Back to GetFilings.com
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, 2002
| | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES AND EXCHANGE ACT OF 1934
For the transition period from ________________________ to
Commission file number 0-8679
BAYLAKE CORP.
(Exact name of Registrant as specified in its charter)
Wisconsin 39-1268055
(State or other jurisdiction of (I.R.S. Employer
incorporated or organization) Identification No.)
217 North Fourth Avenue., Sturgeon Bay, WI 54235
(Address of principal executive offices) (Zip Code)
Registrant's Telephone number, including area code: (920)-743-5551
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock $5 Par Value
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 | |
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes |X| No | |
As of March 17, 2003, 7,517,276 shares of Common Stock were outstanding, and the
aggregate market value of the Common Stock (based upon the $13.50 reported bid
price on that date) held by non-affiliates (excludes a total of 413,572 shares
reported as beneficially owned by directors and executive officers -- does not
constitute an admission as to affiliate status) was approximately $95,900,004.
DOCUMENTS INCORPORATED BY REFERENCE
Part of Form 10-K Into Which
Document Portions of Documents are Incorporated
Definitive Proxy Statement for 2003 Part III
Annual Meeting of Shareholders to be
Filed within 120 days of the fiscal
Year ended December 31, 2002
2002 FORM 10-K
TABLE OF CONTENTS
DESCRIPTION PAGE NO.
----------- --------
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 41
ITEM 8. Financial Statements and Supplementary Data 41
ITEM 9. Changes and Disagreements with Accountants on Accounting and
Financial Disclosure 81
PART III
ITEM 10. Directors and Executive Officers of the Registrant 82
ITEM 11. Executive Compensation 82
ITEM 12. Security Ownership of Certain Beneficial Owners and Management 82
ITEM 13. Certain Relationships and Related Transactions 82
PART IV
ITEM 14. Controls and Procedures 83
ITEM 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K 83
Signatures 84
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 26 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.
Bank Subsidiaries
3
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. 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. On February 19, 2002, the Bank formed a second
additional subsidiary, Fish Creek English Inn, LLC ("English Inn") for purposes
of the operation of a restaurant acquired in the course of liquidation of
problem loans. The English Inn was dissolved by the Bank, effective July 1, 2002
after sale of the business. The results of operations of English Inn are not
considered material to the financial statements.
At December 31, 2002, the Company had total assets of $904.7 million. For
additional financial information, see the Consolidated Financial Statements and
Notes beginning at Item 8 of this Form 10-K.
Corporate Governance Matters
Baylake maintains a website at www.baylake.com. The Company began on March 20,
2003 to make available through that website, free of charge, copies of our
Annual Reports, on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on
Form 8-K, and amendments to those reports, as soon as reasonably practical after
Baylake electronically files those materials with, or furnishes them to, the
Securities and Exchange Commission ("SEC"). The Company's SEC reports can be
accessed through the Baylake Corp link of our website. The SEC also maintains a
website at www.sec.gov that contains reports, proxy statements and other
information regarding SEC registrants.
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,
2002, 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, 2002 amounted to
approximately $664.3 million, consisting of 84.4% residential, commercial,
agricultural and construction real estate loans, 12.0% commercial and industrial
loans, 2.3% installment and 1.3% agricultural loans.
4
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.
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, 2002, the Company's total
deposits amounted to $740.3 million, including interest bearing deposits of
$650.4 million and non-interest bearing deposits of $89.9 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
5
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 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
6
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 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.
The Sarbanes-Oxley Act of 2002 was signed into law on July 30, 2002 and directs
publicly traded companies to comply with a variety of expanded disclosure and
internal control requirements, affecting corporate governance and accounting
practices reforms under the direction of the Securities and Exchange Commission.
The Bank was additionally made subject to Sarbanes-Oxley by direction of the
Board of Governors of the Federal Reserve under an interim rule adopted in
September of 2002, providing that the Board will administer and enforce the
sections of the Sarbanes-Oxley Act with respect to registered banks, consistent
with Regulation H of the Board of Governors of the Federal Reserve.
Employees
At December 31, 2002, Baylake and its subsidiaries had 293 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-three 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-six branches owned
or leased by the Bank are in good condition and considered adequate for present
and near term requirements. The Bank also owned real property under its
liquidation subsidiary, Arborview, LLC, which was valued for holding purposes at
$1.8 million and which was divested at its full value on February 3, 2003. 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 2002.
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.
