BAYLAKE CORP - 10-Q Quarterly Report

Back to GetFilings.com

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

{X} QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 OF THE
SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2005
---------------------------------

OR

{ } TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 OF THE
SECURITIES EXCHANGE ACT OF 1934

For the transition period from to
----------------------- ---------------------

Commission file number 0-8679
--------------------------------------------------------

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

Wisconsin 39-1268055
- --------------------------------------------------------------------------------
(State or other jurisdiction of incorporation (Identification No.)
or organization)

217 North Fourth Avenue, Sturgeon Bay, WI 54235
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)

(920)-743-5551
- --------------------------------------------------------------------------------
(Registrant's telephone number, including area code)

None
- --------------------------------------------------------------------------------
(Former name, former address and former fiscal year,
if changed since last report)

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

Yes X No
------- -------

Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).

Yes X No
------- -------

Applicable Only to Corporate Issuers:

Number of outstanding shares of each of common stock, par value $5.00 per share,
as of May 4, 2005: 7,697,777 shares

BAYLAKE CORP. AND SUBSIDIARIES

INDEX

BAYLAKE CORP. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS (Unaudited)
March 31, 2005 and December 31, 2004
(Amounts in thousands of dollars)

See accompanying notes to Unaudited Consolidated Financial Statements.

3

BAYLAKE CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
(Unaudited)
Three months ended March 31, 2005 and 2004
(Amounts in thousands of dollars except per share data)

See accompanying notes to Unaudited Consolidated Financial Statements.

4

BAYLAKE CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (Unaudited)
Three months ended March 31,
(Amounts in thousands of dollars except for per share data)

See accompanying notes to Unaudited Consolidated Financial Statements.

5

BAYLAKE CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
Three months ended March 31, 2005 and 2004
(Amounts in thousands of dollars)

See accompanying notes to Unaudited Consolidated Financial Statements.

6

BAYLAKE CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
Three months ended March 31, 2005 and 2004
(Amounts in thousands of dollars)

See accompanying notes to Unaudited Consolidated Financial Statements.

7

BAYLAKE CORP. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2005

1. The accompanying consolidated financial statements should be read in
conjunction with Baylake Corp.'s 2004 annual report on Form 10-K. The
accompanying consolidated financial statements are unaudited. These
interim financial statements are prepared in accordance with the
requirements of Form 10-Q, and accordingly do not include all of the
information and footnotes required by U.S. generally accepted
accounting principles for complete financial statements. In the opinion
of management, the unaudited financial information included in this
report reflects all adjustments, consisting of normal recurring
accruals, which are necessary for a fair statement of the financial
position as of March 31, 2005 and December 31, 2004. The results of
operations for the three months ended March 31, 2005 are not
necessarily indicative of results to be expected for the entire year.

2. To prepare financial statements in conformity with U.S. generally
accepted accounting principles, management makes estimates and
assumptions based on available information. These estimates and
assumptions affect the amounts reported in the financial statements and
the disclosures provided, and actual results could differ. The
allowance for loan losses, foreclosed assets, and fair values of
financial instruments are particularly subject to change.

3. Diluted earnings per share, which reflects the potential dilution that
could occur if outstanding stock options were exercised and stock
awards were fully vested and resulted in the issuance of common stock
that then shared in the earnings of the Company, is computed by
dividing net income by weighted average number of common shares and
common stock equivalents. The following table shows the computation of
the basic and diluted earnings per share for the three months ended
March 31 (dollars in thousands, except per share amounts):

8

BAYLAKE CORP. AND SUBSIDIARIES

4. Baylake Corp. declared a cash dividend of $0.15 per share payable on
March 15, 2005 to shareholders of record as of March 1, 2005.

5. The Company has a non-qualified stock option plan, which is described
more fully in the Company's December 31, 2004 Annual Report on Form
10-K. The Company accounts for this plan under the recognition and
measurement principles of APB Opinion No. 25, "Accounting for Stock
Issued to Employees," and related interpretations. No stock-based
employee compensation cost is reflected in net income, as all options
granted under these plans had an exercise price at least equal to the
fair market value of the underlying common stock on the grant date. The
following table illustrates the effect on net income and earnings per
share if the Company had applied the fair value provisions of SFAS 123
"Accounting for Stock-Based Compensation," to stock-based employee
compensation.

The fair value of each option granted was estimated as of the date of
grant using the Black-Scholes option pricing model. The resulting
compensation cost was amortized over the vesting period.

6. Certain amounts reported in the March 31, 2004 Form 10-Q have been
reclassified to conform to the March 31, 2005 presentation.

7. Effect of Newly Issued But Not Yet Effective Accounting Standards: FAS
123R requires all public companies to record compensation cost for
stock options provided to employees in return for employee service. The
cost is measured at the fair value of the options when granted, and
this cost is expensed over the employee service period, which is
normally the

9

BAYLAKE CORP. AND SUBSIDIARIES

vesting period of the options. This will apply to awards granted or
modified after the first year beginning after June 15, 2005.
Compensation cost will also be recorded for prior option grants that
vest after the date of adoption. The effect on results of operations
will depend on the level of future option grants and the calculation of
the fair value of the options granted at such future date, as well as
the vesting periods provided, and so cannot currently be predicted. The
Company has ceased issuing stock options under the current plan and
thus expects no further grants. However, the plan is still in existence
and the Company has reserved the right to grant additional options.
Existing options that will vest after adoption date are expected to
result in an immaterial amount of compensation expense during 2005
though 2008.

SOP 03-3 requires that a valuation allowance for loans acquired in a
transfer, including in a business combination, reflect only losses
incurred after acquisition and should not be recorded at acquisition.
It applies to any loan acquired in a transfer that showed evidence of
credit quality deterioration since it was made.

The effect of these new standards on the Company's financial position
and results of operations is not expected to be material upon adoption.

10

PART 1 - FINANCIAL INFORMATION

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

GENERAL

Baylake is a full-service financial services company, providing a wide variety
of loan, deposit and other banking products and services to its business,
individual or retail, and municipal customers, as well as a full range of trust,
investment and cash management services. The Company is the bank holding company
of Baylake Bank ("Bank"), chartered as a state bank in Wisconsin and a member
bank of the Federal Reserve and Federal Home Loan Bank.

The following sets forth management's discussion and analysis of the
consolidated financial condition and results of operations of Baylake Corp.
("Baylake" or the "Company") for the three months ended March 31, 2005 and 2004
which may not be otherwise apparent from the consolidated financial statements
included in this report. Unless otherwise stated, the "Company" or "Baylake"
refers to this entity and to its subsidiaries on a consolidated basis when the
context indicates. For a more complete understanding, this discussion and
analysis should be read in conjunction with the financial statements, related
notes, the selected financial data and the statistical information presented
elsewhere in this report.

