of credit quality are sound loan
underwriting and administration, systematic monitoring of existing loans and
commitments, effective loan review on an ongoing basis, adequate allowance for
loan losses, and conservative non-accrual and charge-off policies.
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 or reserve for
possible 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 ongoing review of payment performance. Asset quality
administration, including early identification of problem loans and timely
resolution of problems, further enhances management of credit risk and
minimization of loan losses. All specifically identifiable and quantifiable
losses are immediately charged off against the allowance.
Management reviews the adequacy of the Allowance for Loan Losses ("allowance" or
"ALL") on a quarterly basis to determine whether, in management's estimate, the
allowance is adequate to provide for possible losses inherent in the loan
portfolio as of the balance sheet date. Management's evaluation of the adequacy
of the ALL is based primarily on management's periodic assessment and grading of
the loan portfolio as described below. Additional factors considered by
management include the consideration of past loan loss experience, trends in
past due and nonperforming loans, risk characteristics of the various
classifications of loans, current economic conditions, the fair value of
underlying collateral, and other regulatory or legal issues that could affect
credit losses.
Loans are initially graded when originated. They are re-graded as they are
renewed, when there is a loan to the same borrower, when identified facts
demonstrate heightened risk of nonpayment, or if they become delinquent. The
loan review, or, grading process attempts to identify and measure problem and
watch list loans. Problem loans are those loans that management determines have
a higher than average risk for default, with workout and/or legal action
probable within one year. These loans are reported at least quarterly to the
directors' loan committee and reviewed
26
at the officers' loan committee for action to be taken. Watch list loans are
those loans considered as having weakness detected in either character, capacity
to repay or balance sheet concerns and prompt management to take corrective
action at the earliest opportunity. Problem and watch list loans generally
exhibit one or more of the following characteristics:
1. Adverse financial trends and condition
2. Decline in the entire industry
3. Managerial problems
4. Customer's failure to provide financial information or other collateral
documentation
5. Repeated delinquency, overdrafts or renewals
Every significant problem credit is reviewed by the loan review process and
assessments are performed quarterly to confirm the risk rating, proper
accounting and the adequacy of loan loss reserve assigned.
After reviewing the gradings in the loan portfolio, management will allocate or
assign a portion of the ALL to categories of loans and individual loans to cover
management's estimate of probable loss. Allocation is related to the grade of
the loan and includes a component resulting from the application of the
measurement criteria of Statements of Financial Accounting Standards No. 114,
"Accounting by Creditors for Impairment of a Loan" ("SFAS 114") and No. 118,
"Accounting by Creditors for Impairment of a Loan-Income Recognition and
Disclosures" ("SFAS 118"). Allocations also are made for unrated loans, such as
credit card loans, based on historical loss experience adjusted for portfolio
activity. The indirect risk in the form of off-balance sheet unfunded
commitments are also taken into consideration. These allocated reserves are
further supplemented by unallocated reserves based on management's estimate
regarding risk of error, local economic conditions and any other relevant
factors. Management then compares the amounts allocated for probable losses to
the current allowance. To the extent that the current allowance is insufficient
to cover management's best estimate of probable losses, management records
additional provision for credit loss. If the allowance is greater than required
at that point in time, provision expense is adjusted accordingly.
As Table 10 indicates, the ALL at December 31, 2001 was $8.0 million compared
with $7.0 million at the end of 2000. Loans increased 9.0% from December 31,
2000 to December 31, 2001, while the allowance as a percent of total loans
increased due to increased loan loss provision for the year 2001 offset by net
charge-offs for the year. The December 31, 2001 ratio of ALL to outstanding
loans was 1.32% compared with 1.26% at December 31, 2000. Based on management's
analysis of the loan portfolio risk at December 31, 2001, a provision expense of
$2.9 million was recorded for the year ended December 31, 2001, an increase of
$2.3 million compared to the same period in 2000. Net loan charge-offs of $1.9
million occurred in 2001, and the ratio of net charge-offs to average loans for
the period ended December 31, 2001 was 0.32% compared to 0.23% at December 31,
2000. Real estate-mortgage charge-offs represented 65.5% of the total net
charge-offs for the year 2001. Commercial mortgage loan charge-offs accounted
for $1.0 million of the mortgage total and residential mortgage loan charge-offs
totaled $246,000. Commercial loans accounted for $555,000 or 29.3% of the total
net charge-offs for the year 2001. Loans charged-off are subject to periodic
review and specific efforts are taken to achieve maximum recovery of principal
and accrued interest.
TABLE 10. LOAN LOSS EXPERIENCE
Years Ended December 31,
2001 2000 1999 1998 1997
---- ---- ---- ---- ----
(dollars in thousands)
Daily average amount of loans $ 587,995 $ 505,892 $ 421,541 $ 333,484 $ 276,639
--------- --------- --------- --------- ---------
Loans, end of period $ 605,287 $ 555,107 $ 447,019 $ 407,648 $ 293,438
--------- --------- --------- --------- ---------
ALL, at beginning of year $ 7,006 $ 7,611 $ 11,035 $ 3,881 $ 2,893
Loans charged off:
Real estate-mortgage 1,573 1,584 991 355 1
Real estate-construction -- -- 40 -- --
Loans to farmers -- 24 35 -- --
Commercial/industrial loans 983 343 4,097 376 199
Consumer loans 173 123 199 114 121
Lease financing/other loans -- -- -- -- --
--------- --------- --------- --------- ---------
Total loans charged off $ 2,729 $ 2,074 $ 5,362 $ 845 $ 321
Recoveries of loans previously charged off:
Real estate-mortgage 332 290 508 148 1
Real estate-construction -- 2 -- -- --
Loans to farmers -- 11 -- -- --
Commercial/industrial loans 428 557 1,433 186 151
Consumer loans 75 64 47 43 42
Lease financing/other loans -- -- -- -- --
--------- --------- --------- --------- ---------
Total loans charged off 835 924 1,988 377 194
--------- --------- --------- --------- ---------
Net loans charged off ("NCOs") 1,894 1,150 3,374 468 127
--------- --------- --------- --------- ---------
Additions to allowance for loan losses charged $ 2,880 $ 545 $ 850 $ 1,135 $ 1,115
to operating expense
Allowance to related assets acquired -- -- (900) 6,487 --
ALL, at end of year $ 7,992 $ 7,006 $ 7,611 $ 11,035 $ 3,881
Ratio of NCOs during period to average loans 0.32% 0.23% 0.80% 0.14% 0.05%
Outstanding
Ratio of ALL to NCOs 4.2 6.1 2.3 23.6 30.6
Ratio of ALL to total loans end of period 1.32% 1.26% 1.70% 2.71% 1.32%
27
Consistent with generally accepted accounting principles ("GAAP") and with the
methodologies used in estimating the unidentified losses in the loan portfolio,
the ALL consists of several components.
First, the allowance includes a component resulting from the application of the
measurement criteria of SFAS 114 and SFAS 118. The amount of this component is
included in the various categories presented in the following table.
The second component is statistically based and is intended to provide for
losses that have occurred in large groups of smaller balance loans, the credit
quality of which is impracticable to re-grade at end of each period. These loans
would include residential real estate, consumer loans and loans to small
businesses generally of $100,000 and less. The loss factors are based primarily
on the Company's historical loss experience tracked over a three-year period and
accordingly will change over time. Due to the fact that historical loss
experience varies for the different categories of loans, the loss factors
applied to each category also differ.
Finally, the "unallocated" component of the ALL is intended to absorb losses
that may not be provided for by the other components. There are several reasons
that the other components discussed above might not be sufficient to absorb the
losses present in portfolios, and the unallocated portion of the ALL is used to
provide for the losses that have occurred because of these reasons.
The first reason stems from the fact that there are limitations inherent to any
credit risk grading process. Even for experienced loan reviewers, grading loans
and estimating probable losses involves a significant degree of judgement
regarding the present situation with respect to individual loans and the
portfolio as a whole. The overall number of loans in the portfolio also makes it
impracticable to re-grade every loan each quarter. Therefore, the possibility
exists that some currently performing loans will not be as strong as their last
grading estimate and an insufficient portion of the allowance will have been
allocated to them. In addition, it's possible that grading and loan review may
be done without all relevant facts. Troubled borrowers may inadvertently or
deliberately omit important information from correspondence with lending
officers regarding their financial condition and the diminished strength of
repayment sources.
The second is that loss estimation factors are based on historical loss totals.
As such, the factors may not give sufficient weight to such considerations as
the current general economic and business conditions that affect the Company's
borrowers and specific industry conditions that affect borrowers in that
industry. For example, with respect to loans to borrowers who are influenced by
trends in the local tourist industry, management considers the
28
effects of weather conditions, market saturation, and the competition for
borrowers from other tourist destinations and attractions.
Third, the loss estimation factors do not give consideration to the seasoning of
the loan portfolio. Seasoning is relevant because losses are less likely to
occur in loans that have been performing satisfactorily for several years than
in loans that are more recent.
Finally, the loss estimation factors do not give consideration to the interest
rate environment. For example, borrowers with variable rate loans may be less
able to manage their debt service if interest rates rise.
For these reasons, management regards it as both a more practical and a more
prudent practice to maintain the total allowance at an amount larger than the
sum of the amounts allocated as described above.
Table 11 shows the amount of the ALL allocated for the time periods indicated to
each loan type as described. It also shows the percentage of balances for each
loan type to total loans. Management continues to target and maintain the ALL
equal to the allocation methodology plus an unallocated portion, as determined
by economic conditions on the Company's borrowers. In general, it would be
expected that those types of loans which have historically more loss associated
with them will have a proportionally larger amount of the allowance allocated to
them than do loans that have less risk.
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.
TABLE 11: ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES
As of December 31,
-------------------------------------------------------------------------------
2001 2000 1999 1998 1997
---- ---- ---- ---- ----
(dollars in thousands)
Commercial, financial $ 972 $ 1,073 $ 814 $ 1,025 $ 800
& agricultural
Commercial real estate 4,158 2,993 2,605 4,925 1,125
Real estate
Construction 503 302 29 50 50
Residential 1,078 1,395 2,484 3,350 745
Home equity lines 178 148 84 150 25
Consumer 162 140 145 325 270
Credit card 93 68 42 75 75
Loan commitments 144 135 130 -- --
Not specifically 704 752 1,278 1,135 791
Allocated ------- ------- ------- ------- -------
Total allowance $ 7,992 $ 7,006 $ 7,611 $11,035 $ 3,881
While there exists probable asset quality problems in the loan portfolio,
including loans acquired in the BLBNA purchase, management believes sufficient
reserves have been provided in the ALL to absorb probable losses in the loan
portfolio at December 31, 2001. In the time period subsequent to the purchase of
BLBNA, management has undergone extensive efforts to identify and evaluate
problem loans stemming from the BLBNA acquisition. As part of their examination
of the Company since the BLBNA acquisition, various regulatory agencies have
also performed a review of these loans. Although no assurance can be given,
management feels that the majority of problem loans associated with BLBNA have
been identified. Ongoing efforts are being made to collect these loans, and the
29
Company involves the legal process when it believes it 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 ALL. Such
agencies may require that changes in the ALL be recognized when their credit
evaluations differ from those of management, based on their judgements 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 remain 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.
Restructuring loans involve the granting of some concession to the borrower
involving a loan modification, such as payment schedule or interest rate
changes.
TABLE 12: NONPERFORMING LOANS AND OTHER REAL ESTATE OWNED
Years Ended December 31,
2001 2000 1999 1998 1997
---- ---- ---- ---- ----
(dollars in thousands)
Nonaccrual loans $ 9,929 $ 8,479 $ 8,086 $11,060 $ 1,720
Accruing loans past due 90 days or more -- -- -- -- --
Restructured loans 4,744 4,510 4,458 3,028 2,930
------- ------- ------- ------- -------
Total non-performing loans (NPLs) $14,673 $12,989 $12,544 $14,088 $ 4,650
======= ======= ======= ======= =======
Other real estate owned 1,673 877 71 566 229
------- ------- ------- ------- -------
Total non-performing assets (NPAs) $16,346 $13,866 $12,615 $14,654 $ 4,879
======= ======= ======= ======= =======
Ratios:
NPL's to total loans 2.42% 2.34% 2.81% 3.46% 1.58%
NPA's to total assets 1.93% 1.80% 1.95% 2.41% 1.08%
ALL to NPL's 54.47% 53.94% 60.67% 78.33% 83.46%
Non-performing loans at December 31, 2001 were $14.7 million compared to $13.0
million at December 31, 2000. Non-accrual loans represented $9.9 million of the
total of non-performing loans, of which $2.5 million was acquired with the BLBNA
acquisition. Real estate non-accrual loans account for $8.8 million of the
total, of which $3.0 million was residential real estate and $5.3 million was
commercial real estate, while commercial and industrial non-accruals account for
$1.0 million. In the first quarter of 2002, $2.2 million of the commercial real
estate loans were deeded over to the Bank, and a subsidiary in the name of
Arborview LLC ("Arborview") was formed for purposes of operating a community
based residential facility ("CBRF"). Management believes collateral is
sufficient to offset losses in the event additional legal action would be
warranted to collect these non-accrual loans. Troubled debt restructured loans
represent $4.7 million of non-performing loans at December 31, 2001 and $4.5
million at December 31, 2000. Approximately $2.8 million of this total consists
of two commercial real estate credits granted
30
various concessions and have experienced past cash flow problems. These credits
were current at December 31, 2001. Management believes that collateral is
sufficient in those loans classified as troubled debt in event of default. As a
result the ratio of non-performing loans to total loans at the end of 2001 was
2.4% compared to 2.3% at end of year 2000. The Company's ALL was 54.5% of total
non-performing loans at December 31, 2001 compared to 53.9% at end of year 2000.
