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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES AND EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2001
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[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES AND EXCHANGE ACT OF 1934
For the transition period from to
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Commission file number 0-8679
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BAYLAKE CORP.
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(Exact name of Registrant as specified in its charter)
Wisconsin 39-1268055
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(State or other jurisdiction of (I.R.S. Employer
incorporated or organization) Identification No.)
217 North Fourth Avenue., Sturgeon Bay, WI 54235
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(Address of principal executive offices) (Zip Code)
Registrant's Telephone number, including area code: (920)-743-5551
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Securities registered pursuant to Section 12(b) of the Act: None
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Securities registered pursuant to Section 12(g) of the Act: Common Stock
$5 Par Value
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Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K [ ]
As of March 25, 2002, 7,471,576 shares of Common Stock were outstanding, and the
aggregate market value of the Common Stock (based upon the $13.25 reported bid
price on that date) held by non-affiliates (excludes a total of 649,628 shares
reported as beneficially owned by directors and executive officers -- does not
constitute an admission as to affiliate status) was approximately $90,542,718.
DOCUMENTS INCORPORATED BY REFERENCE
Part of Form 10-K Into Which
Document Portions of Documents are Incorporated
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Definitive Proxy Statement for 2002 Part III
Annual Meeting of Shareholders to be
Filed within 120 days of the fiscal
Year ended December 31, 2001
1
2001 FORM 10-K
TABLE OF CONTENTS
DESCRIPTION PAGE NO.
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PART I
ITEM 1. Business 3
ITEM 2. Properties 8
ITEM 3. Legal Proceedings 8
ITEM 4. Submission of Matters to a Vote of Security Holders 8
PART II
ITEM 5. Market for Registrant's Common Equity and Related
Stockholder Matters 8
ITEM 6. Selected Financial Data 9
ITEM 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 12
ITEM 7A. Quantitative and Qualitative Disclosures about Market
Risk 40
ITEM 8. Financial Statements and Supplementary Data 41
ITEM 9. Changes and Disagreements with Accountants on Accounting and
Financial Disclosure. 80
PART III
ITEM 10. Directors and Executive Officers of the Registrant 80
ITEM 11. Executive Compensation 80
ITEM 12. Security Ownership of Certain Beneficial Owners and Management 80
ITEM 13. Certain Relationships and Related Transactions 80
PART IV
ITEM 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K 81
Signatures 82
2
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
The statements contained in this report, including the discussion and analysis
of financial condition and results of operations, that are not historical facts
are "forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995 and are intended to be covered by the safe-harbor
provisions for forward-looking statements contained in that Act. For example,
all statements regarding our expected financial position, business and
strategies are forward-looking statements. The words "anticipates," "believes,"
"estimates," "seeks," "expects," "plans," "intends," and similar expressions, as
they relate to Baylake or its management, are intended to identify
forward-looking statements. Forward-looking statements are made based upon
management's current expectations and beliefs concerning future developments and
their potential effects upon Baylake or the Bank. Although we believe that the
expectations reflected in these forward-looking statements are reasonable, and
have based these expectations on our beliefs as well as assumptions we have
made, these expectations may prove to be incorrect. Actual results may differ
materially from those included in the forward-looking statements. Important
factors that could cause actual results to differ materially from our
expectations include, without limitation, the failure of a significant number of
borrowers to repay their loans, general changes in economic conditions and
interest rates, as well as restrictions imposed on us by regulations or
regulators of the banking industry. Many of these factors are not within the
control of Baylake or management. Baylake undertakes no obligation to update or
revise any forward-looking information, whether as a result of new information,
future developments or otherwise.
ITEM 1. BUSINESS
General
Baylake Corp., a Wisconsin corporation organized in 1976, ("Baylake" or the
"Company") is a registered bank holding company under the Federal Bank Holding
Company Act of 1956, as amended. Baylake's primary activities consist of holding
indirectly the stock of Baylake Bank ("Bank"), and providing a wide range of
banking and related business activities, through the Bank and its other
subsidiaries.
Kewaunee County Banc-Shares, Inc.
Kewaunee County Banc-Shares, Inc., ("KCB"), a Wisconsin corporation organized in
1983 and located in Sturgeon Bay, WI, is a registered bank holding company under
the Federal Bank Holding Company Act of 1956, as amended. It is an intermediate
tier holding company owned 100% by Baylake. KCB's only activity is to acquire
and hold all of the outstanding stock of Bank.
Baylake Bank
The Bank is a Wisconsin State Bank originally chartered in 1876. The Bank
conducts its community banking business through 25 full-service financial
centers located throughout Northeast Wisconsin, in Brown, Door, Green Lake,
Kewaunee, Manitowoc, Outagamie, Waupaca, and Waushara Counties. The Bank has
eight financial centers in Door County, which is known for its seasonal and
tourism related services. The balance of the Bank's financial centers are
located in the previously mentioned counties, with the highest concentration,
after Door County, in Brown County, which has six financial centers. Other
principal industries in Bank's market area include light industry and
manufacturing, agriculture, food related products, and to a lesser degree,
lumber and furniture.
The Bank is an independent community bank offering a full range of financial
services primarily to small businesses and individuals located in its market
area. To complement the Bank's traditional banking products, such as demand
deposit accounts, various savings account plans, certificates of deposit and
real estate, consumer, commercial/industrial and agricultural loans, the Bank
offers its customers a variety of services. These services include transfer
agency, personal and corporate trust, insurance agency, brokerage, financial
planning, cash management and electronic banking services.
3
Bank Subsidiaries
In addition to its banking operations, the Bank owns four non-bank subsidiaries:
Baylake Investments, Inc., located in Las Vegas, Nevada, which holds and manages
a portion of the Bank's investment and loan portfolio; Bank of Sturgeon Bay
Building Corporation, which owns the Bank's main office building in Sturgeon
Bay, Wisconsin and nearby conference center facilities and underlying real
property; Cornerstone Financial, Inc., which manages the conference center
facilities; and Baylake Insurance Agency, Inc., which offers various types of
insurance products to the general public as an independent agent. The Bank also
owns a minority interest (49.8% of the outstanding common stock) in United
Financial Services, Inc. ("UFS"), a data processing services company, located in
Grafton, Wisconsin, that provides data processing services to approximately 23
banks (including Bank) and ATM processing services to 50 banks. The revenues
generated by Bank's wholly-owned subsidiaries and UFS amount, in aggregate, to
less than 5% of the Bank's total income. On January 24, 2002, the Bank formed an
additional subsidiary, Arborview LLC ("Arborview") for purposes of the operation
of a community based residential facility, acquired as a result of loan
problems.
At December 31, 2001, the Company had total assets of $845.8 million. For
additional financial information, see the Consolidated Financial Statements and
Notes beginning at Item 8 of this Form 10-K.
Acquisitions
Effective October 1, 1998, Baylake acquired Evergreen Bank, N.A., ("Evergreen")
from M&I Marshall & Ilsley Bank, Milwaukee, Wisconsin ("M&I"). Pursuant to the
stock purchase agreement with M&I, Baylake is only required to pay M&I for the
Evergreen stock it purchased upon certain events set forth in the stock purchase
agreement. Although the payment period set forth in the stock purchase agreement
expired, Baylake has committed to M&I that it will treat the payment terms of
the stock purchase agreement as though they had not expired. As of December 31,
2001, none of the events that would require Baylake to pay any funds to M&I has
occurred. In connection with Baylake's acquisition of Evergreen, Baylake changed
the name of Evergreen, to Baylake Bank, N.A. ("BLBNA"). On March 15, 1999, BLBNA
merged with and into Baylake Bank.
Lending
The Company offers short-term and long-term loans on a secured and unsecured
basis for business and personal purposes. It makes real estate,
commercial/industrial, agricultural and consumer loans, in accordance with the
basic lending policies established by its board of directors. The Company
focuses lending activities on individuals and small businesses in its market
area. Lending has, historically, been exclusively within the State of Wisconsin.
The Company does not conduct any substantial business with foreign obligors. The
markets served by the Company include a wide variety of industries; therefore,
Baylake believes the broad business base of its market area limits its exposure
to the problems in any particular industry group. However, any general weakness
in the economy of Northeastern Wisconsin (as a result, for example, of a decline
in its manufacturing and tourism industries or otherwise) could have a material
adverse effect on the business and operations of Baylake.
The Company's total outstanding loans as of December 31, 2001 amounted to
approximately $605.3 million, consisting of 82.6% residential, commercial,
agricultural and construction real estate loans, 13.3% commercial and industrial
loans, 2.8% installment and 1.3% agricultural loans.
Investments
The Company maintains a portfolio of other investments, primarily consisting of
U.S. Treasury securities, U.S. Government Agency securities, mortgage-backed
securities, and obligations of states and their political subdivisions. The
Company attempts to balance its portfolio to manage interest rate risks,
maximize tax advantages and meet its liquidity needs while endeavoring to
maximize investment income.
4
Deposits
The Company offers a broad range of depository products, including non-interest
bearing demand deposits, interest-bearing demand deposits, various savings and
money market accounts and certificates of deposit. Deposits at the Company are
insured by the Bank Insurance Fund of the Federal Deposit Insurance Corporation
("FDIC") up to statutory limits. At December 31, 2001, the Company's total
deposits amounted to $669.9 million, including interest bearing deposits of
$593.8 million and non-interest bearing deposits of $76.1 million.
Other Customer Services and Products
Other services and products offered by the Company include transfer agency, safe
deposit box services, personal and corporate trust services, conference center
facilities, insurance agency and brokerage services, cash management, financial
planning and electronic banking services, including eBanc, an Internet banking
product for its customers.
Competition
The financial services industry is highly competitive. The Company competes with
other financial institutions and businesses in both attracting and retaining
deposits and making loans in all of its principal markets. The primary factors
in competing for deposits are interest rates, personalized services, the quality
and range of financial services, convenience of office locations and office
hours. Competition for deposit products comes primarily from other commercial
banks, savings banks, credit unions and non-bank competitors, including
insurance companies, money market and mutual funds, and other investment
alternatives. The primary factors in competing for loans are interest rates,
loan origination fees, the quality and range of lending services and
personalized services. Competition for loans comes primarily from other
commercial banks, savings banks, mortgage banking firms, credit unions, finance
companies, leasing companies, and other financial intermediaries. The Company
also faces direct competition from members of bank holding company systems that
have greater assets and resources than those of the Company.
Regulation and Supervision
The banking industry is highly regulated by both federal and state regulatory
authorities. Regulation includes, among other things, capital and reserve
requirements, dividend limitations, limitations on products and services
offered, geographical limits, consumer credit regulations, community
reinvestment requirements and restrictions on transactions with affiliated
parties. The system of supervision and regulation applicable to Baylake and the
Bank establishes a comprehensive framework for our respective operations and is
intended primarily for the protection of the FDIC's deposit funds, the
depositors of the Bank and the public, rather than shareholders of the Bank or
Baylake. Any change in government regulation may have a material adverse effect
on the business of Baylake and the Bank.