FORWARD-LOOKING INFORMATION

This discussion and analysis of financial condition and results of operations,
and other sections of this report, may contain forward-looking statements that
are based on the current expectations of management. Such expressions of
expectations are not historical in nature and are forward-looking statements
within the meaning of the Private Securities Litigation Reform Act of 1995.
Words such as "anticipates," "believes," "estimates," "expects," "forecasts,"
"intends," "is likely," "plans," "projects," and other such words are intended
to identify in such forward-looking statements. The statements contained herein
and in such forward-looking statements involve or may involve certain
assumptions, risks and uncertainties, many of which are beyond the control of
the Company, that may cause actual future results to differ materially from what
may be expressed or forecasted in such forward-looking statements. Readers
should not place undue expectations on any forward-looking statements. In
addition to the assumptions and other factors referenced specifically in
connection with such statements, the following factors could impact the business
and financial prospects of the relationships; demand for financial products and
financial services; the degree of competition by traditional and non-traditional
financial services competitors; changes in banking legislation or regulations;
changes in tax laws and the results of recent Wisconsin state tax developments;
changes in interest rates; changes in prices; the impact of technological
advances; governmental and regulatory policy changes; trends in customer
behavior as well as their ability to repay loans; and changes in the general
economic conditions, nationally or in the State of Wisconsin.

11

CRITICAL ACCOUNTING POLICIES

In the course of the Company's normal business activity, management must select
and apply many accounting policies and methodologies that lead to the financial
results presented in the consolidated financial statements of the Company. Some
of these policies are more critical than others.

Allowance for Loan Losses: The allowance for loan losses ("ALL") is a valuation
allowance for probable incurred credit losses. Loan losses are charged against
the allowance when management believes the uncollectibility of a loan balance is
confirmed. Subsequent recoveries, if any, are credited to the allowance.
Management estimates the allowance balance required using past loan loss
experience, the nature and volume of the portfolio, information about specific
borrower situations and the estimated collateral values, economic conditions,
and other factors. Allocations of the allowance may be made for specific loans,
but the entire allowance is available for any loan that, in management's
judgment, should be charged-off.

The allowance consists of specified and general components. The specific
component relates to loans that are individually classified as impaired or loans
other classified as substandard or doubtful. The general component covers
non-classified loans and is based on historical loss experience adjusted for
current factors.

A loan is impaired when full payment under the loan terms is not expected.
Commercial and commercial real estate loans are individually evaluated for
impairment. If a loan is impaired, a portion of the allowance is allocated so
that the loan is reported, net, at the present value of estimated future cash
flows using the loan's existing rate or at the fair value of collateral, if
repayment is expected solely from the collateral. Large groups of smaller
balance homogeneous loans, such as consumer and residential real estate loans,
are collectively evaluated for impairment, and accordingly, they are not
separately identified for impairment disclosures.

Goodwill: Goodwill results from business acquisitions and represents the excess
of the purchase price over the fair value of the acquired tangible assets and
liabilities and identifiable intangible assets. Goodwill is assessed at least
annually for impairment, and any such impairment will be recognized in the
period identified.

Income tax accounting: The assessment of tax assets and liabilities involves the
use of estimates, assumptions, interpretations, and judgments concerning certain
accounting pronouncements and federal and state tax codes. There can be no
assurance that future events, such as court decisions or positions of federal
and state taxing authorities, will not differ from management's current
assessment, the impact of which could be significant to the consolidated results
of the Company's operations and reported earnings. The Company believes that the
tax assets and liabilities are adequate and properly recorded in the
consolidated financial statements. The reserve does not include any specific
reserves relative to any position recently taken by state taxing authorities.

Income tax expense may be affected by developments in the state of Wisconsin.
Like many financial institutions that are located in Wisconsin, a subsidiary of
the Bank located in the state of Nevada holds and manages various investment
securities. Due to that fact that these subsidiaries are out of state, income
from their operations has not been subject to Wisconsin state taxation. Although
the Wisconsin Department of Revenue issued favorable tax rulings regarding
Nevada subsidiaries of Wisconsin financial institutions, the Department
representatives have recently stated that the Department intends to revoke those
rulings and tax some or all these subsidiaries' income, even though there has
been no intervening change in the law. The Department also implemented a program
in 2003 for the audit of Wisconsin financial institutions who have

12

formed and contributed assets to subsidiaries located in Nevada; to date, the
Company and its subsidiaries have not been audited on these matters.

The Department sent letters in July 2004 to financial institutions in Wisconsin,
whether or not they are undergoing an audit, reporting on settlements involving
17 banks and their out-of-state investment subsidiaries. The letter provided a
summary of currently available settlement parameters. For periods before 2004,
they include: restrictions on the types of subsidiary income excluded from
Wisconsin taxation; assessment of certain back taxes for a limited period of
time; and interest (but not penalties) on any past-due taxes. For 2004 and going
forward, there are similar provisions plus limits on the amount of subsidiaries'
assets as to which their income will be excluded from Wisconsin tax. Settlement
on the terms outlined would result in the Department's rescission of related
prior letter rulings, and would purport to be binding going forward except for
future legislation or change by mutual agreement. By implication, the Department
appears to accept the general proposition that some out-of-state investment
subsidiary income is not subject to Wisconsin taxes.

The Company continues to believe that it has reported income and paid Wisconsin
taxes correctly in accordance with applicable tax laws and the Department's
prior longstanding interpretations thereof, including interpretations issued
specifically to it. However, in view of the Department's subsequent change in
position (even if that change does not have a basis in law), the aggressive
stance now being taken by the Department, the settlements by some other banks,
and the potential effect that decisions by other similarly situated institutions
may have on the Company's alternatives going forward, the Company has determined
that it would be prudent to obtain and consider a settlement proposal from the
Department; however, the Company has not yet received a specific proposal nor
has any assessment been made against the Company or its subsidiaries. The
Company will need to review any settlement proposal in more specific detail to
quantify in any definitive way the Department's view of its exposure and to
evaluate alternatives. Although there will likely be challenges to the
Department's actions and interpretations, the Bank's net income would be reduced
if the Department succeeds in its actions and interpretations. The Bank could
also incur costs in the future to address any action taken against it by the
Department.

RESULTS OF OPERATIONS

The following table sets forth the Company's net income and related summary
information for the three-months periods ended March 31, 2005 and 2004, as well
as comparisons between the respective periods.