The following table shows, for those loans accounted for on a non-accrual basis
for the years ended as indicated, the gross interest that would have been
recorded if the loans had been current in accordance with their original terms
and the amount of interest income that was included in interest income for the
period.
TABLE 13: FOREGONE LOAN INTEREST
Years ended December 31,
------------------------------------------
2001 2000 1999
---- ---- ----
(dollars in thousands)
Interest income in accordance with original terms $ 1,212 $ 1,065 $ 929
Interest income recognized (346) (460) (442)
-------- -------- -------
Reduction in interest income $ 866 $ 605 $ 487
======== ======== =======
Potential problem loans are performing loans that management believes may incur
difficulties in complying with loan repayment terms. Management's decision to
place loans in this category does not necessarily mean that the Company expects
to take losses on such loans, but that management needs to be more vigilant in
its efforts to oversee the loans and recognize that a higher degree of risk is
associated with these nonperforming loans. At December 31, 2001, potential
problem loans amounted to a total of $10.5 million compared to a total of $8.7
million at end of 2000. $6.3 million of the problem loans stem from two
commercial credits experiencing cash flow concerns. $5.4 million of those loans
went to non-accrual status during the first quarter of 2002. Various commercial
loans totaling $3.5 million, mortgage loans totaling $675,000 and consumer loans
totaling $30,000 make up the balance of the total potential problem loans. With
the exceptions noted above, potential problem loans are not concentrated in a
particular industry but rather cover a diverse range of businesses. Except as
noted above, management does not presently expect significant losses from
credits in the potential problem loan category.
Other real estate owned, which represents property that the Company acquired
through foreclosure or in satisfaction of debt, consisted of twelve properties
totaling $1.7 million at end of year 2001. This compared to eight properties
totaling $877,000 at end of year 2000. Management actively seeks to ensure that
properties held are administered to minimize any risk of loss.
Net cost of operation of other real estate for 2001, 2000, and 1999 consists of
the following and are shown in Table 14:
TABLE 14: OTHER REAL ESTATE OPERATION SUMMARY
2001 2000 1999
---- ---- ----
(dollars in thousands)
Loss on disposition of properties and $ 475 $ 254 $ 219
other costs
Gains on disposition of properties $ 227 $ 276 $ 336
----- ----- -----
and expense recoveries
Net (gains) losses $ 248 $ (22) $(117)
===== ====== =====
Investment Portfolio
The investment portfolio is intended to provide the Company with adequate
liquidity, flexibility in asset/liability management and, lastly, its earning
potential.
31
TABLE 15: INVESTMENT SECURITIES PORTFOLIO
2001 2000 1999
---- ---- ----
(dollars in thousands)
Investment Securities Held to Maturity
(HTM):
Obligations of states and political $ 22,205 $ 18,422 $ 19,380
-------- -------- --------
Subdivisions
Total amortized cost and carrying value $ 22,205 $ 18,422 $ 19,380
======== ======== ========
Total fair value $ 22,398 $ 18,503 $ 19,259
======== ======== ========
Investment Securities Available for Sale
AFS):
U.S. Treasury and other agency $ 21,505 $ 32,252 $ 22,851
Securities
Obligations of states and political 32,639 33,067 32,413
Subdivisions
Mortgage-backed securities 73,183 67,629 71,876
Other 14,303 1,311 1,674
-------- -------- --------
Total amortized cost $141,630 $134,259 $128,814
======== ======== ========
Total fair value and carrying value $144,895 $135,089 $125,700
======== ======== ========
Total Investment Securities:
Total amortized cost $163,835 $152,681 $148,194
Total fair value $167,293 $153,592 $144,959
Total carrying value $167,100 $153,511 $145,080
Investment securities are classified as held to maturity or available for sale.
The Company determined at year end 2001 that all of its taxable securities,
including U.S. Treasury, U.S. Agency securities and municipal bond securities
purchased in 2001 were to be classified as available for sale. In addition, the
Company determined that its non-taxable local municipals were classified as
available for sale. In the case of the Company's non-taxable securities and
municipal bond investments purchased prior to 1996, they were determined to be
held to maturity. This determination was made because the Company wanted to
retain the municipal bond issues due to their higher after-tax yields, and local
non-taxable issues due to their lessened marketability. Held to maturity
securities are those securities the Company has both the intent and ability to
hold until maturity. Under this classification, securities are stated at cost,
adjusted for amortization of premiums and accretion of discounts which are
recognized as adjustments to interest income. Gains or losses on disposition are
based on the net proceeds and the adjusted carrying amount of the securities
sold, using the specific identification method. At December 31, 2001, securities
held to maturity had an aggregate market value of approximately $22.4 million
compared with amortized cost of $22.2 million.
Investment securities classified as available for sale are those securities
which the Company has determined might be sold to manage interest rates or in
response to changes in interest rates or other economic factors. While the
Company has no current intention of selling those securities, they may not be
held to maturity. Investment securities available for sale at December 31, 2001
and 2000 are carried at market value. Adjustments up or down to market value at
December 31, 2001 and 2000 are recorded as a separate component of equity, net
of tax with one exception. In the event of a market value loss with regards to
investments held in the investment subsidiary, the market value loss is recorded
without a tax benefit since the loss would be treated as a capital loss. Premium
amortization and discount accretion are recognized as adjustments to interest
income. Realized gains or losses on disposition are based on the net proceeds
and the adjusted carrying amount of the securities sold using the specific
identification method. At December 31, 2001, securities available for sale had a
market and carrying value of $144.9 million. The reserve for market adjustment
of securities, net of tax, and reflected in the stockholders' equity section
stood at $2.1 million at December 31, 2001.
32
TABLE 16: INVESTMENT SECURITIES PORTFOLIO MATURITY DISTRIBUTION (dollars in
thousands)
Investment securities HTM - maturity distribution and weighted average yield
--------------------------------------------------------------------------------------
Within one After one year After five years After ten years Total
year But within five But within ten
Years Years
Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield
------ ----- ------ ----- ------ ----- ------ ----- ------ -----
Obligations of $ 3,740 5.76% $ 9,186 6.72% $ 3,603 8.43% $ 5,676 9.28% $ 22,205 7.49%
states and ------- ----- ------- ----- ------- ----- ------- ----- -------- -----
political
subdivisions
Total carrying $ 3,740 5.76% $ 9,186 6.72% $ 3,603 8.43% $ 5,676 9.28% $ 22,205 7.49%
Value ======= ==== ======= ===== ======= ===== ======= ===== ======== =====
Investment securities AFS - maturity distribution and weighted average yield
--------------------------------------------------------------------------------------
Within one year After one year After five years After ten years Total
But within five But within ten
years years
Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield
------ ------ ------ ----- ------ ----- ------ ----- ------ -----
Treasury $ -- -- $ 1,244 6.53% $ -- -- $ -- -- $ 1,244 5.99%
Agencies 2,036 6.65% 16,233 6.28% 3,237 7.07% -- -- 21,496 6.43%
Mortgage-backed 7,256 6.11% 62,900 5.98% -- -- 4,102 3.77% 74,348 5.87%
Securities
Obligations of 2,017 7.68% 8,937 7.28% 11,871 7.84% 10,679 7.49% 33,504 7.57%
states and
political
subdivisions
Other 12,767 1.77% -- -- -- -- 1,536 5.83% 14,303 2.21%
------- ----- ------- ----- ------- ----- ------- ----- -------- -----
Total carrying $24,076 3.99% $89,394 6.17% $15,108 7.68% $16,317 6.40% 144,895 5.99%
value ======= ===== ======= ===== ======= ===== ======= ===== ======= =====
At December 31, 2001 and 2000, the Company's investment portfolio did not
contain, other than U.S. treasury and federal agencies, securities of any single
issuer that were payable from and secured by the same source of revenue of
taxing authority where the aggregate book value of such securities exceed 10% of
stockholders' equity.
Investment securities averaged $164.4 million in 2001 compared with $152.8
million in 2000. The average balance of securities increased partly as a result
of investment earnings reinvested at the investment subsidiary during 2001. In
2001, taxable securities comprised approximately 67.7% of the total average
investments compared to 68.0% in 2000. Tax-exempt securities on average for 2001
accounted for 32.3% of the total average investments compared to 32.0% in 2000.
Deposits
Deposits are the Company's largest source of funds. At December 31, 2001,
deposits were $669.9 million, an increase of $115.9 million or 20.9% from $554.0
million recorded at December 31, 2000. Brokered deposits increased from $11.5
million at year end 2000 to $47.6 million at year end 2001. Average total
deposits for 2001
33
were $614.0 million, an increase of 17.4% over 2000. Included in these results
was an increase in average brokered deposits from $14.4 million in 2000 to $35.7
million in 2001. Average deposits increased 6.1% in 2000 compared to 1999
results.
TABLE 17: AVERAGE DEPOSITS DISTRIBUTION
2001 2000 1999
---- ---- ----
Amount % of Total Amount % of Total Amount % of Total
------ ---------- ------ ---------- ------ ----------
(dollars in thousands)
Noninterest-bearing $ 67,012 11% $ 61,214 12% $ 56,755 11%
demand deposits
Interest-bearing demand 44,015 7% 44,965 9% 47,313 10%
Deposits
Savings deposits 197,993 32% 164,858 31% 141,972 29%
Other time deposits 194,106 32% 184,904 35% 189,975 38%
Time deposits $100,000 75,192 12% 52,771 10% 32,689 7%
and over (excluding
brokered deposits)
Brokered certificates of 35,712 6% 14,411 3% 24,118 5%
Deposits -------- -------- -------- -------- -------- --------
Total deposits $614,032 100% $523,123 100% $492,822 100%
======== ======== ======== ======== ======== ========
As shown in Table 17, non-interest bearing demand deposits in 2001 averaged
$67.0 million, up 9.5% from $61.2 million recorded in 2000. This $5.8 million
increase is attributable to improvement in the seasonal increases in these funds
throughout the year along with an emphasis of attracting new customer
relationships and selling more services to existing customers. At December 31,
2001, non-interest-bearing demand deposits were $76.1 million compared with
$69.9 million at year end 2000.
Interest bearing deposits generally consist of interest-bearing checking,
savings deposits, money market accounts, individual retirement accounts ("IRAs")
and certificates of deposit ("CDs"). In 2001, interest-bearing deposits averaged
$547.0 million, an increase of 18.4%. Within the category of interest bearing
deposits, savings deposits, including money market accounts, increased $33.1
million or 20.1%. During the year 2001, the Company focused on marketing its
money market accounts, which offered increased customer flexibility and
competitive rates. During the same period, time deposits, including CDs and IRAs
(other than brokered time and time over $100,000) increased in average deposits
$9.2 million or 5.0%, primarily the result of a shift in customer preferences.
Average time deposits over $100,000 increased by $22.4 million or 42.5%. 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. 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.
Emphasis will be placed on generating additional core deposits in 2002 through
competitive pricing of deposit products and through the branch delivery systems
that have already been established. The Company will also attempt to attract and
retain core deposit accounts through new product offerings and customer service.
The Company also may increase brokered CD's during the year 2002 as an
additional source of funds to provide for loan growth.
Short-Term Borrowings and Other Borrowings
Short-term borrowings consist of federal funds purchased, securities under
agreements to repurchase, and advances from FHLB. As indicated in Table 19,
average 2001 short-term borrowings were $21.8 million compared to $44.0 million
during 2000. The decrease of $22.2 million occurred as a result of growth in
core deposits and an increase in noncore funding sources such as brokered time
deposits, time deposits greater than $100,000 and increased term loans with FHLB
offset to a lesser extent by increased loan demand and increased investment
balances.
34
Average short-term borrowings increased $29.5 million to $44.0 million in 2000
from $14.5 million in 1999 due to other forms of funding used during the year.
TABLE 18: SHORT-TERM BORROWINGS
December 31,
------------------------------------------------
2001 2000 1999
---- ---- ----
(dollars in thousands)
Federal funds purchased and securities
sold under agreements to repurchase:
Balance end of year $ 2,837 $37,538 $ 9,231
Average amounts outstanding during year $13,237 $22,672 $14,469
Maximum month-end amounts outstanding $47,009 $38,289 $30,382
Average interest rates on amounts 3.91% 6.87% 5.44%
Outstanding at end of year
Average interest rates on amounts 5.49% 6.66% 5.31%
Outstanding during year
Federal Home Loan Bank advances:
Balance end of year -- $42,000 --
Average amounts outstanding during year $ 8,517 $21,339 --
Maximum month-end amounts outstanding $23,000 $42,000 --
Average interest rates on amounts -- 6.24% --
outstanding at end of year
Average interest rates on amounts 5.30% 6.84% --
outstanding during year
Other borrowings consist of term loans with FHLB. Average other borrowings in
2001 were $94.6 million compared to $83.6 million. The increase of $11.0 million
or 13.1% occurred as a result of reducing FHLB advances during the year.
Federal funds are purchased from money center banks and correspondent banks at
prevailing overnight interest rates. Securities are sold to bank customers under
repurchase agreements at prevailing market rates. Borrowings with the FHLB are
secured by one to four family residential mortgages and eligible investment
securities allowing the Company to use it for additional funding purposes. These
borrowings with original maturities less than one year are included as short
term borrowings. Borrowings with original maturities greater than one year or
callable notes with call features greater than one year are included in the
other borrowings category.
