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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

☒  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended September 30, 2015

 

OR

 

☐  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from _________________to ________________

 

Commission file number 001-16339

 

 

BAYLAKE CORP.

(Exact name of registrant as specified in its charter) 

Wisconsin             (State or other jurisdiction of incorporation or organization)	39-1268055             (I.R.S. Employer Identification No.)
217 North Fourth Avenue, Sturgeon Bay, WI (Address of principal executive offices)	54235 (Zip Code)
(920) 743-5551 (Registrant’s telephone number, including area code)
None (Former name, former address and former fiscal year, if changed since last report)

 

 

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

Yes ☒   No ☐

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

 

Yes ☒   No ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer ☐	Accelerated filer ☒	Non-accelerated filer ☐ (Do not check if a smaller reporting company)	Smaller reporting company ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes ☐   No ☒

 

The number of outstanding shares of common stock, $5.00 par value per share, as of October 30, 2015 was 9,320,255 shares.

 

 

BAYLAKE CORP.

index 

		PAGE NO.
PART I - FINANCIAL INFORMATION
ITEM 1 -	FINANCIAL STATEMENTS	3
ITEM 2 -	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	32
ITEM 3 -	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	56
ITEM 4 -	CONTROLS AND PROCEDURES	57
PART II - OTHER INFORMATION
ITEM 1 -	LEGAL PROCEEDINGS	58
ITEM 1A -	RISK FACTORS	58
ITEM 2 -	UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	58
ITEM 3 -	DEFAULTS UPON SENIOR SECURITIES	58
ITEM 4 -	MINE SAFETY DISCLOSURES	58
ITEM 5 -	OTHER INFORMATION	59
ITEM 6 -	EXHIBITS	59

  

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PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

BAYLAKE CORP.
CONSOLIDATED BALANCE SHEETS
September 30, 2015 (unaudited) and December 31, 2014
(Dollar amounts in thousands)

		September 30,				December 31,
		2015				2014
ASSETS
Cash and due from financial institutions		$	75,634			$	60,189
Federal funds sold			663				1,176
Securities held to maturity, at amortized cost			25,519				25,612
Securities available for sale, at fair value			158,121				182,912
Loans held for sale			175				1,290
Loans, net of allowance of $6,510 at September 30, 2015 and $7,051 at December 31, 2014			685,131				672,306
Cash surrender value of life insurance			23,647				23,587
Premises and equipment, net			20,948				20,206
Premises and equipment held for sale			784				844
Federal Home Loan Bank stock			4,238				4,238
Other real estate owned, net			3,977				4,266
Goodwill			7,222				7,222
Deferred income taxes, net			3,630				4,707
Accrued interest receivable			2,830				2,559
Other assets			10,649				10,509
Total Assets		$	1,023,168			$	1,021,623
LIABILITIES AND STOCKHOLDERS’ EQUITY
Deposits
Noninterest-bearing		$	186,677			$	153,113
Interest-bearing			613,171				612,429
Total Deposits			799,848				765,542
Federal Home Loan Bank advances			41,610				60,455
Repurchase agreements			48,076				64,869
Subordinated debentures			16,100				16,100
Convertible promissory notes			—				1,650
Accrued expenses and other liabilities			6,933				7,503
Total Liabilities			912,567				916,119
Commitments and Contingencies - Note 15
Common stock, $5 par value, authorized 50,000,000 shares; Issued-10,158,768 shares at September 30, 2015 and 9,777,834 shares at December 31, 2014; Outstanding-9,320,255 shares at September 30, 2015 and 9,054,821 shares at December 31, 2014			50,794				48,889
Additional paid-in capital			12,917				12,654
Retained earnings			55,685				51,123
Treasury stock 838,513 shares at September 30, 2015 and 723,013 shares at December 31, 2014			(10,943	)			(9,497	)
Accumulated other comprehensive income			2,148				2,335
Total Stockholders’ Equity			110,601				105,504
Total Liabilities and Stockholders’ Equity		$	1,023,168			$	1,021,623
See accompanying Notes to Consolidated Financial Statements

 

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BAYLAKE CORP.
CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
Three and Nine months ended September 30, 2015 and 2014
(Dollar amounts in thousands, except per share data)

 

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2015				2014				2015				2014
INTEREST AND DIVIDEND INCOME
Loans, including fees		$	7,317			$	6,862			$	21,779			$	20,898
Taxable securities			930				1,269				3,225				3,768
Tax exempt securities			339				377				1,038				1,120
Federal funds sold			34				33				62				62
Total Interest and Dividend Income			8,620				8,541				26,104				25,848
INTEREST EXPENSE
Deposits			328				400				1,003				1,226
Repurchase agreements			13				24				50				74
Federal Home Loan Bank advances and other debt			219				175				716				589
Subordinated debentures			67				65				198				194
Convertible promissory notes			—				119				27				571
Total Interest Expense			627				783				1,994				2,654
Net interest income before provision for loan losses			7,993				7,758				24,110				23,194
Provision for loan losses			—				—				200				—
Net interest income after provision for loan losses			7,993				7,758				23,910				23,194
NONINTEREST INCOME
Fees from fiduciary activities			295				287				892				791
Fees from loan servicing			133				133				428				433
Fees from financial services to customers			301				281				841				799
Fees for other services to customers			980				1,003				2,826				2,667
Net gain on sale of loans			247				199				731				452
Net change in valuation of mortgage servicing rights, net of payments and payoffs			(25	)			3				(48	)			(131	)
Net realized gain on sale of securities			132				71				384				232
Net gains (losses) on sale of premises and equipment			12				(4	)			12				1
Increase in cash surrender value of life insurance			78				85				263				287
Income in equity of UFS subsidiary			213				299				900				881
Other noninterest (expense) income			(93	)			(28	)			2				99
Total Noninterest Income			2,273				2,329				7,231				6,511
NONINTEREST EXPENSE
Salaries and employee benefits			3,883				3,630				12,543				12,086
Occupancy expense			550				544				1,667				1,618
Equipment expense			339				328				1,020				982
Data processing and courier expense			243				222				706				625
FDIC insurance expense			147				156				444				456
Operation of other real estate owned			178				339				417				646
Loan and collection expense			16				6				50				43
Other outside services			301				250				904				876
Audit and legal expense			322				201				740				530
Costs relating to UFS tax strategy implementation			—				—				163				—
Other noninterest expenses			965				832				2,615				2,408
Total Noninterest Expense			6,944				6,508				21,269				20,270
Income before provision for income taxes			3,322				3,579				9,872				9,435
Provision for income taxes			1,031				1,122				2,992				2,754
Net Income		$	2,291			$	2,457			$	6,880			$	6,681
Basic earnings per share		$	0.25			$	0.29			$	0.74			$	0.82
Diluted earnings per share		$	0.24			$	0.26			$	0.73			$	0.73
Cash dividends paid per share		$	0.09			$	0.08			$	0.25			$	0.22
See accompanying Notes to Consolidated Financial Statements

  

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BAYLAKE CORP.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)

Three and Nine Months ended September 30, 2015 and 2014

(Dollar amounts in thousands)

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2015				2014				2015				2014
Net Income		$	2,291			$	2,457			$	6,880			$	6,681
Other comprehensive income (loss), net of tax
Unrealized gains on securities
Net unrealized holding gains (losses)  arising during the period			1,162				1,695				77				1,856
Less: reclassification adjustment for gains realized in net income			(132	)			(71	)			(384	)			(232	)
Tax effect			(404	)			318				120				(637	)
Other comprehensive income (loss)			626				1,942				(187	)			987
Comprehensive income		$	2,917			$	4,399			$	6,693			$	7,668

 

See accompanying Notes to Consolidated Financial Statements

 

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BAYLAKE CORP.

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (Unaudited)

Nine Months ended September 30, 2015

(Dollar amounts in thousands, except share data)

																	Accumulated
								Additional									Other
		Common Stock						Paid-In			Retained			Treasury			Comprehensive			Stockholders’
		Shares			Amount			Capital			Earnings			Stock			Income			Equity
Balance, January 1, 2015			9,054,821		$	48,889		$	12,654		$	51,123		$	(9,497	)	$	2,335		$	105,504
Net income			—			—			—			6,880			—			—			6,880
Net changes in unrealized gains on securities available for sale			—			—			—			—			—			77			77
Reclassification adjustment for net gains realized in income			—			—			—			—			—			(384	)		(384	)
Tax effect			—			—			—			—			—			120			120
Total comprehensive income																					6,693
Purchase of treasury stock			(115,500	)		—			—			—			(1,446	)		—			(1,446	)
Stock-based compensation expense recognized, net			—			—			330			—			—			—			330
Vesting of RSUs			35,556			178			(178	)		—			—			—			—
Tax benefit from vesting of RSUs			—			—			81			—			—			—			81
Exercise of stock options			15,378			77			34			—			—			—			111
Tax benefit from exercise of stock options/RSUs			—			—			—			—			—			—			—
Forfeiture of stock options/RSUs not exercised			—			—			—			—			—			—			—
Tax expense from forfeiture of unexercised stock options/RSUs			—			—			(4	)		—			—			—			(4	)
Conversion of debentures			330,000			1,650			—			—			—			—			1,650
Cash dividends - ($0.25 per share)			—			—			—			(2,318	)		—			—			(2,318	)
Balance, September 30, 2015			9,320,255		$	50,794		$	12,917		$	55,685		$	(10,943	)	$	2,148		$	110,601

 

See accompanying Notes to Consolidated Financial Statements

 

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BAYLAKE CORP.

CONSOLIDATED STATEMENTS OF CASH  FLOWS (Unaudited)

Nine months ended September 30, 2015 and 2014

(Dollar amounts in thousands)

		2015				2014
CASH FLOWS FROM OPERATING ACTIVITIES
Reconciliation of net income to net cash provided by operating activities:
Net Income		$	6,880			$	6,681
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization			949				982
Amortization of debt issuance costs			—				26
Amortization of core deposit intangible			17				15
Provision for loan losses			200				—
Net amortization of premium/discount on securities			1,166				1,208
Increase in cash surrender value of life insurance			(263	)			(287	)
Net realized gain on sale of securities			(384	)			(232	)
Net gain on sale of loans			(731	)			(452	)
Proceeds from sale of loans held for sale			38,396				22,232
Origination of loans held for sale			(36,632	)			(20,955	)
Change in valuation of mortgage servicing rights, net of payments and payoffs			48				131
Provision for valuation allowance on other real estate owned			154				508
Provision for valuation allowance on land held for sale			60				—
Net (gains) losses on sale of premises and equipment			(12	)			(1	)
Net gain on disposals of other real estate owned			(32	)			(48	)
Provision for deferred income tax expense			1,197				848
Stock-based compensation expense			330				262
Forfeiture of options not exercised and RSUs not vested			—				(7	)
Tax (expense) benefit from exercise/forfeiture of options			(4	)			5
Income in equity of UFS subsidiary			(900	)			(881	)
Changes in assets and liabilities:
Accrued income taxes			71				11
Accrued interest receivable and other assets			93				(1,088	)
Income tax refunds			—				(173	)
Accrued expenses and other liabilities			(570	)			(741	)
Net cash provided by operating activities			10,033				8,044
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from sale of securities available for sale			12,803				4,588
Principal payments on securities available for sale			27,155				22,349
Purchase of securities held to maturity			—				(15,456	)
Purchase of securities available for sale			(16,163	)			(4,328	)
Purchase of FHLB stock			—				(640	)
Proceeds from sale of other real estate owned			539				1,437
Proceeds from sale of premises and equipment			39				82
Proceeds from life insurance death benefit			203				196
Loan originations and payments, net			(13,397	)			(14,746	)
Additions to premises and equipment			(1,718	)			(776	)
Net change in federal funds sold			513				(1,580	)
Dividend from UFS subsidiary			342				417
Net cash provided in purchase or sale of branches			—				12,086
Net cash provided by investing activities			10,316				3,629

 

See accompanying Notes to Unaudited Consolidated Financial Statements.

 

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BAYLAKE CORP.

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

Nine months ended September 30, 2015 and 2014

(Dollar amounts in thousands)

		2015				2014
CASH FLOWS FROM FINANCING ACTIVITIES
Net change in deposits		$	34,306			$	(4,890	)
Net change in repurchase agreements			(16,793	)			(13,173	)
Repayments on Federal Home Loan Bank advances			(28,845	)			(62,530	)
Proceeds from Federal Home Loan Bank advances			10,000				50,300
Tax benefit from vesting of restricted stock units			81				92
Proceeds from exercise of stock options			111				7
Purchase of treasury stock			(1,446	)			(3,231	)
Cash dividends paid			(2,318	)			(1,789	)
Net cash used in financing activities			(4,904	)			(35,214	)
Net change in cash			15,445				(23,541	)
Beginning cash			60,189				76,179
Ending cash		$	75,634			$	52,638
Supplemental cash flow information:
Interest paid		$	1,984			$	2,762
Income taxes paid (refunded), net			1,620				1,977
Supplemental noncash disclosure:
Transfers from loans to other real estate owned		$	372			$	586
Mortgage servicing rights resulting from sale of loans			82				51
Conversion of debentures to equity			1,650				5,025

 

See accompanying Notes to Unaudited Consolidated Financial Statements. 

 

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BAYLAKE CORP.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2015

 

1.