TABLE 1
SUMMARY RESULTS OF OPERATIONS
($ in thousands, except per share data)

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

The increase in net income for the three-month periods is primarily due to
increased net interest income, other income and a reduction in the provision for
loan losses. This increase was partially offset by an increase in other expenses
and income tax expense.

Net Interest Income

Net interest income is the largest component of the Company's operating income
(net interest income on a tax-equivalent basis plus other non-interest income),
accounting for 79.8% of total operating income for the three months ended March
31, 2005, as compared to 80.5% for the same period in 2004. Net interest income
represents the difference between interest earned on loans, investments and
other interest earning assets offset by the interest expense attributable to the
deposits and the borrowings that fund such assets. Interest fluctuations
together with changes in the volume and types of earning assets and
interest-bearing liabilities combine to affect total net interest income. This
analysis discusses net interest income on a tax-equivalent basis in order to
provide comparability among the various types of earned interest income.
Tax-exempt interest income is adjusted to a level that reflects such income as
if it were fully taxable.

Net interest income on a tax equivalent basis for the three months ended March
31, 2005 increased $792,000, or 9.8%, to $8.9 million from $8.1 million over the
comparable period a year ago. The increase results from improvement in our net
interest margin and from increased loan levels.

Net interest margin is tax-equivalent net interest income expressed as a
percentage of average earning assets. The net interest margin exceeds the
interest rate spread because of the use of non-interest bearing sources of funds
to fund a portion of earning assets. As a result, the level of funds available
without interest cost (demand deposits and equity capital) is an important
component increasing net interest margin.

The net interest margin for the first quarter of 2005 was 3.66%, up 10 basis
points ("bps") from 3.56% for the comparable period in 2004. This comparable
period increase was attributable to an 8 bps increase in interest rate spread
(the net result of a 48 bps increase in the yield on earning assets offset
partially by a 40 bps increase in the cost of interest-bearing liabilities).

As the Federal Reserve Board ("FRB") has steadily increased interest rates
during the latter half of 2004 and the early part of 2005, average interest
rates were higher in 2005 than in 2004. Interest rates rose steadily during the
quarter with two rate increases totaling 50 bps between the comparable first
quarter periods. The Company had positioned the balance sheet to be slightly
asset sensitive (which means that assets will re-price faster than liabilities);
thus, the rate increases impacted net interest income positively. The Company
expects that in a gradually increasing interest rate environment, we would
continue to anticipate that our income statement would benefit from asset
sensitivity over the long term, although changes in the portfolio or the pace of
increases could affect that trend

14

For the three months ended March 31, 2005, average-earning assets increased
$61.4 million, or 6.7%, when compared to the same period last year. The Company
recorded an increase in average loans of $40.3 million, or 5.6%, for the first
quarter of 2005 compared to the same period a year ago. Loans have typically
resulted in higher rates of interest income to the Company than have investment
securities, which further positively affected income in the quarter.

Interest rate spread is the difference between the tax-equivalent rate earned on
average earning assets and the rate paid on average interest-bearing
liabilities. The interest rate spread increased for the quarter ended March 31,
2005 when compared to the same period a year ago. The interest rate spread
increased 8 bps to 3.40% at March 31, 2005 from 3.32% in the same quarter in
2004. While the average yield on earning assets increased 48 bps during the
period, the average rate paid on interest-bearing liabilities increased 40 bps
over the same period. The increase in the rates paid on interest-bearing
liabilities occurred as a result of a higher cost of funding from deposits and
other wholesale funding such as federal funds purchased and loans from the
Federal Home Loan Bank. We would expect that trend to continue in light of the
recent Federal Reserve Board interest rate increases.

TABLE 2
NET INTEREST INCOME ANALYSIS ON A TAX-EQUIVALENT BASIS
($ In thousands)

Three months ended March 31,

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 92.7% and 92.8%, respectively, for the first three months
of 2005 and 2004, respectively.

Provision for Loan Losses

The provision for loan losses ("PFLL") is the cost of providing an allowance for
probable incurred losses. Prior to the third quarter of 2004, the Company
determined the allowance by risk rating loans that were classified as
substandard or doubtful thru a grading process that was predicated on various
risk rating matrices and the assignment of potential loss based on those
ratings. In addition, the remaining loans in the portfolio were assigned risk
weightings based on their various classifications. During the third quarter of
2004, the Company further enhanced its methodologies to individually review
substandard and doubtful loans for impairment and bring other factors into the
process to evaluate the ALL. The Company made these enhancements to more
accurately reflect the risk inherent in the loan portfolio by engaging in the
additional analysis.

16

As previously discussed, the allowance consists of specific and general
components. The specific component relates to loans that are individually
classified as impaired or loans otherwise classified as substandard or doubtful.
The general component covers non-classified loans and is based on historical
loss experience adjusted for current factors. These current factors, include
loan growth, net charge-offs, changes in the composition of the loan portfolio,
delinquencies, management's evaluation of loan quality, general economic factors
and collateral values.

As a result of this process, the PFLL for the first three months of 2005 was
$30,000 as compared to a PFLL of $775,000 for the first three months in 2004.
The calculation of the amount took into account net improvements in the loan
portfolio in the period. Net loan charge-offs in the first three months of 2005
were $196,000 compared with net charge-offs of $283,000 for the same period in
2004. Net charge-offs as a percentage of average loans is a key measure of asset
quality. Net charge-offs to average loans were 0.10% for the first three months
of 2005 compared to 0.16% for the same period in 2004. For the three months
ended March 31, 2005, non-accrual loans increased $2.4 million, in part as the
result of a transfer to non-accrual of a $2.1 million commercial real estate
credit from the watch list. As a result, there was not a material change in the
amount of reserve allocated to this credit. At the end of April, this credit had
been reduced to $1.1 million and was current. Restructured loans decreased
significantly, primarily as a result of a $4.8 million credit that has improved
in asset quality and has performed according to the modified loan terms and has
been transferred to a performing loan status, as a result. Total non-performing
loans therefore decreased $3.1 million in the quarter.

TABLE 3
ALLOWANCE FOR LOAN LOSSES
($ in thousands)

As described more fully in Table 7 below, non-accrual loans increased during the
period from December 31, 2004, however, the total amount of non-performing loans
decreased by $3,052,000 and non-performing assets decreased by $3,246,000.
Furthermore, despite the increase in non-accrual loans during the quarter ended
March 31, 2005, the required allocation of the allowance for such loans
increased only minimally resulting in a provision of $30,000 for the first
quarter of 2005.