Long-Term Debt
Long-term debt of $158,000 consists of a land contract requiring annual payments
of $53,000 plus interest calculated at prime plus one quarter of one percent.
The land contract was for the purchase of one of the properties in the Green Bay
region for a branch location.
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 subsidiary of the Company.
The aggregate principal amount of the debentures due 2031, to the trust
subsidiary is $16,597,940. For additional details, please make reference to the
Consolidated Financial Statements and the accompanying footnotes.
35
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 and interest, and proceeds
from the issuance of its securities. In 2001, the Company generated additional
funds through the issuance of trust preferred securities totaling $16.1 million.
The Company manages its liquidity position in order to provide funds necessary
to pay dividends to its shareholders. Dividends received from Bank totaled
$800,000 in 2001 and will continue to be the Company's main source of long-term
liquidity. The dividends from the Bank were sufficient to pay cash dividends to
the Company's shareholders of $3.3 million in 2001.
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 their assets and strong
capital positions.
Maturing investments have been a primary source of liquidity at the Bank. Sales
of investments totaling $36.1 million were made in 2001. $47.6 million in
investments were purchased in 2001. This resulted in net cash of $11.4 million
used in investing activities for 2001. At December 31, 2001, the carrying or
book value of investment securities maturing within one year amounted to $20.6
million or 12.3% of the total investment securities portfolio. This compares to
a 8.3% level for investment securities with one year or less maturities as of
December 31, 2000. Within the investing activities of the statement of cash
flows, sales and maturities of investment securities during 2001 totaled $36.1
million. At the end of 2001, the investment portfolio contained $97.1 million of
U.S. Treasury and federal agency backed securities representing 58.1% of the
total investment portfolio. These securities tend to be highly marketable and
had a market value above amortized cost at end of year 2001 amounting to $2.4
million.
Deposit growth is another source of liquidity for the Bank. As a financing
activity reflected in 2001 Consolidated Statements of Cash Flows, deposits
provided $115.9 million in cash inflow during 2001. The Company's overall
average deposit base grew $90.9 million or 17.4% during 2001. Deposit growth,
especially core deposits, is the most stable source of liquidity for the Bank.
Federal funds sold averaged $5.3 million in 2001 compared to $14,000 in 2000.
The reduction was the result of above average deposit growth, including non-core
funding sources offset by to a lesser degree with above average growth in loans.
Funds provided from the maturity of these assets typically are used as funding
sources for seasonal loan growth, which typically have higher yields. Short-term
and liquid by nature, federal funds sold generally provide a yield lower than
other earning assets. The Bank has a strategy of maintaining a sufficient level
of liquidity to accommodate fluctuations in funding sources and will at times
take advantage of specific opportunities to temporarily invest excess funds at
narrower than normal rate spreads while still generating additional interest
revenue. At December 31, 2001, the Bank had $4.5 million in federal funds sold.
The scheduled maturity of loans can provide a source of additional liquidity.
The Bank has $174.7 million of loans maturing within one year, or 28.9% of total
loans.
Within the classification of short-term borrowings and other borrowings at
year-end 2001, federal funds purchased and securities sold under agreements to
repurchase totaled $2.8 million compared with $37.5 million at the end of 2000.
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 term, are another source
of funds. They totaled $90.0 million at year end 2001.
The Bank's liquidity resources were sufficient in 2001 to fund the growth in
loans and investments, increase the volume of interest earning assets and meet
other cash needs when necessary.
36
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 2001, management expects deposit growth, including
brokered CD's, 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. 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.
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.
Interest Rate Risk
Interest rate risk is the exposure to a bank's earnings and capital arising from
changes in future interest rates. All banks assume interest rate risk as an
integral part of normal banking operations. Control and monitoring of interest
rate risk is a primary objective of asset/liability management. Baylake's
Asset/Liability Committee ("ALCO") manages risks associated with changing
interest rates, changing asset and liability mixes, and the impact on such
changes on earnings. The sensitivity of net interest income to market rate
changes is evaluated monthly by ALCO.
In order to limit exposure to interest rate risk, the Company has developed
strategies to manage its liquidity, shorten the effective maturities of certain
interest-earning assets, and increase the effective maturities of certain
interest-bearing liabilities. The Company has focused on the establishment of
adjustable rate mortgages ("ARM's") in its residential lending product line; the
concerted efforts made to attract and sell core deposit products through the use
of Company's branching and delivery systems and marketing efforts; and the use
of other available sources of funding to provide longer term funding
possibilities.
Interest rate sensitivity analysis can be performed in several different ways.
The traditional method of measuring interest sensitivity is called "gap"
analysis. The mismatch between asset and liability repricing characteristics in
specific time intervals is referred to as "interest rate sensitivity gap." If
more liabilities than assets reprice in a given time interval a liability gap
position exists. In general, liability sensitive gap positions in a declining
interest rate environment increase net interest income. Alternatively, asset
sensitive positions, where assets reprice more quickly than liabilities,
negatively impact the net interest income in a declining rate environment. In
the event of an increasing rate environment, opposite results would occur in
that a liability sensitivity gap position would decrease net interest income and
an asset sensitivity gap position would increase net interest income. The
sensitivity of net interest income to changing interest rates can be reduced by
matching the repricing characteristics of assets and liabilities.
The following table entitled "Asset and Liability Maturity Repricing Schedule"
indicates that the Company is liability sensitive. The analysis considers money
market index accounts and 25% of NOW accounts to be rate sensitive within three
months. Regular savings, money market deposit accounts and 75% of NOW accounts
are considered to be rate sensitive within one to five years. While these
accounts are contractually short-term in nature, it is the Company's experience
that repricing occurs over a longer period of time. The Company views its
savings and NOW accounts to be core deposits and relatively non-price sensitive,
as it believes it could make repricing adjustments for these types of accounts
in small increments without a material decrease in balances. All other earning
categories include loans and investments as well as other paying liability
categories such as time deposits are scheduled according to their contractual
maturities. The "static gap analysis" provides a representation of the Company's
earnings sensitivity to changes in interest rates. It is a static indicator and
does not reflect various repricing characteristics. Accordingly, a "static gap
analysis" may not be indicative of the sensitivity of net interest income in a
changing rate environment.
37
TABLE 19: INTEREST RATE SENSITIVITY ANALYSIS
As of December 31, 2001
With three Four to six Seven to twelve Over one Over five Total
Months Months Months Year to five Years
Years
(dollars in thousands)
Earning assets
Investment securities $ 22,840 $ 5,080 $ 6,346 $ 98,580 $ 40,698 $173,476
Federal funds sold 4,452 4,452
Loans and leases:
Variable rate 256,680 21,789 18,658 297,127
Fixed rate 48,181 34,381 43,947 160,396 13,754 300,659
-------- -------- -------- -------- -------- ---------
Total loans and leases 304,861 56,170 43,947 179,054 13,754 597,786
-------- -------- -------- -------- -------- ---------
Total earning assets $332,157 $ 61,178 $ 50,293 $277,634 $ 54,452 $775,714
-------- -------- -------- -------- -------- ---------
Interest bearing
liabilities
NOW accounts 12,427 37,282 49,709
Savings deposits 180,836 37,900 218,736
Time deposits 88,001 98,487 76,676 62,200 30 325,394
Borrowed funds 47,889 10,000 35,106 92,995
Trust preferred 0 0 0 0 16,100 16,100
-------- -------- -------- -------- -------- ---------
Total interest $329,153 $ 98,487 $ 86,676 $172,488 $ 16,130 $702,934
liabilities -------- -------- -------- -------- -------- ---------
Interest sensitivity $ 3,004 $(37,309) $(36,383) $105,146 $ 38,322 $ 72,780
periods)
Cumulative sensitivity 3,004 (34,305) (70,688) 34,458 72,780
GAP
Ratio of cumulative 0.39% (4.42%) (9.11%) 4.44% 9.38%
rate sensitivity GAP
sensitive assets
Ratio of rate 100.91% 62.12% 58.02% 160.96% 337.58%
sensitive assets
to rate sensitive
liabilities
Cumulative ratio 100.91% 91.98% 86.26% 105.02% 110.35%
of rate sensitive
assets to rate
sensitive liabilities
In addition to the "static gap analysis", determining the sensitivity of future
earnings to a hypothetical plus or minus 100 basis point parallel rate shock can
be accomplished through the use of simulation modeling. Simulation of earnings
includes the modeling of the balance sheet as an ongoing entity. Balance sheet
items are modeled to project income based on a hypothetical change in interest
rates. The resulting net income for the next twelve-month period is compared to
the net income calculated using flat rates. This difference represents the
Company's earnings sensitivity to a plus or minus 100 basis point parallel rate
shock. The resulting simulations indicated that net interest income would
increase by approximately 2.8% if rates rose by a 100 basis point shock, and
projected that net interest income would decrease by approximately 5.5% if rates
fell by a 100 basis point shock under these scenarios for the period ended
December 31, 2002. This result was within the policy limits established by the
Company.
The results of the simulations are based solely on immediate and sustained
parallel changes in market rates and do not reflect the earnings sensitivity
that may arise from such factors as the change in spread between key market
rates and the shape of the yield curve. The above results also are considered to
be conservative estimates due to the fact that no management action is factored
into the analysis to deal with potential income variances.
38
Management continually reviews its interest risk position through the ALCO
process. Management's philosophy is to maintain relatively matched rate
sensitive asset and liability positions within the range described above in
order to provide earnings stability in the event of significant interest rate
changes.
Capital Resources
Stockholders' equity at December 31, 2001 increased $6.0 million or 11.3% to
$59.1 million, compared with $53.1 million at 2000 year end. This increase
includes an increase of $1.6 million to capital in 2001 due to the impact of
Statement of Financial Accounting Standards No. 115. Without the effect of this
increase, stockholders' equity would have increased $4.4 million or 8.4% for
2001 over 2000, which compares to an increase of $3.7 million or 7.7% for 2000
over 1999. With the SFAS 115 adjustment included in 2000 capital, capital
increased $6.9 million or 15.0% compared to 1999 year end.
In 2001, the Company completed a Trust Preferred Security offering in the amount
of $16.1 million to enhance regulatory capital and to add liquidity. Under
applicable regulatory guidelines, the Trust Preferred Securities qualify as Tier
1 capital up to a maximum of 25% of Tier 1 capital. Any additional portion of
Trust Preferred Securities would qualify as Tier 2 capital. As of December 31,
2001, $16.1 million of the Trust Preferred Securities qualify as Tier 1 Capital.
The Company's capital base (before SFAS 115 change) increased primarily due to
the retention of earnings. The Company's dividend reinvestment plan typically
provides capital improvement, as the holders of approximately 26% of Company's
Common Stock participate in the plan.
Cash dividends paid in 2001 were $0.45 per share compared with $0.41 in 2000.
The Company provided a 9.8% increase in normal dividends per share in 2001 over
2000 as a result of above average earnings.
In 1997, the Company's Board of Directors authorized management to repurchase up
to 7,000 shares of the Company's common stock each calendar quarter in the
market. The shares repurchased would be used to fill its needs for the dividend
reinvestment program, any future benefit plans, and the Company's stock purchase
plan. Shares repurchased are held as treasury stock and, accordingly, are
accounted for as a reduction of stockholders' equity. The Company repurchased
none of its common shares in 2001 for treasury stock purchases.
The adequacy of the Company's capital is regularly reviewed to ensure that
sufficient capital is available for current and future needs and is in
compliance with regulatory guidelines. The assessment of overall capital
adequacy depends upon a variety of factors, including asset quality, liquidity,
stability of earnings, changing competitive forces, economic conditions in
markets served and strength of management. Management is confident that because
of current capital levels and projected earnings levels, capital levels are more
than adequate to meet the ongoing and future concerns of the Company.
The Federal Reserve Board has established capital adequacy rules which take into
account risk attributable to balance sheet assets and off-balance sheet
activities. All banks and bank holding companies must meet a minimum total
risk-based capital ratio of 8%. Of the 8% required, at least half must be
comprised of core capital elements defined as Tier 1 capital. The federal
banking agencies also have adopted leverage capital guidelines which banking
organizations must meet. Under these guidelines, the most highly rated banking
organizations must meet a leverage ratio of at least 3% Tier 1 capital to
assets, while lower rated banking organizations must maintain a ratio of at
least 4% to 5%. Failure to meet minimum capital requirements can initiate
certain mandatory -and possible additional discretionary- actions by regulators
that, if undertaken, could have a direct material effect on the consolidated
financial statements.
At December 31, 2001 and 2000, the Company was categorized as "well" and
"adequately capitalized", respectively, 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%.
39
The following table presents the Company's and the Bank's capital ratios as of
December 31 for each of the previous two years.