8
Cash dividends per
Calendar period High Low share
--------------- ---- --- ------------------
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
2002 1st Quarter $14.00 $12.95 $0.120
2nd Quarter $13.40 $12.75 $0.120
3rd Quarter $13.90 $13.05 $0.120
4th Quarter $13.60 $13.30 $0.130
Baylake had approximately 1,705 shareholders of record at March 17, 2003.
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,
2002 2001 2000 1999 1998
-------- -------- --------- --------- --------
(dollars in thousands, except per share data)
RESULTS OF OPERATIONS:
Interest Income $ 51,564 $ 59,023 $ 56,036 $ 46,467 $ 38,061
Interest Expense 22,188 32,053 32,099 23,280 19,148
-------- -------- --------- --------- --------
Net Interest Income 29,376 26,970 23,937 23,187 18,913
Provision for Loan Losses 5,700 2,880 545 850 1,135
-------- -------- --------- --------- --------
Net interest income after provision for
loan losses 23,676 24,090 23,392 22,337 17,778
Non-interest income:
Gain on sale of loans 1,425 873 240 295 893
Loan servicing fees 1,327 1,461 837 875 846
Trust fees 637 664 517 553 451
Service charges on deposit accounts 2,853 1,836 1,489 1,369 1,074
Securities gains (losses), net 509 0 0 (2) 0
Other 4,002 1,473 1,603 1,466 1,113
-------- -------- --------- --------- --------
Total non-interest income 10,753 6,307 4,686 4,556 4,377
Non-interest expense
Salaries and employee benefits 13,743 11,923 10,353 9,700 7,772
9
Occupancy expense, net 3,585 3,235 3,047 2,668 2,192
Data processing 1,040 986 932 872 699
Other non-interest expense 4,560 4,379 4,280 4,247 3,213
Operation of other real estate 203 248 (22) (117) 15
-------- -------- --------- --------- --------
Total non-interest expense 23,131 20,771 18,590 17,370 13,891
-------- -------- --------- --------- --------
Income before income tax 11,298 9,626 9,488 9,523 8,264
Income tax provision 2,575 2,091 2,778 2,600 2.247
-------- -------- --------- --------- --------
Net income $ 8,723 $ 7,535 $ 6,710 $ 6,923 $ 6,017
PER SHARE DATA: (1)
Net income per share (basic) $ 1.17 $ 1.01 $ 0.90 $ 0.94 $ 0.82
Net income per share (diluted) 1.15 0.99 0.87 0.90 0.80
Cash dividends per common share 0.49 0.45 0.41 0.37 0.47
Book value per share 8.74 7.91 7.14 6.21 6.17
SELECTED FINANCIAL CONDITION DATA
(AT END OF PERIOD):
Total assets $904,656 $845,713 $ 772,268 $ 646,310 $607,438
Investment securities (2) 151,366 167,100 153,511 145,080 128,046
Total loans 665,887 607,715 555,831 447,767 408,921
Total deposits 740,324 669,812 554,005 504,074 495,284
Short-term borrowings (3) 10,056 2,837 79,538 9,231 3,758
Other borrowings (4) 65,000 90,000 77,700 80,000 53,000
Notes payable and subordinated debt 106 158 211 264 392
Trust preferred securities 16,100 16,100 0 0 0
Total shareholders' equity 65,400 59,130 53,127 46,210 45,272
PERFORMANCE RATIOS:
Return on average assets 1.00% 0.93% 0.95% 1.12% 1.21%
Return on average total shareholders'
equity 13.82% 13.37% 13.76% 15.07% 13.87%
Net interest margin (5) 3.87% 3.79% 3.88% 4.35% 4.42%
Net interest spread (5) 3.61% 3.34% 3.37% 3.89% 3.85%
Non-interest income to average assets 1.23% 0.78% 0.66% 0.74% 0.88%
Non-interest expense to average assets 2.65% 2.57% 2.63% 2.82% 2.79%
Net overhead ratio (6) 1.42% 1.79% 1.97% 2.08% 1.91%
Average loan-to-average deposit ratio 91.80% 95.76% 96.71% 85.54% 86.28%
Average interest-earning assets to
average interest-bearing liabilities 109.55% 110.36% 110.78% 111.14% 113.63%
ASSET QUALITY RATIOS: (7)(8)
Non-performing loans to total loans 3.32% 2.42% 2.34% 2.80% 3.45%
Allowance for loan losses to:
Total loans 1.71% 1.32% 1.26% 1.70% 2.71%
Non-performing loans 51.66% 54.47% 53.94% 60.67% 78.33%
Net charge-offs to average loans 0.36% 0.32% 0.23% 0.80% 0.14%
Non-performing assets to total assets 2.76% 1.93% 1.80% 1.95% 2.41%
CAPITAL RATIOS: (9)
Shareholders' equity to assets 7.23% 6.99% 6.88% 7.15% 7.45%
Tier 1 risk-based capital 9.74% 10.15% 7.77% 8.81% 7.97%
Total risk-based capital 10.99% 11.34% 8.92% 10.07% 9.22%
Leverage ratio 8.24% 8.24% 6.38% 6.79% 6.02%
RATIO OF EARNINGS TO FIXED CHARGES: (10)
Including deposit interest 1.51x 1.30x 1.30x 1.41x 1.43x
Excluding deposit interest 3.33x 2.27x 2.11x 3.55x 3.44x
10
(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. See the discussion of this transaction under
Item 1. "Business" and Note 20 of Notes to Consolidated Financial Statements for
additional details on this transaction.
