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

 

Nonperforming loans are as follows:

 

NONPERFORMING LOANS

		June 30,  2015				March 31,  2015				December 31, 2014				September 30, 2014				June 30, 2014
Nonaccrual loans		$	4,708			$	5,731			$	5,155			$	5,647			$	6,794
Loans restructured in a troubled debt restructuring, nonaccrual			62				—				—				256				256
Total nonperforming loans (“NPLs”)		$	4,770			$	5,731			$	5,155			$	5,903			$	7,050
Restructured loans, accruing		$	6,816			$	6,907			$	8,656			$	8,656			$	8,472

During the quarter ended June 30, 2015, $0.3 million of additional loan balances became nonaccrual, of which $0.1 million related to a single relationship. This increase was offset by $0.9 million of payments received during the second quarter of 2015, $0.1 million in loans brought current, and $0.2 million of nonaccrual loan balances charged off. One nonaccrual loan was transferred to other real estate owned during the second quarter of 2015, totaling less than $0.1 million.

During the quarter ended June 30, 2015, one restructured loan of $0.1 million was changed to nonaccrual status. This loan was restructured during the quarter ended March 31, 2015, but had continued to accrue interest under its restructured terms. No loans were restructured during the second quarter of 2015.

 

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BAYLAKE CORP.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2015

(Dollar amounts in thousands)

9.           Other Real Estate Owned, Net

Other real estate owned is summarized as follows:

		For the six months ended June 30,
		2015				2014
Beginning balance		$	5,093			$	8,566
Transfer of net realizable value to other real estate owned			45				75
Sale proceeds			(196	)			(1,162	)
Net gain from disposal of other real estate owned			6				43
Valuation allowance related to properties disposed			(152	)			(646	)
Total other real estate owned			4,796				6,876
Valuation allowance for losses			(774	)			(1,823	)
Total other real estate owned, net		$	4,022			$	5,053

Changes in the valuation allowance for losses on total other real estate owned were as follows:

		For the six months ended June 30,
		2015				2014
Beginning balance		$	827			$	2,268
Provision charged to operations			99				201
Amounts related to properties disposed			(152	)			(646	)
Balance at end of period		$	774			$	1,823

 

The foreclosure process commences on consumer real estate loans when a borrower becomes 120 or greater days delinquent in accordance with Consumer Finance Protection Bureau suggested guidelines.  Foreclosure procedures and timelines may vary depending on a variety of factors, including where the property resides.  At both June 30, 2015 and December 31, 2014, the recorded investment in consumer mortgage loans that were in the process of foreclosure was $0.3 million.  Additionally, $0.2 million at June 30, 2015 and $0.3 million at December 31, 2014 of loans serviced for and guaranteed by FHLMC were in the process of foreclosure. Although these loans continue to be serviced by the Bank, these loans are sold to FHLMC once originated and therefore, no balances are included in the Company’s balance sheet.

Consumer mortgage properties are derecognized as mortgage loans and classified as Other Real Estate Owned when the Bank has control of the property, regardless of whether legal title has been transferred in the completed foreclosure process.  At both June 30, 2015 and December 31, 2014, titles relating to all of the consumer mortgage loan properties classified as Other Real Estate Owned had been transferred to the Company.

 

10.         Income Taxes

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

A tax position is recognized as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination.  The amount recognized is the largest amount of tax benefit that has a greater than 50% chance of being realized on examination.  For tax positions not meeting the “more likely than not” test, no tax benefit is recorded.

 

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BAYLAKE CORP.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2015

(Dollar amounts in thousands, except per share data)

Management regularly reviews the carrying amount of the Company’s deferred income tax assets to determine if the establishment of a valuation allowance is necessary.  If, based on the available evidence, it is more likely than not that all or a portion of the deferred income tax assets will not be realized in future periods, a deferred income tax valuation allowance would be established.  Consideration is given to various positive and negative factors that could affect the realization of the deferred income tax assets. In evaluating available evidence, management considers, among other things, historical financial performance, expectation of future earnings, the ability to carry back losses to recoup taxes previously paid, length of statutory carryforward periods, experience with operating loss and tax credit carryforwards not expiring unused, tax planning strategies and timing of reversals of temporary differences.  Significant judgment is required in assessing future earnings trends and the timing of reversals of temporary differences.  The evaluation is based on current tax laws as well as management’s expectations of future performance.  At June 30, 2015 and December 31, 2014, the Company determined that no valuation allowance was required to be taken against the deferred income tax asset.

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

The Company is no longer subject to examination by U.S. Federal taxing authorities for years before 2011 and for Wisconsin state income taxes for years before 2010. The Internal Revenue Service (“IRS”) conducted audits of the Company’s 2011 federal income tax return in 2013 and of the Company’s 2012 federal tax return in 2014. There were no significant adjustments related to the audits. The Company does not expect the total amount of unrecognized tax benefits to significantly increase or decrease in the next twelve months.

The Company recognizes interest and/or penalties related to income tax matters in income tax expense.

11.         Equity Investment

 

The Bank owns a 99.2% interest (500 shares) in United Financial Services, Incorporated (“UFS, Inc.”), a data processing company. During the third quarter of 2014, a tax strategy reorganization of UFS, Inc. was launched with the intent of providing a more favorable tax structure to UFS, Inc. and its shareholders, including the Bank.  This transaction was completed in the fourth quarter of 2014.  As part of this reorganization, UFS, LLC was formed.  Collectively, UFS, Inc. and UFS, LLC are referred to as the “UFS.” UFS, Inc. owns a 50.2% profits interest in UFS, LLC.  Under the new structure, the Bank owns a 49.8% indirect profits interest in UFS, LLC through its 99.2% ownership of UFS, Inc. As part of the transaction, the Bank paid $0.7 million to UFS, LLC’s other 49.8% shareholder during the fourth quarter of 2014 as reimbursement from the disproportionate share of tax obligations borne by that shareholder resulting from the overall restructuring transaction. Approximately $0.1 million of that reimbursement was returned to the Bank in the first quarter of 2015 due to a revision of the amount calculated. The transaction was settled during the second quarter of 2015 with the Bank making a $0.2 million additional reimbursement to the other shareholder as the tax calculations for the transaction were finalized.

In addition to the ownership interest, the Bank and UFS, Inc. have a common member on each of their respective Boards of Directors. The investment in this entity is carried on the Bank’s balance sheet under the equity method of accounting and the pro rata share of its net income is included in noninterest income in the consolidated statement of operations and increases the Bank’s investment in UFS. As dividends are received from UFS, Inc. the Bank’s investment is reduced. The carrying value of the Bank’s investment in UFS, Inc. was $4.9 million at June 30, 2015 and $4.6 million at December 31, 2014.  The book value of UFS, Inc. was approximately $9,893 per share and $9,279 per share at June 30, 2015 and December 31, 2014, respectively.

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BAYLAKE CORP.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2015

(Dollar amounts in thousands)

12.         Mortgage Servicing Rights

The Company has obligations to service residential first mortgage loans and commercial loans that have been sold in the secondary market with servicing retained.  Mortgage servicing rights (“MSRs”) are recorded at fair value when such loans are sold. On a quarterly basis, MSRs are valued based on a model that calculates their fair value using assumptions comparable to those used by market participants in estimating the present value of future net servicing income.

 

Changes in the carrying value of MSRs are as follows:

MORTGAGE SERVICING RIGHTS

		For the three months ended June 30, 2015								For the six months ended June 30, 2014
		2015				2014				2015				2014
Balance at beginning of period		$	845			$	906			$	841			$	967
Additions from loans sold with servicing retained			34				15				54				31
Loan payments and payoffs			(25	)			(25	)			(43	)			(45	)
Changes in valuation			18				(32	)			20				(89	)
Fair value of MSRs at the end of period		$	872			$	864			$	872			$	864

Unpaid principal balance of loans serviced for others was $124.7 million and $123.4 million at June 30, 2015 and June 30, 2014, respectively.

13.         Promissory Notes

During 2009 and 2010, the Company issued 10% Convertible Notes due June 30, 2017 totaling $9.5 million. The Convertible Notes were offered and sold in reliance on the exemption from registration under Section 4(2) of the Securities Act of 1933 and Rule 506 promulgated thereunder.

The Convertible Notes accrued interest at a fixed rate of 10% per annum upon issuance and until maturity or earlier conversion or redemption. Interest was payable quarterly, in arrears, on January 1, April 1, July 1, and October 1 of each year. The Convertible Notes were convertible into shares of common stock at a conversion ratio of one share of common stock for each $5.00 in aggregate principal amount held on the record date of the conversion, subject to certain adjustments as described in the Convertible Notes (the “Conversion Ratio”).  Prior to the fifth anniversary of issuance, each holder of the Convertible Notes could convert up to 100% (at the discretion of the holder) of the original principal amount into shares of common stock at the Conversion Ratio. Beginning on July 1, 2014, the Company was entitled to redeem the notes in whole or in part.  A notice of redemption superseded and took priority over any notice of conversion.   On October 1, 2014, one-half of the original principal amounts were mandatorily convertible into common stock at the Conversion Ratio if voluntary conversion had not occurred. The principal amount of any Convertible Notes that were not converted was payable at maturity on June 30, 2017.

Beginning January 1, 2014, the Company began redeeming Convertible Notes at the investors’ option under the terms described in the preceding paragraph.  In 2014, $6.1 million of Convertible Notes converted into 1,220,000 shares of the Company’s common stock under this option.  On October 1, 2014, an additional $1.7 million of Convertible Notes was converted into 330,000 shares of the Company’s common stock under the mandatory conversion provision of the Convertible Notes.  During the first quarter of 2015, $0.6 million of Convertible Notes were converted into 115,000 shares of the Company’s common stock at the option of the holder.  On April 1, 2015, the remaining $1.1 million of Convertible Notes were converted in full under the voluntary conversion provisions into 215,000 shares of the Company’s Common Stock, resulting in no remaining outstanding Convertible Notes at June 30, 2015.

 

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BAYLAKE CORP.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2015

(Dollar amounts in thousands)

14.         Troubled Debt Restructuring

A troubled debt restructuring (“TDR”) is a loan modification resulting from a borrower experiencing financial difficulty and the Bank granting a concession to that borrower that would not otherwise be considered except for the borrower’s financial difficulties.  A TDR may be on either accrual or nonaccrual status based upon the performance of the borrower and management’s assessment of collectability.  A TDR remains classified as such until a sufficient period of performance under the restructured terms has occurred, generally six months, at which time it is no longer deemed to be a TDR.
 