TABLE 20: CAPITAL
Actual For Capital Adequacy To Be Well Capitalized
Purposes Under Prompt
Corrective Action
Provisions
(dollars in thousands)
At December 31, 2001:
Total capital (to risk weighted assets):
The Company $ 76,044 11.34% $ 53,663 8.00% N/A N/A
The Bank $ 72,022 10.73% $ 53,715 8.00% $ 67,144 10.00%
Tier 1 capital (to risk weighted assets):
The Company $ 68,052 10.15% $ 26,831 4.00% N/A N/A
The Bank $ 64,030 9.54% $ 26,858 4.00% $ 40,286 6.00%
Tier 1 capital (to average assets):
The Company $ 68,052 8.24% $ 33,032 4.00% N/A N/A
The Bank $ 64,030 7.75% $ 33,032 4.00% $ 41,290 5.00%
At December 31, 2000:
Total capital (to risk weighted assets):
The Company $ 54,055 8.92% $ 48,464 8.00% N/A N/A
The Bank $ 61,237 10.10% $ 48,512 8.00% $ 60,640 10.00%
Tier 1 capital (to risk weighted assets):
The Company $ 47,049 7.77% $ 24,232 4.00% N/A N/A
The Bank $ 54,232 8.94% $ 24,255 4.00% $ 36,384 6.00%
Tier 1 capital (to average assets):
The Company $ 47,049 6.38% $ 29,518 4.00% N/A N/A
The Bank $ 54,232 7.35% $ 29,518 4.00% $ 36,897 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 7 A. Quantitative and Qualitative Disclosure about Market Risk.
Information required by this item is set forth in Item 7 under the captions
"Interest Rate Risk."
40
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Company's Consolidated Financial Statements and notes to related statements
thereto are set forth on the following pages.
41
BAYLAKE CORP. AND SUBSIDIARIES
Sturgeon Bay, Wisconsin
CONSOLIDATED FINANCIAL STATEMENTS
and
REPORT OF INDEPENDENT
CERTIFIED PUBLIC ACCOUNTANTS
For the Years Ended December 31, 2001, 2000, and 1999
BAYLAKE CORP. AND SUBSIDIARIES
Sturgeon Bay, Wisconsin
TABLE OF CONTENTS
Page
----
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS 1
FINANCIAL STATEMENTS
Consolidated Balance Sheets 2 - 3
Consolidated Statements of Income 4
Consolidated Statements of Changes in Stockholder Equity 5
Consolidated Statements of Cash Flows 6 - 7
Notes to Consolidated Financial Statements 8 - 35
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To the Shareholders and Board of Directors
Baylake Corp.
Sturgeon Bay, Wisconsin
We have audited the accompanying consolidated balance sheets of Baylake
Corp. and subsidiaries as of December 31, 2001 and 2000, and the related
consolidated statements of income, changes in stockholder equity, and cash flows
for each of the three years in the period ended December 31, 2001. These
financial statements are the responsibility of the company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present
fairly the consolidated financial position of Baylake Corp. and subsidiaries at
December 31, 2001 and 2000, and the results of its operations and cash flows for
each of the three years in the period ended December 31, 2001, in conformity
with accounting principles generally accepted in the United States of America.
Madison, Wisconsin SMITH & GESTELAND, LLP
January 23, 2002 SMITH & GESTELAND, LLP
BAYLAKE CORP. AND SUBSIDIARIES
Sturgeon Bay, Wisconsin
CONSOLIDATED BALANCE SHEETS
December 31
2001 2000
-------------- -------------
(Thousands of dollars)
ASSETS
Cash and due from banks $ 24,033 $ 21,695
Federal funds sold 4,452
------------- ------------
Cash and cash equivalents 28,485 21,695
Investment securities available for sale (at market) 144,895 135,089
Investment securities held to maturity (market value
$22,398 and $18,503) 22,205 18,422
Loans held for sale 2,428 724
Loans 605,287 555,107
Less: Allowance for loan losses 7,992 7,006
------------- ------------
Loans, net of allowance for loan losses 597,295 548,101
Bank premises and equipment 21,792 21,313
Federal Home Loan Bank stock (at cost) 6,376 5,955
Accrued interest receivable 5,112 5,733
Income taxes receivable 1,673 1,135
Deferred income taxes 2,048 2,256
Goodwill 4,969 5,455
Other assets 8,513 6,390
------------- ------------
Total assets $ 845,791 $ 772,268
============= ============
The accompanying notes are an integral part of the financial statements.
2
2001 2000
-------------- -------------
(Thousands of dollars)
LIABILITIES
Domestic deposits
Noninterest bearing $ 76,051 $ 69,900
Interest bearing
NOW 49,709 49,582
Savings 218,736 183,369
Time, $100,000 and over 137,148 61,334
Other time 188,246 189,820
------------- ------------
Total interest bearing 593,839 484,105
------------- ------------
Total deposits 669,890 554,005
Short-term borrowings
Federal funds purchased, repurchase agreements,
and Federal Home Loan Bank advances 2,837 79,538
Accrued expenses and other liabilities 6,779 6,868
Dividends payable 897 819
Other borrowings 90,000 77,700
Long-term debt 158 211
Guaranteed preferred beneficial interest in the company's junior
subordinated debt 16,100
------------- ------------
Total liabilities 786,661 719,141
------------- ------------
STOCKHOLDER EQUITY
Common stock $5 par value - authorized 50,000,000 shares in
2001; 10,000,000 in 2000; issued 7,494,734 shares in 2001;
7,468,733 shares in 2000; outstanding 7,471,575 shares in 2001;
7,445,574 shares in 2000 37,474 37,344
Additional paid-in capital 7,319 7,185
Retained earnings 12,843 8,670
Treasury stock (625) (625)
Accumulated other comprehensive income
Net unrealized gain on securities available for sale, net of
tax of $1,146 in 2001 and $277 in 2000 2,119 553
------------- ------------
Total stockholder equity 59,130 53,127
------------- ------------
Total liabilities and stockholder equity $ 845,791 $ 772,268
============= ============
3
BAYLAKE CORP. AND SUBSIDIARIES
Sturgeon Bay, Wisconsin
CONSOLIDATED STATEMENTS OF INCOME
For the Years Ended December 31
2001 2000 1999
----------- ----------- -----------
(Amounts in thousands
except per share data)
Interest income
Interest and fees on loans $ 49,313 $ 46,685 $ 37,586
Interest on investment securities
Taxable 6,887 6,806 6,041
Exempt from federal income taxes 2,631 2,532 2,582
Other interest income 192 13 258
---------- ---------- ----------
Total interest income 59,023 56,036 46,467
---------- ---------- ----------
Interest expense
Interest on deposits 24,455 23,582 19,541
Interest on short-term borrowings 1,178 2,970 768
Interest on other borrowings 4,975 5,529 2,895
Interest on guaranteed preferred beneficial interest in the
company's junior subordinated debt 1,430
Interest on long-term debt 15 18 76
---------- ---------- ----------
Total interest expense 32,053 32,099 23,280
---------- ---------- ----------
Net interest income 26,970 23,937 23,187
Provision for loan losses 2,880 545 850
---------- ---------- ----------
Net interest income after provision for loan losses 24,090 23,392 22,337
---------- ---------- ----------
Other income
Fees from fiduciary activities 664 517 553
Fees from loan servicing 1,461 837 875
Fees for other services to customers 2,444 2,053 1,890
Gains from sales of loans 873 240 295
Securities losses, net (2)
Other income 865 1,039 945
---------- ---------- ----------
Total other income 6,307 4,686 4,556
---------- ---------- ----------
Other expenses
Salaries and employee benefits 11,923 10,353 9,700
Occupancy expense 1,834 1,643 1,430
Equipment expense 1,401 1,404 1,238
Data processing and courier 986 932 872
Operation of other real estate 248 (22) (117)
Other operating expenses 4,379 4,280 4,247
---------- ---------- ----------
Total other expenses 20,771 18,590 17,370
---------- ---------- ----------
Income before income taxes 9,626 9,488 9,523
Income tax expense 2,091 2,778 2,600
---------- ---------- ----------
NET INCOME $ 7,535 $ 6,710 $ 6,923
========== ========== ==========
Basic earnings per common share $1.01 $.90 $.94
Diluted earnings per common share $ .99 $.87 $.90
The accompanying notes are an integral part of the financial statements.
4
BAYLAKE CORP. AND SUBSIDIARIES
Sturgeon Bay, Wisconsin
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDER EQUITY
For the Years Ended December 31
Accumulated
Common Stock Additional Other
------------------------- Paid-in Comprehensive Retained Treasury Total
Shares Amount Capital Income Earnings Stock Equity
----------- ---------- ----------- ---------------- ---------- ---------- ----------
(Amounts in thousands except for shares)
1999
Balance - January 1, 1999 3,694,546 $ 18,473 $ 6,229 $ 1,801 $ 19,394 $ (625) $ 45,272
Net income for the year 6,923 6,923
Net changes in unrealized gain
(loss) on securities available for
sale, net of $1,490 deferred
taxes (4,400) (4,400)
---------
Comprehensive income 2,523
---------
Stock options exercised 53,450 267 518 785
Tax benefit from exercise of stock
options 373 373
Stock dividend - 100% 3,712,337 18,562 (18,562)
Cash dividends declared (2,743) (2,743)
---------- --------- -------- -------- --------- ------ ---------
Balance - December 31, 1999 7,460,333 37,302 7,120 (2,599) 5,012 (625) 46,210
2000
Net income for the year 6,710 6,710
Net changes in unrealized gain
(loss) on securities available for
sale, net of $792 deferred
taxes 3,152 3,152
---------
Comprehensive income 9,862
---------
Stock options exercised 8,400 42 5 47
Tax benefit from exercise of stock
options 60 60
Cash dividends declared (3,052) (3,052)
---------- --------- -------- -------- --------- ------ ---------
Balance - December 31, 2000 7,468,733 37,344 7,185 553 8,670 (625) 53,127
2001
Net income for the year 7,535 7,535
Net changes in unrealized gain
(loss) on securities available for
sale, net of $869 deferred
taxes 1,566 1,566
---------
Comprehensive income 9,101
---------
Stock options exercised 26,001 130 82 212
Tax benefit from exercise of stock
options 52 52
Cash dividends declared (3,362) (3,362)
---------- --------- -------- -------- --------- ------ ---------
Balance - December 31, 2001 7,494,734 $ 37,474 $ 7,319 $ 2,119 $ 12,843 $ (625) $ 59,130
========= ======== ======== ========= ====== =========
Less treasury stock 23,159
----------
7,471,575
==========
The accompanying notes are an integral part of the financial statements.
5
BAYLAKE CORP. AND SUBSIDIARIES
Sturgeon Bay, Wisconsin
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended December 31
2001 2000 1999
------------ ------------ -----------
(Thousands of dollars)
CASH FLOWS FROM OPERATING ACTIVITIES:
Interest received from:
Loans $ 49,721 $ 45,200 $ 37,218
Investments 9,730 9,127 8,716
Fees and service charges 5,676 4,197 4,030
Interest paid to depositors (24,715) (22,797) (19,982)
Interest paid to others (7,935) (8,227) (3,599)
Cash paid to suppliers and employees (18,322) (16,894) (13,558)
Income taxes paid (3,290) (2,887) (3,204)
----------- ----------- ----------
Net cash provided by operating activities 10,865 7,719 9,621
----------- ----------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sale of investments 3,947
Principal payments received on investments 36,141 15,634 45,166
Purchase of investments (47,559) (22,045) (47,306)
Proceeds from sale of other real estate owned 2,839 1,119 1,590
Loans made to customers in excess of principal collected (57,190) (110,743) (43,608)
Capital expenditures (1,925) (4,281) (4,008)
Proceeds on insurance contracts 41
----------- ----------- ----------
Net cash used in investing activities (67,694) (120,316) (44,178)
----------- ----------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in demand deposits, NOW accounts,
and savings accounts 41,646 43,521 13,970
Net increase (decrease) in short-term borrowings (76,702) 71,056 4,825
Net increase (decrease) in time deposits 74,239 5,761 (4,532)
Proceeds from trust preferred securities 16,100
Proceeds from other borrowings and long-term debt 35,000 98,000 50,000
Payments on other borrowings and long-term debt (22,753) (100,453) (23,128)
Proceeds from issuance of stock 264 107 1,158
Debt issuance costs (891) (199)
Redemption of preferred stock (3,160)
Dividends paid (3,284) (2,976) (2,661)
----------- ----------- ----------
Net cash provided by financing activities 63,619 114,817 36,472
----------- ----------- ----------
Net increase in cash and due from banks 6,790 2,220 1,915
Cash and cash equivalents, beginning 21,695 19,475 17,560
----------- ----------- ----------
Cash and cash equivalents, ending $ 28,485 $ 21,695 $ 19,475
=========== =========== ==========
The accompanying notes are an integral part of the financial statements.
6
2001 2000 1999
------------ ------------ -----------
(Thousands of dollars)
Reconciliation of net income to net cash provided
by operating activities:
Net income $ 7,535 $ 6,710 $ 6,923
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 1,934 1,871 1,639
Provision for losses on loans and real
estate owned 2,880 545 850
Amortization of premium on investments 206 146 176
Accretion of discount on investments (364) (177) (152)
Cash surrender value increase (140) (124) (140)
Loss on sale of investment securities 2
Gain on sale of loans and other assets (1,062) (494) (582)
Proceeds from sale of loans held for sale 87,379 23,802 26,505
Origination of loans held for sale (86,506) (23,562) (26,210)
Equity in income of service center (295) (250) (142)
Deferred compensation 90 108 (50)
Deferred income taxes (661) (136) (901)
Changes in assets and liabilities:
Interest receivable 621 (1,586) (234)
Prepaids and other assets 1 (40) 2,040
Unearned income (35) (92) (328)
Interest payable (596) 1,075 (300)
Taxes receivable (538) 27 297
Other liabilities 416 (104) 228
----------- ----------- ----------
Net cash provided by operating activities $ 10,865 $ 7,719 $ 9,621
=========== =========== ==========
SCHEDULE OF NONCASH INVESTING AND
FINANCING ACTIVITIES:
Acquisition of property in lieu of foreclosure $ 3,448 $ 1,619 $ 816
Dividends reinvested in common stock 857 771 736
7
BAYLAKE CORP. AND SUBSIDIARIES
Sturgeon Bay, Wisconsin
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - INFORMATION ABOUT THE COMPANY AND SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES
The consolidated financial statements of Baylake Corp. (the
company) include the accounts of the company, its wholly-owned
subsidiaries; Kewaunee County Banc-Shares, Inc., (KCB) and Baylake
Capital Trust I, and KCB's wholly-owned subsidiary Baylake Bank,
and its wholly-owned subsidiaries; Bank of Sturgeon Bay Building
Corporation, Cornerstone Financial, Inc., Baylake Investments,
Inc., and Baylake Insurance Agency, Inc. All significant
intercompany items and transactions have been eliminated.