Results of Operations
Earnings Summary
Net income in 2002 was $8.7 million, a 15.8% increase from the $7.5 million
earned in 2001. Net income for 2001 showed a 12.3% increase over the 2000
earnings. Basic operating earnings per share increased $0.16 to $1.17 per share
in 2002 compared with $1.01 in 2001, an increase of 15.8%. Basic operating
earnings per share in 2001 showed a 12.2% increase from 2000 results of $0.90
per share. On a diluted earnings per share basis, the Company recorded $1.15 per
share in 2002, compared to $0.99 and $0.87 per share in 2001 and 2000,
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 $0.07.
Although affected by a declining interest rate environment and increased
competition in 2002, net interest income improved. Net interest income for 2002
improved $2.4 million or 8.9% over 2001 levels. Net interest income for 2001
improved $3.0 million or 12.7% over 2000 levels.
Non-interest income during 2002 increased $4.4 million or 70.5% when compared to
2001. The primary factors increasing non-interest income were an increase in
gains on sales of loans, net securities gains, an increase in fees for other
services to customers and increased other income offset by to a lesser degree by
a decrease in fiduciary fees and a decrease in loan servicing fee income.
Non-interest expense increased $2.4 million during 2002, or 11.4% over 2001
levels. Factors contributing to the increase were increased personnel expenses,
occupancy expense, data processing expense, and other operating expense.
For 2002, return on average assets increased to 1.00% compared with 0.93% in
2001 and 0.95% in 2000. This ratio increased as a result of the various factors
discussed above combined with an average asset growth rate of 8.0% in 2002.
Return on average stockholders' equity in 2002 showed an increase to 13.8%
compared to 13.4% in 2001 and 13.8% in 2000. The increase in 2002 compared to
2001 occurred as a result of a higher level of net income and the factors
described above offset to a lesser degree by a higher level of average capital.
Cash dividends declared in 2002 increased 8.9% to $0.49 per share compared with
$0.45 in 2001. This compares to an increase of 9.8% in dividends declared in
2001 as compared to 2000.
12
The major components of net income and changes in these components are
summarized in Table 1 for years ended December 31, 2002, 2001 and 2000 and are
discussed in more detail on the following pages.
TABLE 1: NET INCOME COMPONENTS
Years ended December 31,
2001 to 2002 2000 to 2001
2002 2001 increase 2000 increase
(dollars in thousands)
Net interest Income $29,376 $26,970 8.9% $23,937 12.7%
Provision for Loan losses $ 5,700 $ 2,880 97.9% $ 545 428.4%
Noninterest Income $10,753 $ 6,307 70.5% $ 4,686 34.6%
Noninterest Expense $23,131 $20,771 11.4% $18,590 11.7%
Income before Income taxes $11,298 $ 9,626 17.4% $ 9,488 1.5%
Income tax Expense $ 2,575 $ 2,091 23.1% $ 2,778 (24.7%)
Net income $ 8,723 $ 7,535 15.8% $ 6,710 12.3%
Net Interest Income
Net interest income (on a tax equivalent basis) is the Company's principal
source of revenue accounting for 74.1% of total income in 2002, as compared to
81.8% in 2001 and 84.3% in 2000. 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 $29.4 million, compared
to $27.0 million in 2001 and $23.9 million in 2000. 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 $1.4 million for 2002 and $1.3 million for 2001 and 2000,
resulted in fully taxable equivalent ("FTE") net interest income of $30.8
million, $28.3 million and $25.2 million, respectively. Net interest income on a
tax-equivalent basis reached $30.8 million in 2002, an increase of 8.7% from
$28.3 million in 2001. Net interest income on a tax-equivalent basis was $25.2
million in 2000. The improvement in 2002 net interest income of $2.5 million was
due in spite of a decrease in the volume of net average earning assets of
$849,000. Average-earning assets increased 6.3% offset by an increase of 7.1% 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 decreased 12.2% while interest expense for 2002 decreased 30.8%.