Management believes that the current provision conforms to the Company's loan
loss reserve policy and is adequate in view of the present condition of the
Company's loan portfolio. However, a decline in the quality of our loan
portfolio, as a result of general economic conditions, factors affecting
particular borrowers or our market area, or otherwise, could affect the adequacy

17

of the allowance. If there are significant charge-offs against the allowance, or
we otherwise determine that the allowance is inadequate, we will need to make
higher provisions in the future. See "Risk Management and the Allowance for Loan
Losses" and "Non-Performing Loans, Potential Problem Loans and Other Real
Estate" below for more information related to non-performing loans.

Non-Interest Income

Total non-interest income increased $293,000, or 14.9% to $2.3 million for the
first quarter of 2005 when compared to the first quarter of 2004. The
non-interest income to average assets ratio was 0.86% for the three months ended
March 31, 2005 compared to 0.81% for the same period in 2004. The increase in
non-interest income for the three-month periods is mainly due to increases in
other services to customers and other income offset by a decrease in gains from
sales of loans.

Table 4 reflects the various components of non-interest income for the
comparable quarters.

TABLE 4
NON-INTEREST INCOME
($ in thousands)

Service charges on deposit accounts increased $70,000 for the three-month period
ended March 31, 2005 due in part to the implementation of an overdraft privilege
program started in the third quarter of 2004 and other price increases
implemented during the latter part of 2004.

In the first quarter of 2005, gains from sales of loans were affected by a
slowdown in refinancing activity throughout the industry due to higher mortgage
rates. In comparison, the same period in 2004 saw slightly higher levels of loan
refinancing as a result of the historically low interest rate environment. Gains
from sales of loans decreased $100,000 between the comparable quarters of 2005
and 2004. The decrease was driven primarily by secondary mortgage and commercial
loan production (loan production to be sold to the secondary market) and
resulting sales. As interest rates have increased over the quarter, the Company
has seen a decrease in the number of loan applications. Secondary loan
production declined 60.0% between the comparable first three-

18

month periods ($7.7 million in the first three months of 2005 versus $19.4
million in the first three months of 2004).

For the three-month period ended March 31, 2005, the increase in other income
was related to a gain on sale of stock of $179,000 in connection with a third
party acquisition of Pulse (an ATM operator/provider) in which the Bank held
shares.

Financial service income increased $38,000, or 25.7%, as a result of additional
business generated and aided by favorable market conditions.

Non-Interest Expense

Non-interest expense increased $673,000 or 10.6%, to $7.0 million for the three
months ended March 31, 2005 compared to the same period in 2004. The
non-interest expense to average assets ratio was 2.68% for the three months
ended March 31, 2005 compared to 2.61% for the same period in 2004.

Net overhead expense is total non-interest expense less total non-interest
income excluding securities gains. The net overhead expenses to average assets
ratio was 1.82% for the three months ended March 31, 2005 compared to 1.80% for
the same period in 2004. The efficiency ratio is total non-interest expense as a
percentage of the sum of net-interest income on a fully taxable equivalent basis
and total non-interest income. The efficiency ratio for the three months ended
March 31, 2005 was 63.03% compared to 63.13% for the same period in 2004.

TABLE 5
NON-INTEREST EXPENSE
($ in thousands)

19

Salaries and employee benefits showed an increase of $663,000, or 17.2%, to $4.5
million for the first quarter of 2005 compared to the same period in 2004. The
number of full-time equivalent employees was 308 as of March 31, 2005 compared
to 300 as of March 31, 2004. For the three months ended March 31, 2005,
salary-related expenses increased $132,000, or 4.9%, due principally to merit
increases between the years. In the first quarter, the Company implemented the
Baylake Bank Supplemental Executive Retirement Plan ("Plan"), which is intended
to provide certain management and highly compensated employees of the Bank who
have contributed, and are expected to continue to contribute, to the Bank's
success by providing for deferred compensation in addition to that available
under the Bank's other retirement programs. It amounted to approximately
$300,000 in expenses related to the vested portion of the Plan contributions in
the first quarter of 2005. Accrued bonus expense and benefit costs, principally
for health insurance and pension costs, represent the remaining increase in
personnel-related costs. The increase in health insurance costs is expected to
continue for the balance of 2005 and for 2006. Management will continue its
efforts to control salaries and employee benefits expense, although increases in
these expenses are likely to continue in future years.

Expenses related to the operation of other real estate owned decreased $77,000
to $48,000 for the 2005 three-month period compared to the same period in 2004.
Included in these expenses were net gains taken on the sale of other real estate
owned amounting to $43,000 for the first three months of 2005 compared to net
gains taken on sale of $52,000 for the same period in 2004. In addition, costs
related to the holding of other real estate owned properties decreased $86,000
to $91,000 for the first three months of 2005.

Legal and professional expense for 2005 increased substantially, by $84,000, to
$176,000. The increase was the result of increased costs relative to SEC
compliance primarily as a result of enhanced requirements imposed by the
Sarbanes-Oxley Act of 2002 and related SEC actions.

Income Taxes

Income tax expense for the Company for the three months ended March 31, 2005 was
$1.2 million, an increase of $451,000, or 58.8%, compared to the same period in
2004. The higher tax expense in 2005 reflected the Company's increase in before
tax earnings.

The Company's effective tax rate (income tax expense divided by income before
taxes) was 32.0% for the three months ended March 31, 2005 compared with 28.8%
for the same period in 2004. The effective tax rate of 32.0% consisted of a
federal effective tax rate of 27.8% and Wisconsin State effective tax rate of
4.2%. Taxable income increased while tax-exempt interest income from municipal
investments and income from BOLI did not increase in a like manner.

Income tax expense recorded in the consolidated statements of income involves
interpretation and application of certain accounting pronouncements and federal
and state tax codes, and is, therefore, considered a critical accounting policy.
The Company undergoes examination by various taxing authorities. Such taxing
authorities may require that changes in the amount of tax expense or valuation
allowance be recognized when their interpretations differ from those of
management, based on their judgments about information available to them at the
time of their examinations. See "Critical Accounting Policies-Income Tax
Accounting" above regarding Wisconsin tax matters which may affect our income
tax expense.

20

BALANCE SHEET ANALYSIS

Loans

At March 31, 2005, total loans increased $26.7 million, or 3.5%, to $783.9
million from $757.2 million at December 31, 2004. Growth in the Company's loan
portfolio resulted primarily from an increase in real estate commercial loans to
$437.4 million at March 31, 2005 compared to $424.7 million at December 31,
2004. In addition, growth in real estate construction loans increased to $93.2
million at March 31, 2005 compared to $80.4 million at December 31, 2004. Growth
in commercial real estate mortgages and commercial loans occurred principally as
a result of the Company's expansion efforts (primarily in the Green Bay market)
and the strong economic growth in that market.