Baylake Corp. As a bank holding company, Baylake is subject to regulation by the
Federal Reserve Board under the Bank Holding Company Act of 1956, as amended, or
BHCA. Under the BHCA, Baylake is subject to examination by the Federal Reserve
Board and is required to file reports of its operations and such additional
information as the Federal Reserve Board may require. Baylake is also subject to
supervision and examination by the Wisconsin Department of Financial
Institutions under Wisconsin law. Under Federal Reserve Board policy, Baylake is
expected to act as a source of financial strength to the Bank and to commit
resources to support the Bank in circumstances where Baylake might not do so
absent such policy.
Any loans by a bank holding company to a subsidiary bank are subordinate in
right of payment to deposits and to certain other indebtedness of such
subsidiary bank. In the event of a bank holding company's bankruptcy, any
commitment by the bank holding company to a federal bank regulatory agency to
maintain the capital of a subsidiary bank will be assumed by the bankruptcy
trustee and entitled to a priority of payment.
With certain limited exceptions, the BHCA prohibits bank holding companies from
acquiring direct or indirect ownership or control of voting shares or assets of
any company other than a bank, unless the company involved is engaged solely in
one or more activities which the Federal Reserve Board has determined to be so
closely related to banking or managing or
5
controlling banks as to be incidental to these operations. Under current Federal
Reserve Board regulations, these permissible non-bank activities include such
things as mortgage banking, equipment leasing, securities brokerage, and
consumer and commercial finance company operations. As a result of recent
amendments to the BHCA, many of these acquisitions may be effected by bank
holding companies that satisfy certain statutory criteria concerning management,
capitalization, and regulatory compliance, if written notice is given to the
Federal Reserve within 10 business days after the transaction. In other cases,
prior written notice to the Federal Reserve Board will be required.
The Federal Reserve Board uses capital adequacy guidelines in its examination
and regulation of bank holding companies. If capital falls below minimum
guidelines, a bank holding company may, among other things, be denied approval
to acquire or establish banks or non-bank businesses.
Baylake Bank. As a Wisconsin bank, the Bank is subject to supervision and
regulation by the Wisconsin Department of Financial Institutions (the "WDFI"),
the Board of Governors of the Federal Reserve System and the FDIC. Federal law
and regulations, including provisions added by the Federal Deposit Insurance
Corporation Improvement Act of 1991, or FDICIA, and regulations promulgated
thereunder, establish supervisory standards applicable to the lending activities
of the Bank, including internal controls, credit underwriting, loan
documentation and loan-to-value ratios for loans secured by real property.
The Bank is subject to certain federal and state statutory and regulatory
restrictions on any extension of credit to Baylake or its subsidiaries, on
investments in the stock or other securities of Baylake or its subsidiaries, on
the payment of dividends to Baylake, and on the acceptance of the stock or other
securities of Baylake or its subsidiaries as collateral for loans to any person.
Certain limitations and reporting requirements are also placed on extension of
credit by the Bank to its directors and officers, to directors and officers of
us and our subsidiaries, to principal shareholders of us, and to "related
interests" of such directors, officers and principal shareholders. In addition,
such legislation and regulations may affect the terms upon which any person
becoming a director or officer of us or one of our subsidiaries or a principal
shareholder of us may obtain credit from banks with which we maintain a
correspondent relationship.
The FDIC, the Office of Thrift Supervision, the Federal Reserve Board and the
Office of the Comptroller of the Currency have published guidelines implementing
the FDICIA requirement that the federal banking agencies establish operational
and managerial standards to promote the safety and soundness of federally
insured depository institutions. The guidelines establish standards for internal
controls, information systems, internal audit systems, loan documentation,
credit underwriting, interest rate exposure, asset growth, and compensation,
fees and benefits. In general, the guidelines prescribe the goals to be achieved
in each area, and each institution will be responsible for establishing its own
procedures to achieve those goals. If an institution fails to comply with any of
the standards set forth in the guidelines, the institution's primary federal
bank regulator may require the institution to submit a plan for achieving and
maintaining compliance. The preamble to the guidelines states that the agencies
expect to require a compliance plan from an institution whose failure to meet
one or more of the standards is of such severity that it could threaten the safe
and sound operation of the institution. Failure to submit an acceptable
compliance plan, or failure to adhere to a compliance plan that has been
accepted by the appropriate regulator, would constitute grounds for further
enforcement action.
The Bank's business includes making a variety of types of loans to individuals.
In making these loans, the Bank is subject to state usury and regulatory laws
and to various federal statutes, such as the Equal Credit Opportunity Act, the
Fair Credit Reporting Act, the Truth in Lending Act, the Real Estate Settlement
Procedures Act and the Home Mortgage Disclosure Act, and the regulations
promulgated thereunder, which prohibit discrimination, specify disclosures to be
made to borrowers regarding credit and settlement costs and regulate the
mortgage loan servicing activities of the Bank, including the maintenance and
operation of escrow accounts and the transfer of mortgage loan servicing. The
Riegle Act imposed new escrow requirements on depository and non-depository
mortgage lenders and services under the National Flood Insurance Program. In
receiving deposits, the Bank is subject to extensive regulation under state and
federal law and regulations, including the Truth in Savings Act, the Expedited
Funds Availability Act, the Bank Secrecy Act, the Electronic Funds Transfer Act,
and the Federal Deposit Insurance Act. Violation of these laws could result in
the imposition of significant damages and fines upon the Bank, its directors and
officers.
Under the Community Reinvestment Act, or CRA, and the implementing regulations,
the Bank has a continuing and
6
affirmative obligation to help meet the credit needs of its local community
including low and moderate-income neighborhoods, consistent with the safe and
sound operation of the institution. The CRA requires the board of directors of
financial institutions, such as the Bank, to adopt a CRA statement for each
assessment area that, among other things, describes its efforts to help meet
community credit needs and the specific types of credit that the institution is
willing to extend. The Bank's service area is designated and comprised of the
eight counties within the geographic area of Central and Northeast, Wisconsin.
The Bank's board of directors is required to review the appropriateness of this
delineation at least annually.
Financial institution regulation has been the subject of significant legislation
in recent years and may be the subject of further significant legislation in the
future. This regulation substantially affects the business and financial results
of all financial institutions and holding companies, including Baylake and its
subsidiaries. As an example, Baylake is subject to the capital and leverage
guidelines of the Board of Governors of the Federal Reserve System ("FRB"),
which requires that Baylake's capital to asset ratio meet certain minimum
standards. For a discussion of the Federal Reserve Board's guidelines and the
Company's applicable ratios, see the section entitled "Capital Resources" under
Item 7: "Management's Discussion and Analysis of Financial Condition and Results
of Operation."
In addition to general requirements that banks retain specified levels of
capital and otherwise conduct their business in a safe and sound manner,
Wisconsin law requires that dividends of Wisconsin banks declared and paid
without approval of the WDFI be paid out of current earnings or, no more than
once within the immediate preceding two years, out of undivided profits in the
event that there have been insufficient net profits. Any other dividends require
the prior written consent of the WDFI. The Bank is in compliance with all
applicable capital requirements and may pay dividends to Baylake.
Current federal law provides that adequately managed bank holding companies from
any state may acquire banks and bank holding companies located in any other
state, subject to certain conditions. Wisconsin law generally permits
establishment of full service bank branch offices statewide.
Recent Legislation. The Gramm-Leach-Bliley Act, or Gramm-Leach, was signed into
law on November 12, 1999 and authorizes bank holding companies that meet
specified conditions to elect to become "financial holding companies" and
thereby engage in a broader array of financial activities than previously
permitted. Such activities include selling and underwriting insurance (including
annuities), underwriting and dealing in securities, and merchant banking.
Gramm-Leach also authorizes banks to engage through "financial subsidiaries" in
certain of the activities permitted for financial holding companies. In February
2001, the Federal Reserve Bank of Chicago approved our election to become a
financial holding company; however, we have no current plans to pursue expanded
activities under Gramm-Leach.
Employees
At December 31, 2001, Baylake and its subsidiaries had 286 full-time equivalent
employees. Baylake considers the relationship with its employees to be good.
7
ITEM 2. PROPERTIES
Baylake does not directly own any real property of any kind. However, the Bank
owns twenty-two branches and leases the Company's main office building in
Sturgeon Bay, Wisconsin from its subsidiary, the Bank of Sturgeon Bay Building
Corporation.
The main office building located in Sturgeon Bay serves as headquarters for
Baylake as well as the main banking office of the Bank. The main office also
accommodates the expanded business of the Bank, primarily an insurance agency
(Baylake Insurance Agency) and financial services. The twenty-five branches
owned or leased by the Bank are in good condition and considered adequate for
present and near term requirements. In addition, the Bank owns other real
property that, when considered in the aggregate, is not material to its
financial position.
ITEM 3. LEGAL PROCEEDINGS
Baylake and its subsidiaries may be involved from time to time in various
routine legal proceedings incidental to its business. Neither Baylake nor any of
its subsidiaries is currently engaged in any legal proceedings that are expected
to have a material adverse effect on the results of operations or financial
position of Baylake.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of security holders during the fourth
quarter of fiscal year 2001.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED SECURITY HOLDER
MATTERS
Historically, trading in shares of the Company's Common Stock has been limited.
Since mid-1993, Baylake Common Stock has been listed on the OTC Bulletin Board
(Trading symbol: bylk.ob), an electronic interdealer quotation system providing
real-time quotations on eligible securities. Trading in Baylake Common Stock has
been conducted principally by certain brokerage and investment firms with
offices in Door County, Wisconsin that have provided price quotations, and have
assisted individual holders of Baylake Common Stock who wish to purchase or sell
shares. In addition, since May 1993, prices for Baylake Common Stock have
generally been reported regularly in The Milwaukee Journal Sentinel based on
information provided by a local brokerage firm.
The following table summarizes high and low bid prices and cash dividends paid
for the Baylake Common Stock for the periods indicated. Bid prices are computed
from those obtained from two brokerage firms, and, since May 1993 from bid
prices reported in The Milwaukee Journal Sentinel. The reported high and low
prices represent interdealer bid prices, without retail mark-up, mark-downs or
commission, and may not necessarily represent actual transactions.
Calendar period High Low Cash dividends per
--------------- ---- --- ------------------
share
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2000 1st Quarter $26.00 $21.50 $0.100
2nd Quarter $23.50 $19.88 $0.100
3rd Quarter $21.00 $18.00 $0.100
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4th Quarter $18.25 $14.50 $0.110
2001 1st Quarter $16.25 $11.00 $0.110
2nd Quarter $15.00 $12.80 $0.110
3rd Quarter $16.25 $13.00 $0.110
4th Quarter $13.75 $12.75 $0.120
Baylake had approximately 1,707 shareholders of record at March 15, 2002.