The consolidated financial statements of Baylake Corp. (the “Company”) include the accounts of the Company, its wholly owned subsidiaries Baylake Bank (the “Bank”) and Admiral Asset Management, LLC (“Admiral”), and the Bank’s wholly owned subsidiary, Bay Lake Investments, Inc. All significant intercompany items have been eliminated. The accompanying interim consolidated financial statements should be read in conjunction with the 2014 Annual Report on Form 10-K of the Company. The accompanying consolidated financial statements are unaudited. These interim consolidated financial statements are prepared in accordance with the requirements of Form 10-Q, and accordingly do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America (“U.S. GAAP”) for complete financial statements. In the opinion of management, the unaudited consolidated financial information included in this report reflects all adjustments, consisting of normal recurring accruals of operations for the three and nine month periods ending September 30, 2015 and 2014 necessary to make the consolidated financial information not misleading. The consolidated results of operations for the three and nine months ended September 30, 2015 are not necessarily indicative of results to be expected for the entire year. Management of the Company has evaluated all subsequent events to October 30, 2015, the date the interim consolidated financial statements were issued, and determined that all subsequent events have been recognized and disclosed in the accompanying consolidated financial statements through the date of this report.

 

2.

Use of Estimates

 

To prepare consolidated financial statements in conformity with U.S. GAAP, management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the consolidated financial statements and the disclosures provided, and actual results could differ. The allowance for loan losses, value of other real estate owned, other than temporary impairment of securities, mortgage servicing rights, income tax assets and liabilities, and fair values of financial instruments are particularly subject to change.

 

3.

Earnings Per Share

 

Basic earnings per share is computed by dividing net income available to common stockholders by the weighted average number of common shares outstanding during the period. Diluted earnings per share, which reflects the potential dilution that could occur if outstanding stock options were exercised, stock awards were fully vested, and promissory notes were converted, resulting in the issuance of common stock that then shared in the Company’s earnings, is computed by dividing net income as adjusted for the income impact of assumed conversions by the weighted average number of common shares outstanding and common stock equivalents. The following table shows the computation of the basic and diluted earnings per share:

 

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BAYLAKE CORP.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2015

(Dollar amounts in thousands, except per share data)

 

EARNINGS PER SHARE

 

		Three months ended September 30,								Nine months ended September 30,
		2015				2014				2015				2014
(Numerator):
Net income available to common stockholders		$	2,291			$	2,457			$	6,880			$	6,681
Plus:  Income impact of assumed conversions
Interest on 10% convertible debentures, net of income tax			—				72				16				347
Income available to common stockholders plus assumed conversions		$	2,291			$	2,529			$	6,896			$	7,028
(Denominator):
Weighted average number of common shares outstanding-basic			9,320,255				8,611,631				9,267,250				8,101,490
Plus:  Incremental shares of assumed conversions:
Dilutive effect of stock options (1)			47,775				45,427				48,407				44,379
Dilutive effect of restricted stock units (2)			24,427				32,238				26,720				35,977
Dilutive effect of convertible promissory notes (3)			—				875,000				70,879				1,446,465
Dilutive potential common shares			72,202				952,665				146,006				1,526,821
Adjusted weighted-average shares			9,392,457				9,564,296				9,413,256				9,628,311
Basic Earnings Per Share		$	0.25			$	0.29			$	0.74			$	0.82
Diluted Earnings Per Share		$	0.24			$	0.26			$	0.73			$	0.73

 

(1)

For the three and nine months ended September 30, 2015 and 2014, respectively, there were 114,197 and 61,469 outstanding stock options that were not included in the computation of diluted earnings per share because they were considered anti-dilutive.

 

(2)

For the three months ended September 30, 2015 and 2014, respectively, there were no outstanding restricted stock units that were not included in the computation of diluted earnings per share because they were considered anti-dilutive. For the nine months ended September 30, 2015 and 2014, there were 0 and 14,416 restricted stock units, respectively, which were not included in the computation of diluted earnings per share because they are considered anti-dilutive.

 

(3)

At September 30, 2015, the Company had no outstanding convertible notes (the “Convertible Notes”). At September 30, 2014, the Company had $4.4 million of the Convertible Notes outstanding. The Convertible Notes were convertible into shares of common stock of the Company 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 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 common stock at the Conversion Ratio. On October 1, 2014, one-half of the original principal amounts of the Convertible Notes were mandatorily convertible at the Conversion Ratio if voluntary conversion had not yet occurred. The principal amount of any Convertible Note that had not been converted would be payable at maturity on June 30, 2017. At September 30, 2014, the entire 1,875,000 of common shares issuable upon conversion of remaining outstanding Convertible Notes are included in the computation of diluted earnings per share since the average market price per share for the three and nine months ended September 30, 2014 exceeded the conversion price of $5.00 per share. On April 1, 2015, all of the remaining outstanding debentures were converted to shares of common stock under the provisions for voluntary conversion.

 

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BAYLAKE CORP.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2015

 

4.

Recent Accounting Pronouncement

 

In September 2015, the Financial Accounting Standards Board (“FASB”) issued Accounting Standard Update (“ASU”) no. 2015-16 Business Combinations (Topic 805): Simplifying the Accounting for Measurement-Period Adjustments. The amendments in this update require that an acquirer recognize adjustments to estimated amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. The amendments require that the acquirer record, in the same period’s financial statements, the effect on earnings of changes in depreciation, amortization or other income effects, if any, as a result of the change to the estimated amounts, calculated as if the account had been completed at the acquisition date. The amendments also require an entity to present separately on the face of the income statement or disclose in the notes the portion of the amount recorded in current-period earnings by line item that would have been recorded in previous reporting periods if the adjustment to the estimated amounts had been recognized as of the acquisition date. This guidance is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. The adoption of this guidance is not expected to have a significant impact on the consolidated financial condition, results of operations or liquidity of the Company.

 

In August 2015, the FASB issued ASU 2015-03, Interest - Imputation of Interest (Subtopic 835-30): Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements-Amendments to SEC Paragraphs Pursuant to Staff Announcement at June 8, 2015 EITF Meeting (SEC Update). The original ASU (2015-03) issued in April 2015 required that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. Given the absence of authoritative guidance within ASU 2015-03 for debt issuance costs related to line-of-credit arrangements, the SEC staff stated that they would not object to an entity deferring and presenting debt issuance costs as an asset and subsequently amortizing those deferred debt issuance costs ratably over the term of the line-of-credit arrangement, regardless of whether there are any outstanding borrowings on the line-of-credit arrangement. This guidance is effective for fiscal years beginning after December 15, 2015 and interim periods with fiscal years beginning after December 15, 2016. A reporting entity may apply the amendments prospectively or retrospectively to all prior periods presented in the financial statements. Early adoption is permitted provided that the guidance is applied from the beginning of the fiscal year of adoption. The adoption of this guidance is not expected to have a significant impact on the consolidated financial condition, results of operations or liquidity of the Company.

 

In May 2015, FASB issued ASU No. 2015-08 Business Combinations (Topic 805): Pushdown Accounting – Amendments to SEC Paragraphs Pursuant to Staff Accounting Bulletin No. 115. Amendments in this update amend SEC paragraphs pursuant to Staff Accounting Bulletin (“SAB”) No. 115, which supersedes several paragraphs in ASC 805-50 in response to the SEC’s November 2014 publication of SAB 115.The SEC issued SAB 115 in connection with the release of FASB ASU No. 2014-17, “Pushdown Accounting.” This guidance is effective immediately. The adoption of this guidance did not have a significant impact on the consolidated financial condition, results of operations or liquidity of the Company.

 

In February 2015, the FASB issued ASU No. 2015-02 Consolidation (Topic 810): Amendments to the Consolidation Analysis. The amendments in this update rescind the indefinite deferral of FASB Statement No. 167, Amendments to FASB Interpretation No. 46(R), included in FASB Accounting Standards Update No. 2010-10, Consolidation (Topic 810): Amendments for Certain Investment Funds. However, the amendments in this update provide a scope exception from Topic 810 for reporting entities with interests in legal entities that are required to comply with or operate in accordance with requirements similar to those in Rule 2a-7 of the Investment Company Act of 1940 for registered money market funds. This guidance is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. The adoption of this guidance is not expected to have a significant impact on the consolidated financial condition, results of operations or liquidity of the Company.

 

In January 2015, the FASB issued ASU No. 2015-01 Income Statement - Extraordinary and Unusual Items (Subtopic 225-20): Simplifying Income Statement Presentation by Eliminating the Concept of Extraordinary Items. The amendment eliminates from U.S. GAAP the concept of extraordinary items. Subtopic 225-20, Income Statement – Extraordinary and Unusual Items, required that an entity separately classify, present, and disclose extraordinary events and transactions. Presently, an event or transaction is presumed to be an ordinary and usual activity of the reporting entity unless evidence clearly supports its classification as an extraordinary item. If an event or transaction meets the criteria for extraordinary classification, an entity is required to segregate the extraordinary item from the results of ordinary operations and show the item separately in the income statement, net of tax, after income from continuing operations. The entity also is required to disclose applicable income taxes and either present or disclose earnings-per-share data applicable to the extraordinary item. This guidance is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. A reporting entity may apply the amendments prospectively or retrospectively to all prior periods presented in the financial statements. Early adoption is permitted provided that the guidance is applied from the beginning of the fiscal year of adoption. The adoption of this guidance is not expected to have a significant impact on the consolidated financial condition, results of operations or liquidity of the Company.

 

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In August 2014, the FASB issued ASU No. 2014-15, Presentation of Financial Statements – Going Concern (Subtopic 205-40). In connection with preparing financial statements for each annual and interim reporting periods, an entity’s management should evaluate whether there are conditions or events, considered in the aggregate, that raise substantial doubt about the entity’s ability to continue as a going concern within one year after the date that the financial statements are issued (or within one year after the date that the financial statements are available to be issued when applicable). Management’s evaluation should be based on relevant conditions and events that are known and reasonably knowable at the date that the financial statements are issued (or at the date that the financial statements are available to be issued when applicable). The amendments in this update are effective for the annual period ending after December 15, 2016, and for annual periods and interim periods thereafter. The adoption of this guidance is not expected to have a significant impact on the consolidated financial condition, results of operations or liquidity of the Company.

 

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606). Under the amended guidance, an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. This guidance is effective prospectively for annual and interim periods beginning after December 15, 2016. Management is currently evaluating this guidance and does not expect this guidance to have a significant impact on the consolidated financial condition, results of operations or liquidity of the Company.

 

In January 2014, the FASB issued ASU No. 2014-04, Receivables – Troubled Debt Restructurings by Creditors (Subtopic 310-40) Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure (a consensus of the FASB Emerging Issues Task Force). The amendments in ASU 2014-04 clarify when an in-substance repossession or foreclosure occurs — that is, when a creditor should be considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan such that the loan receivable should be derecognized and the real estate property recognized. The ASU requires a creditor to reclassify a collateralized consumer mortgage loan to real estate property upon obtaining legal title to the real estate collateral, or upon the borrower voluntarily conveying all interest in the real estate property to the lender to satisfy the loan through a deed in lieu of foreclosure or similar legal agreement. This ASU was effective for the Company beginning January 1, 2015. The provisions of this guidance did not have a significant impact on the consolidated financial condition, results of operations or liquidity of the Company.

 

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BAYLAKE CORP.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2015

 

5.

Fair Value

 

Accounting guidance establishes a fair value hierarchy that requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The guidance describes three levels of inputs that may be used to measure fair value: 

 

Level 1:

Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

Level 2:

Significant other observable inputs, other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

Level 3:

Significant unobservable inputs that reflect a reporting entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

 

A financial instrument’s categorization within the valuation hierarchy is based upon the lowest level of input within the valuation hierarchy that is significant to the fair value measurement.

 

The methods and assumptions used to estimate fair value are described below.

 

Securities available for sale - the fair value of securities available for sale is determined by obtaining quoted prices on nationally recognized securities exchanges (Level 1 inputs) or matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities (Level 2 inputs). For other securities not able to be priced on matrix pricing, outside third parties are relied upon (Level 3 inputs). One of the Company’s securities available for sale at September 30, 2015 and December 31, 2014 was measured using Level 3 inputs.

 

Non-impaired loans and deposits - the fair value of fixed rate non-impaired loans and deposits and non-impaired variable rate loans and deposits with infrequent repricing or repricing limits is based on discounted cash flows using current market rates applied to the estimated life and credit risk (Level 3 inputs).

 

Impaired Loans - the fair value of impaired loans is based on a review of comparable collateral in similar marketplaces (Level 3 inputs) or an analysis of expected cash flows of the loan in relationship to the contractual terms of the loan (Level 3 inputs). Impaired loans are carried at the lower of amortized cost or fair value less estimated costs to sell. Impaired loans are not carried at fair value if there is sufficient collateral or if expected repayments exceed the recorded investments of such loans.

 

Mortgage servicing rights - the fair value of mortgage servicing rights is based on a valuation model that calculates the present value of estimated net servicing income. The valuation model incorporates assumptions that market participants would use in estimating future net servicing income. These assumptions include servicing costs, expected loan lives, discount rates, and the determination of whether the loan is likely to be refinanced. The Company compares the valuation model inputs and results to published industry data for reasonableness (Level 2 inputs).

 

Other real estate owned - the fair value of other real estate owned is determined using a variety of market information including, but not limited to, appraisals, professional market assessments, and real estate tax assessment information. Properties obtained by the Bank in foreclosure are adjusted to fair value less estimated costs to sell upon their transfer to other real estate owned, establishing a new cost basis. Subsequently, other real estate owned is carried at the lower of cost or fair value less estimated costs to sell (Level 3 inputs).