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
13
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, 2002. 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 $1.4 million to FTE net interest income, while changes
in the rates resulted in a $1.0 million increase, for a net increase of $2.4
million.
Average loans outstanding grew from $588.0 million in 2001 to $635.4 million in
2002, an increase of 8.1%. The increase in loan volume was a significant
contributing factor to the increase in net interest income. Average loans
outstanding increased from $505.9 million in 2000 to $588.0 million in 2001, an
increase of 16.2%. The mix of average loans to average total assets increased
from 71.6% in 2000 to 72.7% in 2001 and to 72.8% in 2002. 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 2002 saw an increase of the interest rate spread for the Company in
spite of a lower interest rate environment. The interest rate spread increased
27 basis points in 2002 to 3.61% from 3.34% in 2001, as the average yield on
earning assets decreased 142 basis points while the average rate paid on
interest-bearing liabilities decreased 167 basis points over the same period. In
contrast, interest rate spread decreased 3 basis points in 2001 compared to 2000
results. The decrease in the Company's earning assets yield reflects a
decreasing rate environment impacting rates on the variable priced loans and
repricing fixed rate loans (for competitive reasons) for the year 2002.
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. A
decreased rate environment also affected the funding side of the balance sheet.
Yields on interest-paying liabilities decreased 167 basis points. 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 166 basis points from 4.47% in 2001 to 2.81% in 2002.
Average short-term borrowings decreased $643,000 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 2.6% in
2002 compared to 2.9% in 2001. Yields on these borrowings decreased 340 basis
points in 2002 compared to 2001 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 2002. Other borrowings on average decreased $22.1
million to $72.5 million. As a percentage of interest-bearing liabilities, other
borrowings decreased to 10.0% from 14.0% in 2001. Yields on these borrowings
decreased 141 basis points to 3.85% from 5.26% in 2001.
An additional source of funds generated in 2001 were proceeds from the trust
preferred securities offering. These resulted in an average of $16.1 million in
funds for 2002 (compared to an average of $14.0 million in 2001, based on the
fact that the $16.1 million in trust preferred securities were issued in
February 2001) at a cost of 10.2%.
The net interest margin for 2002 was 3.87% compared to 3.79% in 2001. The
increase in net interest margin was in part related to a decline in the free
funds ratio, an increase in the interest rate spread offset by an increase in
non-accrual 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
14
further impacted the net interest margin for the year 2002. The free funds
ratio, or the level of non-interest bearing funds that support earning assets,
improved to 18.5% from 17.5% in 2001.
The net interest margin for 2001 was 3.79% compared to 3.88% in 2000 as interest
rate spread declined during that period. The decrease in 2001 during a declining
interest rate environment occurred primarily as the result of an increase in
non-accrual loans, a decline in the free funds ratio and a 3 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 91.1% in 2002 compared with 92.5% in 2001 and 92.1% in
2000. The ratio decreased in 2002 as a result of 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,
-----------------------
2002 2001 2000
--------- --------- --------- --------- ------- --------- --------- --------- ---------
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) $ 635,368 $ 587,995 $ 505,892
Less: non-accruals (15,665) (10,613) (8,396)
========= ========= =========
U.S. Treasuries 1,235 77 6.23% 1,229 78 6.35% 1,164 79 6.79%
Agencies 97,684 5,239 5.36% 99,972 6,202 6.20% 94,882 6,127 6.46%
State and Municipal