Dividends on Baylake Common Stock have historically been paid in cash on a
quarterly basis in March, June, September and January, and Baylake expects to
continue this practice for the immediate future. The holders of Baylake Common
Stock are entitled to receive such dividends when and as declared by Baylake's
Board of Directors. The ability of Baylake to pay dividends is dependent upon
receipt by Baylake of dividends from the Bank, which is subject to regulatory
restrictions. Such restrictions, which govern state chartered banks, generally
limit the payment of dividends on bank stock to the bank's undivided profits
after all payments of all necessary expenses, provided that the bank's surplus
equals or exceeds its capital, as discussed further in Item 7. "Management
Discussion and Analysis of Financial Condition and Results of Operation-Capital
Resources". In determining the payment of cash dividends, the Board of Directors
of Baylake considers the earnings, capital and debt servicing requirements,
financial ratio guidelines issued by the FRB and other banking regulators,
financial conditions of Baylake and the Bank, and other relevant factors. In
addition, under the terms of Baylake's 10.00% Junior Subordinated Debentures due
2031, Baylake would be precluded from paying dividends on the Common Stock if it
was in default under the Debentures, if it exercised its right to defer payments
of interest on the Debentures, or if certain related defaults occurred. Baylake
maintains a dividend reinvestment plan enabling participating shareholders to
elect to purchase shares of Baylake Common Stock in lieu of receiving cash
dividends. Such shares may be newly issued securities or acquired in the market
and will be purchased on behalf of participating shareholders at their then fair
market value.
ITEM 6. SELECTED FINANCIAL DATA
Year Ended December 31,
2001 2000 1999 1998 1997
---- ---- ---- ---- ----
(dollars in thousands, except per share data)
RESULTS OF OPERATIONS:
Interest Income $ 59,023 $ 56,036 $ 46,467 $ 38,061 $ 31,577
Interest Expense 32,053 32,099 23,280 19,148 14,662
-------- -------- -------- -------- --------
Net Interest Income 26,970 23,937 23,187 18,913 16,915
Provision for Loan Losses 2,880 545 850 1,135 1,115
-------- -------- -------- -------- --------
Net interest income after 24,090 23,392 22,337 17,778 15,800
provision for loan losses
Non-interest income:
Gain on sale of loans 873 240 295 893 678
Loan servicing fees 1,461 837 875 846 731
Trust fees 664 517 553 451 491
Service charges on deposit 1,836 1,489 1,369 1,074 844
accounts
Securities gains (losses), net 0 0 (2) 0 292
Other 1,473 1,603 1,466 1,113 1,032
-------- -------- -------- -------- --------
Total non-interest income 6,307 4,686 4,556 4,377 4,068
Non-interest expense
Salaries and employee benefits 11,923 10,353 9,700 7,772 7,003
Occupancy expense, net 3,235 3,047 2,668 2,192 2,035
Data processing 986 932 872 699 642
9
Other non-interest expense 4,379 4,280 4,247 3,213 2,861
Operation of other real estate 248 (22) (117) 15 30
-------- -------- -------- -------- --------
Total non-interest expense 20,771 18,590 17,370 13,891 12,571
-------- -------- -------- -------- --------
Income before income tax 9,626 9,488 9,523 8,264 7,297
Income tax provision 2,091 2,778 2,600 2,247 2,027
-------- -------- -------- -------- --------
Net income $7,535 $6,710 $6,923 $6,017 $5,270
PER SHARE DATA: (1)
Net income per share (basic) $1.01 $0.90 $0.94 $0.82 $0.72
Net income per share (diluted) 0.99 0.87 0.90 0.80 0.71
Cash dividends per common share 0.45 0.41 0.37 0.47 0.40
Book value per share 7.91 7.14 6.21 6.17 5.71
SELECTED FINANCIAL CONDITION
DATA (AT END OF PERIOD):
Total assets $845,791 $772,268 $646,310 $607,438 $450,062
Investment securities (2) 167,100 153,511 145,080 128,046 114,899
Total loans 607,715 555,831 447,767 408,921 293,438
Total deposits 669,890 554,005 504,074 495,284 345,976
Short-term borrowings (3) 2,837 79,538 9,231 3,758 20,649
Other borrowings (4) 90,000 77,700 80,000 53,000 36,000
Notes payable and subordinated 158 211 264 392 383
debt
Trust preferred securities 16,100 0 0 0 0
Total shareholders' equity 59,130 53,127 46,210 45,272 41,855
PERFORMANCE RATIOS:
Return on average assets 0.93% 0.95% 1.12% 1.21% 1.29%
Return on average total 13.37% 13.76% 15.07% 13.87% 13.14%
shareholders' equity
Net interest margin (5) 3.80% 3.86% 4.35% 4.42% 4.77%
Net interest spread (5) 3.38% 3.34% 3.89% 3.85% 4.12%
Non-interest income to average 0.78% 0.66% 0.74% 0.88% 1.00%
assets
Non-interest expense to average 2.57% 2.63% 2.82% 2.79% 3.08%
assets
Net overhead ratio (6) 1.79% 1.97% 2.08% 1.91% 2.08%
Average loan-to-average deposit 95.76% 96.71% 85.54% 86.28% 83.14%
ratio
Average interest-earning assets 109.90% 110.78% 111.14% 113.63% 116.51%
to average interest-bearing
liabilities
ASSET QUALITY RATIOS: (7)(8)
Non-performing loans to total 2.42% 2.34% 2.80% 3.45% 1.58%
loans
Allowance for loan losses to:
Total loans 1.32% 1.26% 1.70% 2.71% 1.32%
Non-performing loans 54.47% 53.94% 60.67% 78.33% 83.46%
Net charge-offs to average loans 0.32% 0.23% 0.80% 0.14% 0.05%
Non-performing assets to 1.93% 1.80% 1.95% 2.41% 1.03%
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total assets
CAPITAL RATIOS: (9)
Shareholders' equity to assets 6.99% 6.88% 7.15% 7.45% 9.30%
Tier 1 risk-based capital 10.10% 7.77% 8.81% 7.97% 11.31%
Total risk-based capital 11.29% 8.92% 10.07% 9.22% 12.52%
Leverage ratio 8.22% 6.38% 6.79% 6.02% 8.86%
RATIO OF EARNINGS TO FIXED
CHARGES: (10)
Including deposit interest 1.30x 1.30x 1.41x 1.43x 1.50x
Excluding deposit interest 2.27x 2.11x 3.55x 3.44x 5.24x
(1) Earnings and dividends per share are based on the weighted average
number of shares outstanding for the period. All per share data has
been adjusted to reflect (a) a 2 for 1 stock dividend paid on November
15, 1999 and (b) a 3 for 2 stock dividend paid on May 15, 1998.
(2) Includes securities classified as held-to-maturity and available for
sale.
(3) Consists of Federal Home Loan Bank advances, federal funds purchased
and collateralized borrowings.
(4) Consists of Federal Home Loan Bank term notes and Company borrowings
from unaffiliated correspondent bank.
(5) Net interest margin represents net interest income as a percentage of
average interest-earning assets, and net interest rate spread
represents the difference between the weighted average yield on
interest-earning assets and the weighted average cost of
interest-bearing liabilities.
(6) Net overhead ratio represents the difference between noninterest
expense and noninterest income, divided by average assets.
(7) Non-performing loans consist of non-accrual loans, guaranteed loans 90
days or more past due but still accruing interest and restructured
loans.
(8) The increases in non-performing loans culminating with the period ended
December 31, 1998 were due, in part, to various troubled loans acquired
as a result of the acquisition of Evergreen. For additional
information, see in Item 7. "Management's Discussion and Analysis of
Financial Condition and Result of Operations-Non-performing Loans,
Potential Problem Loans and Other Real Estate."
(9) The capital ratios are presented on a consolidated basis. For
information on Baylake and the Bank's regulatory capital requirements,
see Item 7. "Management's Discussion and Analysis of Financial
Condition and Results of Operations-Capital Resources" and Item 1.
"Business-Regulation and Supervision".
(10) For purposes of calculating the ratio of earnings to fixed charges,
earnings consist of income before taxes plus interest and rent expense.
Fixed charges consist of interest and rent expense.
11
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
General
The following sets forth management's discussion and analysis of the
consolidated financial condition and results of operations of the Baylake Corp.
("Baylake" or the "Company"), which may not be otherwise apparent from the
consolidated financial statements included in this report at Item 8. This
discussion and analysis should be read in conjunction with those financial
statements, related notes, the selected financial data and the statistical
information presented elsewhere in this report for a more complete understanding
of the following discussion and analysis.
On October 1, 1998, the Company acquired Evergreen Bank, N.A. and changed its
name to Baylake Bank, N.A. ("BLBNA"). The acquisition was accounted for using
the purchase method of accounting. Therefore, any consideration paid to M&I
could affect future income. See the discussion of this transaction under Item 1.
"Business" and Note 13 of Notes to Consolidated Financial Statements for
additional details on this transaction.
All per share information has been restated to reflect the 2-for-1 dividend paid
on November 1999.
Results of Operations
Earnings Summary
Net income in 2001 was $7.5 million, a 12.3% increase from the $6.7 million
earned in 2000. Net income for 2000 showed a 3.1% decrease over the 1999
earnings. Basic operating earnings per share increased $0.11 to $1.01 per share
in 2001 compared with $0.90 in 2000, an increase of 12.2%. Basic operating
earnings per share in 2000 showed a 4.2% decrease from 1999 results of $0.94 per
share. On a diluted earnings per share basis, the Company recorded $0.99 per
share in 2001, compared to $0.87 and $0.90 per share in 2000 and 1999,
respectively.
Net income for 2001 and 2000 includes amortization expense of $327,000 of
goodwill related to the purchase of Four Seasons (holding company of financial
institution named "The Bank", acquired by the Company on July 1, 1996) and
$159,000 related to the acquisition of BLBNA. This expense reduced after-tax net
income in 2001 and 2000 by $486,000 or earnings per share by $0.06. Net income
for 1999 reflected amortization expense of $453,000 related to goodwill, thereby
reducing after-tax earnings per share by $0.06.
Although affected by a declining interest rate environment and increased
competition in 2001, net interest income improved. Net interest income for 2001
improved $3.0 million or 12.7% over 2000 levels. Net interest income for 2000
improved $750,000 or 3.2% over 1999 levels. For 2001, interest income increased
by 5.3% while interest expense decreased 0.1%.
Non-interest income during 2001 increased $1.6 million or 34.6% when compared to
2000. The primary factors increasing non-interest income were an increase in
gains on sales of loans, an increase in loan servicing fees, an increase in fees
for other services to customers and increased fiduciary income offset by a
decrease in other income.