 

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BAYLAKE CORP.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2015

(Dollar amounts in thousands)

 

ASSETS MEASURED AT FAIR VALUE ON A RECURRING BASIS

 

Assets measured at fair value on a recurring basis are summarized below:

 

		September 30, 2015				Quoted Prices in Active Markets For Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)
Assets:
Securities available for sale:
U.S. government-sponsored agency securities		$	2,269			$	—			$	2,269			$	—
Mortgage-backed securities			90,710				—				90,606				104
Obligations of states and political subdivisions			59,728				—				59,728				—
Private placement and corporate bonds			3,509				—				3,509				—
Other securities			1,905				—				1,905				—
Total securities available for sale			158,121				—				158,017				104
Mortgage servicing rights			875				—				875				—
Total		$	158,996			$	—			$	158,892			$	104

 

		December 31, 2014				Quoted Prices in Active Markets For Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)
Assets:
Securities available for sale:
U.S. government-sponsored agency securities		$	2,747			$	—			$	2,747			$	—
Mortgage-backed securities			115,714				—				115,460				254
Obligations of states and political subdivisions			59,002				—				59,002				—
Private placement and corporate bonds			3,544				—				3,544				—
Other securities			1,905				—				1,905				—
Total securities available for sale			182,912				—				182,658				254
Mortgage servicing rights			841				—				841				—
Total		$	183,753			$	—			$	183,499			$	254

 

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 BAYLAKE CORP.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2015

(Dollar amounts in thousands)

 

The following table presents additional information about assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3):

 

		For the three months ended September 30, 2015				For the nine months ended September 30, 2015
Balance, beginning of period		$	151			$	254
Other comprehensive gain			—				5
Principal payments			(47	)			(155	)
Balance, end of period		$	104			$	104

 

ASSETS MEASURED AT FAIR VALUE ON A NON-RECURRING BASIS

 

Assets measured at fair value on a non-recurring basis are summarized below:

 

		September 30, 2015				Quoted Prices in Active Markets For Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)
Assets:
Impaired loans with allocated allowances		$	1,139			$	—			$	—			$	1,139
Other real estate owned, net			3,977				—				—				3,977
Total		$	5,116			$	—			$	—			$	5,116

 

		December 31, 2014				Quoted Prices in Active Markets For Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)
Assets:
Impaired loans with allocated allowances		$	1,451			$	—			$	—			$	1,451
Other real estate owned, net			4,266				—				—				4,266
Total		$	5,717			$	—			$	—			$	5,717

 

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BAYLAKE CORP.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2015

(Dollar amounts in thousands)

 

Required Financial Disclosures about Fair Value of Financial Instruments

 

The accounting guidance for financial instruments requires disclosures of estimated fair value of certain financial instruments and the methods and significant assumptions used to estimate their fair values. Certain financial instruments and all nonfinancial instruments are excluded from the scope of this guidance. Accordingly, the fair value disclosures required by this guidance are only indicative of the value of individual financial instruments as of the dates indicated and should not be considered an indication of the Company’s fair value.

 

The following table presents the carrying amount and estimated fair value of certain financial instruments:

		September 30, 2015								December 31, 2014
		Carrying Amount				Fair Value				Carrying Amount				Fair Value
FINANCIAL ASSETS
Cash and due from financial institutions		$	75,634			$	75,634			$	60,189			$	60,189
Federal funds sold			663				663				1,176				1,176
Securities held to maturity			25,519				26,603				25,612				26,181
Securities available for sale			158,121				158,121				182,912				182,912
Loans held for sale			175				179				1,290				1,314
Loans, net			685,131				686,637				672,306				675,481
Federal Home Loan Bank stock			4,238				4,238				4,238				4,238
Mortgage servicing rights			875				875				841				841
Other real estate owned, net			3,977				3,977				4,266				4,266
Accrued interest receivable			2,830				2,830				2,559				2,559
FINANCIAL LIABILITIES
Deposits		$	799,848			$	799,824			$	765,542			$	765,370
Federal Home Loan Bank advances			41,610				42,255				60,455				60,475
Repurchase agreements			48,076				48,076				64,869				64,869
Subordinated debentures			16,100				16,100				16,100				16,100
Convertible promissory notes			—				—				1,650				1,642
Accrued interest payable			292				292				283				283

 

The methods and assumptions that were used to estimate the fair value of financial assets and financial liabilities that are measured at fair value on a recurring and non-recurring basis have been previously disclosed. The following methods and assumptions were used to estimate the fair value of other financial instruments for which it is practicable to estimate that value:

 

(a)

Cash and Due from Financial Institutions

 

The carrying amount of cash and due from financial institutions approximates fair value.

 

(b)

Federal Funds Sold

 

The carrying amount of federal funds sold approximates fair value.

 

(c)

Securities Held to Maturity and Available for Sale

 

The fair value of securities held to maturity and securities available for sale is based on quoted prices in active markets, or if quoted prices are not available for a specific security, then fair values are estimated by using pricing models, quoted prices of securities with similar characteristics or discounted cash flows.

 

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BAYLAKE CORP.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2015

 

(d)          Loans Held for Sale

Loans held for sale, which generally consists of the current production of first-lien residential mortgage loans, are carried at the lower of cost or estimated fair value. Fair value is estimated based on actual market quotes from investors in the secondary market.

 

(e)          Federal Home Loan Bank Stock

It is not practical to determine the fair value of Federal Home Loan Bank (“FHLB”) stock due to restrictions placed on its transferability. No secondary market exists for FHLB stock. The stock is bought and sold at par by the FHLB. Management believes that the recorded value is representative of fair value.

 

(f)           Accrued Interest Receivable

 

The carrying amount of accrued interest receivable approximates fair value.

 

(g)          Deposits

 

The carrying amount of demand deposits (interest-bearing and noninterest-bearing), savings deposits, and money market deposits approximates fair value. The carrying amount of variable rate time deposits, including certificates of deposit, approximates fair value. For fixed rate time deposits, fair value is based on discounted cash flows using current market interest rates.

 

(h)          Federal Home Loan Bank Advances

 

The carrying amount of variable rate FHLB advances approximates fair value. For fixed rate advances, fair value is based on discounted cash flows using current market interest rates.

 

(i)           Repurchase Agreements

 

The carrying amount of repurchase agreements approximates fair value.

 

(j)           Subordinated Debentures

 

The carrying amount of variable rate subordinated debentures approximates fair value.

 

(k)          Convertible Promissory Notes

 

The carrying amount of convertible promissory notes is based on current rates for similar financing.

 

(l)           Accrued Interest Payable

 

The carrying amount of accrued interest payable approximates fair value.

 

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BAYLAKE CORP.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2015
(Dollar amounts in thousands) 

 

6.          Investments

 

The fair value of securities available for sale (“AFS”), the fair value of securities held to maturity (“HTM”) and the related unrealized gains and losses as of September 30, 2015 and December 31, 2014 are as follows:  

		September 30, 2015
		Fair Value				Gross Unrealized Gains				Gross Unrealized Losses
Securities Available for Sale:
U.S. government-sponsored agency securities		$	2,269			$	44			$	—
Mortgage-backed securities			90,710				2,172				(343	)
Obligations of states and political subdivisions			59,728				1,707				(35	)
Private placement and corporate bonds			3,509				—				(10	)
Other securities			1,905				—				—
Total Securities Available for Sale		$	158,121			$	3,923			$	(388	)
Securities Held to Maturity:
Mortgage-backed securities		$	21,428			$	909			$	—
Private placement and corporate bonds			5,175				175				—
Total Securities Held to Maturity		$	26,603			$	1,084			$	—
Total Investment Securities		$	184,724			$	5,007			$	(388	)

		December 31, 2014
		Fair Value				Gross Unrealized Gains				Gross Unrealized Losses
Securities Available for Sale:
U.S. government-sponsored agency securities		$	2,747			$	—			$	(4	)
Mortgage-backed securities			115,714				2,492				(640	)
Obligations of states and political subdivisions			59,002				2,027				(57	)
Private placement and corporate bonds			3,544				24				—
Other securities			1,905				—				—
Total Securities Available for Sale		$	182,912			$	4,543			$	(701	)
Securities Held to Maturity:
Mortgage-backed securities		$	21,131			$	519			$	—
Private placement and corporate bonds			5,050				50				—
Total Securities Held to Maturity		$	26,181			$	569			$	—
Total Investment Securities		$	209,093			$	5,112			$	(701	)

   

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BAYLAKE CORP.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2015
(Dollar amounts in thousands)

At September 30, 2015 and December 31, 2014, the mortgage-backed securities portfolios at market value were $112.1 million (60.7%) and $136.8 million (65.4%), respectively, of the investment portfolios. Approximately 4.8%, or $5.4 million, of the mortgage-backed securities outstanding at September 30, 2015 were issued by the Government National Mortgage Association (“GNMA”); an agency of the United States government. An additional 91.3%, or $102.3 million, of the mortgage-backed securities outstanding at September 30, 2015 were issued by either the Federal National Mortgage Association (“FNMA”), the FHLB or the Federal Home Loan Mortgage Corporation (“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 3.9%, or $4.4 million of the outstanding mortgage-backed securities at September 30, 2015. Management evaluates these non-agency mortgage-backed securities at least quarterly and more frequently when economic or market concerns warrant such evaluation.

 

Securities with unrealized losses at September 30, 2015 and December 31, 2014, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, are as follows: 

		September 30, 2015
		Less than 12 Months								12 Months or More								Total
Description of Securities		Fair Value				Unrealized Loss				Fair Value				Unrealized Loss				Fair Value				Unrealized Loss
Securities Available for Sale:
Mortgage-backed securities		$	4,661			$	(10	)		$	14,875			$	(333	)		$	19,536			$	(343	)
Obligations of states and political subdivisions			5,066			$	(24	)			1,063			$	(11	)			6,129				(35	)
Private placement and corporate bonds			3,509				(10	)			—				—				3,509				(10	)
Total temporarily impaired		$	13,236			$	(44	)		$	15,938			$	(344	)		$	29,174			$	(388	)

  

		December 31, 2014
		Less than 12 Months								12 Months or More								Total
Description of Securities		Fair Value				Unrealized Loss				Fair Value				Unrealized Loss				Fair Value				Unrealized Loss
Securities Available for Sale:
U.S. government-sponsored agency securities		$	—			$	—			$	2,747			$	(4	)		$	2,747			$	(4	)
Mortgage-backed securities			2,689				(6	)			30,216				(634	)			32,905				(640	)
Obligations of states and political subdivisions			857				(4	)			2,935				(53	)			3,792				(57	)
Total temporarily impaired		$	3,546			$	(10	)		$	35,898			$	(691	)		$	39,444			$	(701	)

 

At September 30, 2015, the AFS mortgage-backed securities category with continuous unrealized losses for twelve months or more comprised eight securities. The obligations of states and political subdivisions securities category with continuous unrealized losses for twelve months or more comprised three securities. No private placement and corporate bonds had continuous losses for twelve months or more at September 30, 2015.

 

At December 31, 2014 the AFS mortgage-backed securities category with continuous unrealized losses for twelve months or more comprised thirteen securities. The obligations of states and political subdivisions category with continuous unrealized losses for twelve months or more comprised ten securities. The U.S. government sponsored agency securities category with continuous unrealized losses for twelve months or more comprised one security.

 

At both September 30, 2015 and December 31, 2014, the HTM portfolio had no unrealized losses.

 

Management evaluates securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. As part of such monitoring, the credit quality of individual securities and their issuers is assessed. Adjustments to market value that are considered temporary are recorded as a separate component of other comprehensive income, net of tax. If an impairment of a security is identified as other-than-temporary based on information available, such as the decline in the creditworthiness of the issuer, external market ratings or the anticipated or realized elimination of associated dividends, such impairments are further analyzed to determine if a credit loss exists. If there is a credit loss, it will be recorded in the consolidated statement of operations. Unrealized losses other than credit losses will continue to be recognized in other comprehensive income, net of tax. Unrealized losses reflected in the preceding tables have not been included in the results of operations because the unrealized losses were not deemed other-than-temporary. Management does not have the intent to sell the securities and has determined that it is not more likely than not that the Company will be required to sell the securities before their anticipated recovery, and therefore, there is no other-than-temporary impairment.

 

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BAYLAKE CORP.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2015
(Dollar amounts in thousands) 

 

7.            Loans

 

Loans held for investment, including purchased loan participations from other financial institutions and in the syndicated loan market, are summarized as follows:

		September 30, 2015				December 31, 2014
Construction		$	34,885			$	40,808
Real estate-Residential			153,895				152,091
Real estate-Commercial			316,679				304,446
Commercial-Syndicated			66,225				65,429
Commercial-Other			93,666				88,045
Consumer			5,672				6,075
Tax exempt			21,131				22,964
Gross loans			692,153				679,858
Less: Deferred origination fees, net of costs			(512	)			(501	)
Less: Allowance for loan losses			(6,510	)			(7,051	)
Loans, net		$	685,131			$	672,306

 

Loans having a carrying value of $144.9 million and $142.0 million are pledged as collateral for borrowings from the FHLB at September 30, 2015 and December 31, 2014, respectively.