obligations (1) 57,701 4,163 7.21% 53,158 4,051 7.62% 49,363 3,912 7.92%
Other Securities 7,671 510 6.65% 7,671 483 6.30% 6,457 467 7.23%
Federal funds sold 1,132 19 1.68% 5,347 174 3.25% 14 1 7.14%
Other money market
instruments 10,043 149 1.48% 2,963 78 2.63% 1,188 69 5.81%
--------- --------- --------- --------- ------- --------- --------- --------- ---------
Total earning assets $ 795,169 $ 52,983 6.66% $ 747,722 $60,379 8.08% $ 650,564 $ 57,340 8.81%
========= ========= ========= ======= ========= =========
15
Allowance for loan
losses (8,383) (7,349) (7,999)
Non-accrual loans 15,665 10,613 8,396
Cash and due from
banks 18,447 16,288 14,937
Other assets 52,176 41,162 40,548
========= ========= =========
Total assets $ 873,074 $ 808,436 $ 706,446
========= ========= =========
LIABILITIES AND
STOCKHOLDERS'
EQUITY
Interest bearing
liabilities
NOW accounts $ 53,170 $ 526 0.99% $ 44,015 $ 514 1.17% $ 44,965 $ 837 1.86%
Savings accounts 201,344 3,038 1.51% 197,993 6,940 3.51% 164,858 7,890 4.79%
Time deposits 361,555 13,771 3.81% 305,012 17,001 5.57% 252,086 14,855 5.89%
========= ========= ==== ========= ======= ==== ========= ========= ====
Total interest-bearing
deposits 616,069 17,335 2.81% 547,020 24,455 4.47% 461,909 23,582 5.11%
Short-term borrowings 18,708 375 2.00% 19,351 1,084 5.60% 41,798 2,847 6.81%
Securities sold under
agreement to
repurchase 2,332 38 1.63% 2,403 94 3.91% 2,213 123 5.56%
Other borrowings 72,534 2,790 3.85% 94,589 4,975 5.26% 83,629 5,529 6.61%
Trust preferred 16,100 1,645 10.22% 14,031 1,430 10.19%
Long term debt 106 5 4.72% 159 15 9.43% 211 18 8.53%
========= ========= ==== ========= ======= ==== ========= ========= ====
Total interest-bearing
liabilities $ 725,849 $ 22,188 3.06% $ 677,553 $32,053 4.73% $ 589,760 $ 32,099 5.44%
Demand deposits 76,030 67,012 61,214
Accrued expenses and
other liabilities 8,069 7,519 6,718
Stockholders' equity 63,126 56,352 48,754
========= ========= =========
Total liabilities and
stockholders' equity $ 873,074 $ 808,436 $ 706,446
========= ========= =========
Net interest income
and rate spread $ 30,795 3.61% $28,326 3.34% $ 25,241 3.37%
Net interest margin 3.87% 3.79% 3.88%
(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)
2002 compared to 2001 2001 compared to 2000
Increase (Decrease) due to Increase (Decrease) due to
Volume Rate Net Volume Rate Net
------ ---- --- ------ ---- ---
(dollars in thousands)
Interest income:
Loans (2) $ 3,270 $ (9,757) $(6,487) $ 7,160 $(4,532) $ 2,628
U.S. treasuries 1 (2) (1) 1 (2) (1)
Agencies (251) (712) (963) 81 (6) 75
State and
municipal obligations (2) 264 (152) 112 142 (3) 139
16
Other securities 86 (59) 27 82 (66) 16
Federal funds sold (104) (51) (155) 277 (104) 173
Other money market
instruments 146 (75) 71 75 (66) 9
------- -------- ------- ------- ------- -------
Total earning assets $ 3,411 $(10,807) $(7,396) $ 7,817 $(4,778) $ 3,039
======= ======== ======= ======= ======= =======
Interest expense:
NOW accounts $ 99 $ (87) $ 12 $ (14) $ (309) $ (323)
Savings accounts 84 (3,986) (3,902) 1,374 (2,324) (950)
Time deposits 2,653 (5,883) (3,230) 3,034 (888) 2,146
Short term borrowings (24) (685) (709) (1,393) (370) (1,763)
Securities sold under
agreement to repurchase (2) (54) (56) 9 (38) (29)
Other borrowings (1,004) (1,181) (2,185) 651 (1,205) (554)
Trust preferred 211 4 215 715 715 1,430
Long term debt (4) (6) (10) (5) 2 (3)
======= ======== ======= ======= ======= =======
Total interest-bearing
liabilities $ 2,012 $(11,877) $(9,865) $ 4,370 $(4,416) $ (46)
Net interest income $ 1,399 $ 1,070 $ 2,469 $ 3,447 $ (362) $ 3,085
======= ======== ======= ======= ======= =======
(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 2002 as % of 2001 as % of
2002 2001 Change Total Assets Total Assets
---- ---- ------ ------------ ------------
(dollars in thousands)
ASSETS
Loans, net of
non-accrual loans $619,703 $577,382 7.3% 71.0% 71.4%
Investment securities
Taxable 107,290 108,872 (1.5%) 12.3 13.5
Tax-exempt 57,001 53,158 7.2% 6.5 6.6
Short-term investments 11,175 8,310 34.5% 1.3 1.0
-------- -------- --- ----- -----
Total earning assets 795,169 747,722 6.3% 91.1 92.5