Changes in TDRs for the six months ended June 30, 2015 are as follows:

		Construction				Real Estate- Residential				Real Estate- Commercial				Commercial- Syndicated				Commercial- Other				Consumer				Tax Exempt				Total
Accruing
January 1, 2015		$	—			$	—			$	8,640			$	—			$	16			$	—			$	—			$	8,656
Principal payments			—				—				(32	)			—				—				—				—				(32	)
Charge-offs			—				—				—				—				—				—				—				—
Advances			—				—				—				—				—				—				—				—
New restructured			—				—				—				—				—				62				—				62
Transfers out of TDRs			—				—				(1,792	)			—				(16	)			—				—				(1,808	)
Transfers to nonaccrual			—				—				—				—				—				(62	)			—				(62	)
June 30, 2015		$	—			$	—			$	6,816			$	—			$	—			$	—			$	—			$	6,816
Nonaccrual
January 1, 2015		$	—			$	—			$	—			$	—			$	—			$	—			$	—			$	—
Principal payments			—				—				—				—				—				—				—				—
Charge-offs			—				—				—				—				—				—				—				—
Advances			—				—				—				—				—				—				—				—
New restructured			—				—				—				—				—				—				—				—
Transfers to other real estate owned			—				—				—				—				—				—				—				—
Transfers from accruing			—				—				—				—				—				62				—				62
June 30, 2015		$	—			$	—			$	—			$	—			$	—			$	62			$	—			$	62
Totals
January 1, 2015		$	—			$	—			$	8,640			$	—			$	16			$	—			$	—			$	8,656
Principal payments			—				—				(32	)			—				—				—				—				(32	)
Charge-offs			—				—				—				—				—				—				—				—
Advances			—				—				—				—				—				—				—				—
New restructured			—				—				—				—				—				62				—				62
Transfers out of TDRs			—				—				(1,792	)			—				(16	)			—				—				(1,808	)
Transfers to other real estate owned			—				—				—				—				—				—				—				—
June 30, 2015		$	—			$	—			$	6,816			$	—			$	—			$	62			$	—			$	6,878

 

During the first quarter of 2015, one loan totaling $0.1 million was restructured and was subsequently transferred to nonaccrual status during the quarter ended June 30, 2015. Also during the six months ended June 30, 2015, $1.8 million of accruing restructured loans were removed from restructured status due to compliance with their restructured terms for at least six months.

 

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BAYLAKE CORP.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2015

(Dollar amounts in thousands)

A summary of troubled debt restructurings as of June 30, 2015 and December 31, 2014 is as follows:

		June 30, 2015								December 31, 2014
		Number of Modifications				Recorded Investment				Number of Modifications				Recorded Investment
Construction			—			$	—				—			$	—
Real estate – Residential			—				—				—				—
Real estate – Commercial			8				6,816				9				8,640
Commercial-Syndicated			—				—				—				—
Commercial-Other			—				—				1				16
Consumer			1				62				—				—
Tax exempt			—				—				—				—
Total			9			$	6,878				10			$	8,656

 

A summary of troubled debt restructurings as of June 30, 2015 by restructure type is as follows:

		Accruing				Nonaccruing				Total
Payment schedule changes		$	6,550			$	62			$	6,612
Interest rate reduction			266				—				266
Total		$	6,816			$	62			$	6,878

 

15.         Commitments and Contingencies

 

The following is a summary of the Company’s off-balance sheet commitments, all of which were lending-related commitments:

LENDING RELATED COMMITMENTS

		June 30, 2015				December 31, 2014
Commitments to fund unused home equity line loans		$	60,122			$	59,163
Commitments to fund 1-4 family loans			3,872				2,606
Commitments to fund residential real estate construction loans			4,371				3,014
Commitments unused on commercial lines of credit loans			181,914				154,405
Commitments unused on consumer lines of credit loans			9,624				9,333
Total commitments to extend credit		$	259,903			$	228,521
Financial standby letters of credit		$	40,078			$	9,757

 

The increase in financial standby letters of credit during the first six months of 2015 resulted from origination of a standby letter of credit with the FHLB on behalf of a municipal customer as collateral for their interest bearing deposit balances. This fluctuating balance financial standby letter of credit (“LOC”) through the FHLB Public Link Deposit program is supported by loan and/or investment security collateral as an alternative to directly pledging of investment securities to specific customers. Under the agreement with this customer, the amount of the LOC may increase or decrease quarterly with a maximum limit between $20.0 million to $40.0 million, depending on the time of year. At June 30, 2015, this LOC was $30 million.

 

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

General

Baylake Corp. (“we,” “us” or “our”) is a Wisconsin corporation that is registered with the Board of Governors of the Federal Reserve (the “Federal Reserve”) as a bank holding company under the Bank Holding Company Act of 1956, as amended. We have two wholly- owned subsidiaries: Admiral Asset Management, LLC (“Admiral”) and Baylake Bank (the “Bank”). Admiral was formed in the fourth quarter of 2013 as a registered investment advisory subsidiary to provide investment advisory services in addition to those offered by the Bank. The Bank is a Wisconsin state-chartered bank that provides a wide variety of loan, deposit and other banking products and services, as well as a full range of trust, investment and treasury management services to its business, retail and municipal customers. The Bank is a member of the Federal Reserve and the Federal Home Loan Bank of Chicago.

The following sets forth management’s discussion and analysis of our consolidated financial condition at June 30, 2015 and December 31, 2014 and our consolidated results of operations for the three and six months ended June 30, 2015 and 2014. This discussion and analysis should be read together with the consolidated financial statements and accompanying notes contained in Part I of this Form 10-Q, as well as our Annual Report on Form 10-K for the year ended December 31, 2014.

Forward-Looking Information

This discussion and analysis of consolidated financial condition and results of operations, and other sections of this report, may contain forward-looking statements that are based on the current expectations of management. Such expressions of expectations are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Words such as “anticipates,” “believes,” “estimates,” “expects,” “forecasts,” “intends,” “is likely,” “plans,” “projects,” and other such words are intended to identify such forward-looking statements. The statements contained herein and in such forward-looking statements involve or may involve certain assumptions, risks and uncertainties, many of which are beyond our control that may cause actual future results to differ materially from what may be expressed or forecasted in such forward-looking statements. Readers should not place undue expectations on any forward-looking statements. In addition to the assumptions and other factors referenced specifically in connection with such statements, the following factors could cause actual results to differ materially from the forward-looking statements: the factors described under “Risk Factors” in Item 1A of Part II of this Quarterly Report on Form 10-Q and Part I of our Annual Report on Form 10-K for the year ended December 31, 2014, which are incorporated herein by reference, and other risks that may be identified or discussed in this Form 10-Q.

Acquisition Agreement

On May 8, 2015, we announced the signing of a definitive agreement to acquire NEW Bancshares, Inc. (“NEW”) in a cash and stock transaction. NEW, headquartered in Kewaunee, Wisconsin, is the parent company of Union State Bank (“Union”), which operates four locations in northeast Wisconsin. At June 30, 2015, Union had approximately $85.8 million in total assets, $49.3 million in loans, and $74.61 million in deposits.

Under the terms of the agreement, we will pay approximately $9.7 million in total consideration in the merger, subject to adjustment as described in the merger agreement, approximately 60% of which will be paid in cash and 40% in our common stock. In order to complete the acquisition transaction as structured, we may borrow up to $6.0 million with an anticipated final maturity of ten years.  The transaction is subject to regulatory and NEW shareholder approval as well as certain closing conditions. The transaction is expected to be completed in the fourth quarter of 2015.

Branch Closure

In January 2015, we announced our intention to close one of our branches in Brown County. This closure was consummated in April 2015, however, the property is being retained for use in future bank operations.

Land Held for Sale

In April 2015, we accepted an offer to sell a vacant real estate property we own located in Neenah, Wisconsin. The property is reflected in our Consolidated Balance Sheet as Premises and Equipment held for sale in the amount of $0.8 million. This transaction is expected to be completed no later than September 1, 2015, pending satisfaction of conditions in the offer,and is expected to result in a gain on sale of $0.1 million.

 

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Branch Facilities

 

In June 2015, we entered into an agreement to purchase, subject to conditions of the agreement, a building and the accompanying real estate in Sister Bay, Wisconsin in the amount of $1.1 million. The transaction is expected to be completed no later than the fourth quarter of 2015. The property, post renovation, is intended to be utilized as the new location for our branch currently located in Sister Bay.

 

Critical Accounting Policies

 

In the course of our normal business activity, management must select and apply many accounting policies and methodologies that lead to the financial results presented in our consolidated financial statements. The following is a summary of what management believes are our critical accounting policies.

 

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

 

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

 

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

 

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

 

Other Real Estate Owned: Other real estate owned acquired through or in lieu of loan foreclosure, or bank facilities no longer intended for use in bank operations are initially recorded at fair value, less estimated costs to sell, establishing a new cost basis. Fair value is determined using a variety of market information including, but not limited to, appraisals, professional market assessments, and real estate tax assessment information. If the fair value declines subsequent to foreclosure, a valuation allowance is recorded through expense. Costs incurred after acquisition are expensed.

 

Income Tax Accounting: The assessment of income tax assets and liabilities involves the use of estimates, assumptions, interpretations, and judgments concerning certain accounting pronouncements and federal and state tax codes. There can be no assurance that future events, such as court decisions or positions of federal and state taxing authorities, will not differ from management’s current assessment, the impact of which could be significant to the consolidated results of our operations and reported earnings.

 

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Goodwill:  Goodwill represents the excess of the cost of businesses acquired over fair value of net identifiable assets at the date of acquisition.  Goodwill is not amortized, but is subject to impairment tests on an annual basis or more frequently if deemed appropriate. For Goodwill valuation purposes, the Goodwill of our organization is collectively evaluated as one segment. The operations are managed and financial performance is evaluated on a company wide basis. All of the financial service operations are considered by management to be aggregated in the reportable operating segment. Goodwill is subject to a periodic assessment by applying a fair value test based upon a two-step method.  The first step of the process compares the fair value of the reporting unit with its carrying value, including any goodwill.  During 2014, we, with the assistance of a third party valuation firm, determined an estimated cash fair value of our common stock.  Consideration was given to our nature and history, the competitive and economic outlook for our trade area and for the banking industry in general, our book value and financial condition, our future earnings and dividend paying capacity, the size of the block valued, and the prevailing market prices of bank stocks. The following valuation methodologies were considered: (i) net asset value – defined as our net worth, (ii) market value – defined as the price at which knowledgeable buyers and sellers would agree to buy and sell our common stock, and (iii) investment value – defined as an estimate of the present value of the future benefits, usually earnings, cash flow, or dividends, that will accrue to our common stock. When consideration was given to the three valuation methodologies, as well as all other relevant valuation variables and factors, the fully-diluted cash fair value range of our common shares was considered to be in excess of the book value.  Since the valuation range obtained from that firm exceeded our carrying value including goodwill, we did not fail step one of the impairment test established under accounting principles generally accepted in the United States of America and, therefore, no goodwill impairment was recognized.  If the carrying amount would have exceeded fair value, we would have performed the second step to measure the amount of impairment loss.  Based on the valuation obtained as of September 30, 2014, our most recent annual valuation exceeded our carrying value by a range of 51% to 61%.

As of June 30, 2015 the total balance of goodwill held on our balance sheet was $7.2 million. As of June 30, 2015, there are no conditions that would require goodwill impairment to be reevaluated.

 

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Results of Operations

 

The following table sets forth our results of operations and related summary information for the three and six month periods ended June 30, 2015 and 2014.