 

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BAYLAKE CORP.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2015
(Dollar amounts in thousands)

 

A breakdown of the allowance for loan losses and recorded investment in loans as of and for the nine months ended September 30, 2015 is as follows: 

		Construction				Real Estate- Residential				Real Estate- Commercial				Commercial- Syndicated				Commercial- Other				Consumer				Tax Exempt				Not Specifically Allocated				Total
Allowance for Loan Losses:
Beginning balance		$	252			$	779			$	3,282			$	1,047			$	1,082			$	54			$	—			$	555			$	7,051
Charge-offs			—				(90	)			(391	)			—				(645	)			(36	)			—				—				(1,162	)
Recoveries			15				14				245				—				138				9				—				—				421
Provision			(124	)			(291	)			(732	)			79				60				24				—				1,184				200
Ending balance		$	143			$	412			$	2,404			$	1,126			$	635			$	51			$	—			$	1,739			$	6,510
Loans:
Ending balance		$	34,885			$	153,895			$	316,167			$	66,225			$	93,666			$	5,672			$	21,131			$	—			$	691,641
ALL			(143	)			(412	)			(2,404	)			(1,126	)			(635	)			(51	)			—				(1,739	)			(6,510	)
Recorded Investment		$	34,742			$	153,483			$	313,763			$	65,099			$	93,031			$	5,621			$	21,131			$	(1,739	)		$	685,131
Ending balance:
Individually evaluated		$	—			$	622			$	9,343			$	—			$	181			$	55			$	—			$	—			$	10,201
Collectively evaluated			34,885				153,273				306,824				66,225				93,485				5,617				21,131				—				681,440
Total		$	34,885			$	153,895			$	316,167			$	66,225			$	93,666			$	5,672			$	21,131			$	—			$	691,641

  

A breakdown of the allowance for loan losses and recorded investment in loans as of and for the year ended December 31, 2014 is as follows: 

		Construction				Real Estate- Residential				Real Estate- Commercial				Commercial- Syndicated				Commercial- Other				Consumer				Tax Exempt				Not Specifically Allocated				Total
Allowance for Loan Losses:
Beginning balance		$	372			$	1,373			$	4,431			$	218			$	445			$	64			$	—			$	755			$	7,658
Charge-offs			(162	)			(88	)			(656	)			(178	)			(116	)			(83	)			—				—				(1,283	)
Recoveries			56				126				439				—				37				18				—				—				676
Provision			(14	)			(632	)			(932	)			1,007				716				55				—				(200	)			—
Ending balance		$	252			$	779			$	3,282			$	1,047			$	1,082			$	54			$	—			$	555			$	7,051
Loans:
Ending balance		$	40,808			$	152,091			$	303,945			$	65,429			$	88,045			$	6,075			$	22,964			$	—			$	679,357
ALL			(252	)			(779	)			(3,282	)			(1,047	)			(1,082	)			(54	)			—				(555	)			(7,051	)
Recorded Investment		$	40,556			$	151,312			$	300,663			$	64,382			$	86,963			$	6,021			$	22,964			$	(555	)		$	672,306
Ending Balance:
Individually evaluated		$	—			$	849			$	12,101			$	—			$	848			$	13			$	—			$	—			$	13,811
Collectively evaluated			40,808				151,242				291,844				65,429				87,197				6,062				22,964				—				665,546
Total		$	40,808			$	152,091			$	303,945			$	65,429			$	88,045			$	6,075			$	22,964			$	—			$	679,357

 

Table of Contents

 

BAYLAKE CORP.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2015
(Dollar amounts in thousands)

 

A summary of past due loans at September 30, 2015 and December 31, 2014 is as follows:

		September 30, 2015
			30-89 Days Past Due (accruing)				90 Days or More Past Due or on Non-accrual				Total
Construction		$	87			$	—			$	87
Real estate – Residential			639				521				1,160
Real estate – Commercial			846				2,866				3,712
Commercial-Syndicated			—				—				—
Commercial-Other			1				181				182
Consumer			28				55				83
Tax exempt			—				—				—
Total		$	1,601			$	3,623			$	5,224

 

			December 31, 2014
			30-89 Days Past Due (accruing)				90 Days or More Past Due or on Non-accrual				Total
Construction		$	—			$	—			$	—
Real estate – Residential			313				849				1,162
Real estate – Commercial			996				3,461				4,457
Commercial-Syndicated			—				—				—
Commercial-Other			11				832				843
Consumer			35				13				48
Tax exempt			—				—				—
Total		$	1,355			$	5,155			$	6,510

  

Credit Quality: Management utilizes a risk grading matrix on each of the Company’s commercial loans. Loans are graded on a scale of 0001 to 0007. A description of the loan grades is as follows:

 

0001 - Excellent risk. Borrowers of highest quality and character. Almost no risk possibility. Balance sheets are very strong with superior liquidity, excellent debt capacity and low leverage. Cash flow trends are positive and stable. Excellent ratios.

 

0002 - Very good risk. Good ratios in all areas. High quality borrower. Normally quite liquid. Differs slightly from a 0001 customer.

 

0003 - Strong in most categories. Possible higher levels of debt or shorter track record. Minimal attention required. Good management.

 

0004 - Better than average risk. Adequate ratios, fair liquidity, desirable customer. Proactive management. Performance trends are positive. Any deviations are limited and temporary.

 

0005 - Satisfactory risk. Some ratios slightly weak. Overall ability to repay is adequate. Capable and generally proactive management in all critical positions. Margins and cash flow may lack stability, but trends are stable to positive. Company is normally profitable year-to-year but may experience an occasional loss.

 

Table of Contents

 

BAYLAKE CORP.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2015
(Dollar amounts in thousands)

 

0006 A - Weakness detected in either management, capacity to repay, or balance sheet. Erratic profitability and financial performance. Loan demands more attention. Includes loans deemed to have weaknesses, but that are less than 90 days past due.

 

0006 B - Have weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or in the Bank’s collateral position at some future date. Loans with this rating do not expose the Bank to sufficient risk to warrant adverse classification. Includes loans deemed to have weaknesses, but are less than 90 days past due.

 

0007 – Have well defined weaknesses and trends that jeopardize the repayment of the loan. Range from workout to legal. Includes loans that are on nonaccrual and/or are 90 days or more past due.

 

In addition to the risk grading on commercial loans, management utilizes a risk grading process on its real estate mortgage, consumer, and municipal loans when the loan becomes past due 90 days or more and/or is moved to nonaccrual status.

 

Below is a breakdown of loans by risk grading as of September 30, 2015:

			0001-0005				0006A				0006B				0007(1)				Total
Commercial-Syndicated		$	59,389			$	—			$	4,016			$	2,820			$	66,225
Commercial-Other			89,110				2,889				1,232				435				93,666
Real estate – Commercial			274,452				26,414				3,494				12,319				316,679
Construction			33,529				1,169				—				187				34,885
			456,480				30,472				8,742				15,761				511,455
Real estate - Residential			151,180				1,379				200				1,136				153,895
Consumer			5,617				—				—				55				5,672
Tax exempt			21,131				—				—				—				21,131
Total		$	634,408			$	31,851			$	8,942			$	16,952				692,153
Deferred origination fees, net of costs																			(512	)
Total loans																		$	691,641
Percent of Total Loans			91.6	%			4.6	%			1.3	%			2.5	%			100.0	%

 

(1)	Included in the 0007 risk grading are $6.8 million of loans that are evaluated but not considered impaired because, in the event of default, no loss is expected, therefore they are included in loans that are collectively evaluated for the general allowance for loan losses (“ALL”) allocation.

 

Table of Contents

 

BAYLAKE CORP.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2015
(Dollar amounts in thousands)

 

Below is a breakdown of loss by risk grading as of December 31, 2014:

			0001-0005				0006A				0006B				0007(1)				Total
Commercial-Syndicated		$	60,694			$	4,735			$	—			$	—			$	65,429
Commercial-Other			81,530				4,224				1,240				1,051				88,045
Real estate – Commercial			255,711				26,124				5,632				16,979				304,446
Construction			38,679				1,153				783				193				40,808
			436,614				36,236				7,655				18,223				498,728
Real estate - Residential			148,835				1,299				414				1,543				152,091
Consumer			6,062				—				—				13				6,075
Tax exempt			21,994				970				—				—				22,964
Total		$	613,505			$	38,505			$	8,069			$	19,779				679,858
Deferred origination fees, net of costs																			(501	)
Total loans																		$	679,357
Percent of Total Loans			90.2	%			5.7	%			1.2	%			2.9	%			100.0	%

 

⁽¹⁾ Included in the 0007 risk grading are $6.0 million of loans that are evaluated but not considered impaired because, in the event of default, no loss is expected, therefore they are included in loans that are collectively evaluated for the general ALL allocation.

 

Loan balances with a risk grading of 0005 or better were $634.4 million as of September 30, 2015, representing 91.6% of the total loan portfolio, versus $613.5 million as of December 31, 2014, representing 90.2% of the total loan portfolio.

 

Loan balances with a risk grading of 0006A decreased by $6.7 million since December 31, 2014. The decrease resulted primarily from a $3.5 million loan for which the underlying collateral was sold and $3.4 million was applied to the loan. The remaining $0.1 million loan balance was charged off. Additionally, $6.6 million of loan balances were downgraded to risk category 0006B, of which $4.4 million related to one syndicated loan relationship, $1.0 million of loans were upgraded to risk categories 0001-0005 and $5.3 million of loan payments and payoffs were received. This decrease was offset in part by $3.8 million of loans being upgraded from 0006B and 0007 as well as $5.9 million of credits that were downgraded from categories 0001-0005.

 

Loan balances with a risk grading of 0006B have increased by $0.9 million since December 31, 2014. The increase resulted primarily from $6.6 million of loans downgraded from risk grading 0006A and $0.2 million upgraded from category 0007 offset in part by $1.7 million of payments and payoffs received and $4.2 million of loan balances upgraded to risk category 0006A and categories 0001-0005.

 

Loan balances with risk grading of 0007 decreased $2.8 million from December 31, 2014. This decrease resulted from $3.6 million of payments and payoffs were received, $1.3 million of loan balances charged off, collateral supporting $0.3 million of loan balances being moved to other real estate and $0.8 million loan balances were upgraded to categories 0001-0005. Offsetting these reductions are $3.2 million of loan balances downgraded from categories 0001-0005 and 0006A. 

 

8.

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 the Company’s 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.

 

Table of Contents

 

BAYLAKE CORP.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2015
(Dollar amounts in thousands)

 

The ALL consists of specific reserves on certain impaired loans and general reserves for non-impaired loans. Specific reserves reflect estimated losses 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 the Bank’s historical loss experience which is updated quarterly. The general reserve portion of the ALL also includes consideration of certain qualitative factors such 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 nature and volume of past-due, nonaccrual and/or classified loans, 5) changes in 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.

 

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 that 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 the Company’s 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 regulators may require that changes in the ALL be recognized when such regulators’ credit evaluations differ from those of management based on information available to the regulators at the time of their examinations.

 

Information regarding impaired loans as of September 30, 2015 is as follows:

 

IMPAIRED LOANS AND ALLOCATED ALLOWANCE 

September 30, 2015		Construction				Real Estate- Residential				Real Estate- Commercial				Commercial- Syndicated				Commercial- Other				Consumer				Tax Exempt				Not Specifically Allocated				Totals
With an allowance recorded:
Recorded investment		$	—			$	36			$	1,055			$	—			$	—			$	48			$	—			$	—			$	1,139
Unpaid principal balance			—				43				1,264				—				—				52				—				—				1,359
Related Allowance			—				7				209				—				—				4				—				—				220
With no related allowance recorded:
Recorded investment		$	—			$	579			$	8,079			$	—			$	181			$	3			$	—			$	—			$	8,842
Unpaid principal balance			—				579				8,079				—				181				3				—				—				8,842
Related Allowance			—				—				—				—				—				—				—				—				—
Total:
Recorded investment		$	—			$	615			$	9,134			$	—			$	181			$	51			$	—			$	—			$	9,981
Unpaid principal balance			—				622				9,343				—				181				55				—				—				10,201
Related allowance			—				7				209				—				—				4				—				—				220
Average recorded investment during quarter		$	—			$	803			$	9,498			$	—			$	256			$	64			$	—			$	—			$	10,621
Interest income recognized while impaired during the period		$	—			$	2			$	71			$	—			$	4			$	—			$	—			$	—			$	77

 

Table of Contents

 

BAYLAKE CORP.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2015

(Dollar amounts in thousands)

 

Information regarding impaired loans as of December 31, 2014 is as follows:

 

IMPAIRED LOANS AND ALLOCATED ALLOWANCE

December 31, 2014		Construction				Real Estate- Residential				Real Estate- Commercial				Commercial- Syndicated				Commercial- Other				Consumer				Tax Exempt				Not Specifically Allocated				Totals
With an allowance recorded:
Recorded investment		$	—			$	83			$	1,367			$	—			$	—			$	1			$	—			$	—			$	1,451
Unpaid principal balance			—				168				2,008				—				634				2				—				—				2,812
Related allowance			—				85				641				—				634				1				—				—				1,361
With no related allowance recorded:
Recorded investment		$	—			$	681			$	10,093			$	—			$	214			$	11			$	—			$	—			$	10,999
Unpaid principal balance			—				681				10,093				—				214				11				—				—				10,999
Related allowance			—				—				—				—				—				—				—				—				—
Total:
Recorded investment		$	—			$	764			$	11,460			$	—			$	214			$	12			$	—			$	—			$	12,450
Unpaid principal balance			—				849				12,101				—				848				13				—				—				13,811
Related allowance			—				85				641				—				634				1				—				—				1,361
Average recorded investment during quarter		$	408			$	532			$	13,031			$	—			$	228			$	3			$	—			$	—			$	14,202
Interest income recognized while impaired during the period		$	—			$	5			$	351			$	—			$	—			$	—			$	—			$	—			$	356

 

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

 

		September 30, 2015				June 30, 2015				March 31, 2015				December 31, 2014				September 30, 2014
Nonaccrual loans		$	3,352			$	4,708			$	5,731			$	5,155			$	5,647
Loans restructured in a troubled debt restructuring, nonaccrual			271				62				—				—				256
Total nonperforming loans (“NPLs”)		$	3,623			$	4,770			$	5,731			$	5,155			$	5,903
Restructured loans, accruing		$	6,578			$	6,816			$	6,907			$	8,656			$	8,656

 

During the quarter ended September 30, 2015, $0.3 million of additional loan balances became nonaccrual, of which $0.2 million related to a previously restructured, accruing loan. This increase was offset by $0.3 million of payments received during the third quarter of 2015, $0.2 million in loans brought current, and $0.6 million of nonaccrual loan balances charged off. One nonaccrual loan was transferred to other real estate owned during the third quarter of 2015, totaling $0.3 million.