Non-interest expense increased $2.2 million during 2001, or 11.7% over 2000
levels. Factors contributing to the increase were increased personnel expenses,
occupancy expense, data processing expense, other operating expenses and an
increase in operation of other real estate.
For 2001, return on average assets declined to 0.93% compared with 0.95% in 2000
and 1.12% in 1999. This ratio declined as a result of the various factors
discussed above combined with an average asset growth rate of 14.4% in 2001.
Return on average stockholders' equity in 2001 showed a decrease to 13.4%
compared to 13.8% in 2000 and 15.1% in 1999. The decrease in 2001 compared to
2000 occurred as a result of a higher level of average capital and the factors
described above offset to a lesser degree by increased net income.
12
Cash dividends declared in 2001 increased 9.8% to $0.45 per share compared with
$0.41 in 2000. This compares to an increase of 10.8% in dividends declared in
2000 as compared to 1999.
The major components of net income and changes in these components are
summarized in Table 1 for years ended December 31, 2001, 2000 and 1999 and are
discussed in more detail on the following pages.
TABLE 1: NET INCOME COMPONENTS
Years ended December 31,
2001 2000 2000 to 2001 1999 1999 to 2000
increase increase
(dollars in thousands)
Net interest $26,970 $23,937 12.7% $23,187 3.2%
Income
Provision for $ 2,880 $ 545 428.4% $ 850 (35.9%)
Loan losses
Noninterest $ 6,307 $ 4,686 34.6% $ 4,556 2.9%
Income
Noninterest $20,771 $18,590 11.7% $17,370 7.0%
Expense
Income before $ 9,626 $ 9,488 1.5% $ 9,523 (.4%)
Income taxes
Income tax $ 2,091 $ 2,778 (24.7%) $ 2,600 6.8%
Expense
Net income $ 7,535 $ 6,710 12.3% $ 6,923 (3.1%)
Net Interest Income
Net interest income (on a tax equivalent basis) is the Company's principal
source of revenue accounting for 81.8% of total income in 2001, as compared to
84.3% in 2000 and in 1999. Net interest income represents the difference between
interest earned on loans, investments and other interest earning assets offset
by the interest expense attributable to funding sources, principally deposits
and borrowings. Interest rate fluctuations together with changes in the volume
and types of earning assets and interest-bearing liabilities combine to affect
total net interest income. This analysis discusses net interest income on a
tax-equivalent basis in order to provide comparability among the various types
of interest income earned. Tax-exempt interest income is adjusted to a level
that reflects such income as if it were fully taxable.
Net interest income in the consolidated statements of income (which excludes the
taxable equivalent adjustment on tax exempt assets) was $27.0 million, compared
to $23.9 million in 2000 and $23.2 million in 1999. The taxable equivalent
adjustments (the adjustments to bring tax-exempt interest to a level that would
yield the same after-tax income had that income been subject to taxation, using
a 34% tax rate) of $1.3 million for 2001, 2000 and 1999, resulted in fully
taxable equivalent ("FTE") net interest income of $28.3 million, $25.2 million
and $24.5 million, respectively. Net interest income on a tax-equivalent basis
reached $28.3 million in 2001, an increase of 12.2% from $25.2 million in 2000.
Net interest income on a tax-equivalent basis was $24.5 million in 1999. The
improvement in 2001 net interest income of $3.1 million was due in part to an
increase in the volume of net average earning assets of $3.5 million. In spite
of this, average-earning assets increased 14.0% offset by an increase of 14.9%
in average interest-bearing liabilities. The benefit from an increase in earning
assets, non-interest bearing deposits and a decrease in the cost on interest
paying liabilities were offset, in part, by an increase in interest-bearing
liabilities and a decrease in the yield on interest earning assets. As a result,
interest income increased 5.3% while interest expense for 2001 decreased 0.2%.
13
Interest rate spread and net interest margin are terms utilized to measure and
explain changes in net interest income. Interest rate spread is the difference
between the yield on earning assets ("EAs") and the rate paid on
interest-bearing liabilities (IBLs") that fund those assets. The net interest
margin is expressed as the percentage of tax-equivalent net interest income as a
percentage of average EAs. The net interest margin exceeds the interest rate
spread because of the use of non-interest bearing sources of funds (net free
funds), principally composed of demand deposits and stockholders' equity, to
fund a portion of EAs. To compare tax-exempt asset yields to taxable yields, the
yield on tax-exempt loans and securities is computed on an FTE basis. As a
result, the level of funds available without interest cost is an important
factor affecting the ability to increase net interest margin.
Table 2 provides average balances of EAs and IBLs, the associated income and
expense, and the corresponding interest rates earned and paid, as well as net
interest income, interest rate spread, and net interest margin on an FTE basis
for the three years ended December 31, 2001. Tables 3 through 4 present
additional information for the discussion of FTE net interest income, interest
rate spread, and net interest margin.
As indicated in Tables 2 and 3, increases in volume and changes in the mix of
both EAs and IBLs added $3.4 million to FTE net interest income, while changes
in the rates resulted in a $362,000 decline, for a net increase of $3.1 million.
Average loans outstanding grew from $505.9 million in 2000 to $588.0 million in
2001, an increase of 16.2%. The increase in loan volume was a significant
contributing factor to the increase in interest income. Average loans
outstanding increased from $421.5 million in 1999 to $505.9 million in 2000, an
increase of 20.0%. The mix of average loans to average total assets increased
from 68.3% in 1999 to 71.6% in 2000 and to 72.7% in 2001. The relationship of a
higher volume of loans as a percentage of the asset mix has provided a source of
higher yielding assets, which has contributed to an increase in net interest
income.
The year 2001 saw a slight reduction of the interest rate spread for the Company
due to a lower interest rate environment further compressing interest spreads.
The interest rate spread decreased 3 basis points in 2001 to 3.34% from 3.37% in
2000, as the average yield on earning assets decreased 73 basis points while the
average rate paid on interest-bearing liabilities decreased 70 basis points over
the same period. In contrast, interest rate spread decreased 51 basis points in
2000 compared to 1999 results. The decrease in the Company's earning assets
yield reflects a decreasing rate environment impacting rates on the variable
priced loans for the year 2001. Increased investment interest income, which
resulted from an increased investment portfolio, offset by lower yields on the
investment portfolio, have contributed to some of the decrease in the yields on
interest earning assets. Yields on interest-paying liabilities decreased 71
basis points. A decreased rate environment also affected the funding side of the
balance sheet. Decreased interest costs resulted from a lower rate environment
offset to a lesser extent by increased competition for retail deposits;
increased balances in indexed accounts and additional reliance on wholesale
funding. Yields on interest bearing deposits decreased 64 basis points from
5.11% in 2000 to 4.47% in 2001.
Average short-term borrowings decreased $22.4 million as deposit growth from
core and non-core funding exceeded loan demand, decreasing reliance on other
short-term wholesale funding sources. Short-term borrowings consist of federal
funds purchased and overnight borrowings from the Federal Home Loan Bank
("FHLB") of Chicago. These funding sources decreased the percentage of average
short-term borrowings as a percentage of average interest-bearing liabilities to
2.4% in 2001 compared to 5.9% in 2000. Yields on these borrowings decreased 121
basis points in 2001 compared to 2000 contributing to an overall decrease in the
yields paid on interest-bearing liabilities.
Additional sources of funds consisted of other borrowings. Other borrowings
consist of term loans with the FHLB and other term loans taken out by the
Company during the year 2001. Other borrowings on average increased $11.0
million to $94.5 million. As a percentage of interest-bearing liabilities, other
borrowings decreased to 11.7% from 11.8% in 2000. Yields on these borrowings
decreased 135 basis points to 5.26% from 6.61% in 2000.
An additional source of funds generated in 2001 were proceeds from the trust
preferred securities offering. These resulted in an average of $14.0 million
generated for 2001 at a cost of 10.2%.
The net interest margin for 2001 was 3.79% compared to 3.88% in 2000. The
decline in net interest margin was in part related to a decline in the free
funds ratio, a decrease in the interest rate spread and an increase in
non-accrual
14
loans. The impact from competition as it relates to the commercial
loan portfolio and costs related to new product offerings had a negative effect
on the change in net interest margin. A declining interest rate environment
further compressed the net interest margin for the year 2001. The free funds
ratio, or the level of non-interest bearing funds that support earning assets,
declined to 16.2% from 16.5% in 2000.
The net interest margin for 2000 was 3.88% compared to 4.35% in 1999 as interest
rate spread declined during that period. The decrease in 2000 during a rising
interest rate environment occurred primarily as the result of a decrease in
non-accrual loans and a decline in the free funds ratio offset to a greater
extent by a 51 basis point decrease in the interest rate spread. Increased
competition, especially as it relates to the commercial loan portfolio,
negatively affected net interest margin.
The ratio of average earning assets to average total assets measures
management's ability to employ overall assets for the production of interest
income. This ratio was 92.5% in 2001 compared with 92.1% in 2000 and 91.5% in
1999. The ratio increased in 2001 as a result of an increase in net free funds
offset to a lesser degree by an increase in non-accrual loans.
Competition in the financial services industry will also affect net interest
margin. Spreads will be a focus of management's attention, as the Company
constantly seeks to attract lower cost core deposits, service the needs of
customers, and provide attractively priced products. Competition for high
quality assets will also affect asset yields.
Growth in net interest income primarily is the result of growth in the level of
earning asset volumes and changes in asset mix. Interest rate spread management
through asset and liability pricing and increased levels of non-interest-bearing
sources of funds also aid in improving net interest income. Management will
continue its focus on maintaining an appropriate mix of quality earning assets
as well as seeking to achieve appropriate growth in volumes.
Changes in the levels of market interest rates also affect net income, but are
less directly under the control of the Company. Although a stable rate
environment has been experienced, management believes that a gradual increase in
interest rates will not adversely affect the earning capacity of the Company.
Past experience has shown that, although the Company remains in a short-term
negative interest rate sensitivity gap, deposits tend not to be repriced as
quickly as loans in a rising rate scenario and are repriced more frequently in a
falling interest rate environment. More discussion on this subject is referenced
in the section titled "Interest Rate Risk"below.