Baylake Bank owns a 49% interest in United Financial Services,
Inc., (UFS) a data processing service. 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 revenue. Amounts paid
to UFS for data processing services for Baylake's banks were
$850,000, $815,000, and $755,000, in 2001, 2000, and 1999,
respectively. At December 31, 2001 and 2000, Baylake Bank had loans
of $180,000 and $235,000, respectively, to UFS.
Baylake Bank makes commercial, mortgage, and installment loans to
customers substantially all of whom are located in Door, Brown,
Kewaunee, Manitowoc, Waushara, Outagamie, Green Lake and Waupaca
Counties of Wisconsin. Although Baylake Bank has a diversified
portfolio, a substantial portion of its debtors' ability to honor
their contracts is dependent upon the economic condition of the
local industrial businesses, and commercial, agricultural and
tourism industries.
The preparation of financial statements in conformity with
generally accepted accounting principles requires management to
make estimates and assumptions that affect the amounts reported in
the financial statements and accompanying notes. Actual results
could differ from those estimates.
For comparability, certain 2000 and 1999 amounts have been
reclassified to conform with classification adopted in 2001.
The company's financial instruments that are exposed to
concentrations of credit risk consist primarily of cash and due
from banks. The company places these assets with high credit
quality institutions. At times such assets may be in excess of FDIC
insurance limit.
Investment securities classified as held to maturity are those
securities which the bank has both the intent and the ability to
hold until maturity. Under this classification, securities are
stated at cost, adjusted for amortization of premiums and accretion
of discounts which are recognized as adjustments to interest
income. Gains or losses on disposition are based on the net
proceeds and the adjusted carrying amount of the securities sold,
using the specific identification method.
8
BAYLAKE CORP. AND SUBSIDIARIES
Sturgeon Bay, Wisconsin
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - INFORMATION ABOUT THE COMPANY AND SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES (continued)
Investment securities classified as available for sale are those
securities which Baylake Bank has determined might be sold to
manage interest rate risk or in response to changes in interest
rates or other economic factors. While the company has no current
intention of selling these securities, they may not be held to
maturity.
Investment securities available for sale are carried at market
value. Adjustments up or down to market value are recorded as a
separate component of equity, net of tax. Premium amortization and
discount accretion are recognized as adjustments to interest
income. Realized gains or losses on disposition are based on the
net proceeds and the adjusted carrying amount of the securities
sold, using the specific identification method.
Loans, including loans held for sale, are stated at face value, net
of deferred loan origination fees (net of costs) and the allowance
for loan losses. Interest on loans is calculated using the simple
interest method on daily balances of the principal amount
outstanding or an amortized method.
Loan origination fees and related costs are deferred and the net
deferred revenue is amortized over the term of the loans using the
effective interest rate method.
The allowance for loan losses is maintained at a level that is
management's best estimate of probable loan losses incurred as of
the balance sheet date. Management's determination of the adequacy
of the allowance is based on an evaluation of the portfolio, past
loan loss experience, current domestic and international economic
conditions, volume, growth and composition of the loan portfolio,
and other relevant factors. The allowance is increased by
provisions for loan losses charged against income.
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 collectibility is in doubt, cash receipts on nonaccrual loans
are used to reduce principal rather than recorded as interest
income.
Depreciable assets are stated at cost less accumulated
depreciation. Depreciation is charged to operating expense over the
estimated useful lives of the assets, using the straight-line and
accelerated methods.
Mortgage servicing rights of $400,000, $215,000, and $236,000 were
capitalized and $204,000, $101,000, and $106,000 were amortized
during 2001, 2000, and 1999, respectively. The amount of impairment
was not material.
9
BAYLAKE CORP. AND SUBSIDIARIES
Sturgeon Bay, Wisconsin
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - INFORMATION ABOUT THE COMPANY AND SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES (continued)
Other real estate, which is included in other assets, comprises
properties acquired through a foreclosure proceeding or acceptance
of a deed in lieu of foreclosure. These properties are carried at
the lower of cost or fair value, minus estimated costs to sell,
based on appraised value at the date acquired. Loan losses arising
from the acquisition of such property are charged against the
allowance for loan losses. An allowance for losses on other real
estate is maintained for subsequent valuation adjustments on a
specific property basis.
Goodwill is being amortized on a straight-line basis over 15 years.
Amortization expense was $486,000, $486,000, and $453,000 in 2001,
2000, and 1999, respectively.
The company expenses all advertising costs as they are incurred.
Total advertising costs for the years ended December 31, 2001,
2000, and 1999 were $293,000, $339,000, and $233,000, respectively.
The company applies APB Opinion No. 25, "Accounting for Stock
Issued to Employees" (APB No. 25) and related interpretations in
accounting for its stock-based compensation plans. Under Statement
of Financial Accounting Standards ("SFAS") No. 123, "Accounting for
Stock-Based Compensation", companies may elect to recognize
stock-based compensation expense based on the fair value of the
awards or continue to account for stock-based compensation under
APB No. 25. The company has elected to continue to apply the
provisions of APB No. 25 with the disclosure requirements of SFAS
No. 123 in Note 17.
Income taxes are provided for the tax effects of transactions
reported in the financial statements and consist of taxes currently
due plus deferred taxes related primarily to differences between
the basis of the allowance for loan losses, deferred loan
origination fees, deferred compensation, mortgage loan servicing,
market value adjustments of securities, and depreciation for
financial and income tax reporting. The deferred tax assets and
liabilities represent the future tax return consequences of those
differences, which will either be taxable or deductible when the
assets and liabilities are recovered or settled.
The company and its subsidiaries file a consolidated federal income
tax return. The subsidiaries provide for income taxes on a
separate-return basis, and remit to the company amounts determined
to be currently payable, if any.
Earnings per share are based on the weighted average number of
shares outstanding during each year.
For purposes of the statement of cash flows, the company considers
cash, due from banks, and federal funds sold as cash and cash
equivalents.
10
BAYLAKE CORP. AND SUBSIDIARIES
Sturgeon Bay, Wisconsin
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - INFORMATION ABOUT THE COMPANY AND SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES (continued)
During 2001, the Financial Accounting Standards Board issued
Statements of Financial Accounting Standards (SFAS) No. 141,
"Business Combinations" and No. 142 "Goodwill and Other
Intangibles". SFAS No. 141 requires that all business combinations
initiated after June 30, 2001, be accounted for under the purchase
method and establishes the specific criteria for the recognition of
intangible assets separately from goodwill. Under SFAS No. 142,
goodwill will no longer be amortized, but will be subject to
impairment tests at least annually. SFAS No. 142 will be effective
for the company on January 1, 2002. Management is in the process of
implementation of SFAS No.'s 141 and 142 and the impact on the
financial statements of the company has not yet been determined.
NOTE 2 - RESTRICTIONS ON CASH AND DUE FROM BANKS
The company's subsidiary, Baylake Bank, is required to maintain
average reserve balances by the Federal Reserve Bank. The average
amount of those reserve balances for the year ended December 31,
2001, was approximately $6,954,000.
NOTE 3 - INVESTMENT SECURITIES
The amortized cost and estimated market values of investments are
as follows:
December 31, 2001
-------------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
------------ ------------ ------------ ------------
(Thousands of dollars)
Available For Sale
U.S. Treasury and other U.S.
government agencies $ 21,505 $ 1,235 $ $ 22,740
Obligations of states and
political subdivisions 32,639 889 24 33,504
Mortgage-backed securities 73,183 1,359 194 74,348
Other 14,303 14,303
----------- --------- ------ -----------
$ 141,630 $ 3,483 $ 218 $ 144,895
=========== ========= ====== ===========
Held to Maturity
Obligations of states and
political subdivisions $ 22,205 $ 216 $ 23 $ 22,398
=========== ========= ====== ===========
11
BAYLAKE CORP. AND SUBSIDIARIES
Sturgeon Bay, Wisconsin
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 3 - INVESTMENT SECURITIES (continued)
December 31, 2000
---------------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
------------- ------------ --------------- ------------
(Thousands of dollars)
Available For Sale
U.S. Treasury and other U.S.
government agencies $ 32,252 $ 748 $ 3 $ 32,997
Obligations of states and
political subdivisions 33,067 757 29 33,795
Mortgage-backed securities 67,629 107 750 66,986
Other 1,311 1,311
------------ --------- --------- ------------
$ 134,259 $ 1,612 $ 782 $ 135,089
============ ========= ========= ============
Held to Maturity
Obligations of states and
political subdivisions $ 18,422 $ 119 $ 38 $ 18,503
============ ========= ========= ============
Results of sales of securities were as follows:
Available for Sale
------------------------------------------
2001 2000 1999
----------- ----------- -----------
(Thousands of dollars)
Proceeds $ None $ None $ 3,947
Realized gains 21
Realized losses 23
12
BAYLAKE CORP. AND SUBSIDIARIES
Sturgeon Bay, Wisconsin
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 3 - INVESTMENT SECURITIES (continued)
The amortized cost and estimated market value of investments at
December 31, 2001, by contractual maturity, are shown below.
Expected maturities will differ from contractual maturities because
borrowers may have the right to call or prepay obligations with or
without call or prepayment penalties.
Available for Sale Held to Maturity
----------------------------- ----------------------------
Estimated
Amortized Market Amortized Estimated
Cost Value Cost Value
------------ ------------ ------------ ------------
(Thousands of dollars)
Due in one year or less $ 16,750 $ 16,820 $ 3,740 $ 3,753
Due after one year through
five years 25,135 26,405 9,186 9,298
Due after five years through
ten years 14,492 15,108 3,457 3,525
Due after ten years 12,070 12,214 5,822 5,822
----------- ----------- ---------- ----------
68,447 70,547 22,205 22,398
Mortgage-backed securities 73,183 74,348
----------- ----------- ---------- ----------
$ 141,630 $ 144,895 $ 22,205 $ 22,398
=========== =========== ========== ==========
Securities pledged to secure public and trust deposits and borrowed
funds had a carrying value of $78,791,000 and $103,902,000 at
December 31, 2001 and 2000, respectively.
NOTE 4 - LOANS
Major classifications of loans are as follows:
December 31, December 31,
2001 2000
----------------- -----------------
(Thousands of dollars)
Commercial, financial, and agricultural $ 377,034 $ 335,868
Real estate - construction 67,939 41,524
Real estate - mortgage 143,748 160,150
Installment 16,890 17,925
------------- ------------
605,611 555,467
Less: Deferred loan origination
fees, net of costs (324) (360)
------------- ------------
Net loans $ 605,287 $ 555,107
============= ============
13
BAYLAKE CORP. AND SUBSIDIARIES
Sturgeon Bay, Wisconsin
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 4 - LOANS (continued)
Loans having a carrying value of $41,904,000 are pledged as
collateral for borrowings from the Federal Home Loan Bank at
December 31, 2001.
Certain directors and officers of the company and the subsidiary
banks, including their immediate families, companies in which they
are principal owners, and trusts in which they are involved, were
loan customers of the subsidiary during 2001 and 2000. Such loans
were made in the ordinary course of business at normal credit
terms, including interest rate and collateralization, and do not
represent more than a normal risk of collection.
A summary of the changes in those loans is as follows:
2001 2000
----------- ------------
(Thousands of dollars)
Balance at beginning of year $ 5,427 $ 5,594
New loans made 4,547 3,836
Repayments received (4,819) (3,844)
Loans related to former officers and directors (266) (159)
---------- -----------
Balance at end of year $ 4,889 $ 5,427
========== ===========
Loans on which the accrual of interest has been discontinued or
reduced amounted to $9,929,000 and $8,479,000 at December 31, 2001
and 2000, respectively. If these loans had been current throughout
their terms, interest income for the nonaccrual period would have
approximated $1,212,000 and $1,065,000 for 2001 and 2000,
respectively. Interest income which has been recorded amounted to
$346,000 and $460,000 for 2001 and 2000, respectively, for these
nonaccrual loans.
Changes in the allowance for loan losses were as follows:
2001 2000 1999
----------- ----------- ------------
(Thousands of dollars)
Balance at beginning of year $ 7,006 $ 7,611 $ 11,035
Allowance related to assets acquired (900)
Provision charged to operations 2,880 545 850
Recoveries 835 924 1,988
Loans charged off (2,729) (2,074) (5,362)
---------- ---------- -----------
Balance at end of year $ 7,992 $ 7,006 $ 7,611
========== ========== ===========
14
BAYLAKE CORP. AND SUBSIDIARIES
Sturgeon Bay, Wisconsin
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 4 - LOANS (continued)
In 1999, it was determined that the allowance that had been
established for assets acquired in 1998 was in excess of the amount
needed to absorb potential losses on those assets based on a review
of information received subsequent to year-end. Accordingly, the
allowance was reduced $900,000 with a corresponding reduction in
goodwill related to the acquisition.