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

TABLE 6
LOAN PORTFOLIO ANALYSIS
($ in thousands)

Risk Management and the Allowance for Loan Losses

The loan portfolio is the Company's primary asset subject to credit risk. To
reflect this credit risk, the Company sets aside an allowance for probable
incurred credit losses through periodic charges to earnings. These charges are
shown in the Company's consolidated income statement as provision for loan
losses. See "Provision for Loan Losses" above. Credit risk is controlled and
monitored through the use of lending standards, a thorough review of potential
borrowers, and an on-going review of payment performance. Asset quality
administration, including early identification of problem loans and timely
resolution of problems, further enhances management of credit risk and
minimization of loan losses. All specifically identifiable and quantifiable
losses are charged off against the allowance. Charged-off loans are subject to
periodic review, and specific efforts are taken to achieve maximum recovery of
principal and interest.

As indicated in Table 3 above, the ALL at March 31, 2005 was $10.3 million
compared with $10.4 million at the end of 2004. This was based on management's
analysis of the loan portfolio risk at March 31, 2005. As such a provision
expense of $30,000 was recorded for the quarter ended

21

March 31, 2005. The quarter to date provision has decreased by $745,000 compared
to the same period in 2004, as discussed previously.

The provision for loan losses is predominately a function of management's
evaluation of the loan portfolio, with particular emphasis directed toward
non-performing and other potential problem loans. During these evaluations,
consideration is also given to such factors as management's evaluation of
specific loans, the level and composition of impaired loans, other
non-performing loans, historical loan experience, results of examinations by
regulatory agencies and various other factors.

On a quarterly basis, management reviews the adequacy of the ALL. Commercial
credits are graded by the loan officers and the loan review function validates
the officers' grades. In the event that the loan review function downgrades the
loan, it is included in the allowance analysis at the lower grade. The grading
system is in compliance with the regulatory classifications and the allowance is
allocated to the loans based on the regulatory grading, except in instances
where there are know differences (i.e., collateral value is nominal, etc.). To
establish the appropriate level of the allowance, a sample of loans (including
impaired and non-performing loans) are reviewed and classified as to potential
loss exposure.

Based on an estimation computed pursuant to the requirements of Financial
Accounting Standards Board ("FASB") Statement No. 5, "Accounting for
Contingencies," and FASB Statements No. 114 and 118, "Accounting by Creditors
for Impairment of a Loan," the analysis of the ALL consists of two components:
(i) specific credit allocation established for expected losses resulting from
analysis developed through specific credit allocations on individual loans for
which the recorded investment in the loan exceeds its fair value; (ii) general
portfolio allocation based on historical loan loss experience for each loan
category and adjusted for economic conditions as well as specific and other
factors in the markets in which the Company operates.

In prior years the Company did not consistently use subjective reserves based on
general economic conditions and specific economic factors as a component of the
ALL analysis, but rather used the unallocated portion of the ALL to recognize
this inherent factor. During the third quarter of 2004, as part of its review of
internal control over financial reporting and efforts to improve that control,
the Company refined the process to calculate the ALL to use the subjective
factors and thus the previously unallocated portion was allocated to the various
loan categories. Management believes that there would be no change in the
balance of the ALL if this approach was used in all of the years presented.

The specific credit allocation of the ALL is based on a regular analysis of
loans over a fixed-dollar amount where the internal credit rating is at or below
a predetermined classification. The fair value of the loan is determined based
on either the present value of expected future cash flows discounted at the
loan's effective interest rate, the market price of the loan, or, if the loan is
collateral dependent, the fair value of the underlying collateral less cost of
sale.

The general portfolio allocation component of the ALL is determined
statistically using a loss migration analysis that examines historical loan loss
experience. The loss migration analysis is performed quarterly and loss factors
are updated regularly based on actual experience. The general portfolio
allocation element of the ALL also includes consideration of the amounts
necessary for concentrations and changes in portfolio mix and volume.

The ALL is based on estimates, and ultimate losses will vary from current
estimates. These estimates are reviewed monthly, and as adjustments, either
positive or negative, become

22

necessary, a corresponding increase or decrease is made in the provision for
loan losses. The composition of the loan portfolio has not significantly changed
since year-end 2004.

Management remains watchful of credit quality issues and believes that issues
within the portfolio are reflective of the challenging economic environment
experienced over the past few years. Should the economic climate deteriorate
from current levels, borrowers may experience difficulty, and the level of
non-performing loans, charge-offs and delinquencies could rise and require
further increases in the provision.

Consideration for making such allocations is consistent with the factors
discussed above, and all of the factors are subject to change; thus, the
allocation is not necessarily indicative of the loan categories in which future
loan losses will occur. It would also be expected that the amount allocated for
any particular type of loan will increase or decrease proportionately to both
the changes in the loan balances and to increases or decreases in the estimated
loss in loans of that type. In other words, changes in the risk profile of the
various parts of the loan portfolio should be reflected in the allowance
allocated.

While there exists probable asset quality problems in the loan portfolio,
management believes sufficient reserves have been provided in the ALL to absorb
probable incurred losses in the loan portfolio at March 31, 2005. Ongoing
efforts are being made to collect these loans, and the Company involves the
legal process when necessary to minimize the risk of further deterioration of
these loans for full collection.

While management uses available information to recognize losses on loans, future
adjustments to the ALL may be necessary based on changes in economic conditions
and the impact of such change on the Company's borrowers. As an integral part of
their examination process, various regulatory agencies also review the Company's
ALL. Such agencies may require that changes in the ALL be recognized when their
credit evaluations differ from those of management, based on their judgments
about information available to them at the time of their examination.

Non-Performing Loans, Potential Problem Loans and Other Real Estate

Management encourages early identification of non-accrual and problem loans in
order to minimize the risk of loss. This is accomplished by monitoring and
reviewing credit policies and procedures on a regular basis.

Non-performing loans are a leading indicator of future loan loss potential.
Non-performing loans are defined as non-accrual loans, guaranteed loans 90 days
or more past due but still accruing, and restructured loans. Additionally,
whenever management becomes aware of facts or circumstances that may adversely
impact on the collection of principal or interest on loans, it is the practice
of management to place such loans on non-accrual status immediately rather than
waiting until the loans become 90 days past due. The accrual of interest income
is discontinued when a loan becomes 90 days past due as to principal or
interest. When interest accruals are discontinued, interest credited to income
is reversed. If collection is in doubt, cash receipts on non-accrual loans are
used to reduce principal rather than recorded as interest income.

Restructuring loans involve the granting of some concession to the borrower
involving a loan modification, such as payment schedule or interest rate
changes.