TABLE 2: AVERAGE BALANCES AND INTEREST RATES (INTEREST AND RATES ON A
TAX-EQUIVALENT BASIS)
Year ended December 31,
2001 2000 1999
---- ---- ----
Average Interest Average Average Interest Average Average Interest Average
Balance Rate Balance Rate Balance Rate
(dollars in thousands)
ASSETS:
Earning Assets
Loans (1)(2)(3) $ 587,995 $ 505,892 421,541
Less: non-accruals (10,613) (8,396) (10,364)
--------- --------- -------
Net loans 577,382 $ 49,313 8.54% 497,496 $ 46,685 9.38% 411,177 $ 37,586 9.14%
U.S. Treasuries 1,229 8 6.35% 1,164 79 6.79% 1,156 79 6.83%
Agencies 99,972 6,202 6.20% 94,882 6,127 6.46% 90,249 5,579 6.18%
State and Municipal 53,158 4,051 7.62% 49,363 3,912 7.92% 50,954 3,989 7.83%
obligations (1)
Other Securities 7,671 483 6.30% 6,457 467 7.23% 4,036 265 6.57%
Federal funds sold 5,347 174 3.25% 14 1 7.14% 5,361 245 4.57%
Other money market
instruments 2,963 78 2.63% 1,188 69 5.81% 1,251 5 4.64%
--------- -------- ----- --------- -------- ----- ------- -------- ------
15
Total earning assets $ 747,722 $ 60,379 8.08% $ 650,564 $ 57,340 8.81% $ 564,184 $ 47,801 8.47%
--------- --------- --------- --------- ------ --------- ---------
Allowance for loan (7,349) (7,999) (8,924)
Losses
Non-accrual loans 10,613 8,396 10,364
Cash and due from 16,288 14,937 15,710
Banks
Other assets 41,162 40,548 35,505
Total assets $ 808,436 $ 706,446 616,839
LIABILITIES AND
STOCKHOLDERS'
EQUITY
Interest bearing
liabilities
NOW accounts $ 44,015 $ 514 1.17% $ 44,965 $ 837 1.86% $ 47,313 $ 837 1.77%
Savings accounts 197,993 6,940 3.51% 164,858 7,890 4.79% 141,972 5,325 3.75%
Time deposits 305,012 17,001 5.57% 252,086 14,855 5.89% 246,782 13,379 5.42%
--------- --------- ----- --------- --------- ------ --------- --------- ------
Total interest-bearing 547,020 24,455 4.47% 461,909 23,582 5.11% 436,067 19,541 4.48%
Deposits
Short-term borrowings 19,351 1,084 5.60% 41,798 2,847 6.81% 10,812 605 5.60%
Securities sold under 2,403 94 3.91% 2,213 123 5.56% 3,657 163 4.46%
agreement to
repurchase
Other borrowings 94,589 4,975 5.26% 83,269 5,529 6.61% 56,466 2,950 5.22%
Trust preferred 14,031 1,430 10.19%
Long term debt 159 15 9.43% 211 18 8.53% 265 21 7.92%
--------- --------- ----- --------- --------- ------ --------- --------- ------
Total interest-bearing $ 677,553 $ 32,053 4.73% $ 589,760 $ 32,099 5.44% $ 507,267 $ 23,280 4.59%
Liabilities
Demand deposits 67,012 61,214 56,755
Accrued expenses and 7,519 6,718 6,882
other liabilities
Stockholders' equity 56,352 48,754 45,935
--------- --------- ---------
Total liabilities and $ 808,436 $ 706,446 $ 616,839
--------- --------- ---------
stockholders' equity
Net interest income $ 28,326 3.34% $ 25,241 3.37% $ 24,521 3.88%
And rate spread
Net interest margin 3.79% 3.88% 4.35%
(1) The yield on tax exempt loans and securities is computed on a
tax-equivalent basis using a tax rate of 34% for all periods presented.
(2) Nonaccrual loans and loans held for sale have been included in the
average balances.
(3) Interest income includes net loan fees.
TABLE 3: RATE/VOLUME ANALYSIS (1)
2001 compared to 2000 2000 compared to 1999
Increase (Decrease) due to Increase (Decrease) due to
Volume Rate Net Volume Rate Net
(dollars in thousands)
Interest income:
Loans (2) $ 7,160 $ (4,532) $ 2,628 $ 7,995 $ 1,104 $ 9,099
16
U.S. treasuries 1 (2) (1) 1 (1) 0
Agencies 81 (6) 75 432 116 548
State and municipal
obligations (2) 142 (3) 139 (54) (23) (77)
Other securities 82 (66) 16 167 35 202
Federal funds sold 277 (104) 173 (313) 69 (244)
Other money market
instruments 75 (66) 9 (3) 14 11
------- ------- ------- ------- ------- -------
Total earning assets $ 7,817 $(4,778) $ 3,039 $ 8,225 $ 1,314 $ 9,539
======= ======= ======= ======= ======= =======
Interest expense:
NOW accounts $ (14) $ (309) $ (323) $ (43) $ 43 $ 0
Savings accounts 1,374 (2,324) (950) 977 1,588 2,565
Time deposits 3,034 (888) 2,146 300 1,176 1,476
Short term borrowings (1,393) (370) (1,763) 1,922 320 2,242
Securities sold 9 (38) (29) (72) 32 (40)
under agreement to
repurchase
Other borrowings 651 (1,205) (554) 1,607 972 2,579
Trust preferred 715 715 1,430
Long term debt (5) 2 (3) (4) 1 (3)
------- ------- ------- ------- ------- -------
Total
interest-bearing
liabilities $ 4,370 $(4,416) $ (46) $ 4,687 $ 4,132 $ 8,819
Net interest income $ 3,447 $ (362) $ 3,085 $ 3,538 $(2,818) $ 720
======= ======= ======= ======= ======= =======
(1) The change in interest due to both rate and volume has been allocated
proportional to the relationship to the dollar amounts of the change in
each.
(2) The yield on tax-exempt loans and securities is computed on an FTE
basis using a tax rate of 34% for all periods presented.
17
TABLE 4: SELECTED AVERAGE BALANCES
Percent 2001 as % of 2000 as % of
2001 2000 Change Total Assets Total Assets
---- ---- ------- ------------ ------------
(dollars in thousands)
ASSETS
Loans, net of
non-accrual loans $577,382 $497,496 16.1% 71.4% 70.4%
Investment securities
Taxable 108,872 102,503 6.2% 13.5 14.5
Tax-exempt 53,158 49,363 7.7% 6.6 7.0
Short-term investments 8,310 1,202 NM 1.0 0.2
-------- -------- ---- ------- -----
Total earning assets 747,722 650,564 14.9% 92.5 92.1
Other assets 60,714 55,882 8.6% 7.5 7.9
-------- -------- ---- ------- -----
Total assets $808,436 $706,446 14.4% 100.0% 100.0%
======== ======== ======= =====
LIABILITIES AND
STOCKHOLDERS' EQUITY
Interest-bearing deposits $547,020 $461,909 18.4% 67.7% 65.4%
Short-term borrowings 116,343 127,640 (8.9%) 14.4 18.1
Trust preferred 14,031 0 NM 1.7 0.0
Long-term debt 159 211 (24.6%) 0.0 0.0
Total interest-bearing 677,553 589,760 14.9% 83.8 83.5
Liabilities
Demand deposits 67,012 61,214 9.5% 8.3 8.7
Accrued expenses 7,519 6,718 11.9% 0.9 1.0
Stockholders' equity 56,352 48,754 15.6% 7.0 6.9
-------- -------- ---- ----- -----
Total liabilities and
Stockholders' equity $808,436 $706,446 14.4% 100.0% 100.0%
======== ======== ==== ===== =====
TABLE 5: DISTRIBUTION OF ASSETS, LIABILITIES AND STOCKHOLDERS' EQUITY
For the years
2001 2000 1999 1998 1997
---- ---- ---- ---- ----
(dollars in thousands)
ASSETS
Cash and due from banks $ 16,896 $ 15,142 $ 15,978 $ 11,917 $ 10,162
Investment securities
U.S. Treasuries 1,173 1,164 1,156 2,102 2,691
Agencies 98,040 96,757 89,893 67,824 58,687
State and municipal
obligations 52,082 50,263 50,954 44,614 32,858
Other securities 10,026 7,440 5,019 5,629 4,475
Market adjustment on
AFS securities 3,064 (2,775) 386 2,298 927
--------- --------- --------- --------- ---------
Total investments $ 164,385 $ 152,849 $ 147,378 $ 122,467 $ 99,638
--------- --------- --------- --------- ---------
Federal funds sold 5,347 14 5,361 6,657 17
Loans, net of
unearned income 587,995 505,892 421,541 333,484 276,639
18
Reserve for loan losses (7,349) (7,999) (8,924) (5,833) (3,203)
--------- --------- --------- --------- ---------
Net loans 580,646 497,893 412,617 327,651 273,436
Bank premises and 21,033 20,128 16,795 14,434 12,521
equipment
Other real estate owned 1,501 562 287 93 38
Other assets 18,628 19,858 18,423 14,139 12,441
--------- --------- --------- --------- ---------
Total assets $ 808,436 $ 706,446 $ 616,839 $ 497,358 $ 408,253
========= ========= ========= ========= =========
LIABILITIES AND
STOCKHOLDER'S EQUITY
Demand deposits $ 67,012 $ 61,214 $ 56,755 $ 46,586 $ 41,521
NOW accounts 44,015 44,965 47,313 41,734 38,898
Savings deposits 197,993 164,858 141,972 109,778 88,544
Time deposits 305,012 252,086 246,782 188,412 163,755
--------- --------- --------- --------- ---------
Total deposits $ 614,032 $ 523,123 $ 492,822 $ 386,510 $ 332,718
Short term borrowings $ 19,351 $ 41,798 $ 10,812 $ 15,106 $ 27,701
Securities sold under 2,403 2,213 3,657 3,637 1,800
agreement to repurchase
Other borrowings 94,589 83,629 56,466 42,099 --
Long term debt 159 211 265 387 377
Trust preferred 14,031 -- -- -- --
securities
Other liabilities 7,519 6,718 6,882 6,247 5,562
--------- --------- --------- --------- ---------
Total liabilities $ 752,084 $ 657,692 $ 570,904 $ 453,986 $ 368,158
Common stock $ 37,456 $ 37,333 $ 20,996 $ 18,475 $ 12,302
Additional paid in 7,625 7,125 6,560 8,718 6,038
capital
Retained earnings 9,902 7,234 18,743 15,305 21,347
Net unrealized gains 1,994 (2,313) 261 1,496 609
(losses) on AFS
securities
Treasury stock (625) (625) (625) (622) (201)
--------- --------- --------- --------- ---------
Total equity $ 56,352 $ 48,754 $ 45,935 $ 43,372 $ 40,095
--------- --------- --------- --------- ---------
Total liabilities and
stockholders' equity $ 808,436 $ 706,446 $ 616,839 $ 497,358 $ 408,253
========= ========= ========= ========= =========
Provision for Loan Losses
The provision for loan losses ("PFLL") is the periodic cost, not less than
quarterly, of providing an allowance for anticipated future loan losses. In any
accounting period, the PFLL is based on a function of the methodology used and
management's evaluation of the loan portfolio, especially nonperforming and
other potential problem loans, taking into consideration many factors, including
loan growth, net charge-offs, changes in the composition of the loan portfolio,
delinquencies, management's evaluation of loan quality, general economic factors
and collateral values.