SUMMARY RESULTS OF OPERATIONS

(Dollar amounts in thousands, except per share data)

		Three months ended June 30,								Six months ended June 30,
		2015				2014				2015				2014
Net income, as reported		$	2,382			$	2,159			$	4,589			$	4,224
Earnings per share-basic, as reported		$	0.26			$	0.27			$	0.50			$	0.54
Earnings per share-diluted, as reported		$	0.25			$	0.24			$	0.49			$	0.47
Cash dividends declared per share		$	0.08			$	0.07			$	0.16			$	0.14
Return on average assets			0.98	%			0.88	%			0.94	%			0.88	%
Return on average equity			8.78	%			9.00	%			8.59	%			8.94	%
Efficiency ratio (1)			67.59	%			69.86	%			67.97	%			70.15	%
Efficiency ratio (non-GAAP)-tax equivalent (1)			65.04	%			68.72	%			66.39	%			68.87	%
Efficiency Ratio: GAAP to Non-GAAP reconciliation (1)
Non-interest Expense		$	7,247			$	6,994			$	14,325			$	13,762
Less: significant, nonrecurring expenses			163	(2)			—				163	(2)			—
Non-interest Expense (non-GAAP)		$	7,084			$	6,994			$	14,162			$	13,762
Net-interest Income		$	8,155			$	7,846			$	16,117			$	15,436
Plus: Tax equivalent adjustment relating to tax exempt loans and investments			248				263				508				530
Net-interest income (non-GAAP) – tax equivalent		$	8,403			$	8,109			$	16,625			$	15,966
Non-interest Income		$	2,567			$	2,166			$	4,958			$	4,182
Less: net securities gains			78				92				252				161
Less: net gains relating to disposal of fixed assets			—				5				—				5
Non-interest income (non-GAAP)		$	2,489			$	2,069			$	4,706			$	4,016

(1)

Efficiency ratio is calculated as follows: non-interest expense less significant, non-recurring expenses divided by the sum of taxable equivalent net interest income plus non-interest income, excluding net investment security gains, net gains on sale of fixed assets and land held for sale and significant, non-recurring income. This efficiency ratio is presented on a tax equivalent basis, which adjusts net interest income for the tax-favored status of certain loans and investment securities. Management believes this measure to be the preferred industry measurement of net interest income as it enhances the comparability of such income arising from both taxable and non-taxable sources. However, as calculated, this ratio is not considered to be in accordance with Generally Accepted Accounting Principles (“GAAP”) and as such, the ratio is presented in accordance with GAAP as well.

(2)

The non-deductible payment of $0.2 million to the other member of UFS, LLC pursuant to an agreement between the Bank and the other member relating to the Bank’s pro rata share of the tax liability resulting from a reorganization transaction involving UFS that occurred in the fourth quarter of 2014, but was not settled until the second quarter of 2015 is not considered to be usual or recurring due to its nature.

 

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Net income of $2.4 million for the three months ended June 30, 2015 increased from net income of $2.2 million for the comparable period in 2014. Net interest income before provision for loan losses was $8.2 million for the three months ended June 30, 2015 and $7.8 million for the comparable period last year. The increase resulted from a $0.3 million reduction in interest expense, as well as a $0.1 million increase in interest income.  No PFLL was charged to operations for either the three months ended June 30, 2015 or of the same period of 2014.  Noninterest income increased $0.4 million (18.5%) to $2.6 million for the three months ended June 30, 2015 compared to $2.2 million for the same period of 2014.  The increase resulted primarily from a $0.2 million increase in gain on sale of loans and a $0.1 million increase in each of service charges on deposit accounts, income in equity of UFS and fees from fiduciary services.  Noninterest expense increased $0.2 million (3.6%) to $7.2 million for the second quarter of 2015 compared to $7.0 million for the second quarter of 2014.  This increase resulted primarily from the non-deductible payment of $0.2 million to the other member of UFS, LLC pursuant to an agreement between the Bank and the other member relating to the Bank’s pro rata share of the tax liability resulting from a reorganization transaction involving UFS that occurred in the fourth quarter of 2014, but was not settled until the second quarter of 2015. Additionally, legal and professional costs increased $0.1 million for the second quarter of 2015 compared to the same quarter of 2014, related to the pending acquisition of NEW announced in May of 2015. Finally, $0.1 million of costs were incurred in the second quarter of 2015 related to a branding and business development process launched in the fourth quarter of 2014.

Net income of $4.6 million for the six months ended June 30, 2015 increased from net income of $4.2 million for the comparable period in 2014. Net interest income before provision for loan losses was $16.1 million for the six months ended June 30, 2015 and $15.4 million for the comparable period last year. The increase resulted from a $0.2 million increase in interest income as well as a $0.5 million reduction in interest expense.  A PFLL of $0.2 million was charged to operations for the six months ended June 30, 2015 compared to no PFLL recorded during the comparable period of 2014.  Noninterest income increased $0.8 million (18.6%) to $5.0 million for the six months of 2015 versus $4.2 million for the comparable period of 2014.  The increase resulted primarily from $0.2 million increase in gain on sale of loans, and a $0.2 million increase in service charges on deposit accounts, as well as a $0.1 million increase in each of gains from sale of securities, net change in valuation of mortgage servicing rights, income in equity of UFS, and fees from fiduciary services. Noninterest expense increased $0.5 million (4.1%) to $14.3 million for the six months ended June 30, 2015 compared to $13.8 million for the comparable period 2014.  This increase resulted primarily due to costs recorded during the first quarter of 2015 related to the departure of one of our senior executive officers, the addition of key personnel in the commercial banking and wealth management areas, the non-deductible payment of $0.2 million under the agreement with the other member of UFS in settlement of the UFS reorganization, increased legal and professional costs relating to the pending NEW acquisition and costs associated with the branding initiative begun in the fourth quarter of 2014.

Net Interest Income:

Net interest income is the largest component of our operating income and represents the difference between interest earned on loans, investments and other interest-earning assets, offset by the interest expense attributable to the deposits and borrowings that fund such assets. Interest rate fluctuations, together with changes in the volume and types of interest-earning assets and interest-bearing liabilities, combine to affect total net interest income. This analysis discusses net interest income on a tax-equivalent basis in order to provide comparability among the various types of earned interest income. Tax-exempt interest income is adjusted to a level that reflects such income as if it were fully taxable.

Net interest income on a tax-equivalent basis was $8.4 million for the three months ended June 30, 2015, compared to $8.1 million for the same period in 2014. Average earning assets decreased $2.7 million (0.3%) to $893.6 million for the second quarter of 2015 compared to $896.3 million for the quarter ended June 30, 2014. An increase of $47.0 million (7.4%) in average loans was offset by decreases of $37.3 million (19.8%) in average taxable securities, $11.9 million (39.5%) in federal funds sold and interest-bearing due from financial institutions balances, and $0.5 million (1.2%) in average tax exempt securities.  However, the yield on average earning assets for the quarter ended June 30, 2015 increased 3 bps to 4.08% compared to 4.05% for the same period in 2014 due to the average yield on taxable securities increasing 47 bps to 3.12% for the second quarter of 2015 from 2.65% for the same period in 2014, offset in part by a decrease in the yield on tax exempt securities of 44 bps to 4.56% for the second quarter of 2015 from 5.00% for the same period in 2014, and a decrease in yield of loans of 22 bps to 4.36% during the second quarter of 2015 compared 4.58% for the same period in 2014. The increase in yield on the taxable securities resulted from receipt of prepayment penalties due to prepayment of loans collateralizing a commercial mortgage-backed security. We have continued to focus on prudent loan growth during the second quarter of 2015 in an effort to utilize low cost funding available through liquid cash balances, primarily increased customer demand deposits and repurchase agreements.

Average interest-bearing liabilities for the three months ended June 30, 2015 decreased to $711.2 million from $750.2 million for the same period in 2014, offset by an increase of noninterest-bearing demand deposits from $125.1 million for the three months ended June 30, 2014 to $148.2 million for the three months ended June 30, 2015. The decrease in interest-bearing liabilities is primarily due to use of available deposit balances and due from financial institutions balance to facilitate a reduction of average FHLB advances of $40.6 million (43.4%).  Additionally, average interest-bearing liabilities decreased due to the conversion of the remaining Convertible Notes during the second quarter of 2015.

The cost of average interest-bearing liabilities for the three months ended June 30, 2015 declined 12 bps to 0.39% from 0.51% for the same quarter of 2014. The reductions in the cost of interest-bearing liabilities resulted primarily from a reduction of interest costs associated with repurchase agreements and certificates of deposits as higher cost term deposits matured into the lower cost products.

 

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Interest rate spread is the difference between the interest rate earned on average interest-earning assets and the rate paid on average interest-bearing liabilities.  Interest rate spread increased to 3.69% for the second quarter of 2015 from 3.54% for the second quarter of 2014, resulting from the 3 bp increase in the yield on interest-earning assets, and the 12 bp decrease in the cost of interest-bearing liabilities.

Net interest margin represents net interest income expressed as an annualized percentage of average interest-earning assets. Net interest margin exceeds the interest rate spread because of the use of noninterest-bearing sources of funds (demand deposits and equity capital) to fund a portion of earning assets. Net interest margin for the second quarter of 2015 was 3.77% compared to 3.63% for the same period in 2014.

Net interest income on a tax-equivalent basis was $16.6 million for the six months ended June 30, 2015, compared to $16.0 million for the same period in 2014. The increase for the six months of 2015 resulted primarily from a $0.1 million increase in interest income on interest-earning assets and a $0.5 million decrease in interest expense on interest-bearing liabilities compared to the same period in 2014. Average earning assets increased $18.1 million (2.1%) to $901.7 million for the six months ended June 30, 2015 compared to $883.5 million for the comparable six month period of 2014. An increase of $48.6 million (7.7%) in average loans was partially offset by a decrease of $30.2 million (16.1%) in average taxable securities and a decrease of $0.2 million (0.5%) in tax exempt securities. The yield on average earning assets for the six months ended June 30, 2015 decreased 4 bps to 4.02% compared to 4.06% for the same period in 2014 due to the average yield on loans declining 20 bps to 4.35% from 4.55% for the same period in 2014, and a decrease in the yield on tax exempt securities of 27 bps to 4.73% for the first six months of 2015 from 5.00% for the same period in 2014. This was offset in part by an increase in yield on taxable securities during the first six months of 2015 of 25 bps to 2.92% compared to 2.67% in the first six months of 2014. We have continued to focus on prudent loan growth during the second quarter of 2015 in an effort to utilize low cost funding available through liquid cash balances, primarily increased customer demand deposits and repurchase agreements.

Average interest-bearing liabilities for the six months ended June 30, 2015 decreased to $722.7 million from $741.4 million for the same period in 2014, offset by an increase of noninterest-bearing demand deposits to $145.5 million for the six months ended June 30, 2015 from $122.6 million for the comparable six month period in 2014.

The cost of average interest-bearing liabilities for the six months ended June 30, 2015 declined 12 bps to 0.38% from 0.50% for the same period of 2014. The reductions in the cost of interest-bearing liabilities resulted primarily from a reduction of interest costs associated with repurchase agreements and non-core money market deposits.

Interest rate spread increased to 3.64% for the first six months of 2015 from 3.56% for the same period in 2014, resulting from the 4 bp decrease in the yield on interest-earning assets, offset by the 12 bp decrease in the cost of interest-bearing liabilities.

Net interest margin for the six months ended June 30, 2015 was 3.71% compared to 3.64% for the same period in 2014.