The provision for credit losses charged to expense is based upon
management's best estimate of probable loan losses incurred at the
balance sheet date, including consideration of the banks' credit
loss experience and an evaluation of impaired loans under SFAS 114.
A loan is considered to be impaired when, based upon current
information and events, it is probable that the bank will be unable
to collect all amounts due according to the contractual terms of
the loan.
The following is a summary of activity in investment in loans that
have declined in value and related interest income and allowance
for credit losses accounts:
2001 2000
------------ ------------
(Thousands of dollars)
Impaired loans at December 31 $ 23,740 $ 19,638
Impaired loans at December 31 allowed for $ 23,740 $ 19,638
Average impaired loans during the period $ 23,805 $ 18,800
Interest income recognized while loans impaired $ 1,012 $ 2,198
Interest income using a cash-basis method $ 1,004 $ 2,090
Allowance as of January 1 $ 1,865 $ 1,536
Additions during the year 1,447 1,602
Recoveries of amounts previously allowed for (1,208) (1,273)
----------- -----------
Allowance as of December 31 $ 2,104 $ 1,865
=========== ===========
15
BAYLAKE CORP. AND SUBSIDIARIES
Sturgeon Bay, Wisconsin
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 5 - BANK PREMISES AND EQUIPMENT
2001 2000 1999
------------ ------------ ------------
(Thousands of dollars)
Land $ 4,155 $ 4,074 $ 3,892
Buildings and improvements 18,054 16,930 14,298
Equipment 10,313 9,613 8,275
----------- ----------- -----------
32,522 30,617 26,465
Less accumulated depreciation 10,730 9,304 8,002
----------- ----------- -----------
Bank premises and equipment $ 21,792 $ 21,313 $ 18,463
=========== =========== ===========
Depreciation expense $ 1,449 $ 1,380 $ 1,001
=========== =========== ===========
NOTE 6 - OTHER REAL ESTATE
Other real estate ($1,716,000 in 2001, $931,000 in 2000, and
$164,000 in 1999, net of an allowance for other real estate losses
of $43,000 in 2001, $54,000 in 2000, and $93,000 in 1999) is
included in other assets.
Net cost of operation of other real estate is summarized below:
2001 2000 1999
---------- ---------- ----------
(Thousands of dollars)
Loss on disposition of properties
and other costs $ 475 $ 254 $ 219
Gain on disposition of properties
and expense recoveries (227) (276) (336)
-------- ------- --------
Net (gains) losses $ 248 $ (22) $ (117)
======== ======= ========
Changes in the allowance for losses on other real estate were as
follows:
2001 2000 1999
------- --------- --------
(Thousands of dollars)
Balance at beginning of year $ 54 $ 93 $ 229
Amounts related to properties disposed (11) (39) (136)
------ -------- -------
Balance at end of year $ 43 $ 54 $ 93
====== ======== =======
16
BAYLAKE CORP. AND SUBSIDIARIES
Sturgeon Bay, Wisconsin
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 7 - DEPOSITS
At December 31, 2001, the scheduled maturities of time deposits
were as follows:
(Thousands of dollars)
2002 $ 262,223
2003 53,145
2004 6,157
2005 3,805
2006 34
Thereafter 30
------------
$ 325,394
============
Deposits from the company's directors and officers held by Baylake
Bank at December 31, 2001 and 2000, amounted to $8,040,000 and
$6,400,000, respectively.
NOTE 8 - SHORT-TERM BORROWINGS
Short-term borrowings consisted of the following at December 31:
2001 2000 1999
------------ ------------ -----------
(Thousands of dollars)
Federal funds purchased $ $ 35,000 $ 6,330
Federal Home Loan Bank Loan 42,000
Securities sold under agreements
to repurchase 2,837 2,538 2,901
----------- ----------- ----------
$ 2,837 $ 79,538 $ 9,231
=========== =========== ==========
The average outstanding balance of total short-term borrowings
amounted to $21,754,000 in 2001 and $44,011,000 in 2000. The
weighted-average interest rate on these borrowings was 5.42% for
2001 and 6.75% for 2000. The average outstanding balance is
determined on a daily average basis and the weighted-average
interest rate is calculated by dividing the actual interest paid on
all short-term borrowings by the average balance for the year.
The maximum amount outstanding at any month end was $70,009,000
during 2001 and $80,289,000 during 2000.
17
BAYLAKE CORP. AND SUBSIDIARIES
Sturgeon Bay, Wisconsin
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 9 - LONG-TERM DEBT
Long-term debt consisted of a land contract requiring annual
principal payments of $53,000 plus interest calculated at prime
+1/4%. The balance at December 31, 2001 and 2000 was $158,000 and
$211,000, respectively.
NOTE 10 - OTHER BORROWINGS
Other borrowings consists of the following at December 31:
2001 2000
------------- ------------
(Thousands of dollars)
Federal Home Loan Bank loans secured by real estate mortgages and
mortgage backed agency securities. Interest rates range from 2.46%
to 6.93%. The loans are due at various dates from February 4, 2002
through January 3, 2011. $ 90,000 $ 70,000
Line of credit with a correspondent bank. Interest rate of 1% less
than prime. $100,000 principal payments due quarterly. The line
is due March 29, 2002, and is secured by 3,800 shares of stock in
Baylake Bank (a subsidiary of the company). The line was repaid
during 2001. 1,700
Term notes with a correspondent bank. Interest rate of 1% less than
prime. The loans are due on various dates through September 29,
2001, and are secured by 2,000 shares of stock in Baylake Bank (a
subsidiary of the company). The notes were repaid
during 2001. 6,000
------------ -----------
$ 90,000 $ 77,700
============ ===========
Other borrowings are due as follows for the years ending December
31:
2002 $ 55,000
2003 10,000
2007 and thereafter 25,000
------------
$ 90,000
============
18
BAYLAKE CORP. AND SUBSIDIARIES
Sturgeon Bay, Wisconsin
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 11 - GUARANTEED PREFERRED BENEFICIAL INTEREST IN THE COMPANY'S
JUNIOR SUBORDINATED DEBT
Baylake Corp. has sponsored a trust with a total outstanding
balance of $16.1 million in trust preferred securities at December
31, 2001, as follows:
Junior Subordinated Debt
Trust Preferred Owned by Trust
------------------------------------------- ------------------------------------------
Initial Initial
Liquidation Principal
Value Distribution Amount Redeemable
Issuance Date (In Millions) Rate (In Millions) Maturity Beginning
------------- ------------ ------------ ------------- --------- ----------
Baylake Capital February 16, March 31, March 31,
Trust I 2001 $16.1 10.0% $16.6 2031 2006
Baylake Capital Trust I is a statutory business trust organized for
the sole purpose of issuing trust preferred securities and
investing the proceeds thereof in junior subordinated debentures of
the company, the sole asset of the trust. The common securities of
the trust are wholly-owned by the company. The trust preferred
securities and common securities of the trust represent preferred
undivided beneficial interests in the assets of Baylake Capital
Trust I, and the holder of the preferred securities will be
entitled to a preference over the common securities of the trust
upon an event of default with respect to distributions and amounts
payable on redemption or liquidation. These trust preferred
securities are tax-advantaged issues that qualify for Tier 1
capital treatment to the company. Distributions on these securities
are included in interest expense on guaranteed preferred beneficial
interest. The preferred securities are traded on the American Stock
Exchange under the symbol BYL_p.
The trust's ability to pay amounts due on the trust preferred
securities is solely dependent upon the company making payment on
the related junior subordinated debentures to the trust. The
company's obligations under the junior subordinated debentures
constitute a full and unconditional guarantee by the company of the
trust's obligations under the trust securities issued by the trust.
NOTE 12 - DIVIDENDS AND CAPITAL RESTRICTIONS
Cash dividends per share to shareholders were $.45, $.41, and $.37
in 2001, 2000, and 1999, respectively, after adjustment for stock
dividends.
As of December 31, 2001, undistributed earnings of the
subsidiaries, included in consolidated retained earnings, available
for distribution to the company as dividends without prior approval
of regulatory authorities was $23,369,000.
19
BAYLAKE CORP. AND SUBSIDIARIES
Sturgeon Bay, Wisconsin
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 12 - DIVIDENDS AND CAPITAL RESTRICTIONS (continued)
Federal banking regulatory agencies have 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 total 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 possibly additional discretionary - actions by
regulators that, if undertaken, could have a direct material effect
on the consolidated financial statements.
At December 31, 2001 and 2000, the company was categorized as "well
capitalized" and "adequately capitalized", respectively, 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 company's risk-based capital and leverage ratios are as follows
(thousands of dollars):
Risk-Based Capital Ratios
-------------------------------------------------------
December 31, 2001 December 31, 2000
-------------------------- --------------------------
Amount Ratio Amount Ratio
------------ --------- ------------ ---------
Tier 1 capital
Baylake Corp. $ 68,052 10.1% $ 47,049 7.8%
Minimum requirement 26,831 4.0% 24,232 4.0%
Total capital
Baylake Corp. 76,044 11.3% 54,055 8.9%
Minimum requirement 53,663 8.0% 48,464 8.0%
20
BAYLAKE CORP. AND SUBSIDIARIES
Sturgeon Bay, Wisconsin
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 12 - DIVIDENDS AND CAPITAL RESTRICTIONS (continued)
Leverage Ratios
-------------------------------------------------------
December 31, 2001 December 31, 2000
-------------------------- --------------------------
Amount Ratio Amount Ratio
------------ --------- ------------ ---------
Tier 1 capital to average total assets
Baylake Corp. $ 68,052 8.2% $ 47,049 6.4%
Minimum requirement 33,032 4.0% 29,518 4.0%
NOTE 13 - FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK
Baylake Bank is party to financial instruments with
off-balance-sheet risk in the normal course of business to meet the
financing needs of its customers. These financial instruments
include commitments to extend credit, standby letters of credit,
and financial guarantees.
Baylake Bank's exposure to credit loss in the event of
nonperformance by the other party to the financial instrument for
commitments to extend credit and standby letters of credit and
financial guarantees written is represented by the contract or
notional amount of those instruments. The bank uses the same credit
policies in making commitments and conditional obligations as it
does for on-balance-sheet instruments.
Contract or
Notional Amount
-------------------------------
2001 2000
------------- -------------
(Thousands of dollars)
Financial instruments whose contract amounts represent credit risk:
Commitments to extend credit $ 138,996 $ 131,898
Standby letters of credit and
financial guarantees written 5,273 2,581
Commitments to extend credit are agreements to lend to a customer
as long as there is no violation of any condition established in
the contract. Commitments generally have fixed expiration dates or
other termination clauses and may require payment of a fee. Since
many of the commitments are expected to expire without being drawn
upon, the total commitment amounts do not necessarily represent
future cash requirements. Baylake Bank evaluates each customer's
creditworthiness on a case-by-case basis. The amount of collateral
obtained, if deemed necessary by Baylake Bank upon extension of
credit, is based on management's credit evaluation of the
counter-party. Collateral held varies but may include accounts
receivable, inventory, property, plant, and equipment, and
income-producing commercial properties.
21
BAYLAKE CORP. AND SUBSIDIARIES
Sturgeon Bay, Wisconsin
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 13 - FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK (continued)
Standby letters of credit and financial guarantees written are
conditional commitments issued by Baylake Bank to guarantee the
performance of a customer to a third party. Those guarantees are
primarily issued to support private borrowing arrangements. The
guarantees expire in decreasing amounts through 2008, with the
majority expiring within two years. The credit risk involved in
issuing letters of credit is essentially the same as that involved
in extending loan facilities to customers. Baylake Bank does not
require collateral as support for the commitments. Collateral is
obtained based on loan policies upon use of a commitment by a
customer.
NOTE 14 - PENSION PLAN
The subsidiaries have 401(k) Profit Sharing Plans covering all
employees who qualify as to age and length of service. The employer
contributions paid and expensed under all plans for 2001, 2000, and
1999, totaled $713,000, $626,000, and $572,000, respectively.
Certain officers and directors of the company and its subsidiaries
are covered by nonqualified deferred compensation plans. Payments
to be made under these plans are accrued over the anticipated years
of service of the individuals covered. Amounts charged to expense
were $224,000 in 2001, $157,000 in 2000, and $146,000 in 1999.