The PFLL in 2001 at $2.9 million compares to a PFLL of $545,000 for 2000 and
$850,000 for 1999. Net charge-offs in 2001 were $1.9 million compared with net
charge-offs of $1.2 million in 2000 and $3.4 million in 1999. Net charge-offs as
a percentage of average loans is a key measure of asset quality. Net charge-offs
to average loans
19
were 0.32% in 2001 compared with 0.23% in 2000 and 0.80% in 1999. Management
believes that the current provision conforms with the Company's loan loss
reserve policy and is adequate in view of the present condition of the Company's
loan portfolio. See "Risk Management and the Allowance for Loan Losses" below.
Non-Interest Income
Total non-interest income for 2001, excluding securities transactions, was $6.3
million, a $1.6 million increase from 2000, or 34.6%. In 2000, total
non-interest income was $130,000 more than 1999, a 2.9% increase. Trust service
fees, loan servicing fees, gains from sales of loans and service charges
continue to be the primary components of non-interest income as evidenced in
Table 6.
TABLE 6: NONINTEREST INCOME
Years ended December 31, % Change from prior year
------------------------------------------------------------------------
2001 2000 1999 2001 2000
---- ---- ---- ---- ----
(dollars in thousands)
Trust service fees $ 664 $ 517 $ 553 28.4% (6.5%)
Loan servicing income $ 1,461 $ 837 $ 875 74.6% (4.3%)
Service charges on $ 1,836 $ 1,489 $ 1,369 23.3% 8.8%
Deposit accounts
Other fee income $ 608 $ 564 $ 521 7.8% 8.3%
Financial service income $ 300 $ 459 $ 393 (34.6%) 16.8%
Gains from sale of loans $ 873 $ 240 $ 295 263.8% (18.6%)
Other $ 565 $ 580 $ 550 (2.6%) 5.5%
------- ------- -------- ------- -----
Total noninterest income $ 6,307 $ 4,686 $ 4,556 34.6% 2.9%
======= ======= ======== ======= ======
Trust fees increased $147,000 or 28.4% to $664,000 in 2001 compared to 2000,
primarily as a result of an increase in trust estate business and by an increase
in additional assets under management. This compared to a decrease of $36,000 or
6.5% in 2000 compared to 1999, primarily the result of reduced trust estate
business.
Loan servicing fees increased $624,000, or 74.6%, to $1.5 million in 2001. This
followed a decrease of $38,000, or 4.3%, to $837,000 in 2000. The increase in
2001 occurred as a result of increased servicing income due to an increase in
the portfolio of mortgage loan business sold in the secondary market and an
increase in the commercial loan business sold in the secondary market and
serviced by the Company, primarily the result of a falling interest rate
environment in 2001 compared to 2000.
Gains on sales on loans in the secondary market increased $633,000, or 263.8%,
to $873,000 in 2001 primarily as a result of increased gains from sales of
mortgage loans. Premiums increased in the secondary market for mortgage loans
contributing to an increase in $534,000 in gains from the sale of mortgage
loans. In addition, gains from commercial loans increased $99,000 in 2001. An
increase in mortgage loan business sold during 2001 amounted to $78.7 million of
loans sold compared to $17.1 million of mortgage loans sold in 2000. Total loans
sold during 2001 were $86.5 million compared to $23.6 million in 2000.
Service charges on deposit accounts showed an increase of $347,000, or 23.3%,
over 2000 results accounting for the improvement in fee income generated for
other services provided to customers. In addition, a lower rate environment
reduced earnings credits on transaction accounts providing for additional fee
income.
Other income decreased $15,000, or 2.6%, to $565,000 in 2001. Undistributed
income from United Financial Services, Inc., the Bank's data servicing
subsidiary increased $44,000 as a result of increased earnings to $295,000, from
the data processing subsidiary.
20
Non-Interest Expense
Non-interest expense in 2001 increased to $20.8 million, a $2.2 million, or
11.7% increase compared to 2000 results, primarily as a result of increased
personnel, equipment, data processing, and other operating expense. This
followed a $1.2 million or 7.0% increase in 2000 as compared to 1999. Primary
categories impacting the change between 2001 and 2000 are noted in Table 7
below.
TABLE 7: NONINTEREST EXPENSE
Years ended December 31, % Change from prior year
-------------------------------------------------------------------------------
(dollars in thousands)
-------------------------------------------------------------------------------
2001 2000 1999 2001 2000
---- ---- ---- ---- ----
Personnel $ 11,923 $ 10,353 $ 9,700 15.2% 6.7%
Occupancy $ 1,834 $ 1,643 $ 1,430 11.6% 14.9%
Equipment $ 1,401 $ 1,404 $ 1,238 (0.2%) 13.4%
Data processing $ 893 $ 844 $ 797 5.8% 5.9%
Business development $ 594 $ 628 $ 493 (5.4%) 27.4%
and advertising
Stationery and supplies $ 482 $ 536 $ 442 (10.1%) 21.3%
Director fees $ 285 $ 262 $ 247 8.8% 6.1%
FDIC insurance $ 110 $ 140 $ 181 (21.4%) (22.7%)
Goodwill amortization $ 486 $ 486 $ 453 0.0% 7.3%
Legal and professional $ 256 $ 199 $ 373 28.6% (46.6%)
Operation of other real $ 248 $ (22) $ (117) NM (81.2%)
Estate
Other $ 2,259 $ 2,117 $ 2,133 6.7% (0.8%)
-------- -------- -------- ------ -------
Total noninterest expense 20,771 $ 18,590 $ 17,370 11.7% 7.0%
======== ======== ======== ====== ====
Salaries and employee benefits expense is the largest component of non-interest
expense and totaled $11.9 million in 2001, an increase of $1.6 million, or
15.2%, as compared to 2000 results. The increase in 2001 primarily resulted from
staffing increases, bonus expense, increased benefit costs, and normal salary
increases. Salary and employee benefits expense in 2000 totaled $10.4 million,
an increase of $653,000, or 6.7%, as compared to 1999 results. The 1999 increase
resulted primarily from staffing increases, increased benefit costs, and normal
salary increases.
Bonus expense in 2001 was $405,000 compared to $134,000 in 2000. The increase
occurred as a result of bonus expense arising from the Company's
Pay-for-Performance Program in 2001. This program is designed to reward various
divisions upon achievement of certain goals related to improvement in income and
on return on equity. The Company did achieve its return on equity goals and,
accordingly, a bonus payment was made.
The Company's 401(k) profit sharing plan, including a money purchase plan
initiated in 1999, covering all employees who qualify as to age and length of
service increased to $713,000, an increase of $87,000, or 13.9%, over 2000
levels. Expenses in the same category in 2000 were up $54,000, or 9.4%, over
1999 levels.
The number of full-time equivalent employees increased to 286 in 2001 from 272
in 2000, an increase of 5.1%. Employee levels in 2000 increased to 272 from 252
in 1999, an increase of 7.9%. The increases occurred primarily at the Company's
Green Bay locations with emphasis on additional personnel for sales and calling
programs. Management will continue its efforts to control salaries and employee
benefits expense, although increases in these expenses are likely to continue to
occur in future years.
Net occupancy expense for 2001 showed an increase of $191,000, or 11.6%, as
compared to 2000 for a total of $1.8 million. Additional depreciation expense,
real estate tax expense, and other occupancy costs resulted in 2001. This
increase followed an increase of $213,000, or 14.9%, in 2000. Additions of two
facilities in the Green Bay region
21
plus two additional branches built on existing sites accounted for the balance
of the increase in occupancy expense for 2000.
Equipment expense was flat for 2001 decreasing $3,000, or 0.2%, compared to
2000. This followed an increase of $166,000, or 13.4%, in 2000. The increase in
2000 resulted from depreciation expense from past capital expenditures for
equipment that were made to enhance the Company's technological capabilities.
The addition of branches in 2000 also accounted for an increase in equipment
expense in 2000.
Data processing expense in 2001 increased $49,000, or 5.8%, due to an increase
in the volume of transaction activity processed and technology enhancements.
This followed an increase of $47,000, or 5.9%, in 2000 compared to 1999.
Management estimates that data processing expense should show minimal increases
in the next several years with adjustments related only to any volume increases
incurred by the Company.
Business development and advertising expense in 2001 decreased $34,000, or 5.4%
compared to 2000. This compared to an increase of $135,000, or 27.4% in 2000
compared to 1999 as television advertising production costs accounted for much
of the increase.
Supplies expense shows a decrease of $54,000, or 10.1%, in 2001 as compared to
2000. This compared to an increase of $94,000, or 21.3% in 2000 compared to
1999. This increase occurred as a result of additional branches coming online
during the year 2000.
Payments to regulatory agencies decreased $30,000 to $110,000 for 2001
reflecting the net rate reduction in deposit insurance effective for 2001 on a
higher deposit base for the year. For 2000, payments to regulatory agencies
decreased $41,000 to $140,000 when compared to 1999. For the Bank, these charges
related to a debt service assessment related to Financing Corporation ("FICO")
for 2000 and a Federal Deposit Insurance Corporation ("FDIC") assessment for the
first quarter of 2000. As a result of a change in rating assigned of 2A, rating
for adequately capitalized institutions, the Bank experienced higher assessment
costs for the last quarter of 1999 and first quarter of 2000. The higher
assessment occurred as a result of the "Total Risk-Based Capital Ratio"
decreasing to a level below 10%. Prior to the merger of the Bank and BLBNA,
BLBNA had been assigned a risk classification rating of 3B, rating assigned to
troubled and critically under capitalized institutions, therefore in addition to
a FICO assessment, BLBNA also received a FDIC assessment for its Bank Insurance
Fund. The Bank's risk classification changed to 1A, rating assigned to
well-capitalized institutions, on May 31, 2000, thereby enabling Bank to reduce
FDIC premiums accordingly for the remainder of 2000. For additional information
regarding the Company's capital adequacy, see "Capital Resources" below.
Legal and professional expense for 2001 increased $57,000 or 28.6% as various
costs were incurred as a result of legal and collection actions that occurred
during the year. Legal expenses decreased $174,000 during 2000, primarily the
result of the completion of various legal actions stemming from the operations
of the former BLBNA.
Other real estate expenses are netted against income received in the
determination of net other real estate owned expense (income). As a result, the
Company has shown varied results. Other real estate owned showed net expense of
$248,000 in 2001 as a result of various gains taken on property sales. Gains of
$23,000 were taken from lot sales of Idlewild Valley, Inc., a former subsidiary
of the Bank whose value was written off in 1988. In addition, gains of $177,000
from eight commercial property sales and $9,000 from five residential property
sales were realized in 2001. These were offset by losses of $22,000 from the
sale of two commercial properties and two residential properties. Various
operating expenses, net of income, of other real estate totaling $435,000
occurred in 2001. Other real estate owned expenses resulted in net income of
$22,000 in 2000. Gains of $73,000 were realized from lot sales of Idlewild
Valley, Inc., in 2000. In addition, gains of $110,000 from three commercial
property sales and $72,000 from seven residential property sales were realized
in 2000. These were offset by losses of $2,000 from the sale of one commercial
property and two residential properties. Various operating expenses, net of
income, of other real estate totaling $231,000 occurred in 2000.