 

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NET INTEREST INCOME ANALYSIS ON A TAX-EQUIVALENT BASIS

(Dollar amounts in thousands)

		Three months ended June 30, 2015												Three months ended June 30, 2014
		Average Balance				Interest Income/ Expense				Average Yield/ Rate				Average Balance				Interest Income/ Expense				Average Yield/ Rate
ASSETS
Average Interest-Earning Assets:
Loans (1,2)		$	679,519			$	7,391				4.36	%		$	632,472			$	7,229				4.58	%
Taxable securities			151,352				1,181				3.12	%			188,650				1,249				2.65	%
Tax exempt securities (1)			44,405				507				4.56	%			44,934				561				5.00	%
Federal funds sold and interest-bearing due from financial institutions			18,316				11				0.24	%			30,250				19				0.25	%
Total interest-earning assets			893,592				9,090				4.08	%			896,306				9,058				4.05	%
Noninterest earning assets			81,799												82,558
Total assets		$	975,391											$	978,864
LIABILITIES AND STOCKHOLDERS’ EQUITY
Average Interest-Bearing Liabilities:
Total interest-bearing deposits		$	601,226				327				0.22	%		$	593,265				406				0.27	%
Federal funds purchased			32				—				0.63	%			—				—				—	%
Customer repurchase agreements			40,730				12				0.12	%			38,903				24				0.24	%
Federal Home Loan Bank advances			53,081				281				2.12	%			93,716				241				1.03	%
Convertible promissory notes			—				—				—	%			8,175				213				10.44	%
Subordinated debentures			16,100				66				1.62	%			16,100				64				1.58	%
Total interest-bearing liabilities			711,169				686				0.39	%			750,159				948				0.51	%
Demand deposits			148,154												125,057
Accrued expenses and other liabilities			7,235												7,425
Stockholders’ equity			108,833												96,223
Total liabilities and stockholders’ equity		$	975,391											$	978,864
Net interest income						$	8,404											$	8,110
Interest rate spread (3)											3.69	%											3.54	%
Net interest margin (4)											3.77	%											3.63	%

 

(1)	The interest income on tax exempt securities and loans is computed on a tax-equivalent basis using a tax rate of 34% for all periods presented.

(2)	The average loan balances and rates include nonaccrual loans.

(3)	Interest rate spread is the difference between the annualized average yield earned on average interest-earning assets for the period and the annualized average rate of interest accrued on average interest-bearing liabilities for the period.

(4)	Net interest margin is the annualized effect of net interest income for a period divided by average interest-earning assets for the period.

 

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NET INTEREST INCOME ANALYSIS ON A TAX-EQUIVALENT BASIS

(Dollar amounts in thousands)

		Six months ended June 30, 2015												Six months ended June 30, 2014
		Average Balance				Interest Income/ Expense				Average Yield/ Rate				Average Balance				Interest Income/ Expense				Average Yield/ Rate
ASSETS
Average Interest-Earning Assets:
Loans (1,2)		$	677,143			$	14,610				4.35	%		$	628,527			$	14,182				4.55	%
Taxable securities			157,070				2,295				2.92	%			187,280				2,499				2.67	%
Tax exempt securities (1)			44,790				1,060				4.73	%			45,034				1,126				5.00	%
Federal funds sold and interest-bearing due from financial institutions			22,654				28				0.25	%			22,693				29				0.26	%
Total interest-earning assets			901,657				17,993				4.02	%			883,534				17,836				4.06	%
Noninterest earning assets			81,643												83,288
Total assets		$	983,300											$	966,822
LIABILITIES AND STOCKHOLDERS’ EQUITY
Average Interest-Bearing Liabilities:
Total interest-bearing deposits		$	605,988				675				0.22	%		$	598,602				827				0.28	%
Federal funds purchased			44				—				1.14	%			159				1				0.67	%
Customer repurchase agreements			47,593				37				0.16	%			41,643				50				0.24	%
Federal Home Loan Bank advances			52,451				497				1.91	%			76,224				414				1.10	%
Convertible promissory notes			538				27				10.00	%			8,685				452				10.41	%
Subordinated debentures			16,100				131				1.62	%			16,100				129				1.59	%
Total interest-bearing liabilities			722,714				1,367				0.38	%			741,413				1,873				0.50	%
Demand deposits			145,507												122,646
Accrued expenses and other liabilities			7,300												7,439
Stockholders’ equity			107,779												95,324
Total liabilities and stockholders’ equity		$	983,300											$	966,822
Net interest income						$	16,626											$	15,963
Interest rate spread (3)											3.64	%											3.56	%
Net interest margin (4)											3.71	%											3.64	%

 

(1)	The interest income on tax exempt securities and loans is computed on a tax-equivalent basis using a tax rate of 34% for all periods presented.

(2)	The average loan balances and rates include nonaccrual loans.

(3)	Interest rate spread is the difference between the annualized average yield earned on average interest-earning assets for the period and the annualized average rate of interest accrued on average interest-bearing liabilities for the period.

(4)	Net interest margin is the annualized effect of net interest income for a period divided by average interest-earning assets for the period.

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RATE/VOLUME ANALYSIS (1)

(Dollar amounts in thousands)

The following table presents an analysis of changes in net interest income resulting from changes in average volumes in interest-earning assets and interest-bearing liabilities, and average rates earned and paid for the three months ended June 30, 2015 compared to the three months ended June 30, 2014:

		Increase (Decrease) due to (1)
		Volume				Rate				Net
Average Interest-Earning Assets:
Loans		$	522			$	(360	)		$	162
Taxable securities			(257	)			189				(68	)
Tax exempt securities			(7	)			(47	)			(54	)
Federal funds sold and interest-bearing due from financial institutions			(6	)			(2	)			(8	)
Total interest-earning assets		$	252			$	(220	)		$	32
Average Interest-Bearing Liabilities:
Total interest-bearing deposits		$	(24	)		$	(55	)		$	(79	)
Customer repurchase agreements and federal funds purchased			1				(13	)			(12	)
FHLB advances			(138	)			178				40
Convertible promissory notes			(107	)			(106	)			(213	)
Subordinated debentures			—				2				2
Total interest-bearing liabilities		$	(268	)		$	6			$	(262	)
Net interest income		$	520			$	(226	)		$	294

 

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

Management’s ability to employ overall assets for the production of interest income can be measured by the ratio of average interest-earning assets to average total assets.  This ratio was 91.6% for the three months ended June 30, 2015 unchanged from the three months ended June 30, 2014.

RATE/VOLUME ANALYSIS (1)

(Dollar amounts in thousands)

The following table presents an analysis of changes in net interest income resulting from changes in average volumes in interest-earning assets and interest-bearing liabilities, and average rates earned and paid for the six months ended June 30, 2015 compared to the six months ended June 30, 2014:

		Increase (Decrease) due to (1)
		Volume				Rate				Net
Average Interest-Earning Assets:
Loans		$	1,069			$	(641	)		$	428
Taxable securities			(384	)			180				(204	)
Tax exempt securities			(6	)			(60	)			(66	)
Federal funds sold and interest-bearing due from financial institutions			—				(1	)			(1	)
Total interest-earning assets		$	679			$	(522	)		$	157
Average Interest-Bearing Liabilities:
Total interest-bearing deposits		$	(44	)		$	(108	)		$	(152	)
Customer repurchase agreements and federal funds purchased			6				(20	)			(14	)
FHLB advances			(158	)			241				83
Convertible promissory notes			(408	)			(17	)			(425	)
Subordinated debentures			—				2				2
Total interest-bearing liabilities		$	(604	)		$	98			$	(506	)
Net interest income		$	1,283			$	(620	)		$	663

 

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

 

The ratio of average interest-earning assets to average total assets for the six months ended June 30, 2015 was 91.7%, increased from 91.4% for the same period in 2014.

 

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Provision for Loan Losses:

The PFLL is the periodic cost of providing an allowance for probable and inherent losses in our loan portfolio. The ALL consists of specific and general components. Our internal risk system is used to identify loans that meet the criteria for being “impaired” as defined in the accounting guidance. The specific component relates to loans that are individually classified as impaired and where expected cash flows are less than carrying value. The general component covers non-impaired loans and is based on historical loss experience adjusted for qualitative factors. These qualitative factors include:  1) changes in the nature, volume and terms of loans, 2) changes in lending personnel, 3) changes in the quality of the loan review function, 4) changes in the nature and volume of past-due, nonaccrual and/or classified loans, 5) changes in the concentration of credit risk, 6) changes in economic and industry conditions, 7) changes in legal and regulatory requirements, 8) unemployment and inflation statistics, and 9) changes in underlying collateral values.

No PFLL was recorded for the three months ended June 30, 2015 and 2014. No new loans were identified as being impaired during the second quarter of 2015. There were no net loan charge-offs for the three months ended June 30, 2015 and 2014.

A PFLL of $0.2 million was recorded for the six months ended June 30, 2015 compared to no PFLL recorded in the same period of 2014.  Net loan charge-offs for the six months ended June 30, 2015 and 2014 were $0.3 million and $0.2 million, respectively.  Net annualized charge-offs to average loans was 0.09% for the six months ended June 30, 2015 compared to 0.07% for the same period in 2014. For the six months ended June 30, 2015, nonperforming loans decreased by $0.4 million (7.5%) to $4.8 million from $5.2 million at December 31, 2014. Refer to the “Financial Condition - Risk Management and the Allowance for Loan Losses” and “Financial Condition - Nonperforming Loans, Potential Problem Loans and Other Real Estate Owned” sections following for more information related to nonperforming loans. On an ongoing basis, we continue to monitor the level of risk inherent in our loan portfolio in relationship to the return we receive on these loans to achieve an appropriate balance between the two and modify our underwriting expectations as appropriate.

Our management believes that the ALL at June 30, 2015 is appropriate in light of the present condition of the loan portfolio and the amount and quality of the collateral supporting nonperforming loans. We continue to monitor nonperforming loan relationships and will make additional PFLLs, as necessary, if the facts and circumstances change. In addition, a decline in the quality of our loan portfolio as a result of general economic conditions, factors affecting particular borrowers or our market area, or otherwise, could affect the adequacy of the ALL. If there are significant charge-offs against the ALL, or we otherwise determine that the ALL is inadequate or our estimates are different than our regulators’ estimates, we will need to make additional PFLLs in the future.

 

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Noninterest Income:

The following table reflects the various components of noninterest income for the three and six month periods ended June 30, 2015 and 2014, respectively.

NONINTEREST INCOME

(Dollar amounts in thousands)

		Three months ended												Six months ended
		June 30, 2015				June 30, 2014				% Change				June 30, 2015				June 30, 2014				% Change
Fees from fiduciary services		$	314			$	252				24.6	%		$	597			$	504				18.5	%
Fees from loan servicing			142				138				2.9	%			295				300				(1.7	)%
Charges for other services to customers			813				718				13.2	%			1,536				1,349				13.9	%
Other fee income			153				149				2.7	%			310				315				(1.6	)%
Financial services income			268				252				6.3	%			540				518				4.2	%
Net gains on sales of loans			280				126				122.2	%			484				253				91.3	%
Net change in valuation of mortgage servicing rights, net of payments and payoffs			(7	)			(57	)			87.7	%			(23	)			(134	)			82.8	%
Net gains from sale of securities			78				92				(15.2	)%			252				161				56.5	%
Gains from sale of fixed assets			—				5				(100.0	)%			—				5				(100.0	)%
Increase in cash surrender value of life insurance			94				124				(24.2	)%			185				202				(8.4	)%
Equity in income of UFS subsidiary			369				288				28.1	%			687				582				18.0	%
Other income			63				79				(20.3	)%			95				127				(25.2	)%
Total Noninterest Income		$	2,567			$	2,166				18.5	%		$	4,958			$	4,182				18.6	%

Included in the fees for other services to customers in noninterest income on our consolidated statements of operations are service charges on deposit accounts and other fee income.

Noninterest income increased $0.4 million for the three months ended June 30, 2015 versus the comparable period in 2014. Net gains on sales of loans increased $0.2 million (122.2%), net change in valuation of mortgage servicing rights improved $0.1 million (87.7%), fees from fiduciary services increased $0.1 million (24.6%) and service charges on deposit accounts increased $0.1 million (13.2%).