 

One loan of $0.1 million was restructured during the third quarter of 2015 but continues to accrue interest as it is in compliance with its restructured terms.

 

Table of Contents

 

BAYLAKE CORP.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2015

(Dollar amounts in thousands)

 

9.

Other Real Estate Owned, Net

 

Other real estate owned is summarized as follows: 

		For the nine months ended September 30,
		2015				2014
Beginning balance		$	5,093			$	8,566
Transfer of net realizable value to other real estate owned			372				586
Sale proceeds			(539	)			(1,437	)
Net gain from disposal of other real estate owned			32				48
Valuation allowance related to properties disposed			(177	)			(1,179	)
Total other real estate owned			4,781				6,584
Valuation allowance for losses			(804	)			(1,597	)
Total other real estate owned, net		$	3,977			$	4,987

 

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

		For the nine months ended September 30,
		2015				2014
Beginning balance		$	827			$	2,268
Provision charged to operations			154				508
Amounts related to properties disposed			(177	)			(1,179	)
Balance at end of period		$	804			$	1,597

 

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 guidelines. Foreclosure procedures and timelines may vary depending on a variety of factors, including where the property is located. At both September 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 September 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. At September 30, 2015, $1.4 million of consumer mortgage properties were held as other real estate owned.

 

Consumer mortgage properties are derecognized as mortgage loans and classified as Other Real Estate Owned when the Bank has physical possession of and legal title to the property, regardless of whether foreclosure process has been completed. At both September 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.

Table of Contents

 

BAYLAKE CORP.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
September 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 September 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 2012 and for Wisconsin state income taxes for years before 2011. 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 reorganization of UFS, Inc. was launched with the intent of providing a more favorable 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 “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 of costs 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.

 

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 September 30, 2015 and $4.6 million at December 31, 2014. The book value of UFS, Inc. was approximately $9,903 per share and $9,279 per share at September 30, 2015 and December 31, 2014, respectively.

 

Table of Contents

  

BAYLAKE CORP.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2015

(Dollar amounts in thousands)

 

12.           Mortgage Servicing Rights

 

The Company has rights 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 September 30, 2015								For the nine months ended September 30, 2014
		2015				2014				2015				2014
Balance at beginning of period		$	872			$	864			$	841			$	967
Additions from loans sold with servicing retained			28				20				82				51
Loan payments and payoffs			(22	)			(19	)			(65	)			(64	)
Changes in valuation			(3	)			22				17				(67	)
Fair value of MSRs at the end of period		$	875			$	887			$	875			$	887

 

Unpaid principal balance of loans serviced for others was $123.6 million and $123.2 million at September 30, 2015 and September 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 the 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. 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 September 30, 2015.

Table of Contents

 

BAYLAKE CORP.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
September 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 nine months ended September 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			—				—				(152	)			—				—				—				—				(152	)
Charge-offs			—				—				—				—				—				—				—				—
Advances			—				2				—				—				—				—				—				2
New restructured			—				99				—				—				—				62				—				161
Transfers out of TDRs			—				—				(1,792	)			—				(16	)			—				—				(1,808	)
Transfers to nonaccrual			—				—				(219	)			—				—				(62	)			—				(281	)
September 30, 2015		$	—			$	101			$	6,477			$	—			$	—			$	—			$	—			$	6,578
Nonaccrual
January 1, 2015		$	—			$	—			$	—			$	—			$	—			$	—			$	—			$	—
Principal payments			—				—				—				—				—				(10	)			—				(10	)
Charge-offs			—				—				—				—				—				—				—				—
Advances			—				—				—				—				—				—				—				—
New restructured			—				—				—				—				—				—				—				—
Transfers to other real      estate owned			—				—				—				—				—				—				—				—
Transfers from accruing			—				—				219				—				—				62				—				281
September 30, 2015		$	—			$	—			$	219			$	—			$	—			$	52			$	—			$	271
Totals
January 1, 2015		$	—			$	—			$	8,640			$	—			$	16			$	—			$	—			$	8,656
Principal payments			—				—				(152	)			—				—				(10	)			—				(162	)
Charge-offs			—				—				—				—				—				—				—				—
Advances			—				2				—				—				—				—				—				2
New restructured			—				99				—				—				—				62				—				161
Transfers out of TDRs			—				—				(1,792	)			—				(16	)			—				—				(1,808	)
Transfers to other real      estate owned			—				—				—				—				—				—				—				—
September 30, 2015		$	—			$	101			$	6,696			$	—			$	—			$	52			$	—			$	6,849

 

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. During the third quarter of 2015, one loan was restructured and one loan previously restructured for $0.2 million was changed from accruing status to nonaccrual. Also during the nine months ended September 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
September 30, 2015

(Dollar amounts in thousands)

 

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

 

		September 30, 2015								December 31, 2014
		Number of Modifications				Recorded Investment				Number of Modifications				Recorded Investment
Construction			—			$	—				—			$	—
Real estate – Residential			1				101				—				—
Real estate – Commercial			7				6,696				9				8,640
Commercial-Syndicated			—				—				—				—
Commercial-Other			—				—				1				16
Consumer			1				52				—				—
Tax exempt			—				—				—				—
Total			9			$	6,849				10			$	8,656

 

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

		Accruing				Nonaccruing				Total
Payment schedule changes		$	6,428			$	271			$	6,699
Interest rate reduction			150				—				150
Total		$	6,578			$	271			$	6,849

 

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

		September 30, 2015				December 31, 2014
Commitments to fund unused home equity line loans		$	58,979			$	59,163
Commitments to fund 1-4 family loans			720				2,606
Commitments to fund residential real estate construction loans			4,275				3,014
Commitments unused on commercial lines of credit loans			187,297				154,405
Commitments unused on consumer lines of credit loans			9,716				9,333
Total commitments to extend credit		$	260,987			$	228,521
Financial standby letters of credit		$	29,881			$	9,757

  

The increase in financial standby letters of credit during the first nine 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 September 30, 2015, this LOC was $20 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 September 30, 2015 and December 31, 2014 and our consolidated results of operations for the three and nine months ended September 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.

 

Important Information for Investors

This report contains a discussion of a proposed merger transaction involving us and Nicolet Bankshares, Inc. (“Nicolet”). In connection with the proposed merger, Nicolet and we will file a joint proxy statement/prospectus on Form S-4 and other relevant documents concerning the merger with the Securities and Exchange Commission (the “SEC”). BEFORE MAKING ANY VOTING OR INVESTMENT DECISION, INVESTORS ARE URGED TO READ THE JOINT PROXY STATEMENT/PROSPECTUS AND ANY OTHER DOCUMENTS TO BE FILED WITH THE SEC IN CONNECTION WITH THE PROPOSED MERGER OR INCORPORATED BY REFERENCE IN THE JOINT PROXY STATEMENT/PROSPECTUS BECAUSE THEY WILL CONTAIN IMPORTANT INFORMATION ABOUT NICOLET, BAYLAKE AND THE PROPOSED MERGER. When available, the joint proxy statement/prospectus will be delivered to our shareholders and shareholders of Nicolet. Investors may obtain copies of the joint proxy statement/prospectus and other relevant documents (as they become available) free of charge on Nicolet’s website at www.nicoletbank.com Copies of the documents filed with the SEC by us will be available free of charge on our website at www.baylake.com

 

We, Nicolet and certain of our respective directors, executive officers and other members of management and employees may be deemed to be participants in the solicitation of proxies from our shareholders and the shareholders of Nicolet in connection with the proposed merger. Information about our directors and officers, and the directors and executive officers of Nicolet will be included in the joint proxy statement/prospectus for the proposed transaction filed with the SEC. Information about the directors and executive officers of Nicolet is also included in its annual report on Form 10-K for the year ended December 31, 2014, which was filed with the SEC on March 9, 2015. Information about our directors and executive officers of Baylake is also included in the proxy statement for our 2015 annual meeting of shareholders, which was filed with the SEC on April 24, 2015. Additional information regarding the interests of such participants and other persons who may be deemed participants in the transaction will be included in the joint proxy statement/prospectus and the other relevant documents filed with the SEC when they become available.

 

Forward-Looking Information

 

This discussion and analysis of consolidated financial condition and results of operations, and other sections of this report, including the discussion set forth below regarding our pending merger with and into Nicolet, 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 or Nicolet’s control that may cause our, Nicolet’s or the combined company’s 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 our, Nicolet’s or the combined company’s actual results to differ materially from the forward-looking statements: (1) our and Nicolet’s businesses may not integrate successfully or the integration may be more difficult, time-consuming or costly than expected; (2) the expected growth opportunities and cost savings from the transaction may not be fully realized or may take longer to realize than expected; (3) revenues following the transaction may be lower than expected as a result of losses of customers or other reasons, including issues arising in connection with integration of the two banks; (4) deposit attrition, operating costs, customer loss and business disruption following the transaction, including difficulties in maintaining relationships with employees, may be greater than expected; (5) governmental approvals of the transaction may not be obtained on the proposed terms or expected timeframe; (6) the terms of the proposed truncation may need to be modified to satisfy such approvals or conditions; (7) our or Nicolet’s shareholders may fail to approve the transaction; (8) reputational risks and the reaction of the companies’ customers to the transaction; (9) diversion of management time on merger related issues: (10) changes in asset quality and credit risk; (11) the cost and availability of capital: (12) customer acceptance of the combined company’s products and services; (13) customer borrowing, repayment, investment and deposit practices; (14) the introduction, withdrawal, success and timing of business initiatives; (15) the impact, extent and timing of technological changes; (16) severe catastrophic events in our or Nicolet’s geographic area; (17) a weakening of the economies in which the combined company will conduct operations may adversely affect its operating results; (18) the U.S. legal and regulatory framework, including those associated with the Dodd Frank Wall Street Reform and Consumer Protection Act, could adversely affect the operation results of the combined company: (19) the interest rate environment may compress margins and adversely affect net interest income: and (20) competition from other financial services companies in the companies’ markets could adversely affect operations. Additional factors that could cause our results to differ materially from those described in the forward-looking statements can be found 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. All subsequent written and oral forward-looking statements concerning us, Nicolet or the proposed merger or other matters and attributable to us, Nicolet or any person actin on either of our behalf are expressly qualified in their entirety by the cautionary statement above. Neither we nor Nicolet undertake any obligation to update any forward-looking statement, whether written or oral, to reflect the circumstances or events that occur after the date the forward-looking statements are made.

 

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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 September 30, 2015, Union had approximately $81.9 million in total assets, $48.4 million in loans, and $72.5 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.

 

Plan of Merger

 

On September 8, 2015, we announced jointly with Nicolet the signing of an Agreement and Plan of Merger (the “Nicolet Merger Agreement”), pursuant to which we will merge with and into Nicolet (the “Nicolet Merger”). Following the Nicolet Merger, Baylake Bank, our wholly-owned bank subsidiary, will merge with and into Nicolet National Bank, Nicolet’s wholly-owned bank subsidiary, with Nicolet National Bank continuing as the surviving bank, with all bank branches operating under the Nicolet National Bank brand.

 

We and Nicolet have agreed to prepare and file with the Securities and Exchange Commission (the “SEC”) a registration statement on Form S-4, which will include a joint proxy statement/prospectus. As soon as practical following effectiveness of the registration statement on Form S-4, we and Nicolet will each call a special shareholders meeting to approve the Nicolet Merger Agreement. Subject to the provision relating to change in recommendation in connection with a superior proposal, our and Nicolet’s respective boards of directors have agreed to recommend that our respective shareholders approve the Nicolet Merger Agreement.

 

Merger Consideration.  Pursuant to the terms and subject to the conditions set forth in the Nicolet Merger Agreement, at the effective time of the Nicolet Merger, each issued and outstanding share of our common stock (other than our common stock we hold in treasury or held directly or indirectly by Nicolet, which shares will be canceled prior to any exchange therefor), will be exchanged for the right to receive 0.4517 of a share of Nicolet common stock and cash in lieu of any fractional shares.

 

Treatment of Restricted Stock and Stock Options.  At the effective time of the Nicolet Merger, and subject to the exchange ratio outlined in the Nicolet Merger Agreement, each restricted stock unit and option granted by us, whether vested or unvested, shall be substituted with an equity award issued under a Nicolet stock plan or adjusted under a Baylake stock plan to be exercisable for Nicolet common stock.

 

Board of Directors and Executive Officers.  Upon consummation of the Nicolet Merger, the board of directors of Nicolet will consist of sixteen members, eight selected by the Nicolet board of directors and eight selected by our board of directors. The Nominating Committee of the Nicolet board of directors shall consist of two directors each from Nicolet and us for a period of two years after closing. Nicolet will establish a Co-Chairman and Co-Chief Executive Officer structure for Robert B. Atwell and Robert J. Cera, and deliver an employment agreement to Robert J. Cera as of the closing date.

 

Closing Conditions.  Consummation of the Nicolet Merger is subject to certain mutual closing conditions, including, without limitation, (i) the approval of the Nicolet Merger Agreement by our shareholders and the shareholders of Nicolet; (ii) Nicolet listing its common stock on NASDAQ; (iii) the registration statement on Form S-4 shall become effective; (iv) the absence of certain legal proceedings challenging the Nicolet Merger; and (v) the receipt of all required regulatory approvals.

  

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In addition to these mutual conditions, each party’s obligation to consummate the Nicolet Merger is subject to certain other conditions, including, without limitation, (i) the accuracy of each party’s representations and warranties; and (ii) each party’s compliance with its covenants and agreements contained in the Nicolet Merger Agreement.

 

Representations, Warranties and Covenants.  The Nicolet Merger Agreement includes detailed representations, warranties and covenant provisions that are customary for transactions of this type.