23

TABLE 7
NON-PERFORMING ASSETS
($ in thousands)

As indicated in Table 7, non-performing loans at March 31, 2005 were $9.4
million compared to $12.5 million at December 31, 2004. Non-accrual loans
represented $8.3 million of the total non-performing loans. Real estate
non-accrual loans accounted for $7.5 million of the total, of which $1.1 million
was residential real estate, $2.1 million was real estate construction and $4.3
million was commercial real estate, while commercial and industrial non-accrual
loans total $723,000. Of the restructured loans at March 31, 2005, approximately
$470,000 consisted of one commercial credit and conditional loan as to which the
Bank has granted various concessions as a result of the borrowers' past cash
flow problems. Restructured loans were $1.1 million at March 31, 2005 compared
with $6.5 million at year-end 2004. As a result the ratio of non-performing
loans to total loans at March 31, 2005 was 1.20% compared to 1.64% at end of
year 2004. The Company's ALL was 109.4% of total non-performing loans at March
31, 2005 compared to 83.9% at end of year 2004.

Non-performing assets (non-performing loans plus other real estate owned assets)
at March 31, 2005 were $11.8 million compared to $15.0 million at December 31,
2004. Other real estate owned, which represents property that the Company
acquired through foreclosure or in satisfaction of debt, consisted of two
residential and twelve commercial properties totaling $2.4 million. Other real
estate owned at December 31, 2004 totaled $2.6 million and consisted of sixteen
properties.

Potential problem loans are currently performing loans that management believes
may incur difficulties in complying with loan repayment terms. Management's
decision to place loans in

24

this category does not necessarily mean that the Company expects to take losses
on such loans, but that management needs to be more vigilant in its efforts to
oversee the loans and recognize that a higher degree of risk is associated with
these potential problem loans. At March 31, 2005, potential problem loans
amounted to $2.5 million compared to a total of $9.3 million at December 31,
2004.

Investment Portfolio

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

At March 31, 2005, the investment portfolio (which includes investment
securities available for sale) increased $4.3 million, or 2.2%, to $201.7
million from $197.4 million at December 31, 2004. At March 31, 2005 and December
31, 2004, the investment portfolio represented 18.8% of total assets.

Securities available for sale consist of the following:

TABLE 8
INVESTMENT SECURITY ANALYSIS
At March 31, 2005
($ in thousands)

25

At December 31, 2004
($ in thousands)

Deposits

Total deposits at March 31, 2005 decreased $14.6 million, or 1.7%, to $830.0
million from $844.5 million at December 31, 2004. Non-interest bearing deposits
at March 31, 2005 decreased $17.4 million, or 14.5%, to $103.1 million from
$120.5 million at December 31, 2004. Interest-bearing deposits at March 31, 2005
increased $2.8 million, or 0.4%, to $726.9 million from $724.0 million at
December 31, 2004. Brokered CD's totaled $182.8 million at March 31, 2005
compared to $175.4 million at December 31, 2004. Time deposits greater than
$100,000 and brokered time deposits were priced within the framework of the
Company's rate structure and did not materially increase the average rates on
deposit liabilities. If liquidity concerns arose, the Company has alternative
sources of funds such as lines with correspondent banks and borrowing
arrangements with FHLB should the need present itself. Increased competition for
consumer deposits and customer awareness of interest rates continues to limit
the Company's core deposit growth in these types of deposits. Typically, overall
deposits for the first six months tend to decline slightly as a result of the
seasonality of the Company's customer base as customers draw down deposits
during the early first half of the year in anticipation of the summer tourist
season.

Emphasis has been, and will continue to be, placed on generating additional core
deposits in 2005 through competitive pricing of deposit products and through the
branch delivery systems that have already been established. The Company will
also attempt to attract and retain core deposit accounts through new product
offerings and quality customer service. The Company also may increase brokered
time deposits during the remainder of the year 2005 and in 2006 as an additional
source of funds to provide for loan growth in the event that core deposit growth
goals would not be accomplished. Under that scenario, the Company will continue
to look at other wholesale sources of funds, if the brokered CD market became
illiquid or more costly in terms of interest rate.

Borrowings

Federal funds purchased and securities under agreements to repurchase at March
31, 2005 increased $24.2 million to $25.5 million from $1.3 million at December
31, 2004. Federal funds purchased increased from no funds purchased at December
31, 2004 to $23.7 million at March 31,

26

2005 accounting for the majority of the increase. These have increased to fund
the growth in the loan portfolio which was coupled with a decrease in core
deposits during the quarter ended March 31, 2005.

Federal Home Loan Bank Advances totaled $115.2 million at March 31, 2005
compared to $100.2 million at December 31, 2004. Typically, borrowings increase
in order to fund growth in the loan portfolio in periods when borrowings
increase more rapidly than deposits. The Company will borrow monies if borrowing
is a less costly form of funding loans compared to the cost of acquiring
deposits or if deposit growth is not sufficient. Additionally, the availability
of deposits also determines the amount of funds the Company needs to borrow in
order to fund loan demand. The Company anticipates it will continue to use
wholesale funding sources of this nature, if these borrowings add incrementally
to overall profitability.

In connection with the issuance of Trust Preferred Securities in 2001 (see
"Capital Resources"), the Company issued long-term subordinated debentures to
Baylake Capital Trust I, a Delaware Business Trust, formed by the Company. The
aggregate principal amount of the debentures due 2031, to the trust is
$16,597,940. For additional details, please make reference to the Consolidated
Financial Statements and the accompanying footnotes on the Company's Form 10-K
for the year 2004.

CONTRACTUAL OBLIGATIONS, COMMITMENTS, OFF-BALANCE SHEET RISK, AND CONTINGENT
LIABILITIES

The Company utilizes a variety of financial instruments in the normal course of
business to meet the financial needs of its customers. These financial
instruments include commitments to extend credit, commitments to originate
residential mortgage loans held for sale, commercial letters of credit, standby
letters of credit, and forward commitments to sell residential mortgage loans.
Please refer to the Company's Annual Report on Form 10-K for the year ended
December 31, 2004 for discussion with respect to the Company's quantitative and
qualitative disclosures about its fixed and determinable contractual
obligations. Items disclosed in Form 10-K have not materially changed since that
report was filed.

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

TABLE 9
LENDING RELATED COMMITMENTS
($ in thousands)

27

The following table summarizes the Company's significant contractual obligations
and commitments at March 31, 2005:

TABLE 10
CONTRACTUAL OBLIGATIONS
($ in thousands)

LIQUIDITY

Liquidity management refers to the ability of the Company to ensure that cash is
available in a timely manner to meet loan demand and depositors' needs, and to
service other liabilities as they become due, without undue cost or risk, and
without causing a disruption to normal operating activities. The Company and the
Bank have different liquidity considerations.