Noninterest income increased $0.8 million for the six months ended June 30, 2015 versus the comparable period in 2014. Net gains from the sale of loans increased $0.2 million (91.3%), gains on sale of securities increased $0.1 million (56.5%), fees from fiduciary services increased $0.1 million (18.5% and financial services income increased $0.2 (91.3%).  In addition, net changes in the valuation of mortgage servicing rights resulted in a $0.1 million lower reduction in total noninterest income for the six months ended June 30, 2015 versus the comparable period last year.  The increase in fees from fiduciary services and financial services is a result of a focus to expand our market in these product lines.

 

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Noninterest Expense:

 

The following table reflects the various components of noninterest expense for the three and six months ended June 30, 2015 and 2014.

NONINTEREST EXPENSE

(Dollar amounts in thousands)

		Three months ended												Six months ended
		June 30, 2015				June 30, 2014				% Change				June 30, 2015				June 30, 2014				% Change
Salaries and employee benefits		$	4,315			$	4,389				(1.7	)%		$	8,660			$	8,456				2.4	%
Occupancy			550				514				7.0	%			1,117				1,074				4.0	%
Equipment			332				341				(2.6	)%			681				654				4.1	%
Data processing and courier			232				195				19.0	%			463				403				14.9	%
Operation of other real estate owned			152				141				7.8	%			239				307				(22.1	)%
Business development and advertising			250				171				46.2	%			415				309				34.3	%
Charitable contributions			25				14				78.6	%			62				29				113.8	%
Stationery and supplies			113				147				(23.1	)%			183				252				(27.4	)%
Director fees			98				97				1.0	%			192				196				(2.0	)%
FDIC insurance			151				151				—	%			297				300				(1.0	)%
Audit and legal			233				152				53.3	%			418				329				27.1	%
Loan and collection			21				18				16.7	%			34				37				(8.1	)%
Other outside services			279				291				(4.1	)%			603				626				(3.7	)%
Other operating expenses			496				373				33.0	%			961				790				21.6	%
Total Noninterest Expense		$	7,247			$	6,994				3.6	%		$	14,325			$	13,762				4.1	%

Total noninterest expense increased by $0.2 million to $7.2 million for the three months ended June 30, 2015 compared to $7.0 million for the same period ended June 30, 2014.  The noninterest expense to average assets ratio was 3.0% for the three months ended June 30, 2015, increased slightly from 2.9% for the same period in 2014.

Total noninterest expense increase by $0.5 million to $14.3 million for the six months ended June 30, 2015 compared to $13.8 million for the same period ended June 30, 2014.  The noninterest expense to average assets ratio was 2.9% for the six months ended June 30, 2015, unchanged from the same period in 2014.

Net overhead expense is total noninterest expense less total noninterest income. The net overhead expense to average assets ratio was 1.9% for the three months ended June 30, 2015 improved slightly from 2.0% for three months ended June 30, 2014. The efficiency ratio represents total noninterest expense as a percentage of the sum of net interest income on a fully taxable equivalent basis and total noninterest income (excluding net gains on the sale of securities, premises and equipment, branch sales, land held for sale, and the payment made in conjunction with the UFS reorganization transaction). The efficiency ratio improved from 69.9% (68.7% non-GAAP, tax equivalent) for the quarter ended June 30, 2014 to 67.6% (65.0% non-GAAP, tax equivalent) for the quarter ended June 30, 2015, and from 70.2% (68.9% non-GAAP, tax equivalent) for the six months ended June 30, 2014 to 68.0% (66.4% non-GAAP, tax equivalent) for the six months ended June 30, 2015. A lower efficiency ratio represents a more efficient operation.

Salaries and employee benefits were $8.7 million for the six months ended June 30, 2015, compared to $8.5 million for the six months ended June 30, 2014.  Although the number of full-time equivalent employees decreased from 258 at June 30, 2014 to 251 at June 30, 2015, investment in additional, more highly compensated personnel in key areas of the Bank occurred during the first quarter of 2015.  Additionally, $0.2 million of salary and benefits costs were recorded in the first quarter of 2015 related to the departure of one of our senior executive officers.  Commission expense for commissioned salespersons, including financial advisors and mortgage originators, may impact future salary expense based on the levels of production attained. Included in 2015 salary expense is $0.3 million of expense related to our long-term equity incentive plan and $0.2 million related to our performance-based incentive program.

Audit and legal expenses and business development expenses both increased $0.1 million for the six months ended June 30, 2015 compared to the same period of 2014.  The increase in audit and legal resulted primarily from costs incurred relating to the pending acquisition of NEW.  During the fourth quarter of 2014, a branding initiative was begun, resulting in increased business development and advertising cost in the first six months of 2015 compared to the same period in 2014.  Other operating expenses in the six months ended June 30, 2015 included $0.2 million relating to the non-deductible reimbursement paid to the other member of UFS LLC that was not incurred in the same period of 2014.

 

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Income Taxes:

We recorded an income tax expense of $1.1 million for the three months ended June 30, 2015 versus an expense of $0.9 million for the same period in 2014. The increase in tax expense is primarily attributable to a year-over-year increase in pre-tax income for the second quarter of 2015 versus the comparable period of 2014. The effective tax rate for the three months ended June 30, 2015 increased slightly to 31.5% from 28.5% for the same period in 2014. The increased effective tax rate is impacted, in part, by the non-deductibility of the $0.2 million payment made during the second quarter of 2015 relating to the UFS reorganization transaction.

Income tax expense recorded for the six months ended June 30, 2015 was $2.0 million compared to $1.6 million for the same period in 2014. The increase in tax expense is primarily attributable to an increase in pre-tax income for the first six months of 2015 versus the same period in 2014. The effective tax rate for the six months ended June 30, 2015 and 2014 was 29.9% and 27.9% respectively.

We maintain net deferred income tax assets for deductible temporary tax differences, such as allowance for loan losses, nonaccrual loan interest, and other real estate owned valuations as well as net operating loss carry forwards. Our determination of the amount of our deferred income tax assets to be realized is highly subjective and is based on several factors, including projected future income, income tax planning strategies, and federal and state income tax rules and regulations. At June 30, 2015, we determined that no valuation allowance was required to be taken against our net deferred income tax assets. We assess the amount of tax benefits we may realize in future periods in determining the necessity for any valuation allowance.

Financial Condition

 

Loans:

 

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

		June 30, 2015				December 31, 2014				Percent Change
Amount of Loans by Type:
Real estate-mortgage:
Commercial		$	314,799			$	304,446				3.4	%
1-4 family residential
First liens			104,627				106,292				(1.6	)%
Junior liens			5,246				5,623				(6.7	)%
Home equity			39,886				40,176				(0.7	)%
Commercial and agricultural:
Syndicated			66,433				65,429				1.5	%
Other			94,287				88,045				7.1	%
Real estate-construction			31,952				40,808				(21.7	)%
Installment
Credit cards and related plans			1,417				1,353				4.7	%
Other			4,356				4,722				(7.8	)%
Obligations of states and political subdivisions			23,500				22,964				2.3	%
Less:  Deferred origination fees, net of costs			(483	)			(501	)			3.6	%
Less:  Allowance for loan losses			(6,956	)			(7,051	)			1.3	%
Total		$	679,064			$	672,306				1.0	%

 

Net loans increased $6.8 million (1.0%) from $672.3 million at December 31, 2014 to $679.1 million at June 30, 2015. In addition to originating loans, we buy and sell loan participations with other financial institutions, primarily located in markets we serve. These loans are underwritten to the same lending standards as the loans we originate. Additionally, we purchase syndicated loans in the national market that represent small portions of large national credits. These credits are also subject to our normal underwriting guidelines and represent $66.4 million and $65.4 million in loan balances outstanding at June 30, 2015 and December 31, 2014, respectively.

 

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Real estate-mortgage, 1-4 family first lien loans totaled $104.6 million at June 30, 2015, a decrease of $1.7 million (1.6%) from December 31, 2014. Other commercial and agricultural loans totaled $94.3 million at June 30, 2015, an increase of $6.2 million (7.1%) from December 31, 2014. Commercial real estate loans, which totaled $314.8 million at June 30, 2015, comprised 46.4% of our loan portfolio, up $10.4 million from $304.4 million, at December 31, 2014. We attempt to attain overall loan growth while maintaining a prudent portfolio mix.

 

Risk Management and the Allowance for Loan Losses:

 

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

 

The ALL at June 30, 2015 was $7.0 million, compared to $7.1 million at December 31, 2014. On a quarterly basis, management reviews the adequacy of the ALL. The analysis of the ALL consists of three components: (i) specific reserves established for expected losses relating to impaired loans for which the recorded investment in the loans exceeds its fair value; (ii) general reserves based on historical loan loss experience for significant loan classes; and (iii) general reserves based on qualitative factors such as concentrations and changes in portfolio mix and volume. Allocations of the ALL may be made for specific loans but the entire ALL is available for any loan that, in management’s judgment, should be charged off or for which an actual loss is realized.

 

On a regular basis, loan officers review all commercial credit relationships. The loan officers grade commercial credits and the loan review function validates the grades assigned. In the event that the loan review function downgrades a loan, it is included in the ALL analysis process at the lower grade. This grading system is in compliance with regulatory classifications. At least quarterly, all commercial loans that have been deemed impaired are evaluated. In compliance with accounting guidance for impaired loans, the fair value of the loan is determined based on either the present value of expected future cash flows discounted at the loan’s effective interest rate, the market price of the loan or, if the loan is collateral dependent, the fair value of the underlying collateral less the estimated costs to sell. This evaluation may include obtaining supplemental market data and/or routine site visits to offer support to the evaluation process. If the carrying value of the loan exceeds the fair value less estimated cost to sell, a specific reserve is established. Such reserves are reviewed by the Delinquent Account Review Team.

 

We have two other major components of the ALL that do not pertain to specific loans; “General Reserves – Historical” and “General Reserves – Other.” We determine General Reserves – Historical based on our historical recorded charge-offs of loans in particular classes, analyzed as a group. We determine General Reserves – Other by taking into account such qualitative factors as 1) changes in the nature, volume and terms of loans, 2) changes in lending personnel, 3) changes in the quality of the loan review function, 4) changes in the nature and volume of past-due, nonaccrual and/or classified loans, 5) changes in the concentration of credit risk, 6) changes in economic and industry conditions, 7) changes in legal and regulatory requirements, 8) unemployment and inflation statistics, and 9) changes in underlying collateral values. 

  

Nonperforming Loans, Potential Problem Loans and Other Real Estate Owned:

  

Management encourages early identification of nonaccrual and problem loans in order to minimize the risk of loss. Nonperforming loans are defined as nonaccrual loans, loans 90 days or more past due, but still accruing, and nonaccrual loans restructured in a troubled debt restructuring that have not shown a sufficient period of performance with the restructured terms. Additionally, whenever management becomes aware of facts or circumstances that may adversely impact the collection of principal or interest on loans, it is the practice of management to place such loans on nonaccrual status immediately rather than waiting until the loans become 90 days past due. The accrual of interest income is discontinued when a loan becomes 90 days past due as to principal or interest or earlier as deemed appropriate. When interest accruals are discontinued, interest credited to income is reversed. If collection is in doubt, cash received on nonaccrual loans is used to reduce principal rather than recorded as interest income. Restructuring a loan typically involves the granting of some concession to the borrower involving a loan modification such as payment schedule or interest rate changes. Restructured loans may involve loans that have had a charge-off taken against the loan to reduce the carrying amount of the loan to fair market value as determined pursuant to accounting guidance for troubled debt restructurings.