Amortization of goodwill related to the Four Seasons acquisition and BLBNA
acquisition were unchanged for 2001 as compared to 2000. Amortization expense of
$327,000 for Four Seasons and $159,000 for BLBNA were recorded for each of those
years. Amortization of goodwill in 1999 was $453,000 which amounted to $327,000
for Four Seasons and $126,000 for BLBNA.
22
Other operating expenses in 2001 increased $142,000 or 6.7%, primarily the
result of an increase of $108,000 related to other outside service expense, such
as consulting fees and payroll service expenses. Other operating expenses in
2000 decreased $16,000 or 0.8% compared to 1999.
The overhead ratio, which is computed by subtracting non-interest income from
non-interest expense and dividing by average total assets was 1.79% for 2001
compared to 1.97% for 2000 and 2.08% for 1999.
Income Taxes
Income tax expense for the Company in 2001 was $2.1 million, a decrease of
$687,000 or 24.7% compared to 2000. The major part of the decrease was
attributable to $516,000 of net federal tax refunds booked based on an IRS audit
of BLBNA completed in December 2001. This amount was net of $151,000 of tax
assessed and $340,000 of refund claims not booked pending IRS approval. This
followed an increase of $178,000 or 6.8% in 2000 compared to 1999. The higher
tax expense in 2000 reflected the Company's increase in before tax earnings
offset by an increase in tax-exempt interest income.
The Company's effective tax rate, income tax expense divided by income before
taxes, was 21.7% in 2001 compared with 29.3% in 2000 and 27.3% in 1999. Of the
21.7% effective tax rate for 2001, the federal effective tax rate was 20.5%
while the Wisconsin State effective tax rate was 1.2%.
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. A valuation allowance has
been recognized to offset the related deferred tax assets due to the uncertainty
of realizing tax benefits of a portion of loan loss and mortgage servicing
differences.
Income taxes are provided for the tax effects of transactions reported in the
financial statements and consists of taxes currently due plus deferred taxes
related primarily to differences between the basis of the allowance for loan
losses, deferred loan origination fees, deferred compensation, mortgage loan
servicing, market value adjustments of securities, and depreciation for
financial and income tax reporting in accordance with SFAS 109. The deferred tax
assets and liabilities represent the future tax return consequences of those
differences, which will either be taxable or deductible when the assets and
liabilities are recovered or settled.
Balance Sheet Analysis
Loans
Total loans outstanding grew to $605.3 million at December 31, 2001, a 9.0%
increase from the end of 2000. This follows a 24.2% increase at December 31,
2000 over 1999 year end.
The commercial, financial, and agricultural loan classification primarily
consists of commercial loans to small businesses. Loans of this type are in a
broad range of industries and include service, retail, wholesale, and
manufacturing concerns. Agricultural loans are made principally to farmers
engaged in dairy, cherry and apple production. Borrowers are primarily
concentrated in Door, Brown, Outagamie, Waupaca, Waushara and Kewaunee counties,
Wisconsin. The credit risk related to commercial loans made is largely
influenced by general economic conditions, especially those applicable to the
Northeast Wisconsin market area, and the resulting impact on a borrower's
operations.
Commercial loans and commercial real estate loans (including construction loans)
totaled $445.0 million at year end 2001 and comprised 73.5% of the loan
portfolio compared with 68.0% of the portfolio at the end of 2000. Loans in
these classifications grew $67.6 million or 17.9% during 2001. Loans of this
type are in a broad range of industries. The credit risk related to these type
of loans is greatly influenced by general economic conditions and the resulting
impact on the borrower's operations.
Table 8 reflects composition (mix) of the loan portfolio at December 31:
23
TABLE 8: LOAN COMPOSITION
(dollars in thousands)
2001 2000 1999
---- ---- ----
Amount % of Total Amount % of Total Amount % of Total
Amount of loans by type
Real estate-
mortgage
Commercial $288,385 47.6% $251,971 45.4% $201,301 45.0%
1-4 Family residential
First liens 96,626 16.0 109,173 19.7 95,255 21.3%
Junior liens 24,748 4.1 26,513 4.8 23,811 5.3%
Home equity 22,374 3.7 24,464 4.4 18,963 4.3%
Commercial, financial 88,649 14.6 83,897 15.1 66,159 14.8%
and agricultural
Real estate-construction 67,939 11.2 41,524 7.5 26,535 5.9%
Installment
Credit cards and related 2,145 0.4 2,140 0.4 1,810 0.4%
Plans
Other 14,745 2.4 15,785 2.8 13,636 3.1%
Less: deferred fees, net 324 0.1 360 0.1 451 0.1%
of costs
Total loans (net of $605,287 100.0% $555,107 100.0% $447,019 100.0%
unearned income) ======== ======== ========
1998 1997
---- ----
Amount % of Total Amount % of Total
Amount of loans by type
Real estate-
mortgage
Commercial $178,846 43.9% $118,103 40.2%
1-4 Family residential
First liens 101,391 24.9 67,270 22.9
Junior liens 17,122 4.2 16,571 5.7
Home equity 18,051 4.4 16,714 5.7
Commercial,financial 67,550 16.6 47,078 16.1
and agricultural
Real estate-construction 9,553 2.3 14,760 5.0
Installment
Credit cards and related 1,809 0.4 1,790 0.6
Plans
Other 14,105 3.5 11,690 4.0
Less: deferred fees, net 779 0.2 538 0.2
of costs
Total loans (net of $407,648 100.0% $293,438 100.0%
unearned income) ======== ========
Real estate loans (including construction loans) secured by non-residential real
estate properties involve borrower characteristics similar to those for
commercial loans. Because of their similarities, they are combined with
commercial loans for purposes of analysis and discussion.
Management uses an active credit risk management process for commercial loans to
ensure that sound and consistent credit decisions are made. Management attempts
to control credit risk by adhering to detailed
24
underwriting procedures, performing comprehensive loan administration, and
undertaking periodic review of borrowers' outstanding loans and commitments.
Borrower relationships are formally reviewed periodically during the life of the
loan. Further analyses by customer, industry, and location are performed to
monitor trends, financial performance and concentrations.
The Company's loan portfolio is diversified by types of borrowers and industry
groups within the market areas that it serves. Significant loan concentrations
are considered to exist for a financial entity when such amounts are loans to a
multiple of borrowers engaged in similar activities that cause them to be
similarly impacted by economic or other conditions. The Company has identified
certain industry groups within its market area, including lodging, restaurants,
retail shops, small manufacturing, real estate rental properties and real estate
development. At December 31, 2001, there existed one industry group
concentration in the Company's loans that exceeded 10% of total loans. Loans
related to the lodging industry amounted to $62.4 million or 10.3% of total
loans at year end December 31, 2001.
Although management does not believe significant industry group loan
concentrations exist in the Company's loan portfolio, it is aware that its
market area is heavily reliant on seasonal tourism. As a result, a decrease in
tourism could adversely affect one or more industry groups in the Company's loan
portfolio, which could have a corresponding adverse effect on the Company's
earnings.
At the end of 2001, residential real estate mortgage loans totaled $143.7
million and comprised 23.8% of the loan portfolio. These loans decreased $16.4
million or 10.2% during 2001. A lower interest rate environment provided
opportunities for the Company to refinance existing mortgage loans into fixed
rates and sell them into the secondary market. Residential real estate loans
consist of conventional home mortgages, adjustable indexed interest rate
mortgage loans, home equity loans, and secondary home mortgages. Loans are
primarily for properties within the market areas served by the Company.
Residential real estate loans generally contain a limit for the maximum loan to
collateral value of 75% to 80%. Private mortgage insurance may be required when
the loan to value exceeds these limits. Residential real estate loans are
written normally with a one or three year adjustment rate feature.
In 1997, the Company offered adjustable indexed interest rate mortgage loans
based upon market demands. At year end 2001, those loans totaled $43.8 million
dollars. Adjustable indexed interest rate mortgage loans contain an interest
rate adjustment provision tied to the weekly average yield on U.S. Treasury
securities adjusted to a constant maturity of one year, plus an additional
mark-up of 2.75% (the "index") which varies with the mortgage loan product.
Interest rates on indexed mortgage loans are adjusted, up or down, on
predetermined dates fixed by contract, in relation to and based on the index or
market interest rates as of a predetermined time prior to the adjustment date.
Adjustable indexed interest rate mortgage loans have an initial period, ranging
from one or three years, during which the interest rate is fixed, with
adjustments permitted thereafter, subject to annual and lifetime interest rate
caps which vary with the product. Annual limits on interest rate changes are 2%
while aggregate lifetime interest rate increases over the term of the loan are
currently at 6% above the original mortgage loan interest rate. The Company also
participates in a secondary fixed rate mortgage program under the Federal Home
Loan Mortgage Corporation ("FHLMC") guidelines. These loans are sold in the
secondary market and the Company retains servicing rights. At December 31, 2001,
these loans totaled $51.1 million.
Additionally in the last quarter of 1997, the Company began to offer fixed rate
mortgages through participation in secondary fixed rate mortgage programs under
private investors. These loans are sold in the secondary market with servicing
rights sold retained by buyer. In 2001, the Company sold $78.7 million mortgage
loans through the secondary programs.
25
TABLE 9: LOAN MATURITY AND INTEREST RATE SENSITIVITY (1)
Maturity (2)
- ---------------------------------------------------------------------------------------
December 31, 2001 Within 1 Year 1-5 Years After 5 Years Total
- ---------------------------------------------------------------------------------------
(dollars in thousands)
Loans secured
primarily by real estate:
Secured by 1 to 4 $ 33,907 $ 54,049 $ 55,792 $143,748
family residential
properties
Construction 37,525 29,333 1,081 67,939
Other real estate 76,399 154,358 57,628 288,385
Loans to farmers 2,015 5,273 626 7,914
Commercial and 18,745 26,032 34,713 79,490
industrial
Loans to consumers 5,535 10,952 403 16,890
All other loans 607 638 -- 1,245
-------- -------- -------- --------
Total $174,733 $280,635 $150,243 $605,611
- --------------------------------------------------------------------------------------
Interest sensitivity
- --------------------------------------------------------------------------------------
Fixed rate Variable rate
------------- ---------------
Due after one year $213,052 $217,826
----------- ------------
Installment loans to individuals totaled $16.9 million, or 2.8%, of the total
loan portfolio at December 31, 2001 compared to $17.9 million, or 3.2%, at end
of 2000. Installment loans include short-term installment loans, direct and
indirect automobile loans, recreational vehicle loans, credit card loans, and
other personal loans. Individual borrowers may be required to provide collateral
or a satisfactory endorsement or guaranty from another party, depending upon the
specific type of loan and the creditworthiness of the borrower. Loans are made
to individual borrowers located in the market areas served by the Company.