 

No Solicitation.  The Nicolet Merger Agreement restricts the ability of either us or Nicolet to solicit proposals or enter into agreements relating to alternative business combination transactions. However, should either Nicolet or we receive an unsolicited bona fide Acquisition Proposal (as defined in the Nicolet Merger Agreement), and the receiving entity’s board of directors concludes in good faith that such proposal is or would reasonably be likely to result in an Acquisition Proposal which is superior to that described in the Nicolet Merger Agreement, such entity may negotiate with the third party. The receiving party may not terminate the Nicolet Merger Agreement in order to enter into an agreement with respect to such an Acquisition Proposal without providing the other party to the Nicolet Merger Agreement five business days to respond to such unsolicited Acquisition Proposal, during which time the parties to the Nicolet Merger Agreement shall cooperate with each other with the intent of engaging in good faith negotiations.

 

Termination.  The Nicolet Merger Agreement contains certain termination rights for both us and Nicolet, including, among others, the right to terminate, by either party, (i) if the required regulatory approvals are not obtained; (ii) if the Nicolet Merger is not consummated on or before September 8, 2016; (iii) if Nicolet’s shareholders or our shareholders fail to approve the Nicolet Merger Agreement; (iv) upon a breach by either Nicolet or us of our respective representations, warranties, covenants or other agreements contained in the Nicolet Merger Agreement; or (v) if Nicolet or we become subject to a law or order that prevents the Nicolet Merger from being consummated. In addition, Nicolet or we may terminate the Nicolet Merger Agreement to enter into an alternative business combination transaction pursuant to a superior proposal as described above. If the Nicolet Merger Agreement is terminated under certain circumstances by Nicolet or us, the terminating party has agreed to pay the other party a termination fee of $7.0 million.

 

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, we retained the property for use in future bank operations. In October 2015, we entered into a lease with Nicolet whereas Nicolet will lease this branch facility from us for a nominal rent. The term of the lease expires on the date the Nicolet Merger is completed.

 

Land Held for Sale

 

In April 2015, we accepted an offer to sell a vacant real estate property we own located in Neenah, Wisconsin. At December 31, 2014, the property was reflected in our Consolidated Balance Sheet as Premises and Equipment held for sale in the amount of $0.8 million. During the third quarter of 2015, the carrying value of the property was reduced by $0.1 million to expedite the sale of the property. This transaction is expected to be completed no later than December 31, 2015.

 

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 was completed in September 2015. Renovations of $1.2 million are planned and, post renovation, we intend to relocate our current Sister Bay branch to the new facility.

 

In October 2015, we entered into an agreement to renovate our branch facility in Appleton, Wisconsin. The renovations are expected to be completed in the second quarter of 2016 at an estimated cost of $1.1 million. The branch facility is anticipated to remain accessible during usual business hours throughout the renovation.

 

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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 September 30, 2015 the total balance of goodwill held on our balance sheet was $7.2 million. As of September 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 nine month periods ended September 30, 2015 and 2014.

 

SUMMARY RESULTS OF OPERATIONS

(Dollar amounts in thousands, except per share data)

 

		Three months ended September 30,								Nine months ended September 30,
		2015				2014				2015				2014
Net income, as reported		$	2,291			$	2,457			$	6,880			$	6,681
Earnings per share-basic, as reported		$	0.25			$	0.29			$	0.74			$	0.82
Earnings per share-diluted, as reported		$	0.24			$	0.26			$	0.73			$	0.73
Cash dividends declared per share		$	0.09			$	0.08			$	0.25			$	0.22
Return on average assets			0.90	%			0.98	%			0.93	%			0.91	%
Return on average equity			8.32	%			9.64	%			8.49	%			9.18	%
Efficiency ratio (1)			67.64	%			64.52	%			67.86	%			68.24	%
Efficiency ratio (non-GAAP)-tax equivalent (1)			66.97	%			63.30	%			66.58	%			66.98	%
Efficiency Ratio: GAAP to Non-GAAP reconciliation (1)
Non-interest Expense		$	6,944			$	6,508			$	21,269			$	20,270
Less: significant, nonrecurring expenses			—				—				163	(2)			—
Non-interest Expense (non-GAAP)		$	6,944			$	6,508			$	21,106			$	20,270
Net-interest Income		$	7,993			$	7,758			$	24,110			$	23,194
Plus: Tax equivalent adjustment relating to tax exempt loans and investments			247				262				755				791
Net-interest income (non-GAAP) – tax equivalent		$	8,240			$	8,020			$	24,865			$	23,985
Non-interest Income		$	2,273			$	2,329			$	7,231			$	6,511
Less: net securities gains			132				71				384				232
Less: net gains relating to disposal of fixed assets			12				(4	)			12				1
Non-interest income (non-GAAP)		$	2,129			$	2,262			$	6,835			$	6,278

 

⁽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 accounting principles generally accepted in the United State of America (“U.S. GAAP”) and as such, the ratio is presented in accordance with U.S. 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 and is not considered to be usual or recurring due to its nature.

 

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Net income of $2.3 million for the three months ended September 30, 2015 decreased from net income of $2.5 million for the comparable period in 2014. Net interest income before provision for loan losses was $8.0 million for the three months ended September 30, 2015 and $7.8 million for the comparable period last year. The increase resulted from a $0.2 million reduction in interest expense, as well as a modest increase in interest income. No PFLL was charged to operations for either the three months ended September 30, 2015 or of the same period of 2014. Noninterest income of $2.3 million for the three months ended September 30, 2015 was relatively unchanged compared to the same period of 2014. Noninterest expense increased $0.4 million (6.7%) to $6.9 million for the third quarter of 2015 compared to $6.5 million for the third quarter of 2014. During the third quarter of 2015, salaries and benefits costs increased $0.3 million compared to the same quarter of 2014 due to more highly compensated employees hired earlier in 2015. Legal and professional costs increased $0.1 million for the third quarter of 2015 compared to the third quarter of 2014 related to the pending acquisition of NEW announced in May of 2015 and the pending merger with Nicolet, announced in September 2015. Additionally, losses related to unauthorized wires of $0.2 million was incurred in the third quarter of 2015. These increases in costs were offset in part by a $0.2 million decrease in costs relating to the operation of other real estate owned during the quarter ended September 30, 2015 compared to the same quarter in 2014.

 

Net income of $6.9 million for the nine months ended September 30, 2015 increased from net income of $6.7 million for the comparable period in 2014. Net interest income before provision for loan losses was $24.1 million for the nine months ended September 30, 2015 and $23.2 million for the comparable period last year. The increase resulted from a $0.2 million increase in interest income as well as a $0.7 million reduction in interest expense. A PFLL of $0.2 million was charged to operations for the nine months ended September 30, 2015 compared to no PFLL recorded during the comparable period of 2014. Noninterest income increased $0.7 million (11.1%) to $7.2 million for the nine months of 2015 versus $6.5 million for the comparable period of 2014. The increase resulted primarily from a $0.3 million increase in gain on sale of loans, a $0.2 million increase in fees for other services to customers, a $0.2 million increase in gains from sale of securities, and a $0.1 million increase in net change in valuation of mortgage servicing rights offset by a $0.1 million decrease in other income. Noninterest expense increased $1.0 million (4.9%) to $21.3 million for the nine months ended September 30, 2015 compared to $20.3 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 of $0.2 million relating to the pending NEW acquisition and Nicolet merger and costs associated with the branding initiative that began in the fourth quarter of 2014 offset in part by a $0.2 million decline in costs relating to the operation of other real estate owned properties.

 

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 $8.2 million for the three months ended September 30, 2015, compared to $8.0 million for the same period in 2014. Average earning assets increased $17.8 million (1.9%) to $930.2 million for the third quarter of 2015 compared to $912.4 million for the quarter ended September 30, 2014. Increases of $57.5 million (9.1%) in average loans, $0.2 million (0.5%) in tax exempt securities and $0.6 million (1.1%) in federal funds sold and interest bearing due from financial institution balances were offset by decreases of $40.6 million (22.1%) in average taxable securities. The yield on average earning assets for the quarter ended September 30, 2015 decreased 4 bps to 3.79% compared to 3.83% for the same period in 2014 due to the average yield on taxable securities decreasing 16 bps to 2.60% for the third quarter of 2015 from 2.76% for the same period in 2014, a decrease in the yield on tax exempt securities of 52 bps to 4.45% for the third quarter of 2015 from 4.97% for the same period in 2014, and a decrease in yield on loans of 10 bps to 4.26% during the third quarter of 2015 compared 4.36% for the same period in 2014. We have continued to focus on prudent loan growth during the third quarter of 2015 in an effort to utilize low cost funding available through liquid cash balances, primarily from increased customer demand deposits and repurchase agreements.

 

Average interest-bearing liabilities for the three months ended September 30, 2015 decreased to $716.3 million from $736.3 million for the same period in 2014, but were offset by an increase of noninterest-bearing demand deposits from $150.5 million for the three months ended September 30, 2014 to $180.4 million for the three months ended September 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 $29.6 million (41.2%). 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 September 30, 2015 declined 7 bps from 0.42% for the third quarter of 2014 to 0.35% for the third quarter of 2015. 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, offset in part by an increase in the cost of FHLB borrowings as lower cost variable rate advances without associated prepayment penalties were paid off prior to maturity due to available liquidity.

 

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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 from 3.41% for the third quarter of 2014 to 3.45% for the third quarter of 2015, resulting from the 7 bp decrease in the cost of interest-bearing liabilities, offset in part by the 4 bp decrease in the yield on interest-bearing assets.

 

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 third quarter of 2015 was 3.52% compared to 3.49% for the same period in 2014.

 

Net interest income on a tax-equivalent basis was $24.9 million for the nine months ended September 30, 2015, compared to $24.0 million for the same period in 2014. The increase for the nine months of 2015 resulted primarily from a $0.2 million increase in interest income on interest-earning assets and a $0.7 million decrease in interest expense on interest-bearing liabilities compared to the same period in 2014. Average earning assets increased $18.0 million (2.0%) to $911.3 million for the nine months ended September 30, 2015 compared to $893.3 million for the comparable nine month period of 2014. An increase of $51.6 million (8.2%) in average loans, and $0.2 million (0.5%) in federal funds sold and interest-bearing due from financial institutions balances was partially offset by a decrease of $33.7 million (18.1%) in average taxable securities and a decrease of $0.1 million (0.2%) in tax exempt securities. The yield on average earning assets decrease 5 bps from 3.99% for the nine months ended September 30, 2014 to 3.94% for the nine months ended September 30, due to the average yield on loans declining 17 bps from 4.49% to 4.32% for the same period, and a decrease in the yield on tax exempt securities of 36 bps to 4.63% for the first nine months of 2015 from 4.99% for the same period in 2014. This was offset in part by an increase in yield on taxable securities from 2.70% for the first nine months of 2014 to 2.82% for the first nine months of 2015. We have continued to focus on prudent loan growth during the third 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 decreased from $739.7 million for first nine months of 2014 to $720.6 million for the same period in 2015, offset by an increase of noninterest-bearing demand deposits from $132.0 million for the first nine months in 2014 to $157.3 million for the nine months ended September 30, 2015.

 

The cost of average interest-bearing liabilities declined 11 bps from 0.48% for the nine months ended September 30, 2014 to 0.37% or the same period of 2015. 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 from 3.51% for the first nine months of 2014 to 3.57% for the first nine months of 2015 resulting from the 5 bp decrease in the yield on interest-earning assets, offset by the 11 bp decrease in the cost of interest-bearing liabilities.

 

Net interest margin for the nine months ended September 30, 2015 was 3.65% compared to 3.59% for the same period in 2014.

 

The Company continues to focus on increasing lending into broader markets as well as on retaining and expanding customer relationships in an effort to increase yields on interest-earning assets as well as decrease the reduce the reliance on wholesale funding sources, in turn, maintaining the improving the net interest margin.