 

 

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NONPERFORMING ASSETS

(Dollars amounts in thousands)

		June 30,  2015				March 31, 2015				December 31, 2014				September 30, 2014				June 30, 2014
Nonperforming Assets:
Nonaccrual loans		$	4,708			$	5,731			$	5,155			$	5,647			$	6,794
Nonaccrual loans, restructured			62				—				—				256				256
Total nonperforming loans (“NPLs”)		$	4,770			$	5,731			$	5,155			$	5,903			$	7,050
Other real estate owned, net			4,022				4,195				4,266				4,987				5,053
Total nonperforming assets (“NPAs”)		$	8,792			$	9,926			$	9,421			$	10,890			$	12,103
Restructured loans, accruing(1)		$	6,816			$	6,907			$	8,656			$	8,656			$	8,472
Ratios:
ALL to Net Charge-offs (“NCOs”) (annualized)			11.69	x			6.97	x			11.62	x			8.80	x			17.17	x
NCOs to average loans (annualized)			0.09	%			0.15	%			0.10	%			0.13	%			0.07	%
ALL to total loans			1.01	%			1.04	%			1.18	%			1.12	%			1.18	%
NPLs to total loans			0.70	%			0.85	%			0.76	%			0.93	%			1.12	%
NPAs to total assets			0.90	%			1.00	%			0.92	%			1.11	%			1.20	%
ALL to NPLs			145.83	%			122.20	%			136.78	%			119.58	%			105.58	%

 

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

During the quarter ended June 30, 2015, other real estate owned declined by $0.2 million due to six such real estate properties being sold during the second quarter of 2015. One property totaling less than $0.1 million was transferred into other real estate owned during the quarter ended June 30, 2015. Restructured loans accruing at June 30, 2015 decreased $0.1 million from the prior quarter end due to a restructured, accruing loan of $0.1 million being changed to nonaccrual status. No loans were added to the restructured loans accruing category during the second quarter of 2015.

Restructured loans accruing at June 30, 2015 were $6.8 million, a decrease of $1.8 million during the first six months of 2015 primarily due to one restructured accruing loan with modified terms of $1.8 million being transferred out of the restructured loan category due to performances with its restructured terms for a sufficient period of time.

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

PAST DUE LOANS (EXCLUDING NONACCRUALS)

30-89 DAYS PAST DUE

(Dollars amounts in thousands)

		June 30,  2015				March 31, 2015				December 31, 2014				September 30, 2014				June 30,  2014
Secured by real estate		$	2,454				2,303			$	1,309			$	2,603			$	2,026
Commercial, syndicated			—				—				—				—				—
Commercial, other			1				6				11				35				222
Loans to individuals			5				12				35				18				29
All other loans			—				—				—				—				—
Total		$	2,460				2,321			$	1,355			$	2,656			$	2,277
Percentage of total loans			0.36	%			0.35	%			0.19	%			0.42	%			0.36	%

As reflected above, loan balances 30-89 days past due at June 30, 2015 have increased $1.1 million compared to December 31, 2014 and increased $0.2 million from June 30, 2014. The increase in 30-89 days past due loans occurred primarily in real estate-mortgage balances ($0.3 million) and real estate-commercial loans ($0.8 million).  Subsequently, $0.4 million of the loans 30-89 days past due at June 30, 2015 were brought current.

 

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Information regarding other real estate owned is as follows:

OTHER REAL ESTATE OWNED, NET

(Dollars amounts in thousands)

		Six months ended June 30, 2015				Twelve months ended December 31, 2014				Six months  ended June, 2014
Beginning balance		$	5,093			$	8,566			$	8,566
Transfer of loans to other real estate owned			45				1,204				75
Sales proceeds, net			(196	)			(2,525	)			(1,162	)
Net gain from sale of other real estate owned			6				19				43
Valuation allowance recovered upon disposition of other real estate owned			(152	)			(2,171	)			(646	)
Total other real estate owned			4,796				5,093				6,876
Valuation allowance for losses			(774	)			(827	)			(1,823	)
Total other real estate owned, net		$	4,022			$	4,266			$	5,053

 

VALUATION ALLOWANCE ON OTHER REAL ESTATE OWNED

(Dollars amounts in thousands)

		Six months ended June 30, 2015				Twelve months ended  December 31, 2014				Six months ended June 30, 2014
Beginning balance		$	827			$	2,268			$	2,268
Provision charged to operations			99				730				201
Valuation allowance recovered upon disposition of other real estate owned			(152	)			(2,171	)			(646	)
Ending balance		$	774			$	827			$	1,823

The foreclosure process commences on consumer real estate loans when a borrower becomes 120 or greater days delinquent in accordance with Consumer Finance Protection Bureau suggested guidelines.  Foreclosure procedures and timelines may vary depending on a variety of factors, including where the property resides.  At both June 30, 2015 and December 31, 2014, the recorded investment in consumer mortgage loans that were in the process of foreclosure was $0.3 million.  Additionally, $0.2 million at June 30, 2015 and $0.3 million at December 31, 2014 of loans serviced for and guaranteed by FHLMC were in the process of foreclosure. Although these loans continue to be serviced by the Bank, these loans are sold to FHLMC once originated and therefore, no balances are included in the our balance sheet.

Consumer mortgage properties are derecognized as mortgage loans and classified as Other Real Estate Owned when the Bank has control of the property, regardless of whether legal title has been transferred in the completed foreclosure process.  At both June 30, 2015 and December 31, 2014, titles relating to all of the consumer mortgage loan properties classified as Other Real Estate Owned had been transferred to us.

Investment Portfolio:

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

At June 30, 2015, our securities available for sale (“AFS”) decreased $21.2 million (11.6%) to $161.7 million compared to $182.9 million at December 31, 2014. At June 30, 2015, the AFS investment portfolio represented 16.5% of total assets compared to 17.9% at December 31, 2014.  For the six months ended June 30, 2015, principal payments of $20.2 million were received on AFS securities, which included $8.7 million from the maturity or call of such securities. For the six months ended June 30, 2015, we purchased $12.3 million of AFS securities and sold $11.4 million of AFS securities at a $0.2 million gain. Additionally, AFS securities decreased during the six months ended June 30, 2015 by $0.8 million due to net amortization of premiums and discounts originated at the time the securities were purchased and were reduced by a decrease in unrealized gains of $1.3 million.

 

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At June 30, 2015 and December 31, 2014, the held to maturity (“HTM”) investment portfolio comprised three securities totaling $25.6 million. During the six months ended June 30, 2015, we did not purchase any HTM securities.

We closely monitor securities we hold in both our investment portfolios that remain in an unrealized loss position for twelve months or greater. There were no unrealized losses at June 30, 2015 in the HTM securities portfolio. Total gross unrealized losses on AFS securities in such a loss position for twelve months or greater were $0.5 million at June 30, 2015, representing 56.3% of total gross unrealized securities losses. AFS securities in such a loss position for twelve months or greater represented 10.0% of the total AFS investment portfolio. Based on an in-depth analysis of the specific instruments, which may include ratings from external rating agencies and/or brokers, as well as the creditworthiness of the related issuers, including their ability to continue payments under the terms of the security agreements, no unrealized losses were deemed to be other-than-temporary. Additionally, we do not have the intent to sell the securities and it is not more likely than not that we will be required to sell these securities before their anticipated recovery. If at any point in time any losses are considered other-than-temporary, we would be required to recognize other-than-temporary impairment. This would require us to assess the cash flows expected to be collected from the security. The difference between cash flows expected to be collected and the amortized cost basis would result in a credit loss for the amount of the impairment. This amount would reduce our earnings. The remaining portion of the impairment related to factors other than credit loss would be recognized through other comprehensive income (loss). At June 30, 2015 and December 31, 2014, we did not hold securities of any one issuer, other than FNMA, GNMA, FHLMC, or VA, each an agency or corporation of the United States government, in an amount greater than 10% of our stockholders’ equity.  As of June 30, 2015, the highest concentration of loans underlying mortgage-backed securities issued in any state was issued in California, representing approximately 15.1% of the total amount invested in residential mortgage-backed securities.

 

Deposits:

 

Total deposits at June 30, 2015 decreased $7.0 million (0.9%) to $758.5 million from $765.5 million at December 31, 2014. The decrease for the six months was a result of a decrease in our time deposits of $10.5 million (7.6%) for the period, and a decline of $12.9 million (9.2%) in NOW balances offset by an increase in non-interest-bearing demand deposit balances of $12.3 million (8.0%) and an increase in savings deposits of $4.1 million (1.2%). The total decrease in interest-bearing deposits was $19.3 million (3.1%) from December 31, 2014 to June 30, 2015. At June 30, 2015, we did not hold any traditional brokered certificates of deposits, but we held $1.0 million of NOW balances that were considered brokered deposits, a decrease of $7.6 million since December 31, 2014.  Deposits where our customers direct their funds with us to be exchanged with deposits of another participating institution through a depository network (“Reciprocal Deposits”) are considered brokered deposits. At June 30, 2015 we held $1.7 million of such Reciprocal Deposits, unchanged from December 31, 2014.
 

We continue to focus on expanding and retaining customer relationships and attracting core deposit accounts by emphasizing customer service while maintaining competitive pricing. If liquidity concerns arise, we have alternative sources of funds such as lines of credit with correspondent banks and borrowing arrangements with the FHLB and through the discount window at the Federal Reserve Bank.

Other Funding Sources:

Securities repurchase agreements decreased $28.3 million (43.5%) from $64.9 million at December 31, 2014 to $36.6 million at June 30, 2015. We did not have any federal funds purchased at either June 30, 2015 or December 31, 2014. The decline in repurchase agreements during the first six months of 2015 is relating to the planned reduction in a significant commercial customer’s deposit balances.

 

During the second quarter of 2015, one new FHLB advance was taken for $10.0 million to fulfill a forward advance commitment entered into one year prior at a specific rate. FHLB advances were $53.6 million at June 30, 2015, down from $60.5 million at December 31, 2014, a decline of 11.3%, due to the payoff or maturity of $16.9 million of prior period advances. The availability of deposits also determines the amount of funds we need to borrow in order to fund loan demand and operations. FHLB continues to be available as a source of borrowing for future funding needs as we manage our liquidity needs.

 

During the second quarter of 2015, we utilized FHLB advances of varying terms and maturities to maximize and enhance our net interest margin.  At June 30, 2015, all of the $53.6 million FHLB advances outstanding were fixed rate.

 

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Long Term Debt:

 

In March 2006, we issued $16.1 million of variable rate, trust preferred securities (“TruPS”) and $0.5 million of trust common securities through Baylake Capital Trust II (the “Trust”) that adjust quarterly at a rate equal to 1.35% over the three month LIBOR and mature on June 30, 2036. At June 30, 2015, the interest rate on these securities was 1.63%. These securities were issued to replace trust preferred securities issued in 2001 through Baylake Capital Trust I. For bank regulatory purposes, these securities are considered Tier 1 capital.

 

The Trust’s ability to pay amounts due on the TruPS is solely dependent upon us making payment on the related subordinated debentures (“Debentures”) to the Trust. Under the terms of the Debentures, we would be precluded from paying dividends on our common stock if we were in default under the Debentures, if we exercised our right to defer payment of interest on the Debentures or if certain related defaults occurred. At June 30, 2015, we were not in default of any provision under the Debentures and were current on all interest payments on the TruPS.

During 2009 and 2010, we completed several separate closings of a private placement of Convertible Notes.  The Convertible Notes were offered and sold in reliance on the exemption from registration under Section 4(2) of the Securities Act of 1933 and Rule 506 promulgated there under.  The total amount of the Convertible Notes outstanding was $1.7 million as of December 31, 2014. No Convertible Notes were outstanding as of June 30, 2015.