The Company's primary sources of funds are dividends from the Bank, investment
income, and net proceeds from borrowings and the offerings of junior
subordinated obligations, in addition to the issuance of its common stock
securities. The Company manages its liquidity position in order to provide funds
necessary to pay dividends to its shareholders. Dividends received from Bank
totaled $1.2 million for the first three months of 2005 and will continue to be
the Company's main source of long-term liquidity. The dividends from the Bank
along with existing cash were sufficient to pay cash dividends to the Company's
shareholders of $2.3 million in the first three months of 2005.

The Bank meets its cash flow needs by having funding sources available to it to
satisfy the credit needs of customers as well as having available funds to
satisfy deposit withdrawal requests. Liquidity at the Bank is derived from
deposit growth, maturing loans, the maturity of the investment portfolio, access
to other funding sources, marketability of certain of its assets; the

28

ability to use its loan and investment portfolios as collateral for secured
borrowings and strong capital positions.

Maturing investments have been a primary source of liquidity at the Bank. For
the three months ended March 31, 2005, principal payments totaling $2.9 million
were received on investments. $10.5 million in investments were purchased in the
first three months of 2005. This resulted in net cash of $7.6 million used in
investing activities for the first three months of 2005. At March 31, 2005 the
investment portfolio contained $155.4 million of U.S. Treasury and federal
agency backed securities representing 77.1% of the total investment portfolio.
These securities tend to be highly marketable.

Deposit growth is typically another source of liquidity for the Bank in the
latter half of each year, although deposits typically shrink in the first half
resulting in a use of cash. As a financing activity reflected in the March 31,
2005 Consolidated Statements of Cash Flows, deposits decreased and resulted in
$14.6 million of cash outflow during the first three months of 2005. The
Company's overall deposit base decreased 1.7% for the three months ended March
31, 2005. Deposit growth is generally the most stable source of liquidity for
the Bank, although brokered deposits are inherently less stable than locally
generated core deposits. Affecting liquidity are core deposit growth levels,
certificate of deposit maturity structure and retention, and characteristics and
diversification of wholesale funding sources affecting the channels by which
brokered deposits are acquired. Conversely, deposit outflow will cause the Bank
to develop alternative sources of funds which may not be as liquid and
potentially a more costly alternative.

The scheduled maturity of loans can provide a source of additional liquidity.
The Bank has $240.1 million, or 30.6%, of loans maturing within one year.
Factors affecting liquidity relative to loans are loan origination volumes, loan
prepayment rates and the maturity structure of existing loans. The Bank's
liquidity position is influenced by changes in interest rates, economic
conditions and competition. Conversely, loan demand as a need for liquidity will
cause the Company to acquire other sources of funding which could be harder to
find; therefore more costly to acquire.

Within the classification of short-term borrowings at March 31, 2005, federal
funds purchased and securities sold under agreements to repurchase totaled $25.5
million compared to $1.3 million at the end of 2004. Federal funds are purchased
from various upstream correspondent banks while securities sold under agreements
to repurchase are obtained from a base of business customers. Borrowings from
FHLB, short-term or long-term, are another source of funds. They total $115.2
million at March 31, 2005 and $100.2 million at December 31, 2004.

The Bank's liquidity resources were sufficient in the first three months of 2005
to fund the growth in loans and investments, increase the volume of interest
earning assets and meet other cash needs when necessary.

Management expects that deposit growth will continue to be the primary funding
source of the Bank's liquidity on a long-term basis, along with a stable
earnings base, the resulting cash generated by operating activities, and a
strong capital position. Although federal funds purchased and borrowings from
the FHLB provided funds in the first three months of 2005, management expects
deposit growth to be a reliable funding source in the future as a result of
branch expansion efforts and marketing efforts to attract and retain core
deposits. In addition, Bank may acquire additional brokered deposits as funding
for short-term liquidity needs. Shorter-term liquidity needs will mainly be
derived from growth in short-term borrowings, maturing federal funds sold and
portfolio investments, loan maturities and access to other funding sources.

29

In assessing liquidity, historical information such as seasonality (loan
demand's affect on liquidity which starts before and during the tourist season
and deposit draw down which affects liquidity shortly before and during the
early part of the tourist season), local economic cycles and the economy in
general are considered along with the current ratios, management goals and the
unique characteristics of the Company. Management believes that, in the current
economic environment, the Company's and the Bank's liquidity position is
adequate. To management's knowledge, there are no known trends nor any known
demands, commitments, events or uncertainties that will result or are reasonably
likely to result in a material increase or decrease in the Bank's or the
Company's liquidity.

Capital Resources

Stockholders' equity at March 31, 2005 decreased $499,000 or 0.7% to $75.7
million, compared with $76.2 million at end of year 2004. The decrease in
stockholders' equity in 2005 was primarily composed of the change in unrealized
losses on available for sale securities and the payment of dividends, partially
offset by retained earnings and proceeds from the exercise of stock options. The
change in unrealized losses on available for sale securities amounted to $2.0
million for the first three months of 2005; this change resulted the effects of
the increasing interest rate environment. Total dividends paid increased to $2.3
million in the quarter from $2.1 million in 2004, primarily as a result of an
increase in the per share dividends rate to $0.15 from $0.14. Stockholders'
equity to assets at March 31, 2005 was 7.07% compared to 7.27% at the end of
2004.

In 2001, the Company formed Baylake Capital Trust I ("the Trust") as 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 trust preferred securities
enhanced regulatory capital and added liquidity. 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 for the Company 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 Company had $16.6 million of junior subordinated debentures outstanding to
the Trust and the Trust had $16.1 million of trust preferred securities
outstanding at March 31, 2005 and December 31, 2004, respectively. 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 March 31,
2005, all $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 23% of Company's
Common Stock participate in the plan.

Cash dividends paid in the first three months of 2005 were $0.15 per share
compared with $0.14 in 2004. The Company provided a 7.2% increase in normal
dividends per share in 2005 over 2004 as a result of earnings for 2005. Total
funds utilized in the payment of dividends was $2.3 million in the first three
months of 2005, as compared to $2.1 million in the corresponding period of 2004.

30

In 1997, the Company's Board of Directors authorized management, in its
discretion, to repurchase up to 7,000 shares of the Company's common stock each
calendar quarter in the market. The shares repurchased would be used to fill its
needs for the dividend reinvestment program, any future benefit plans, and the
Company's stock purchase plan. Shares repurchased are held as treasury stock and
accordingly, are accounted for as a reduction of stockholders' equity. The
Company repurchased none of its common shares in the first three months of 2005.