Other assets 77,905 60,714 28.3% 8.9 7.5
-------- -------- --- ----- -----
Total assets $873,074 $808,436 8.0% 100.0% 100.0%
======== ======== === ===== =====
LIABILITIES AND
STOCKHOLDERS' EQUITY
Interest-bearing deposits $616,069 $547,020 12.6% 70.6% 67.7%
Short-term borrowings 93,574 116,343 (19.6%) 10.7 14.4
Trust preferred 16,100 14,031 14.7% 1.9 1.7
Long-term debt 106 159 (33.3%) 0.0 0.0
-------- -------- --- ----- -----
Total interest-bearing
Liabilities 725,849 677,553 7.1% 83.2 83.8
Demand deposits 76,030 67,012 13.5% 8.7 8.3
Accrued expenses 8,069 7,519 7.3% 0.9 0.9
Stockholders' equity 63,126 56,352 12.0% 7.2 7.0
-------- -------- --- ----- -----
Total liabilities and
Stockholders'equity $873,074 $808,436 8.0% 100.0% 100.0%
======== ======== === ===== =====
TABLE 5: DISTRIBUTION OF ASSETS, LIABILITIES AND STOCKHOLDERS' EQUITY
For the years
-------------
2002 2001 2000 1999 1998
---- ---- ---- ---- ----
(dollars in thousands)
ASSETS
Cash and due from banks $ 18,990 $ 16,896 $ 15,142 $ 15,978 $ 11,917
Investment securities
U.S. Treasuries 1,183 1,173 1,164 1,156 2,102
Agencies 93,831 98,040 96,757 89,863 67,824
State and municipal obligations 55,544 52,082 50,263 50,954 44,614
Other securities 18,612 10,026 7,440 5,019 5,629
Market adjustment on AFS securities 4,621 3,064 (2,775) 386 2,298
--------- --------- --------- --------- ---------
Total investments $ 173,791 $ 164,385 $ 152,849 $ 147,378 $ 122,467
========= ========= ========= ========= =========
Federal funds sold 1,132 5,347 14 5,361 6,657
Loans, net of unearned income 635,368 587,995 505,892 421,541 333,484
18
Reserve for loan losses (8,383) (7,349) (7,999) (8,924) (5,833)
--------- --------- --------- --------- ---------
Net loans 626,985 580,646 497,893 412,617 327,651
Bank premises and equipment 21,769 21,033 20,128 16,795 14,434
Other real estate owned 990 1,501 562 287 93
Other assets 29,417 18,628 19,858 18,423 14,139
--------- --------- --------- --------- ---------
Total assets $ 873,074 $ 808,436 $ 706,446 $ 616,839 $ 497,358
========= ========= ========= ========= =========
LIABILITIES AND STOCKHOLDER'S EQUITY
Demand deposits $ 76,030 $ 67,012 $ 61,214 $ 56,755 $ 46,586
NOW accounts 53,170 44,015 44,965 47,313 41,734
Savings deposits 201,344 197,993 164,858 141,972 109,778
Time deposits 361,555 305,012 252,086 246,782 188,412
--------- --------- --------- --------- ---------
Total deposits $ 692,099 $ 614,032 $ 523,123 $ 492,822 $ 386,510
Short term borrowings $ 18,708 $ 19,351 $ 41,798 $ 10,812 $ 15,106
Securities sold under agreement to repurchase 2,332 2,403 2,213 3,657 3,637
Other borrowings 72,534 94,589 83,629 56,466 42,099
Long term debt 106 159 211 265 387
Trust preferred securities 16,100 14,031 -- -- --
Other liabilities 8,069 7,519 6,718 6,882 6,247
--------- --------- --------- --------- ---------
Total liabilities $ 809,948 $ 752,084 $ 657,692 $ 570,904 $ 453,986
Common stock $ 37,486 $ 37,456 $ 37,333 $ 20,996 $ 18,475
Additional paid in capital 7,328 7,625 7,125 6,560 8,718
Retained earnings 15,950 9,902 7,234 18,743 15,305
Net unrealized gains (losses) on AFS securities 2,987 1,994 (2,313) 261 1,496
Treasury stock (625) (625) (625) (625) (622)
========= ========= ========= ========= =========
Total equity $ 63,126 $ 56,352 $ 48,754 $ 45,935 $ 43,372
========= ========= ========= ========= =========
Total liabilities and stockholders' equity $ 873,074 $ 808,436 $ 706,446 $ 616,839 $ 497,358
========= ========= ========= ========= =========
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 2002 at $5.7 million compares to a PFLL of $2.9 million for 2001 and
$545,000 for 2000. Net charge-offs in 2002 were $2.3 million compared with net
charge-offs of $1.9 million in 2001 and $1.2 million in 2000. Net charge-offs as
a percentage of average loans is a key measure of asset quality. Net charge-offs
to average loans
19
were 0.36% in 2002 compared with 0.32% in 2001 and 0.23% in 2000. 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 2002, excluding securities transactions, was $10.8
million, a $4.4 million increase from 2001, or 70.5%. In 2001, total