 

The Convertible Notes were convertible into shares of our common stock at a ratio of one share of common stock for each $5.00 in aggregate principal amount held on the record date of the conversion subject to certain adjustments as described in the Convertible Notes (the “Conversion Ratio”). Prior to the quarterly interest date preceding the fifth anniversary of issuance of the Convertible Notes, each holder of the Convertible Notes could convert up to 100% (at the discretion of the holder) of the original principal amount into shares of our common stock at the Conversion Ratio. Beginning on the quarterly interest date prior to the fifth anniversary of the Convertible Notes, we could redeem the notes in whole or in part. A notice of redemption superseded and took priority over any notice of conversion. On October 1, 2014, one-half of the original principal amounts of the Convertible Notes mandatorily converted at the Conversion Ratio.  The principal amount of any Convertible Note that had not been converted would be payable at maturity on June 30, 2017.

On January 1, 2015, $0.6 million of Convertible Notes were converted to 115,000 shares of the Company’s common stock under the voluntary conversion terms of the Convertible Notes. In April 2015, all of the remaining $1.1 million of Convertible Notes were converted to 215,000 shares of the Company’s common stock under the voluntary conversion terms of the Convertible Notes.

In order to complete the acquisition of NEW as structured, we may borrow up to $6.0 million with an anticipated maturity of ten years.

Contractual Obligations:

We use a variety of financial instruments in the normal course of business to meet the financial needs of our customers. These financial instruments include commitments to extend credit, commitments to originate residential mortgage loans held for sale, commercial letters of credit, standby letters of credit, and forward commitments to sell residential mortgage loans. Please refer to our Annual Report on Form 10-K for the year ended December 31, 2014 for quantitative and qualitative disclosures about our fixed and determinable contractual obligations. Contractual obligations disclosed in the 2014 Annual Report on Form 10-K have not materially changed since that report was filed.

The following table summarizes our significant contractual obligations and commitments at June 30, 2015:

CONTRACTUAL OBLIGATIONS

		Within 1 Year				1-3 Years				3-5 Years				After 5 Years				Total
Certificates of deposit and other time deposit obligations		$	80,653			$	35,936			$	11,600			$	—			$	128,189
Repurchase agreements			36,639				—				—				—				36,639
Federal Home Loan Bank advances			16,750				3,550				33,325				—				53,625
Subordinated debentures			—				—				—				16,100				16,100
Operating leases			32,715				51,799				—				—				84,514
Total		$	166,757			$	91,285			$	44,925			$	16,100			$	319,067

 

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Off- Balance Sheet Arrangements:

 

We do not use interest rate contracts (i.e. swaps), forward loans sales or other derivatives to manage interest rate risk and do not have any of these instruments outstanding. The Bank does have, through its normal operations, loan commitments and standby letters of credit outstanding as of June 30, 2015, and December 31, 2014 in the amount of $300.0 million and $238.3 million, respectively. These are further explained in Note 15 of the Notes to Consolidated Financial Statements.

 

Liquidity:

 

Liquidity management refers to our ability to ensure that cash is available on a timely basis to meet loan demand and depositors’ needs and to service other liabilities as they become due without undue cost or risk and without causing a disruption to normal operating activities.  We and the Bank have different liquidity considerations.

 

Our primary sources of funds are dividends from the Bank and net proceeds from borrowings, including offerings of subordinated debentures and convertible promissory notes. We may also undertake offerings of debt and issue our common stock if and when we deem it prudent to do so, subject to regulatory approval. We generally manage our liquidity position in order to provide funds necessary to meet interest obligations of our TruPS and Convertible Notes, pay dividends to our shareholders, subject to regulatory restrictions, and repurchase shares. Restrictions, which govern all state chartered banks, preclude the payment of dividends by the Bank without the prior written consent of the Wisconsin Department of Financial Institutions (“WDFI”) if dividends declared and paid by the Bank in either of the two immediately preceding years exceeded the Bank’s net income for those years, which was not the case.

 

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

Maturing investments have historically been a primary source of liquidity. For the six months ended June 30, 2015, principal payments totaling $11.5 million were received on investments in addition to $8.7 million from maturities. We purchased $12.3 million in investments in the same period. Approximately 4.0%, or $4.5 million, of the mortgage-backed securities outstanding at June 30, 2015 were issued and guaranteed by GNMA, the VA or the FHA; agencies of the United States government.  An additional 92.0%, or $106.9 million, of the mortgage-backed securities outstanding at June 30, 2015 were issued by either FNMA or FHLMC, United States government-sponsored agencies. Non-agency mortgage-backed securities present a level of credit risk that does not exist currently with United States government agency-backed securities, and comprised approximately 4.0%, or $4.7 million, of the outstanding mortgage-backed securities at June 30, 2015.  Management evaluates these non-agency mortgage-backed securities at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. These securities tend to be highly marketable.

Deposit decreases, reflected as a financing activity in the June 30, 2015 unaudited consolidated statements of cash flows, resulted in $4.1 million of cash outflow during the first six months of 2015. In February of 2015, we entered into a customer relationship with a public entity that requires us to provide collateral for their money market deposits through the FHLB’s Public Unit Deposit program.  Under this program, FHLB issues a financial standby letter of credit on our behalf secured by various loans and/or investment securities collateral provided by the Bank.  Our agreement with the public entity customer limits these deposits to maximums of between $20.0 million and $40.0 million and can fluctuate quarterly.  At June 30, 2015 the amount of these money market deposits was $18.9 million.

Customer deposit growth is normally the most stable source of liquidity, although brokered deposits, which are inherently less stable than locally-generated core deposits, are sometimes used. Our reliance on brokered certificates of deposit was eliminated in 2013. We have $1.0 million in brokered NOW accounts at June 30, 2015 compared to $8.5 million of such deposits at December 31, 2014. Additionally, at June 30, 2015, we have $1.7 million of Reciprocal Deposits, unchanged from December 31, 2014. If at any point in the future we fall below the “well capitalized” regulatory capital threshold, it will become more difficult for us to obtain brokered deposits.  Also affecting liquidity are core deposit growth levels, certificate of deposit maturity structure and retention, and characteristics and diversification of wholesale funding sources affecting the channels by which brokered deposits are acquired. Conversely, deposit outflow will cause a need to develop alternative sources of funds, which may not be as liquid and potentially a more costly alternative.

The scheduled payments and maturities of loans can provide a source of additional liquidity. There are $183.9 million, or 26.8% of total gross loans, maturing within one year of June 30, 2015. Factors affecting liquidity relative to loans are loan origination volumes, loan prepayment rates and the maturity structure of existing loans. The liquidity position is influenced by changes in interest rates, economic conditions and competition. Conversely, loan demand creates a need for liquidity that may cause us to acquire other sources of funding, some of which could be more difficult to find and more costly to secure.

Within the classification of short-term borrowings at June 30, 2015, securities repurchase agreements totaled $36.6 million compared to $64.9 million at the end of 2014. Securities repurchase agreements are obtained from a base of business and municipal customers. The decline in such repurchase agreements from December 31, 2014 to June 30, 2015 is primarily due to the planned reduction of a significant commercial customer’s deposit and repurchase balances. Short-term and long-term borrowings from the FHLB are another source of funds and totaled $53.6 million and $60.5 million at June 30, 2015 and December 31, 2014, respectively. We utilize FHLB advances of varying terms and maturities, to maximize our net interest margin and manage our interest rate risk.

 

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We continue to focus on expanding customer deposit relationships and attracting core deposit accounts by emphasizing customer service while maintaining competitive pricing. In the event that core deposit growth goals are not accomplished, we will continue to look at other wholesale sources of funds. In addition, we may acquire additional brokered deposits as funding for short-term liquidity needs. Short-term liquidity needs will also be addressed by growth in short-term borrowings, maturing federal funds sold and portfolio investments, and loan maturities and prepayments.

 

In assessing liquidity, historical information such as seasonality, local economic cycles and the economy in general are considered along with our current financial position and projections. We believe that in the current economic environment our liquidity position is adequate. To our knowledge, there are no known trends nor any known demands, commitments, events, or uncertainties that will result or are reasonably likely to result in material increases or decreases in our liquidity.

 

Capital Resources:

 

In June 2015, we entered into an agreement to purchase, subject to conditions of the agreement, a building and the accompanying real estate in Sister Bay, Wisconsin in the amount of $1.1 million.  The transaction is expected to be completed no later than the fourth quarter of 2015.  The property, post renovation, is intended to be utilized as the new location for our branch currently located in Sister Bay.  The expected cost of the renovations is approximately $1.0 million.  The purchase and the renovation of the facility is expected to be financed using cash from operations.

 

Stockholders’ equity at June 30, 2015 and December 31, 2014 was $108.4 million and $105.5 million, respectively, reflecting an increase of $2.9 million (2.8%) during the first six months of 2015. The increase in stockholders’ equity primarily resulted from net income of $4.6 million, the conversion of $1.6 million of debentures and the vesting of restricted stock units of $0.1 million, partially offset by cash dividends of $1.5 million, the repurchase of 115,500 common shares for $1.4 million under the repurchase program approved by our Board of Directors on May 23, 2013 (the “Repurchase Program”) and a decrease in comprehensive income of $0.8 million during the first six months of 2015. Dividends of $0.16 per share were declared and paid during the six months ended June 30, 2015. The ratio of stockholders’ equity to assets was 11.1% and 10.3% at June 30, 2015 and December 31, 2014, respectively.

 

In July of 2015, we declared a $0.09 per share dividend. Our ability to pay dividends is subject to various factors including, among other things, sufficient earnings, available capital, board discretion, and regulatory compliance.

 

On May 23, 2013, our board of directors approved the Repurchase Program, which was designed to allow us to proactively manage our capital position and return excess capital to shareholders. Pursuant to the Repurchase Program, we may buy up to 400,000 shares of our common stock, representing approximately 5.0% of our outstanding common shares. During the first six months of 2015, we repurchased 115,500 shares pursuant to the Repurchase Program. See Part II, Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds, included elsewhere in this report for details of the stock repurchases during the quarter. On April 15, 2014, our board of directors approved an amendment to and extension of the Repurchase Program to authorize the repurchase of up to an additional 400,000 shares and extended the time period for the Repurchase Program through May 30, 2015. Again on May 16, 2015, our board of directors approved an amendment to, and extension of, the Repurchase Program authorizing a maximum of an additional 400,000 shares to be authorized to be purchased and extending the time period to May 30, 2016.

 

We regularly review the adequacy of our capital to ensure that sufficient capital is available for our current and future needs and it is in compliance with regulatory guidelines. The assessment of overall capital adequacy depends upon a variety of factors, including asset quality, liquidity, stability of earnings, changing competitive forces, economic conditions in markets served and strength of management.

 

The final rules implementing the Basel Committee on Banking Supervision’s capital guidelines for U.S. banks became effective for us on January 1, 2015 with full compliance with all of the final rule requirements to be fully phased in over a multi-year schedule by January 1, 2019.  As of June 30, 2015, our capital levels remained characterized as “well-capitalized” under these new rules.  See the “Regulatory Initiatives Affecting the Banking Industry” section for further discussion of Basel III.

 

We continue to evaluate the potential impact that regulatory rules may have on our liquidity and capital management strategies, including Basel III and those required under the Dodd-Frank Act.  See the “Regulatory Initiatives Affecting the Banking Industry” section below for further discussion on the potential impact that these regulatory rules may have on our liquidity and capital requirements.