 

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NET INTEREST INCOME ANALYSIS ON A TAX-EQUIVALENT BASIS

(Dollar amounts in thousands)

		Three months ended September 30, 2015												Three months ended September 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)		$	687,401			$	7,389				4.26	%		$	629,857			$	6,927				4.36	%
Taxable securities			143,311				930				2.60	%			183,934				1,270				2.76	%
Tax exempt securities (1)			46,183				514				4.45	%			45,939				570				4.97	%
Federal funds sold and interest-bearing due from financial institutions			53,275				34				0.25	%			52,671				34				0.25	%
Total interest-earning assets			930,170				8,867				3.79	%			912,401				8,801				3.83	%
Noninterest earning assets			83,186												83,305
Total assets		$	1,013,356											$	995,706
LIABILITIES AND STOCKHOLDERS’ EQUITY
Average Interest-Bearing Liabilities:
Total interest-bearing deposits		$	611,767				328				0.21	%		$	604,208				399				0.26	%
Federal funds purchased			—				—				—	%			—				—				—	%
Customer repurchase agreements			46,179				13				0.11	%			39,762				25				0.24	%
Federal Home Loan Bank advances			42,268				219				2.06	%			71,867				175				0.96	%
Convertible promissory notes			—				—				—	%			4,375				118				10.83	%
Subordinated debentures			16,100				67				1.63	%			16,100				65				1.58	%
Total interest-bearing liabilities			716,314				627				0.34	%			736,312				782				0.42	%
Demand deposits			180,444												150,467
Accrued expenses and other liabilities			7,325												7,781
Stockholders’ equity			109,273												101,146
Total liabilities and stockholders’ equity		$	1,013,356											$	995,706
Net interest income						$	8,240											$	8,019
Interest rate spread (3)											3.45	%											3.41	%
Net interest margin (4)											3.52	%											3.49	%

 

(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)

		Nine months ended September 30, 2015												Nine months ended September 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)		$	680,600			$	22,000				4.32	%		$	628,975			$	21,113				4.49	%
Taxable securities			152,434				3,225				2.82	%			186,153				3,768				2.70	%
Tax exempt securities (1)			45,259				1,573				4.63	%			45,339				1,697				4.99	%
Federal funds sold and interest-bearing due from financial institutions			32,973				62				0.25	%			32,795				62				0.25	%
Total interest-earning assets			911,266				26,860				3.94	%			893,262				26,640				3.99	%
Noninterest earning assets			82,163												83,294
Total assets		$	993,429											$	976,556
LIABILITIES AND STOCKHOLDERS’ EQUITY
Average Interest-Bearing Liabilities:
Total interest-bearing deposits		$	607,936				1,003				0.22	%		$	600,493				1,226				0.27	%
Federal funds purchased			29				—				1.14	%			105				1				0.67	%
Customer repurchase agreements			47,116				50				0.14	%			41,009				74				0.24	%
Federal Home Loan Bank advances			49,019				716				1.95	%			74,755				589				1.05	%
Convertible promissory notes			357				27				10.00	%			7,232				571				10.52	%
Subordinated debentures			16,100				198				1.62	%			16,100				194				1.59	%
Total interest-bearing liabilities			720,557				1,994				0.37	%			739,694				2,655				0.48	%
Demand deposits			157,280												132,022
Accrued expenses and other liabilities			7,309												7,554
Stockholders’ equity			108,283												97,286
Total liabilities and stockholders’ equity		$	993,429											$	976,556
Net interest income						$	24,866											$	23,985
Interest rate spread (3)											3.57	%											3.51	%
Net interest margin (4)											3.65	%											3.59	%

 

(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 September 30, 2015 compared to the three months ended September 30, 2014:

 

			Increase (Decrease) due to (1)
			Volume				Rate				Net
Average Interest-Earning Assets:
Loans		$	619			$	(157	)		$	462
Taxable securities			(228	)			(112	)			(340	)
Tax exempt securities			3				(59	)			(56	)
Federal funds sold and interest-bearing due from financial institutions			—				—				—
Total interest-earning assets		$	394			$	(328	)		$	66
Average Interest-Bearing Liabilities:
Total interest-bearing deposits		$	(25	)		$	(46	)		$	(71	)
Customer repurchase agreements and federal funds purchased			3				(15	)			(12	)
FHLB advances			(94	)			138				44
Convertible promissory notes			(59	)			(59	)			(118	)
Subordinated debentures			—				2				2
Total interest-bearing liabilities		$	(175	)		$	20			$	(155	)
Net interest income		$	569			$	(348	)		$	221

⁽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 91.8% for the three months ended September 30, 2015 increased from 91.6% for the three months ended September 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 nine months ended September 30, 2015 compared to the nine months ended September 30, 2014:

 

			Increase (Decrease) due to (1)
			Volume				Rate				Net
Average Interest-Earning Assets:
Loans		$	1,688			$	(801	)		$	887
Taxable securities			(613	)			70				(543	)
Tax exempt securities			(4	)			(120	)			(124	)
Federal funds sold and interest-bearing due from financial institutions			1				(1	)			—
Total interest-earning assets		$	1,072			$	(852	)		$	220
Average Interest-Bearing Liabilities:
Total interest-bearing deposits		$	(70	)		$	(153	)		$	(223	)
Customer repurchase agreements and federal funds purchased			10				(35	)			(25	)
FHLB advances			(253	)			380				127
Convertible promissory notes			(520	)			(24	)			(544	)
Subordinated debentures			—				4				4
Total interest-bearing liabilities		$	(833	)		$	172			$	(661	)
Net interest income		$	1,905			$	(1,024	)		$	881

 

⁽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 nine months ended September 30, 2015 was 91.7%, increased from 91.5% 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 September 30, 2015 and 2014. No new loans were identified as being impaired during the third quarter of 2015. There were $0.4 million of net loan charge-offs for the three months ended September 30, 2015, consistent with $0.4 million for the same period 2014.

 

A PFLL of $0.2 million was recorded for the nine months ended September 30, 2015 compared to no PFLL recorded in the same period of 2014. Net loan charge-offs for the nine months ended September 30, 2015 and 2014 were $0.7 million and $0.6 million, respectively. Net annualized charge-offs to average loans was 0.15% for the nine months ended September 30, 2015 compared to 0.13% for the same period in 2014. For the nine months ended September 30, 2015, nonperforming loans decreased by $1.5 million (29.7%) to $3.6 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 September 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 nine month periods ended September 30, 2015 and 2014, respectively.

 

NONINTEREST INCOME

(Dollar amounts in thousands)

		Three months ended												Nine months ended
		September 30, 2015				September 30, 2014				% Change				September 30, 2015				September 30, 2014				% Change
Fees from fiduciary services		$	295			$	287				2.8	%		$	892			$	791				12.8	%
Fees from loan servicing			133				133				—	%			428				433				(1.2	)%
Charges for other services to customers			816				830				(1.7	)%			2,352				2,179				7.9	%
Other fee income			164				173				(5.2	)%			474				488				(2.9	)%
Financial services income			301				281				7.1	%			841				799				5.3	%
Net gains on sales of loans			247				199				24.1	%			731				452				61.7	%
Net change in valuation of mortgage servicing rights, net of payments and payoffs			(25	)			3				(933.3	)%			(48	)			(131	)			63.4	%
Net gains from sale of securities			132				71				85.9	%			384				232				65.5	%
Gains (losses) from sale of fixed assets			12				(4	)			400.0	%			12				1				1100.0	%
Increase in cash surrender value of life insurance			78				85				(8.2	)%			263				287				(8.4	)%
Equity in income of UFS subsidiary			213				299				(28.8	)%			900				881				2.2	%
Other income (expense)			(93	)			(28	)			(232.1	)%			2				99				(98.0	)%
Total Noninterest Income		$	2,273			$	2,329				(2.4	)%		$	7,231			$	6,511				11.1	%

 

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 decreased $0.1 million for the three months ended September 30, 2015 versus the comparable period in 2014 primarily resulting from nominal net gains on sales of securities and gains from sales of loans, offset by a nominal decrease in equity in income from UFS.

 

Noninterest income increased $0.7 million for the nine months ended September 30, 2015 versus the comparable period in 2014. Net gains from the sale of loans increased $0.3 million (61.7%), gains on sale of securities increased $0.2 million (65.5%), net changes in the valuation of mortgage servicing rights improved by $0.1 million, and changes for other services to customers increased $0.2 million (7.9%), all of which were offset by a decrease in other income of $0.1 million (98.0%).

 

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Noninterest Expense:

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

 

NONINTEREST EXPENSE

(Dollar amounts in thousands)

		Three months ended												Nine months ended
		September 30, 2015				September 30, 2014				% Change				September 30, 2015				September 30, 2014				% Change
Salaries and employee benefits		$	3,883			$	3,630				7.0	%		$	12,543			$	12,086				3.8	%
Occupancy			550				544				1.1	%			1,667				1,618				3.0	%
Equipment			339				328				3.4	%			1,020				982				3.9	%
Data processing and courier			243				222				9.5	%			706				625				13.0	%
Operation of other real estate owned			178				339				(47.5	)%			417				646				(35.4	)%
Business development and advertising			147				151				(2.6	)%			562				460				22.2	%
Charitable contributions			7				14				(50.0	)%			70				43				62.8	%
Stationery and supplies			99				121				(18.2	)%			282				374				24.6	%
Director fees			104				94				10.6	%			296				290				2.1	%
FDIC insurance			147				156				(5.8	)%			444				456				(2.6	)%
Audit and legal			322				201				60.2	%			740				530				39.6	%
Loan and collection			16				6				166.7	%			50				43				16.3	%
Other outside services			301				250				20.4	%			904				876				3.2	%
Other operating expenses			608				452				34.5	%			1,568				1,241				26.3	%
Total Noninterest Expense		$	6,944			$	6,508				6.7	%		$	21,269			$	20,270				4.9	%

 

Total noninterest expense increased by $0.4 million to $6.9 million for the three months ended September 30, 2015 compared to $6.5 million for the same period ended September 30, 2014. During the third quarter of 2015, salaries and benefit costs increased $0.3 million compared to the same quarter of 2014 due to the addition of more highly compensated employees earlier in 2015. Legal and professional costs increased $0.1 million for the quarter ended September 30, 2015 compared to the same quarter of 2014 related to the pending NEW acquisition and the pending merger with Nicolet. Additionally, losses related to unauthorized wires of $0.2 million were incurred during the third quarter of 2015. These increases were offset in part by a decrease in costs relating to the operation of other real estate owned of $0.2 million during the third quarter of September 2015 compared to the same quarter of 2014. The noninterest expense to average assets ratio was 2.7% for the three months ended September 30, 2015, increased slightly from 2.6% for the same period in 2014.

 

Total noninterest expense increased by $1.0 million to $21.3 million for the nine months ended September 30, 2015 compared to $20.3 million for the same period ended September 30, 2014.

 

Salaries and employee benefits were $12.5 million for the nine months ended September 30, 2015, compared to $12.1 million for the nine months ended September 30, 2014. Although the number of full-time equivalent employees decreased from 252 at September 30, 2014 to 247 at September 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 $0.1 million related to our performance-based incentive program.

 

Audit and legal expenses increased $0.2 million and business development expenses increased $0.1 million for the nine months ended September 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 and the pending merger with Nicolet. During the fourth quarter of 2014, a branding initiative was begun, resulting in increased business development and advertising cost in the first nine months of 2015 compared to the same period in 2014. Other operating expenses in the nine months ended September 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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The noninterest expense to average assets ratio was 2.9% for the nine months ended September 30, 2015, increased slightly from 2.8% for 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 1.8% for the three months ended September 30, 2015 increased slightly from 1.7% for three months ended September 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 increased from 64.5% (63.3% non-GAAP, tax equivalent) for the quarter ended September 30, 2014 to 67.4% (67.6% non-GAAP, tax equivalent) for the quarter ended September 30, 2015, and from 68.2% (67.0% non-GAAP, tax equivalent) for the nine months ended September 30, 2014 to 67.9% (66.6% non-GAAP, tax equivalent) for the nine months ended September 30, 2015. The increased efficiency ratio is due primarily to the additional costs associated with the acquisition and merger activity. A lower efficiency ratio represents a more efficient operation

 

Income Taxes:

 

We recorded an income tax expense of $1.0 million for the three months ended September 30, 2015 versus an expense of $1.1 million for the same period in 2014. The decrease in tax expense is primarily attributable to a year-over-year decrease in pre-tax income for the third quarter of 2015 versus the comparable period of 2014. The effective tax rate for the three months ended September 30, 2015 decreased slightly to 31.0% from 31.3% for the same period in 2014.

 

Income tax expense recorded for the nine months ended September 30, 2015 was $3.0 million compared to $2.8 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 nine months of 2015 versus the same period in 2014. The effective tax rate for the nine months ended September 30, 2015 and 2014 was 30.3% and 29.2% 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 September 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.

 

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Financial Condition

Loans:

 

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

		September 30, 2015				December 31, 2014				Percent Change
Real estate-mortgage:
Commercial		$	316,679			$	304,446				4.0	%
1-4 family residential
First liens			108,049				106,292				1.7	%
Junior liens			5,895				5,623				4.8	%
Home equity			39,951				40,176				(0.6	)%
Commercial and agricultural:
Syndicated			66,225				65,429				1.2	%
Other			93,666				88,045				6.4	%
Real estate-construction			34,885				40,808				(14.5	)%
Installment
Credit cards and related plans			1,341				1,353				(0.9	)%
Other			4,331				4,722				(8.3	)%
Obligations of states and political subdivisions			21,131				22,964				(8.0	)%
Less:  Deferred origination fees, net of costs			(512	)			(501	)			(2.2	)%
Less:  Allowance for loan losses			(6,510	)			(7,051	)			7.7	%
Total		$	685,131			$	672,306				1.9	%

 

Net loans increased $12.8 million (1.9%) from $672.3 million at December 31, 2014 to $685.1 million at September 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 $66.2 million and $65.4 million in loan balances outstanding at September 30, 2015 and December 31, 2014, respectively.

 

Real estate loans secured by 1-4 family first lien mortgages totaled $108.0 million at September 30, 2015, an increase of $1.8 million (1.7%) from December 31, 2014. Other commercial and agricultural loans totaled $93.7 million at September 30, 2015, an increase of $5.6 million (6.4%) from December 31, 2014. Commercial real estate loans, which totaled $316.7 million at September 30, 2015, comprised 46.2% of our loan portfolio, up $12.3 million (4.0%) from $304.4 million, at December 31, 2014, comprising 45.3% of our loan portfolio at that date. 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 September 30, 2015 was $6.5 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.

 

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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.

 

NONPERFORMING ASSETS

(Dollars amounts in thousands) 

		September 30,  2015			June 30, 2015			March 31, 2015			December 31, 2014			September 30, 2014
Nonperforming Assets:
Nonaccrual loans		$	3,352		$	4,708		$	5,731		$	5,155		$	5,647
Nonaccrual loans, restructured			271			62			—			—			256
Total nonperforming loans (“NPLs”)		$	3,623		$	4,770		$	5,731		$	5,155		$	5,903
Other real estate owned, net			3,977			4,022			4,195			4,266			4,987
Total nonperforming assets (“NPAs”)		$	7,600		$	8,792		$	9,926		$	9,421		$	10,890
Restructured loans, accruing(1)		$	6,578		$	6,816		$	6,907		$	8,656		$	8,656
Ratios:
ALL to Net Charge-offs (“NCOs”) (annualized)			6.57	x		11.69	x		6.97	x		11.62	x		8.80	x
NCOs to average loans (annualized)			0.15	%		0.09	%		0.15	%		0.10	%		0.13	%
ALL to total loans			0.94	%		1.01	%		1.04	%		1.18	%		1.12	%
NPLs to total loans			0.52	%		0.70	%		0.85	%		0.76	%		0.93	%
NPAs to total assets			0.74	%		0.90	%		1.00	%		0.92	%		1.11	%
ALL to NPLs			179.69	%		145.83	%		122.20	%		136.78	%		119.58	%

  

⁽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.