non-interest income was $1.6 million more than 2000, a 34.6% 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
------------------------ ------------------------
2002 2001 2000 2002 2001
---- ---- ---- ---- ----
(dollars in thousands)
Trust service fees $ 637 $ 664 $ 517 (4.1%) 28.4%
Loan servicing income $ 1,327 $1,461 $ 837 (9.2%) 74.6%
Service charges on
Deposit accounts $ 2,853 $1,836 $1,489 55.4% 23.3%
Other fee income $ 720 $ 608 $ 564 18.4% 7.8%
Financial service income $ 575 $ 300 $ 459 91.7% (34.6%)
Bank owned life ins $ 332 $ 0 $ 0 NM NM
Death benefit in excess
Of cash surrender value $ 754 $ 0 $ 0 NM NM
Gains from sale of loans $ 1,425 $ 873 $ 240 63.2% 263.8%
Securities gains $ 509 $ 0 $ 0 NM NM
Other $ 1,621 $ 565 $ 580 186.9% (2.6%)
------- ------ ------ ---- ----
Total noninterest income $10,753 $6,307 $4,686 70.5% 34.6%
======= ====== ====== ==== ====
Trust fees decreased $27,000 or 4.1% to $637,000 in 2002 compared to 2001,
primarily as a result of lower market values on various trust accounts for which
fees are assessed. This compared to an increase of $147,000 or 28.4% 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.
Loan servicing fees decreased $134,000, or 9.2%, to $1.3 million in 2002. This
followed an increase of $624,000, or 74.6%, to $1.5 million in 2001. The
decrease in 2002 resulted from a decrease in commercial loan servicing income.
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.
Service charges on deposit accounts showed an increase of $1.0 million, or
55.4%, over 2001 results accounting for the improvement in fee income generated
for other services provided to customers. A lower rate environment reduced
earnings credits on transaction accounts providing for additional fee income. In
addition, changes were made earlier in the year addressing changes in several
pricing policies and procedures which along with better collection processes
provided additional fee income to the bottom line.
Financial services income increased $275,000, or 91.7%, to $575,000 in 2002 as
compared to 2001 as a result of additional annuity sales and improved staff
expertise.
20
As a result of a purchase of $13 million in business owned life insurance
("BOLI") made during the year, income made during 2002 amounted to $332,000.
Death benefits were recognized in excess of cash surrender value in the amount
of $754,000. Life insurance is held on various directors as a funding vehicle
for several deferred compensation agreements the Company has with them.
Gains on sales on loans in the secondary market increased $552,000, or 63.2%, to
$1.4 million in 2002 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 $527,000 in gains from the sale of mortgage
loans. In addition, gains from commercial loans increased $25,000 in 2002. An
increase in mortgage loan business sold during 2002 amounted to $104.8 million
of loans sold compared to $78.7 million of mortgage loans sold in 2001. Total
loans sold during 2002 were $108.6 million compared to $86.5 million in 2001.
Securities gains for the year ended December 31, 2002 totaled $509,000.
Other income increased $1.1 million to $1.6 million in 2002. Included in the
2002 results was $707,000 of revenues generated by the Arborview LLC
("Arborview") (a recently formed subsidiary created to manage a community based
residential facility) operations. Gains of $107,000 related to the sale of bank
land not deemed necessary for development was recorded in 2002. Included in
other income was income of $133,000 on previously amended tax returns received
during the year. Undistributed income from United Financial Services, Inc., the
Bank's data servicing subsidiary increased $88,000 as a result of increased
earnings to $383,000, from the data processing subsidiary.
Non-Interest Expense
Non-interest expense in 2002 increased to $23.1 million, a $2.4 million, or
11.4% increase compared to 2001 results, primarily as a result of increased
personnel, equipment, data processing, and other operating expense. This
followed a $2.2 million or 11.7% increase in 2001 as compared to 2000. Primary
categories impacting the change between 2002 and 2001 are noted in Table 7
below.