 

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Among other things, the new rules revise capital adequacy guidelines and the regulatory framework for prompt corrective action. Additionally, they modified specified quantitative measures of assets, liabilities, and capital. The impact of these new rules require the Company to maintain capital in excess of previous “well-capitalized” regulatory standards, and in excess of historical levels.

 

The total capital ratios for the previous four quarters are as follows:

		June 30, 2015(1)		March 31, 2015(1)		December 31, 2014		September 30, 2014
Company		15.76%		15.87%		16.14 %		16.54 %
Bank		15.34%		15.54%		15.92 %		15.34 %

(1) March 31, 2015 and June 30, 2015 are calculated under Basel III rules, which became effective January 1, 2015.

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

The following tables present our and the Bank’s capital ratios as of June 30, 2015 and December 31, 2014:

 

CAPITAL RATIOS

(Dollar amounts in thousands)

		Actual								Required For Capital Adequacy Purposes								Required To Be Well Capitalized Under Prompt Corrective Action Provisions
		Amount				Ratio				Amount				Ratio				Amount				Ratio
As of June 30, 2015 (1)
Total Capital (to Risk-Weighted Assets)
Company		$	120,246				15.76	%		$	61,048				8.00	%		$	N/A				N/A
Bank			116,982				15.34	%			60,996				8.00	%			76,245				10.00	%
Tier 1 Capital (to Risk-Weighted Assets)
Company		$	113,290				14.85	%		$	45,786				6.00	%		$	N/A				N/A
Bank			110,026				14.43	%			45,747				6.00	%			60,996				8.00	%
Tier 1 Common Equity (to Risk-Weighted Assets)
Company		$	98,654				12.93	%		$	34,340				4.50	%		$	N/A				N/A
Bank			110,026				14.43	%			34,310				4.50	%			49,559				6.50	%
Tier 1 Capital (to Average Assets)
Company		$	113,290				11.71	%		$	38,706				4.00	%		$	N/A				N/A
Bank			110,026				11.40	%			38,606				4.00	%			48,257				5.00	%

		Actual								Required For Capital Adequacy Purposes								Required To Be Well Capitalized Under Prompt Corrective Action Provisions
		Amount				Ratio				Amount				Ratio				Amount				Ratio
As of December 31, 2014
Total Capital (to Risk-Weighted Assets)
Company		$	118,605				16.14	%		$	58,791				8.00	%		$	N/A				N/A
Bank			116,935				15.92	%			58,753				8.00	%			73,441				10.00	%
Tier 1 Capital (to Risk-Weighted Assets)
Company		$	109,904				14.96	%		$	29,395				4.00	%		$	N/A				N/A
Bank			109,884				14.96	%			29,376				4.00	%			44,064				6.00	%
Tier 1 Capital (to Average Assets)
Company		$	109,904				11.26	%		$	39,032				4.00	%		$	N/A				N/A
Bank			109,884				11.27	%			39,016				4.00	%			48,770				5.00	%

(1) June 30, 2015 are calculated under Basel III rules, which became effective January 1, 2015.

 

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Regulatory Initiatives Affecting the Banking Industry

Basel III

The Federal Reserve and the FDIC approved the final rules and implemented the Basel Committee on Banking Supervision’s capital guidelines for U.S. banks.  Under the final rules, minimum requirements will increase for both the quantity and quality of capital we hold.  The rules include a new common equity Tier 1 capital to risk-weighted assets minimum ratio of 4.5%, raise the minimum ratio of Tier 1 capital to risk-weighted assets from 4.0% to 6.0% , require a minimum ratio of total capital to risk-weighted assets of 8.0%, and require a minimum Tier  1 leverage ratio of 4.0%.  A new capital conservation buffer, comprised of common equity Tier 1 capital, is also established above the regulatory minimum capital requirements.  This capital conservation buffer will be phased-in beginning January 1, 2016 at 0.625% of risk-weighted assets and increase each subsequent year by an additional 0.625% until reaching its final level of 2.5% on January 1, 2019.  Strict eligibility for regulatory capital instruments was also implemented under the final rules.  The final rules also revise the definition and calculation of Tier 1 capital, total capital and risk-weighted assets.

The phase-in period for the final rules became effective for us on January 1, 2015, with full compliance with all of the final rules’ requirements phased in over a multi-year schedule, to be fully phased-in by January 1, 2019.  Although as of June 30, 2015, our capital levels remained characterized as “well-capitalized” under the new rules, our ratios have declined on a comparative basis to our regulatory capital ratios at December 31, 2014 due to compliance with the new rules under Basel III.

 

Item 3. Quantitative and Qualitative Disclosures about Market Risk

 

Our primary market risk exposure is interest rate risk. Interest rate risk is the risk that our earnings and capital will be adversely affected by changes in interest rates. Historically, we have not used derivatives to mitigate our interest rate risk.

 

Our earnings are derived from the operations of our direct and indirect subsidiaries with particular reliance on net interest income, calculated as the difference between interest earned on loans and investments and the interest expense paid on deposits and other interest-bearing liabilities, including advances from FHLB, convertible promissory notes and subordinated debentures. Like other financial institutions, our interest income and interest expense are affected by general economic conditions and by the policies of regulatory authorities, including the monetary policies of the Federal Reserve.

 

Changes in the economic environment may influence, among other matters, the growth rate of loans and deposits, the quality of the loan portfolio and loan and deposit pricing. Fluctuations in interest rates are not predictable or controllable.

 

As of June 30, 2015, we were in compliance with our management policies with respect to interest rate risk. We have not experienced any material changes to our market risk position since December 31, 2014, as described in our 2014 Annual Report on Form 10-K.

 

Our overall interest rate sensitivity is demonstrated by net interest income shock analysis which measures the change in net interest income in the event of hypothetical changes in interest rates. This analysis assesses the risk of change in net interest income in the event of sudden and sustained 100 bps and 200 bps increases and decreases in market interest rates. The table below presents our projected changes in net interest income for the various rate shock levels at June 30, 2015.

 

INTEREST SENSITIVITY

		Change in Net Interest Income Over One Year Horizon
		At June 30, 2015								At December 31, 2014
		Dollar change (in thousands)				Percentage change				Dollar change (in thousands)				Percentage change
Change in levels of interest rates
+200 bps		$	151				0.5	%		$	137				0.4	%
+100 bps			16				0.1	%			67				0.2	%
Base			—				—				—				—
-100 bps			(1,121	)			(3.5	)%			(1,281	)			(3.9	)%
-200 bps			(1,986	)			(6.3	)%			(2,141	)			(6.6	)%

 

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As in the preceding table, at June 30, 2015, the effect of an immediate 200 bp increase in interest rates would increase our net interest income by $0.2 million or 0.5% versus a $0.1 million or 0.4% increase in net interest income from a similar change in interest rates at December 31, 2014. The slight change in the impact of an immediate 200 bp increase in interest rates resulted from reduction of interest sensitive liability balances, offset in part by a reduction of cash balances during the first six months of 2015. The effect of an immediate 200 bp reduction in rates would have decreased our net interest income by $2.0 million or 6.3%, relatively unchanged from a decrease of $2.1 million or 6.6% at December 31, 2014 based upon such a reduction in interest rates. It is projected that rates paid on interest-bearing liabilities in the current low interest rate environment have less ability to continue to decline compared to yields on interest-earning assets. Accordingly, a 200 bp reduction in rates is not considered realistic given the low interest rate environment that currently exists. An interest rate floor of no less than zero is used rather than assuming a negative interest rate.

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

 

Item 4.  Controls and Procedures

 

Disclosures Controls and Procedures: Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures, as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) as of June 30, 2015. Based on such evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of June 30, 2015, our disclosure controls and procedures are effective.

 

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

 

Internal Control Over Financial Reporting

 

There have not been any changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the fiscal quarter to which this report relates that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

 

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PART II – OTHER INFORMATION

Item 1.  Legal Proceedings

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

Item 1A.  Risk Factors

 See “Risk Factors” in Item 1A of our annual report on Form 10-K for the year ended December 31, 2014. There have been no material changes to the risk factors since then.

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

During the quarter ended June 30, 2015, we did not sell any equity securities which were not registered under the Securities Act of 1933, as amended. We repurchased 49,500 shares of our common stock during the second quarter of 2015 at an average price of $12.55 per share. A total of 617,500 shares have been purchased since May 23, 2013 at an average price of $11.98 per share.

		Total Number of Shares Purchased				Average Price Paid per Share				Total Number of Shares Purchased as Part of Publically Announced Plans or Programs(1)				Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs(1)
April 1 – April 30, 2015			—			$	—				—				232,000
May 1 – May 31, 2015			44,500				12.53				44,500				587,500
June 1 – June 30, 2015			5,000				12.74				5,000				582,500
Three Months Ended June 30, 2015			49,500				12.55				49,500
Six Months Ended June 30, 2015			115,000				12.52				115,000
Since May 23, 2013			617,500			$	11.98				617,500				582,500

(1) On May 23, 2013, our Board of Directors approved the Repurchase Program, which authorized us to repurchase up to 400,000 shares of our stock through May 30, 2014. We repurchased an aggregate of 163,000 shares on the open market during the second, third and fourth quarters of 2013 at an average price of $10.48 per share. On April 15, 2014 our Board of Directors amended the Repurchase Program to increase the applicable shares that we could repurchase from 400,000 shares to 800,000 shares and extend the date through which those shares could be repurchased to May 30, 2015. During 2014, we repurchased 339,000 shares on the open market at an average price of $12.51 per share.

 

On May 16, 2015, our Board of Directors amended the Repurchase Program to increase the applicable shares that could be repurchased from 800,000 shares to 1,200,000 shares and extended the date through which those shares could be repurchased to May 30, 2016.  We repurchased 66,000 shares on the open market during the first quarter of 2015 at an average price of $12.50 per share.

 

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

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

Item 3.  Defaults Upon Senior Securities

Not applicable.

Item 4.  Mine Safety Disclosures

Not applicable.

 

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Item 5.  Other Information

Not applicable.

Item 6. Exhibits

 

The following exhibits are furnished herewith:

Exhibit Number		Description
2.1		Agreement and Plan of Merger by and between Baylake Corp. and NEW Bancshares, Inc., dated as of May 5, 2015, incorporated by reference to Exhibit 2.1 from the Company’s Current Report on Form 8-K filed on May 8, 2015.
2.2		Voting Agreement and Release by and between Baylake Corp. and the person listed on Schedule I attached thereto, dated as of May 5, 2015, incorporated by reference to Exhibit 2.2 from the Company’s Current Report on Form 8-K filed on May 8, 2015.
31.1		Certification under Section 302 of Sarbanes-Oxley by Robert J. Cera, Chief Executive Officer, is attached hereto.
31.2		Certification under Section 302 of Sarbanes-Oxley by Kevin L. LaLuzerne, Chief Financial Officer, is attached hereto.
32.1		Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of Sarbanes-Oxley is attached hereto.
32.2		Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of Sarbanes-Oxley is attached hereto.
101		Interactive data files pursuant to Rule 405 of Regulation S-T: (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Operations, (iii) Consolidated Statement of Comprehensive Income, (iv) Consolidated Statement of Changes in Stockholders’ Equity, (v) Consolidated Statements of Cash Flows, and (vi) Notes to Consolidated Financial Statements tagged as blocks of text.

 

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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:	July 31, 2015		/s/ Robert J. Cera
			Robert J. Cera President and Chief Executive Officer
Date:	July 31, 2015		/s/ Kevin L. LaLuzerne
			Kevin L. LaLuzerne Treasurer and Chief Financial Officer

 

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