The adequacy of the Company's capital is regularly reviewed to ensure that
sufficient capital is available for current and future needs and is in
compliance with regulatory guidelines. The assessment of overall capital
adequacy depends upon a variety of factors, including asset quality, liquidity,
stability of earnings, changing competitive forces, economic conditions in
markets served and strength of management. Management is confident that because
of current capital levels and projected earnings levels, capital levels are more
than adequate to meet the ongoing and future concerns of the Company.

The Federal Reserve Board has established capital adequacy rules which take into
account risk attributable to balance sheet assets and off-balance sheet
activities. All banks and bank holding companies must meet a minimum total
risk-based capital ratio of 8%. Of the 8% required, at least half must be
comprised of core capital elements defined as Tier 1 capital. The federal
banking agencies also have adopted leverage capital guidelines which banking
organizations must meet. Under these guidelines, the most highly rated banking
organizations must meet a leverage ratio of at least 3% Tier 1 capital to
assets, while lower rated banking organizations must maintain a ratio of at
least 4% to 5%. Failure to meet minimum capital requirements can initiate
certain mandatory -and possible additional discretionary- actions by regulators
that, if undertaken, could have a direct material effect on the consolidated
financial statements.

At March 31, 2005 and December 31, 2004, the Company was categorized as "well
capitalized" under the regulatory framework for prompt corrective action. There
are no conditions or events since that notification that management believes
have changed the Company's category.

To be "well capitalized" under the regulatory framework, the Tier 1 capital
ratio must meet or exceed 6%, the total capital ratio must meet or exceed 10%
and the leverage ratio must meet or exceed 5%.

The following table presents the Company's and the Bank's capital ratios as of
March 31, 2005 and December 31, 2004:

TABLE 11
CAPITAL RATIOS
($ in thousands)

Management believes that a strong capital position is necessary to take
advantage of opportunities for profitable expansion of product and market share,
and to provide depositor and investor confidence. The Company's capital level is
strong, but also must be maintained at an appropriate level to provide the
opportunity for an adequate return on the capital employed. Management actively
reviews capital strategies for the Company to ensure that capital levels are
appropriate based on the perceived business risks, further growth opportunities,
industry standards, and regulatory requirements.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK.

The Company's financial performance is affected by, among other factors, credit
risk and interest rate risk. The Company does not use derivatives to mitigate
its interest rate risk or credit risk, relying instead on loan review and its
loan loss reserve.

The Company's earnings are derived from the operations of its direct and
indirect subsidiaries with particular reliance on net interest income,
calculated as the difference between interest earned on loans and investments
and the interest expense paid on deposits and other interest bearing
liabilities, including advances from FHLB and other borrowings. Like other
financial institutions, the Company's interest income and interest expense are
affected by general economic conditions and by the policies of regulatory
authorities, including the monetary policies of the Board of Governors of the
Federal Reserve System. Changes in the economic environment may influence, among
other matters, the growth rate of loans and deposits, the quality of the loan
portfolio and loan and deposit pricing. Fluctuations in interest rates are not
predictable or controllable.

32

As of March 31, 2005, the Company was in compliance with its management policies
with respect to interest rate risk. The Company has not experienced any material
changes to its market risk position since December 31, 2004, as described in the
Company's 2004 Form 10-K Annual Report.

The Company's overall interest rate sensitivity is demonstrated by net interest
income analysis. Net interest income analysis measures the change in net
interest income in the event of hypothetical changes in interest rates. This
analysis assesses the risk of change in net interest income in the event of
sudden and sustained 1.0% to 2.0% increases and decreases in market interest
rates. The table below presents the Company's projected changes in net interest
income for the various rate shock levels at March 31, 2005.

TABLE 12
INTEREST SENSITIVITY
($ in thousands)

As shown above, at March 31, 2005, the effect of an immediate 200 basis point
increase in interest rates would increase the Company's net interest income by
$1.6 million or 4.2%. The effect of an immediate 200 basis point reduction in
rates would decrease the Company's net interest income by $2.5 million or 6.9%.

Changes in the mix of earning assets and interest-bearing liabilities increased
the Company's asset sensitivity during the past twelve months.

Computations of the prospective effects of hypothetical interest rate changes
are based on numerous assumptions, including the relative levels of market
interest rates and loan prepayments, and should not be relied upon as indicative
of actual results. Actual values may differ from those projections set forth
above, should market conditions vary from the assumptions used in preparing the
analyses. Further, the computations do not contemplate any actions the Company
may undertake in response to changes in interest rates.

ITEM 4. CONTROLS AND PROCEDURES

DISCLOSURES CONTROLS AND PROCEDURES: The Company's management, with the
participation of the Company's Chief Executive Officer and Chief Financial
Officer, has evaluated the effectiveness of the Company's disclosure controls
and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under
the Securities Exchange Act of 1934, as amended (the "Exchange Act") as of March
31, 2005. Based on such evaluation, the Company's Chief Executive Officer and
Chief Financial Officer have concluded that, as of the end of such period, the
Company's disclosure controls and procedures are effective in timely alerting
them to material information relating to the Company's disclosure controls and
procedures to the Company required to be included in this quarterly report on
Form 10-Q.

33

INTERNAL CONTROL OVER FINANCIAL REPORTING: There have not been any changes in
the Company's internal control over financial reporting (as such term is defined
in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the fiscal
quarter to which this report relates that have materially affected, or are
reasonably likely to materially affect, the Company's internal controls
subsequent to the date of such evaluation with the exception of enhancements
made during the quarter to the calculation of the allowance for loan loss
reserve. Such enhancement is explained in Item 2, Management's Discussion and
Analysis found in the sections entitled "Provision for Loan Losses" and "Balance
Sheet Analysis-Risk Management and the Allowance for Loan Losses" which
discussions are incorporated by reference in this item.

PART II - OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

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

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

None

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None

ITEM 5. OTHER INFORMATION

None

ITEM 6. EXHIBITS

The following exhibits are furnished herewith:

34

32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C.
Section 1350, as Adopted Pursuant to Section 906 of
Sarbanes-Oxley is attached hereto.

32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C.
Section 1350, as Adopted Pursuant to Section 906 of
Sarbanes-Oxley is attached hereto.

SIGNATURES

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

BAYLAKE CORP.
-------------

Date: May 10, 2005 /s/ Thomas L. Herlache
------------ -------------------------------
Thomas L. Herlache
President (CEO)

Date: May 10, 2005 /s/ Steven D. Jennerjohn
------------ -------------------------------
Steven D. Jennerjohn
Treasurer (CFO)

35