22
BAYLAKE CORP. AND SUBSIDIARIES
Sturgeon Bay, Wisconsin
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 15 - INCOME TAX EXPENSE
The taxes applicable to income before income taxes were as follows:
2001 2000 1999
----------- ----------- -----------
(Thousands of dollars)
Taxes currently payable
Federal $ 2,542 $ 2,442 $ 2,025
State 212 311 191
----------- ----------- -----------
2,754 2,753 2,216
----------- ----------- -----------
Deferred income taxes
Federal (571) 21 330
State (92) 4 54
----------- ----------- -----------
(663) 25 384
----------- ----------- -----------
Income tax expense $ 2,091 $ 2,778 $ 2,600
=========== =========== ===========
The provision for income taxes differs from the amount of income
tax determined by applying the statutory federal income tax rate to
pretax income as a result of the following differences:
2001 2000 1999
----------- ----------- -----------
(Thousands of dollars)
Income tax based on statutory rate $ 3,273 $ 3,226 $ 3,242
State income taxes net of federal tax benefit 28 205 113
----------- ----------- -----------
3,301 3,431 3,355
Effect of tax-exempt interest income (749) (702) (761)
Federal tax refund claims based on IRS audit
of acquired company (516)
Other 55 49 6
----------- ----------- -----------
Provision based on effective tax rates $ 2,091 $ 2,778 $ 2,600
=========== =========== ===========
23
BAYLAKE CORP. AND SUBSIDIARIES
Sturgeon Bay, Wisconsin
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 15 - INCOME TAX EXPENSE (continued)
Deferred income taxes reflect the net tax effects of temporary
differences between the carrying amounts of assets and liabilities
for financial reporting purposes and the amounts used for income
tax purposes. A valuation allowance has been recognized to offset
the related deferred tax assets due to the uncertainty of realizing
tax benefits of a portion of loan loss and mortgage servicing
differences. The following is a summary of the significant
components of the company's deferred tax assets and liabilities as
of December 31, 2001 and 2000:
2001 2000
----------- -----------
(Thousands of dollars)
Deferred tax assets
Allowance for loan losses $ 2,590 $ 2,072
Deferred loan origination fees 128 142
Deferred compensation 783 700
Mortgage loan servicing 318 391
Nonaccrual loans 648 430
Accrued vacation pay 104 95
Other 48 47
Investments acquired in merger 46
----------- -----------
Gross deferred tax assets 4,619 3,923
Valuation allowance for deferred tax assets (550) (550)
----------- -----------
Net deferred tax assets 4,069 3,373
----------- -----------
Deferred tax liabilities
Bank premises and equipment 805 776
Market value adjustment on securities
available for sale 1,146 277
Other 70 64
----------- -----------
Total deferred tax liabilities 2,021 1,117
----------- -----------
Net deferred asset $ 2,048 $ 2,256
=========== ===========
24
BAYLAKE CORP. AND SUBSIDIARIES
Sturgeon Bay, Wisconsin
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 16 - EARNINGS AND DIVIDENDS PER SHARE
Earnings and dividends per share are based on the weighted average
number of shares outstanding for the year, restated for the 100%
stock dividend paid in November 1999. A reconciliation of the basic
and diluted earnings per share amounts is as follows:
2001 2000 1999
------------ ------------- ------------
Basic weighted average number of
common shares outstanding 7,467,986 7,443,999 7,403,429
Additional common dilutive stock
option shares 143,135 298,563 289,149
------------ ------------- ------------
Diluted weighted average number
of common shares outstanding 7,611,121 7,742,562 7,692,578
============ ============= ============
Additional common stock option
shares that have not been
included due to their
antidilutive effect 216,450 60,000
There is no difference between basic and diluted income available
to common stockholders.
See Note 17 for information on additional stock options issued
subsequent to year end. These shares would not have changed
materially the calculation of the number of common shares or
potential common shares outstanding at the end of the period if the
transaction had occurred before December 31, 2001.
25
BAYLAKE CORP. AND SUBSIDIARIES
Sturgeon Bay, Wisconsin
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 17 - STOCK OPTION PLAN
The company has a non-qualified stock option plan under which
certain officers and key salaried employees may purchase shares of
the company's stock at an established exercise price. Unless
earlier terminated, these options will expire ten years from the
date of grant. The options become exercisable 20% per year,
commencing one year from date of grant.
Activity in the plan is summarized as follows:
Weighted
Average
Number Option Price Exercise
of Shares Per Share Price
----------- ---------------- -----------
Shares under option at December 31, 1998 614,900 $ 4.67 - 11.50 $ 9.33
Options granted 126,000 15.25 15.25
Options exercised (94,400) 4.67 - 9.75 8.31
--------- ---------------- ----------
Shares under option at December 31, 1999 646,500 4.67 - 15.25 10.64
Options granted 60,000 25.00 25.00
Options exercised (8,400) 4.67 - 8.95 5.64
--------- ---------------- --------
Shares under option at December 31, 2000 698,100 4.67 - 25.00 11.93
Options granted 30,975 13.00 - 14.75 14.72
Options exercised (26,000) 4.67 - 11.50 8.12
--------- ---------------- ----------
Shares under option at December 31, 2001 703,075 $ 4.67 - 25.00 $ 12.19
========= ================ ==========
Subsequent to year-end, options to purchase up to an additional
22,000 shares were granted. The exercise price was established at
100% of the fair market value of the stock on the date of grant, or
$13.00 per share.
The options outstanding at December 31, 2001, were:
Weighted
Weighted-Average Average
Number of Shares Exercise Price Remaining
Price ------------------------------- ------------------------------- Life
Range Outstanding Exercisable Outstanding Exercisable (In Years)
---------------- -------------- -------------- -------------- -------------- -------------
$ 4.67 5,700 5,700 $ 4.67 $ 4.67 1.3
8.92 - 11.50 480,400 408,400 9.72 9.76 4.2
13.00 - 15.25 156,975 50,400 15.15 15.25 7.4
25.00 60,000 12,000 25.00 25.00 8.0
---------- ---------- ---------- ---------- ----
703,075 476,500 $ 12.19 $ 10.66 5.2
========== ========== ========== ========== ====
26
BAYLAKE CORP. AND SUBSIDIARIES
Sturgeon Bay, Wisconsin
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 17 - STOCK OPTION PLAN (continued)
Options exercisable at December 31, 2000 and 1999, were 394,500 and
285,300, respectively. The weighted average exercise price for
options exercisable at December 31, 2000 and 1999, was $10.03 and
$9.53, respectively.
Statement of Financial Accounting Standards No. 123 (SFAS 123),
"Accounting for Stock-Based Compensation" establishes financial
accounting and reporting standards for stock-based employee
compensation plans.
SFAS 123 defines a fair value based method of accounting for
employee stock option or similar equity instruments. Under the fair
value based method, compensation cost is measured at the grant date
based on the fair value of the award using an option-pricing model
that takes into account the stock price at the grant date, the
exercise price, the expected life of the option, the volatility of
the underlying stock, expected dividends and the risk-free interest
rate over the expected life of the option. The resulting
compensation cost is recognized over the service period, which is
usually the vesting period.
Compensation cost can also be measured and accounted for using the
intrinsic value based method of accounting prescribed in Accounting
Principles Board Opinion No. 25 (APB 25), "Accounting for Stock
Issued to Employees." Under the intrinsic value based method,
compensation cost is the excess, if any, of the quoted market price
of the stock at grant date or other measurement date over the
amount paid to acquire the stock.
The largest difference between SFAS 123 and APB 25 as it relates to
the company is the amount of compensation cost attributable to the
company's stock option plan. Under APB 25 no compensation cost is
recognized for the stock option plan because the exercise price is
equal to the quoted market price at the date of grant and therefore
there is no intrinsic value. SFAS 123 compensation cost would equal
the calculated fair value of the options granted.
As permitted by SFAS 123, the company continues to measure
compensation cost for the stock option plan using the accounting
method prescribed by APB 25.
27
BAYLAKE CORP. AND SUBSIDIARIES
Sturgeon Bay, Wisconsin
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 17 - STOCK OPTION PLAN (continued)
Had compensation cost for the company's options granted after
January 1, 1995, been determined according to SFAS 123, the
company's net income and earnings per share would have been reduced
to the following proforma amounts:
2001 2000 1999
----------- ----------- -----------
(Thousands of dollars)
Net income
As reported $ 7,535 $ 6,710 $ 6,923
Proforma 7,137 6,320 6,578
Basic earnings per common share
As reported 1.01 .90 .94
Proforma .96 .85 .89
Diluted earnings per common share
As reported .99 .87 .90
Proforma .94 .83 .82
The fair value of each option grant was estimated as of the date of
grant using the Black-Scholes option pricing model. The resulting
compensation cost was amortized over the vesting period.
The grant date fair values and assumptions used to determine such
values are as follows:
2001 2000 1999
--------- --------- ---------
Weighted average grant date fair value $ 14.72 $ 7.13 $ 5.14
Assumptions:
Risk-free interest rates 4.58% 5.12% 6.50%
Expected volatility 52.40% 27.40% 19.08%
Expected term (in years) 8.00 8.00 8.00
Expected dividend yield 3.36% 2.93% 1.60%
28
BAYLAKE CORP. AND SUBSIDIARIES
Sturgeon Bay, Wisconsin
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 18 - DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL
INSTRUMENTS
Provided below is the information required by Statement of
Financial Accounting Standards No. 107, "Disclosures about Fair
Value of Financial Instruments" (SFAS 107). These amounts represent
estimates of fair values at a point in time. Significant estimates
regarding economic conditions, loss experience, risk
characteristics associated with particular financial instruments
and other factors were used for the purposes of this disclosure.
These estimates are subjective in nature and involve matters of
judgment. Therefore, they cannot be determined with precision.
Changes in the assumptions could have a material impact on the
amounts estimated.
Many of the company's financial instruments lack an available
trading market. Furthermore, most of the financial instruments are
intended to be held to maturity. Therefore, it is not probable that
the fair values shown will be realized in a current transaction.
The estimated fair values disclosed do not reflect the value of
assets and liabilities that are not considered financial
instruments. In addition, the significant value of long-term
relationships with depositors and other customers are not
reflected.
A. CASH AND DUE FROM BANKS
These instruments are, by definition, short-term and do not
present any unanticipated credit issues. Therefore, the
carrying amount is a reasonable estimate of fair value.
B. INVESTMENT SECURITIES
The estimated fair values of securities are provided in Note 3
to the financial statements. These are based on quoted market
prices, when available. If a quoted market price is not
available, fair value is estimated using quoted market prices
for similar securities.
C. LOANS
The carrying amount (total outstandings excluding unearned
income and reserve for loan losses) and estimated fair value
of loans outstanding at December 31, 2001, are $605,287,000
and $616,479,000, and for December 31, 2000, are $555,107,000
and $541,738,000. In order to determine the fair values for
loans, the loan portfolio was segmented based on loan type,
credit quality and repricing characteristics. For certain
variable rate loans with no significant credit concerns and
frequent repricings, estimated fair values are based on the
carrying values. The fair values of other loans are estimated
using discounted cash flow analyses. The discount rates used
in these analyses are generally based on origination rates for
similar loans of comparable credit quality. However, where
appropriate, adjustments have been made to more accurately
reflect market rates. Maturity estimates are based on
historical experience with prepayments and current economic
and lending conditions.
29
BAYLAKE CORP. AND SUBSIDIARIES
Sturgeon Bay, Wisconsin
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 18 - DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL
INSTRUMENTS (continued)
D. DEPOSITS
The carrying amount and estimated fair value of deposits
outstanding at December 31, 2001, are $669,890,000 and
$672,646,000 and for December 31, 2000, are $554,005,000 and
$554,237,000. Under SFAS 107, the fair value of deposits with
no stated maturity is equal to the amount payable on demand.
Therefore, the fair value estimates for these products do not
reflect the benefits that the company receives from the
low-cost, long-term funding they provide. These benefits are
significant. The estimated fair values of fixed rate time
deposits are based on discounted cash flow analyses. The
discount rates used in these analyses are based on market
rates currently offered for deposits of similar remaining
maturities. Because of the repricing characteristics and the
competitive nature of the company's rates offered on variable
rate time deposits, carrying amount is a reasonable estimate
of the fair value.
E. SHORT-TERM BORROWINGS
Short-term borrowings reprice frequently and therefore the
carrying amount is a reasonable estimate of fair value.
F. GUARANTEED PREFERRED BENEFICIAL INTEREST IN THE COMPANY'S
JUNIOR SUBORDINATED DEBT AND OTHER BORROWINGS
The carrying amount and estimated fair value of guaranteed
preferred beneficial interest in the company's junior
subordinated debt and other borrowings outstanding at December
31, 2001, are $106,100,000 and $109,178,000 and for December
31, 2000, are $77,700,000 and $77,869,000. The estimated fair
values of fixed rate time borrowings are based on discounted
cash flow analyses. The discount rates used in these analyses
are based on market rates currently offered for borrowings of
similar remaining maturities.
G. COMMITMENTS TO EXTEND CREDIT, STANDBY LETTERS OF CREDIT, AND
LETTERS OF CREDIT
Pricing of these financial instruments is based on the credit
quality and relationship, fees, interest rates, probability of
funding, and compensating balance and other covenants or
requirements. Loan commitments generally have fixed expiration
dates, are variable rate and contain termination and other
clauses which provide for relief from funding in the event
that there is a significant deterioration in the credit
quality of the customer. Many loan commitments are expected
to, and typically do, expire without being drawn upon. The
carrying amounts are reasonable estimates of the fair value of
these financial instruments. Carrying amounts are comprised of
the unamortized fee income and, where necessary, reserves for
any expected credit losses from these financial instruments.
30
BAYLAKE CORP. AND SUBSIDIARIES
Sturgeon Bay, Wisconsin
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 19 - COMMITMENTS AND CONTINGENCIES
During 2000, the company entered into a ten year lease to rent
space in a building in Green Bay. The annual base rent is $76,000
and shall increase as of the beginning of each December based on
the Consumer Price Index.
During 2000, the company entered into a seven year lease to rent
space for a branch bank location in Howard, Wisconsin. The annual
base rent is $33,000 and increases by 15% after five years. The
company must also pay its proportional share of costs for common
areas at the mall.
Rent expense for 2001 and 2000 was $110,000 and $87,000,
respectively.
Future minimum lease payments under these agreements are as
follows:
2002 $ 113,601
2003 115,837
2004 118,135
2005 120,498
2006 126,831
2007 and thereafter 282,777
-------------
$ 877,679
=============
As part of the Evergreen Bank, N.A. ("Evergreen") acquisition, the
company was required to contribute $7 million of capital to
Evergreen. No payments to the seller of Evergreen have been made,
but are contingently payable based on a formula set forth in the
stock purchase agreement, not to exceed $2 million. The contingent
payments are not accrued at December 31, 2001, since the amount, if
any, is not estimable.