 

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The ALL to NPL ratio increased from 136.78% at December 31, 2014 to 179.69% at September 30, 2015 due primarily to a decrease in nonperforming loans in the first nine months of 2015. During the quarter ended September 30, 2015, other real estate owned declined slightly due to the sale of two such real estate properties totaling $0.3 million. Offsetting the sale, three properties totaling $0.3 million were transferred into other real estate owned during the quarter ended September 30, 2015.

 

Restructured loans accruing at September 30, 2015 decreased $0.2 million from the prior quarter end due to a restructured, accruing loan of $0.2 million being changed to nonaccrual status. One loan of $0.1 million was added to the restructured loans accruing category and payments of $0.1 million were received on restructured accruing loans during the quarter ended September 30, 2015. Restructured loans accruing at September 30, 2015 were $6.6 million, a decrease of $2.1 million during the first nine months of 2015 primarily due to one restructured accruing loan with modified terms totaling $1.8 million being transferred out of the restructured loan category upon performance 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)

 

		September 30, 2015				June 30, 2015				March 31, 2015				December 31, 2014				September 30, 2014
Secured by real estate		$	1,572			$	2,454			$	2,303			$	1,309			$	2,603
Commercial, syndicated			—				—				—				—				—
Commercial, other			1				1				6				11				35
Loans to individuals			28				5				12				35				18
All other loans			—				—				—				—				—
Total		$	1,601			$	2,460			$	2,321			$	1,355			$	2,656
Percentage of total loans			0.23	%			0.36	%			0.35	%			0.19	%			0.42	%

 

As reflected above, loan balances 30-89 days past due at September 30, 2015 have increased $0.2 million compared to December 31, 2014 but decreased $1.1 million from September 30, 2014. The increase in 30-89 days past due loans during the first nine months of 2015 occurred primarily in real estate-mortgage balances ($0.3 million) and construction loans ($0.1 million) offset in part by a decrease in real estate-commercial loans ($0.2 million). Subsequently, $0.4 million of the loans 30-89 days past due at September 30, 2015 were brought current.

 

Information regarding other real estate owned is as follows:

 

OTHER REAL ESTATE OWNED, NET

(Dollars amounts in thousands)

		Nine months ended September 30, 2015			Twelve months ended December 31, 2014			Nine months ended September 30, 2014
Beginning balance		$	5,093		$	8,566		$	8,566
Transfer of loans to other real estate owned			372			1,204			586
Sales proceeds, net			(539	)		(2,525	)		(1,437	)
Net gain from sale of other real estate owned			32			19			48
Valuation allowance recovered upon disposition of other real estate owned			(177	)		(2,171	)		(1,179	)
Total other real estate owned			4,781			5,093			6,584
Valuation allowance for losses			(804	)		(827	)		(1,597	)
Total other real estate owned, net		$	3,977		$	4,266		$	4,987

 

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VALUATION ALLOWANCE ON OTHER REAL ESTATE OWNED

 (Dollars amounts in thousands)

 

		Nine months ended September 30, 2015				Twelve months ended December 31, 2014				Nine months ended September 30, 2014
Beginning balance		$	827			$	2,268			$	2,268
Provision charged to operations			154				730				508
Valuation allowance recovered upon disposition of other real estate owned			(177	)			(2,171	)			(1,179	)
Ending balance		$	804			$	827			$	1,597

 

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 guidelines. Foreclosure procedures and timelines may vary depending on a variety of factors, including where the property in located. At both September 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 September 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 September 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. At September 30, 2015, $1.4 million of consumer mortgage properties were held as other real estate owned.

 

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 September 30, 2015, our securities available for sale (“AFS”) decreased $24.8 million (13.6%) to $158.1 million compared to $182.9 million at December 31, 2014. At September 30, 2015, the AFS investment portfolio represented 15.5% of total assets compared to 17.9% at December 31, 2014. For the nine months ended September 30, 2015, principal payments of $27.2 million were received on AFS securities, which included $9.9 million from the maturity or call of such securities. For the nine months ended September 30, 2015, we purchased $16.2 million of AFS securities and sold $12.8 million of AFS securities at a $0.4 million gain. Additionally, AFS securities decreased during the nine months ended September 30, 2015 by $1.1 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 $0.3 million.

 

At September 30, 2015 and December 31, 2014, the held to maturity (“HTM”) investment portfolio comprised three securities totaling $25.5 million and $25.6 million, respectively. During the nine months ended September 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 September 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 $0.3 million at September 30, 2015, representing 88.7% of total gross unrealized securities losses. AFS securities in such a loss position for twelve months or greater represented 10.3% 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 September 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 September 30, 2015, the highest concentration of loans underlying mortgage-backed securities issued in any state was issued in California, representing approximately 15.5% of the total amount invested in residential mortgage-backed securities.

 

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Deposits:

 

Total deposits at September 30, 2015 increased $34.3 million (4.5%) to $799.8 million from $765.5 million at December 31, 2014. The increase for the nine months was a result of an increase in non-interest-bearing demand deposit balances of $33.6 million (21.9%) and an increase in savings deposits of $20.9 million (6.3%), offset in part by a decrease in NOW balances of $5.3 million (3.8%) and a decrease in our time deposits of $14.9 million (10.7%). The total increase in interest-bearing deposits was $0.1 million (0.1%) from December 31, 2014 to September 30, 2015. At September 30, 2015, we did not hold any traditional brokered certificates of deposits, but we held $0.3 million of NOW balances that were considered brokered deposits, a decrease of $8.2 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 September 30, 2015 we held $1.6 million of such Reciprocal Deposits, decreased from $1.7 million at 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 $16.8 million (25.9%) from $64.9 million at December 31, 2014 to $48.1 million at September 30, 2015. We did not have any federal funds purchased at either September 30, 2015 or December 31, 2014. The decline in repurchase agreements during the first nine months of 2015 is related to the planned reduction in a significant commercial customer’s balances.

 

During the third quarter of 2015, no new FHLB advance were taken. FHLB advances were $41.6 million at September 30, 2015, down from $60.5 million at December 31, 2014, a decline of $18.9 million (31.2%), primarily due to the payoff or maturity of $16.8 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 third quarter of 2015, we utilized FHLB advances of varying terms and maturities to maximize and enhance our net interest margin. At September 30, 2015, all of the $41.6 million FHLB advances outstanding were fixed rate.

 

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 September 30, 2015, the interest rate on these securities was 1.68%. 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 September 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 were $1.7 million as of December 31, 2014. No Convertible Notes were outstanding as of September 30, 2015.

 

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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 our 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 our 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 September 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		$	79,733			$	33,300			$	10,771			$	—			$	123,804
Repurchase agreements			48,076				—				—				—				48,076
Federal Home Loan Bank advances			4,750				3,550				33,310				—				41,610
Subordinated debentures			—				—				—				16,100				16,100
Operating leases			32,715				43,620				—				—				76,335
Total		$	165,274			$	80,470			$	44,081			$	16,100			$	305,925

 

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 September 30, 2015, and December 31, 2014 in the amount of $290.9 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.

 

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Maturing investments have historically been a primary source of liquidity. For the nine months ended September 30, 2015, principal payments totaling $17.3 million were received on investments in addition to proceeds of $9.9 million from maturities. We purchased $16.2 million in investments in the same period. Approximately 4.8%, or $5.4 million, of the mortgage-backed securities outstanding at September 30, 2015 were issued and guaranteed by GNMA; an agency of the United States government. An additional 91.3%, or $102.3 million, of the mortgage-backed securities outstanding at September 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 3.9%, or $4.4 million, of the outstanding mortgage-backed securities at September 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 increases, reflected as financing activity in the September 30, 2015 unaudited consolidated statements of cash flows, resulted in $34.3 million of cash outflow during the first nine 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 September 30, 2015 the amount of these money market deposits was $20.1 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 $0.3 million in brokered NOW accounts at September 30, 2015 compared to $8.5 million of such deposits at December 31, 2014. Additionally, at September 30, 2015, we have $1.6 million of Reciprocal Deposits, decreased $0.1 million 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 $190.8 million, or 27.6% of total gross loans, maturing within one year of September 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 September 30, 2015, securities repurchase agreements totaled $48.1 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 September 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 $41.6 million and $60.5 million at September 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.

 

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 was completed in September 2015. We intend, post renovation, to relocate our current Sister Bay branch into the new building. The expected cost of the renovations is approximately $1.2 million. Additionally, in October 2015, we entered into an agreement to renovate our Appleton, Wisconsin branch. The expected cost of this renovation is $1.1 million and is anticipated to be completed in the second quarter of 2016. Both the purchase and the renovation of the Sister Bay facility and the renovation of the Appleton facility are expected to be financed using cash from operations.

 

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Stockholders’ equity at September 30, 2015 and December 31, 2014 was $110.6 million and $105.5 million, respectively, reflecting an increase of $5.1 million (4.8%) during the first nine months of 2015. The increase in stockholders’ equity primarily resulted from net income of $6.9 million, the conversion of $1.6 million of debentures, the exercise of stock options of $0.1 million, stock based compensation of $0.3 million, and the vesting of restricted stock units of $0.1 million, partially offset by cash dividends of $2.3 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 $0.2 million during the first nine months of 2015. Dividends of $0.25 per share were declared and paid during the nine months ended September 30, 2015. The ratio of stockholders’ equity to assets was 10.8% and 10.3% at September 30, 2015 and December 31, 2014, respectively.

 

In October 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 (“Basel III”) became effective for us on January 1, 2015 with full compliance with all of the final rule requirements to be fully phased in incrementally through January 1, 2019. As of September 30, 2015, our capital levels characterize us 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.

 

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. These new rules require us 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:

			September 30, 2015(1)		June 30, 2015(1)		March 31, 2015(1)		December 31, 2014
Company			15.90%		15.76%		15.87%		16.14%
Bank			15.35%		15.34%		15.54%		15.92%

 

⁽¹⁾ March 31, 2015, June 30, 2015, and September 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.

 

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The following tables present our and the Bank’s capital ratios as of September 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 September 30, 2015 (1)
Total Capital (to Risk-Weighted Assets)
Company		$	121,645			15.90	%	$	61,224			8.00	%	$	N/A			N/A
Bank			117,397			15.35	%		61,173			8.00	%		76,466			10.00	%
Tier 1 Capital (to Risk-Weighted Assets)
Company		$	115,135			15.04	%	$	45,918			6.00	%	$	N/A			N/A
Bank			110,887			14.50	%		45,880			6.00	%		61,173			8.00	%
Tier 1 Common Equity (to Risk-Weighted Assets)
Company		$	100,334			13.11	%	$	34,439			4.50	%	$	N/A			N/A
Bank			110,887			14.50	%		34,410			4.50	%		49,703			6.50	%
Tier 1 Capital (to Average Assets)
Company		$	115,135			11.45	%	$	40,229			4.00	%	$	N/A			N/A
Bank			110,887			11.05	%		40,141			4.00	%		50,176			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⁾ September 30, 2015 ratios are calculated under Basel III rules, which became effective January 1, 2015.

Regulatory Initiatives Affecting the Banking Industry

 

Basel III

 

The Federal Reserve and the FDIC approved the final rules implementing Basel III. 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 incrementally, to be fully phased-in by January 1, 2019. Although as of September 30, 2015, we were categorized 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.

 

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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 September 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 September 30, 2015.

 

INTEREST SENSITIVITY

		Change in Net Interest Income Over One Year Horizon
		At September 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		$	1,090				3.4	%		$	137				0.4	%
+100 bps			502				1.6	%			67				0.2	%
Base			—				—				—				—
-100 bps			(1,453	)			(4.6	)%			(1,281	)			(3.9	)%
-200 bps			(2,389	)			(7.5	)%			(2,141	)			(6.6	)%

 

As in the preceding table, at September 30, 2015, the effect of an immediate 200 bp increase in interest rates would increase our net interest income by $1.1 million or 3.4% 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 change in the impact of an immediate 200 bp increase in interest rates resulted from reduction of interest sensitive liability balances, and a reduction of cash balances during the first nine months of 2015. The effect of an immediate 200 bp reduction in rates would have decreased our net interest income by $2.4 million or 7.5%, 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.

 

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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 September 30, 2015. Based on such evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of September 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 September 30, 2015, we did not sell any equity securities which were not registered under the Securities Act of 1933, as amended and did not repurchase any shares of our common stock. 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)
July 1 – July 31, 2015			—		$	—			—			582,500
August 1 – August 31, 2015			—			—			—			582,500
September 1 – September 30, 2015			—			—			—			582,500
Three Months Ended September 30, 2015			—			—			—
Nine Months Ended September 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
2.3		First Amendment to Agreement and Plan of Merger by and between Baylake Corp. and NEW Bancshares, Inc. dated as of October 14, 2015, incorporated by reference to Exhibit 2.1 from the Company’s Current Report on For 8-K filed on October 16, 2015.
2.4		Agreement and Plan of Merger between Nicolet Bankshares, Inc. and Baylake Corp., dated September 8, 2015, incorporated by reference to Exhibit 2.1 from the Company’s Current Report on For 8-K filed on September 11, 2015.
3.1		Bylaws of Baylake Corp., as amended through October 20, 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:	October 30, 2015		/s/ Robert J. Cera
			Robert J. Cera
			President and Chief Executive Officer
Date:	October 30, 2015		/s/ Kevin L. LaLuzerne
			Kevin L. LaLuzerne
			Treasurer and Chief Financial Officer