Credit risks for loans of this type are generally influenced by general economic
conditions (especially in the market areas served), the characteristics of
individual borrowers and the nature of the loan collateral. Credit risk is
primarily controlled by reviewing the creditworthiness of the borrowers as well
as taking the appropriate collateral and guaranty positions on such loans.
Critical factors in the overall management of credit quality are sound loan
underwriting and administration, systematic monitoring of existing loans and
commitments, effective loan review on an ongoing basis, adequate allowance for
loan losses, and conservative non-accrual and charge-off policies.
Risk Management and the Allowance for Loan Losses
The loan portfolio is the Company's primary asset subject to credit risk. To
reflect this credit risk, the Company sets aside an allowance or reserve for
possible credit losses through periodic charges to earnings. These charges are
shown in the Company's consolidated income statement as provision for loan
losses. See "Provision for Loan Losses" above. Credit risk is controlled and
monitored through the use of lending standards, a thorough review of potential
borrowers, and an ongoing review of payment performance. Asset quality
administration, including early identification of problem loans and timely
resolution of problems, further enhances management of credit risk and
minimization of loan losses. All specifically identifiable and quantifiable
losses are immediately charged off against the allowance.
Management reviews the adequacy of the Allowance for Loan Losses ("allowance" or
"ALL") on a quarterly basis to determine whether, in management's estimate, the
allowance is adequate to provide for possible losses inherent in the loan
portfolio as of the balance sheet date. Management's evaluation of the adequacy
of the ALL is based primarily on management's periodic assessment and grading of
the loan portfolio as described below. Additional factors considered by
management include the consideration of past loan loss experience, trends in
past due and nonperforming loans, risk characteristics of the various
classifications of loans, current economic conditions, the fair value of
underlying collateral, and other regulatory or legal issues that could affect
credit losses.
Loans are initially graded when originated. They are re-graded as they are
renewed, when there is a loan to the same borrower, when identified facts
demonstrate heightened risk of nonpayment, or if they become delinquent. The
loan review, or, grading process attempts to identify and measure problem and
watch list loans. Problem loans are those loans that management determines have
a higher than average risk for default, with workout and/or legal action
probable within one year. These loans are reported at least quarterly to the
directors' loan committee and reviewed
26
at the officers' loan committee for action to be taken. Watch list loans are
those loans considered as having weakness detected in either character, capacity
to repay or balance sheet concerns and prompt management to take corrective
action at the earliest opportunity. Problem and watch list loans generally
exhibit one or more of the following characteristics:
1. Adverse financial trends and condition
2. Decline in the entire industry
3. Managerial problems
4. Customer's failure to provide financial information or other collateral
documentation
5. Repeated delinquency, overdrafts or renewals
Every significant problem credit is reviewed by the loan review process and
assessments are performed quarterly to confirm the risk rating, proper
accounting and the adequacy of loan loss reserve assigned.
After reviewing the gradings in the loan portfolio, management will allocate or
assign a portion of the ALL to categories of loans and individual loans to cover
management's estimate of probable loss. Allocation is related to the grade of
the loan and includes a component resulting from the application of the
measurement criteria of Statements of Financial Accounting Standards No. 114,
"Accounting by Creditors for Impairment of a Loan" ("SFAS 114") and No. 118,
"Accounting by Creditors for Impairment of a Loan-Income Recognition and
Disclosures" ("SFAS 118"). Allocations also are made for unrated loans, such as
credit card loans, based on historical loss experience adjusted for portfolio
activity. The indirect risk in the form of off-balance sheet unfunded
commitments are also taken into consideration. These allocated reserves are
further supplemented by unallocated reserves based on management's estimate
regarding risk of error, local economic conditions and any other relevant
factors. Management then compares the amounts allocated for probable losses to
the current allowance. To the extent that the current allowance is insufficient
to cover management's best estimate of probable losses, management records
additional provision for credit loss. If the allowance is greater than required
at that point in time, provision expense is adjusted accordingly.
As Table 10 indicates, the ALL at December 31, 2001 was $8.0 million compared
with $7.0 million at the end of 2000. Loans increased 9.0% from December 31,
2000 to December 31, 2001, while the allowance as a percent of total loans
increased due to increased loan loss provision for the year 2001 offset by net
charge-offs for the year. The December 31, 2001 ratio of ALL to outstanding
loans was 1.32% compared with 1.26% at December 31, 2000. Based on management's
analysis of the loan portfolio risk at December 31, 2001, a provision expense of
$2.9 million was recorded for the year ended December 31, 2001, an increase of
$2.3 million compared to the same period in 2000. Net loan charge-offs of $1.9
million occurred in 2001, and the ratio of net charge-offs to average loans for
the period ended December 31, 2001 was 0.32% compared to 0.23% at December 31,
2000. Real estate-mortgage charge-offs represented 65.5% of the total net
charge-offs for the year 2001. Commercial mortgage loan charge-offs accounted
for $1.0 million of the mortgage total and residential mortgage loan charge-offs
totaled $246,000. Commercial loans accounted for $555,000 or 29.3% of the total
net charge-offs for the year 2001. Loans charged-off are subject to periodic
review and specific efforts are taken to achieve maximum recovery of principal
and accrued interest.
TABLE 10. LOAN LOSS EXPERIENCE
Years Ended December 31,
2001 2000 1999 1998 1997
---- ---- ---- ---- ----
(dollars in thousands)
Daily average amount of loans $ 587,995 $ 505,892 $ 421,541 $ 333,484 $ 276,639
--------- --------- --------- --------- ---------
Loans, end of period $ 605,287 $ 555,107 $ 447,019 $ 407,648 $ 293,438
--------- --------- --------- --------- ---------
ALL, at beginning of year $ 7,006 $ 7,611 $ 11,035 $ 3,881 $ 2,893
Loans charged off:
Real estate-mortgage 1,573 1,584 991 355 1
Real estate-construction -- -- 40 -- --
Loans to farmers -- 24 35 -- --
Commercial/industrial loans 983 343 4,097 376 199
Consumer loans 173 123 199 114 121
Lease financing/other loans -- -- -- -- --
--------- --------- --------- --------- ---------
Total loans charged off $ 2,729 $ 2,074 $ 5,362 $ 845 $ 321
Recoveries of loans previously charged off:
Real estate-mortgage 332 290 508 148 1
Real estate-construction -- 2 -- -- --
Loans to farmers -- 11 -- -- --
Commercial/industrial loans 428 557 1,433 186 151
Consumer loans 75 64 47 43 42
Lease financing/other loans -- -- -- -- --
--------- --------- --------- --------- ---------
Total loans charged off 835 924 1,988 377 194
--------- --------- --------- --------- ---------
Net loans charged off ("NCOs") 1,894 1,150 3,374 468 127
--------- --------- --------- --------- ---------
Additions to allowance for loan losses charged $ 2,880 $ 545 $ 850 $ 1,135 $ 1,115
to operating expense
Allowance to related assets acquired -- -- (900) 6,487 --
ALL, at end of year $ 7,992 $ 7,006 $ 7,611 $ 11,035 $ 3,881
Ratio of NCOs during period to average loans 0.32% 0.23% 0.80% 0.14% 0.05%
Outstanding
Ratio of ALL to NCOs 4.2 6.1 2.3 23.6 30.6
Ratio of ALL to total loans end of period 1.32% 1.26% 1.70% 2.71% 1.32%
27
Consistent with generally accepted accounting principles ("GAAP") and with the
methodologies used in estimating the unidentified losses in the loan portfolio,
the ALL consists of several components.
First, the allowance includes a component resulting from the application of the
measurement criteria of SFAS 114 and SFAS 118. The amount of this component is
included in the various categories presented in the following table.
The second component is statistically based and is intended to provide for
losses that have occurred in large groups of smaller balance loans, the credit
quality of which is impracticable to re-grade at end of each period. These loans
would include residential real estate, consumer loans and loans to small
businesses generally of $100,000 and less. The loss factors are based primarily
on the Company's historical loss experience tracked over a three-year period and
accordingly will change over time. Due to the fact that historical loss
experience varies for the different categories of loans, the loss factors
applied to each category also differ.
Finally, the "unallocated" component of the ALL is intended to absorb losses
that may not be provided for by the other components. There are several reasons
that the other components discussed above might not be sufficient to absorb the
losses present in portfolios, and the unallocated portion of the ALL is used to
provide for the losses that have occurred because of these reasons.
The first reason stems from the fact that there are limitations inherent to any
credit risk grading process. Even for experienced loan reviewers, grading loans
and estimating probable losses involves a significant degree of judgement
regarding the present situation with respect to individual loans and the
portfolio as a whole. The overall number of loans in the portfolio also makes it
impracticable to re-grade every loan each quarter. Therefore, the possibility
exists that some currently performing loans will not be as strong as their last
grading estimate and an insufficient portion of the allowance will have been
allocated to them. In addition, it's possible that grading and loan review may
be done without all relevant facts. Troubled borrowers may inadvertently or
deliberately omit important information from correspondence with lending
officers regarding their financial condition and the diminished strength of
repayment sources.
The second is that loss estimation factors are based on historical loss totals.
As such, the factors may not give sufficient weight to such considerations as
the current general economic and business conditions that affect the Company's
borrowers and specific industry conditions that affect borrowers in that
industry. For example, with respect to loans to borrowers who are influenced by
trends in the local tourist industry, management considers the
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effects of weather conditions, market saturation, and the competition for
borrowers from other tourist destinations and attractions.
Third, the loss estimation factors do not give consideration to the seasoning of
the loan portfolio. Seasoning is relevant because losses are less likely to
occur in loans that have been performing satisfactorily for several years than
in loans that are more recent.
Finally, the loss estimation factors do not give consideration to the interest
rate environment. For example, borrowers with variable rate loans may be less
able to manage their debt service if interest rates rise.
For these reasons, management regards it as both a more practical and a more
prudent practice to maintain the total allowance at an amount larger than the
sum of the amounts allocated as described above.
Table 11 shows the amount of the ALL allocated for the time periods indicated to
each loan type as described. It also shows the percentage of balances for each
loan type to total loans. Management continues to target and maintain the ALL
equal to the allocation methodology plus an unallocated portion, as determined
by economic conditions on the Company's borrowers. In general, it would be
expected that those types of loans which have historically more loss associated
with them will have a proportionally larger amount of the allowance allocated to
them than do loans that have less risk.
Consideration for making such allocations is consistent with the factors
discussed above, and all of the factors are subject to change; thus, the
allocation is not necessarily indicative of the loan categories in which future
loan losses will occur. It would also be expected that the amount allocated for
any particular type of loan will increase or decrease proportionately to both
the changes in the loan balances and to increases or decreases in the estimated
loss in loans