The acquisition was accounted for using the purchase method of
accounting. Under the purchase method, net assets purchased are
recorded at their fair market values on the date of acquisition.
Any excess of the purchase price over the value of the net assets
is recorded as goodwill. The goodwill recorded on the Evergreen
acquisition is the result of assumption of liabilities having a
market value in excess of market value of assets received. Any
payments made in the future to the former shareholder of Evergreen
may affect the goodwill recorded. Goodwill is being amortized on a
straight-line basis over 15 years.
31
BAYLAKE CORP. AND SUBSIDIARIES
Sturgeon Bay, Wisconsin
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 20 - CONDENSED FINANCIAL INFORMATION - PARENT
COMPANY ONLY
BAYLAKE CORP.
(Parent Company Only)
CONDENSED BALANCE SHEETS
December 31
2001 2000
------------ ------------
(Thousands of dollars)
ASSETS
Cash in bank $ 3,636 $ 462
Dividend receivable 600
Receivable from subsidiary 188 129
Prepaid expenses 1,059 199
Investment in subsidiaries 71,247 60,310
------------ ------------
Total assets $ 76,130 $ 61,700
============ ============
LIABILITIES AND STOCKHOLDER
EQUITY
Liabilities
Dividends payable $ 897 $ 819
Accrued expense 3 54
Debentures to subsidiary 16,100
Other borrowings 7,700
------------ ------------
Total liabilities 17,000 8,573
Stockholder equity 59,130 53,127
------------ ------------
Total liabilities and stockholder equity $ 76,130 $ 61,700
============ ============
32
BAYLAKE CORP. AND SUBSIDIARIES
Sturgeon Bay, Wisconsin
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 20 - CONDENSED FINANCIAL INFORMATION - PARENT
COMPANY ONLY (continued)
BAYLAKE CORP.
(Parent Company Only)
CONDENSED STATEMENTS OF INCOME
For the Years Ended December 31
2001 2000 1999
----------- ----------- ------------
(Thousands of dollars)
Income
Dividends from subsidiaries $ 200 $ 2,645 $ 2,076
Interest income 216 11 11
----------- ----------- ------------
Total income 416 2,656 2,087
----------- ----------- ------------
Expenses
Interest 1,551 322
Other 171 67 54
Income taxes (benefit) (509) (128) (10)
----------- ----------- ------------
Total expenses 1,213 261 44
----------- ----------- ------------
Income (loss) before
equity in undistributed net
income of subsidiaries (797) 2,395 2,043
Equity in undistributed net income
of subsidiaries 8,332 4,315 4,880
----------- ----------- ------------
NET INCOME $ 7,535 $ 6,710 $ 6,923
=========== =========== ============
33
BAYLAKE CORP. AND SUBSIDIARIES
Sturgeon Bay, Wisconsin
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 20 - CONDENSED FINANCIAL INFORMATION - PARENT
COMPANY ONLY (continued)
BAYLAKE CORP.
(Parent Company Only)
CONDENSED STATEMENT OF CASH FLOWS
For the Years Ended December 31
2001 2000 1999
---------- ---------- -----------
(Thousands of dollars)
CASH FLOWS FROM OPERATING ACTIVITIES:
Cash paid to suppliers $ (189) $ (218) $ (59)
Interest received 216 11 11
Interest paid (1,557) (316)
Dividends received 800 2,788 1,994
Income taxes (paid) received 454 381 (241)
---------- ---------- -----------
Net cash provided by (used in) operating
activities (276) 2,646 1,705
---------- ---------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital contributed to subsidiary (1,039) (7,345)
---------- ---------- -----------
Net cash used in investing activities (1,039) (7,345)
---------- ---------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Dividends paid (3,284) (2,976) (2,660)
Issuance of debt 16,100 7,700
Payments on debt (7,700)
Issuance of stock 264 108 1,157
Debt issue costs (891)
---------- ---------- -----------
Net cash provided by (used in) financing
activities 4,489 4,832 (1,503)
---------- ---------- -----------
Net increase in cash 3,174 133 202
Cash and due from banks, beginning 462 329 127
---------- ---------- -----------
Cash and due from banks, ending $ 3,636 $ 462 $ 329
========== ========== ===========
Reconciliation of net income to net cash provided by operating
activities:
Net income $ 7,535 $ 6,710 $ 6,923
Adjustments to reconcile net income to net
cash provided by operating activities:
Undistributed earnings of subsidiary (8,332) (4,315) (4,880)
Amortization 30
Change in receivable from subsidiary (58) 253 (251)
Change in prepaid expenses (199)
Change in dividends receivable 600 143 (82)
Change in accrued expenses (51) 54 (5)
---------- ---------- -----------
Net cash provided by (used in) operating
activities $ (276) $ 2,646 $ 1,705
========== ========== ===========
SUPPLEMENTAL SCHEDULE OF NONCASH
FINANCING ACTIVITIES:
Dividends reinvested in common stock $ 854 $ 771 $ 735
34
NOTE 21 - BUSINESS SEGMENTS
The company has two business segments for which discrete financial
information is available: banking and non-banking.
Banking provides commercial, mortgage, and consumer lending,
deposit services, trust services, and other traditional bank
services. These services are provided primarily through branch
banks, and ATMs.
Non-banking includes insurance agency services and conference
facilities through two of the company's wholly-owned subsidiaries.
2001
--------------------------------------------------------------------
Intercompany
Banking Non-Banking Amounts Totals
------------ --------------- ------------------ -------------
(Amounts in thousands)
Interest revenue $ 59,023 $ 19 $ (19) $ 59,023
Interest expense 32,072 (19) 32,053
Provision for loan losses 2,880 2,880
Noninterest revenue 6,167 140 6,307
Noninterest expenses 20,657 114 20,771
Income taxes 2,074 17 2,091
Net income 7,507 28 7,535
Total assets 846,294 580 (1,083) 845,791
2000
--------------------------------------------------------------------
Intercompany
Banking Non-Banking Amounts Totals
------------ --------------- ------------------ -------------
(Amounts in thousands)
Interest revenue $ 56,036 $ 21 $ (21) $ 56,036
Interest expense 32,120 (21) 32,099
Provision for loan losses 545 545
Noninterest revenue 4,557 129 4,686
Noninterest expense 18,482 108 18,590
Income taxes 2,760 18 2,778
Net income 6,686 24 6,710
Total assets 772,774 536 (1,042) 772,268
35
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information set forth under the sections titled "Proposal No. 1, Election of
Directors," "Information on Executive Officers" and "Compliance with Section
16(a) of the Exchange Act" contained in the definitive proxy statement for the
Company's 2002 Annual Meeting of Stockholders is incorporated herein by
reference.
Item 11. EXECUTIVE COMPENSATION
The information set forth under the sections titled "Director Fees and
Benefits", "Executive Compensation", "Board of Directors Compensation Committee
Report on Management Compensation", "Compensation Committee Interlocks and
Insider Participation" and "Performance Graph" contained in the definitive proxy
statement for the Company's 2002 Annual Meeting of Stockholders is incorporated
herein by reference.
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information set forth under the section titled "Ownership of Baylake Common"
contained in the definitive proxy statement for the Company's 2002 Annual
Meeting of Stockholders is incorporated herein by reference.
36
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information set forth in the section titled "Certain Transactions with
Management" in the definitive proxy statement for the Company's 2002 Annual
Meeting of Stockholders is incorporated herein by reference.
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) 1. and 2.
The consolidated financial statements and supplementary data contained in Item 8
of this report are filed as part of this report. All schedules are omitted
because of the absence of the conditions under which they are required or
because the required information is included in the consolidated financial
statements or related notes.
(a) 3.
See Item 14(c) below.
(b) Reports on Form 8-K
None.
(c) Exhibits Required by Item 601 of Regulation S-K
Reference is made to the Exhibit Index on page 84 for exhibits filed as part of
this report.
(d) Additional Financial Statements
Not applicable.
37
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) 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.
By: /s/ Steven D. Jennerjohn
------------------------
Steven D. Jennerjohn
Treasurer
Date: March 19,2002
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that each individual whose signature appears
below hereby designates and appoints Thomas L. Herlache and Steven D.
Jennerjohn, and each of them, any one of whom may act without the joinder of the
other, as such person's true and lawful attorney-in-fact and agents (the
"Attorneys-in-Fact") with full power of substitution and resubstitution, for
such person and in such person's name, place and stead, in any and all
capacities, to sign any and all amendments to this report, and to file the same,
with all exhibits thereto, and other documents in connection therewith, the
Securities and Exchange Commission and any state securities commission, granting
unto said Attorneys-in-Fact and agents, and each of them, full power and
authority to do and perform each and every act and thing requisite and necessary
to be done in and about the premises, as fully to all intents and purposes as he
might or could do in person, hereby ratifying and conforming all that said
Attorneys-in-Fact and agents or any of them, or their or his substitutes, may
lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended,
this report has been signed by the following persons in the capacities and on
these dates indicated.
/s/ Thomas L. Herlache /s/ Richard A. Braun
------------------- -----------------
Thomas L. Herlache Richard A. Braun, Director
President, Chief Executive Vice-Chairman of the Board and
Officer and Director(Principal Executive Vice-President
Executive Officer)
38
/s/ Steven D. Jennerjohn /s/ John W. Bunda
--------------------- --------------
Steven D. Jennerjohn John W. Bunda, Director
Treasurer
(Principal Financial and
Accounting Officer)
/s/ Robert W. Agnew /s/ John D. Collins
---------------- ----------------
Robert W. Agnew, Director John D. Collins, Director
/s/ George Delveaux, Jr.
- --------------------- ---------------------
Ronald D. Berg, Director George Delveaux, Jr., Director
/s/ Roger G. Ferris /s/ Joseph J. Morgan
---------------- -----------------
Roger G. Ferris, Director Joseph J. Morgan, Director
/s/ Ruth Nelson /s/ William Parsons
--------------- -------------------
Ruth Nelson, Director William Parsons, Director
/s/ Paul Jay Sturm
------------------
Paul Jay Sturm, Director
*Each of the above signatures is affixed as of March 19, 2002.
39
Sequentially Exhibit Description
Numbered Page No.
- -- 2.1 Agreement and Plan of Acquisition dated March 13,
1996 between Baylake Corp. and Four Seasons of Wis
Corp. (1)
- -- 2.4 Stock Purchase Agreement, dated as of October 1,
1998, among the Company, M&I and Evergreen (2)
- -- 3.1 Articles of Incorporation, as amended (3)
- -- 3.2 Bylaws, as amended (4)
- -- 3.3 Amendment to increase authorized shares of common
stock of Baylake Corp. from 10,000,000 to
50,000,000 shares (5)
- -- 4.1 Junior subordinated debenture dated February 16,
2002, by and between Company and Wilmington Trust
Company, as Indenture Trustee (6)
- -- 10.1 Baylake Corp. 1993 Stock Option Plan (7)
- -- 10.2 Baylake Bank's Pay-for-Performance (bonus)
program (8)
- -- 10.3 Baylake Bank's Deferred Compensation Program with
Thomas L. Herlache (9)
- -- 10.4 Baylake Bank's Agreement for Early Retirement with
Ronald D. Berg (10)
- -- 10.5 Baylake Bank's Deferred Compensation and Salary
Continuation Agreement with Richard A. Braun (11)
- -- 10.6 Baylake Corp. Stock Purchase Plan (12)
Page 86 12.1 Statement Re Computation of Ratios
Page 88 21.1 List of Subsidiaries
Page 89 23.1 Consent of Smith & Gesteland
Page 82 24.1 Power of Attorney (contained on the Signature Page)
(1) Incorporated by reference to Exhibit 2.1 from the Company's Annual Report
on Form 10-K for the fiscal year ended December 31, 1996.
(2) Incorporated by reference to Exhibit 2.1 from the Company's Current Report
on Form 8-K filed October 15, 1998.
(3) Incorporated by reference to Exhibit 3.1 from the Company's Annual Report
on Form 10-K for the fiscal year ended December 31, 1993.
(4) Incorporated by reference to Exhibit 3.2 from the Company's Annual Report
on Form 10-K for the fiscal year ended December 31, 1993.
(5) Incorporated by reference to Exhibit 3.3 from the Company's Proxy Statement
for the 2001 Annual Meeting of Shareholders.
(6) Incorporated by reference to Exhibit 4.1 from the Company's Form S-3 filed
February 12, 2001 for Trust Preferred Securities issued under Baylake
Capital Trust I on February 16, 2001.
(7) Incorporated by reference to Exhibit A from the Company's Proxy Statement
for the 1993 Annual Meeting of Shareholders.
(8) Incorporated by reference to Description thereof under "Board
Directors/Compensation Committee Report on Management's Compensation" in
the Company's Proxy Statement for the 1994 Annual Meeting of Shareholders.
(9) Incorporated by reference to Exhibit 10.3 from the Company's Annual Report
on Form 10-K for the fiscal year ended December 31, 1993.
40
(10) Incorporated by reference to Exhibit 10.4 from the Company's Annual Report
on Form 10-K for the fiscal year ended December 31, 1993.
(11) Incorporated by reference to Exhibit 10.5 from the Company's Annual Report
on Form 10-K for the fiscal year ended December 31, 1993.
(12) Incorporated by reference to Exhibit 4 from the Company's Form S-3 filed on
February 10, 1998.
41