TABLE 7: NONINTEREST EXPENSE
Years ended December 31, % Change from prior year
------------------------ ------------------------
2002 2001 2000 2002 2001
---- ---- ---- ---- ----
(dollars in thousands)
Personnel $13,743 $11,923 $ 10,353 15.3% 15.2%
Occupancy $ 2,163 $ 1,834 $ 1,643 17.9% 11.6%
Equipment $ 1,422 $ 1,401 $ 1,404 1.5% (0.2%)
Data processing $ 942 $ 893 $ 844 5.5% 5.8%
Business development
and advertising $ 628 $ 594 $ 628 5.7% (5.4%)
Stationery and supplies $ 611 $ 482 $ 536 26.8% (10.1%)
Director fees $ 266 $ 285 $ 262 (6.7%) 8.8%
FDIC insurance $ 116 $ 110 $ 140 5.5% (21.4%)
Goodwill amortization $ 0 $ 486 $ 486 NM 0.0%
Legal and professional $ 230 $ 256 $ 199 (10.2%) 28.6%
Operation of other real
Estate $ 203 $ 248 $ (22) (18.1%) NM
Other $ 2,807 $ 2,259 $ 2,117 24.3% 6.7%
------- ------- -------- ---- ----
Total noninterest expense $23,131 $20,771 $ 18,590 11.4% 11.7%
======= ======= ======== ==== ====
21
Salaries and employee benefits expense is the largest component of non-interest
expense and totaled $13.7 million in 2002, an increase of $1.8 million, or
15.3%, as compared to 2001 results. The increase in 2002 primarily resulted from
staffing increases, bonus expense, increased benefit costs, and normal salary
increases. Salary and employee benefits expense in 2001 totaled $11.9 million,
an increase of $1.6 million, or 15.2%, as compared to 2000 results. The 2001
increase resulted primarily from staffing increases, increased benefit costs,
and normal salary increases.
Bonus expense in 2002 was $588,000 compared to $405,000 in 2001. The increase
occurred as a result of bonus expense arising from the Company's
Pay-for-Performance Program in 2002. 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 $810,000, an increase of $97,000, or 13.6%, over 2001
levels. Expenses in the same category in 2001 were up $87,000, or 13.9%, over
2000 levels.
Salary expense was $10.0 million in 2002, an increase of $1.3 million, or 15.7%,
as compared to 2001 results. This includes salary expense of $487,000 related to
the Arborview operation. This followed an increase of $916,000, or 11.9% for
2001 results compared to 2000. The number of full-time equivalent employees
increased to 293 in 2002 from 286 in 2001, an increase of 2.4%. Employee levels
in 2001 increased to 286 from 272 in 2000, an increase of 5.1%. 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 2002 showed an increase of $329,000, or 17.9%, as
compared to 2001 for a total of $2.2 million. Additional depreciation expense,
real estate tax expense, and other occupancy costs resulted in 2002. This
increase followed an increase of $191,000, or 11.6%, in 2001. Included in 2002
results were occupancy expenses of $188,000 related to the Arborview operation.
Addition of a facility in the Green Bay market and costs related to the
modernization of various facilities accounted for the balance of the increase in
occupancy expense for 2002.
Equipment expense for 2002 increased slightly, $21,000, or 1.5%, compared to
2001. This followed a decrease of $3,000, or 0.2%, in 2001. The increase in 2002
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 2002 also accounted for an increase in equipment expense in 2002.
Data processing expense in 2002 increased $49,000, or 5.5%, due to an increase
in the volume of transaction activity processed and technology enhancements.
This followed an increase of $49,000, or 5.8%, in 2001 compared to 2000.
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 increased $34,000, or 5.7%,
compared to 2001. More emphasis was placed on business referral and development
calls for 2002 accounting for the balance of the increase. This compared to a
decrease of $34,000, or 5.4% in 2001 compared to 2000.
Supplies expense shows an increase of $129,000, or 26.8%, in 2002 as compared to
2001. This increase occurred as a result of additional branches coming online
during the year 2002. This compared to a decrease of $54,000, or 10.1%, in 2001
as compared to 2000.
Payments to regulatory agencies increased $6,000 to $116,000 for 2002. This
followed a decrease of $30,000 in 2001 compared to 2000 reflecting the net rate
reduction in deposit insurance effective for 2001 on a higher deposit base for
the year. The Bank's risk classification has remained at 1A, rating assigned to
well-capitalized institutions. For additional information regarding the
Company's capital adequacy, see "Capital Resources" below.
Legal and professional expense for 2002 decreased $26,000 or 10.2%. Legal
expenses increased $57,000 during 2001, primarily the result of the completion
of various legal actions stemming from the operations of the former BLBNA.
22
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
$203,000 in 2002. Gains of $24,000 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 $77,000 from two commercial property sales and $12,000 from
three residential property sales were realized in 2002. These were offset by
losses of $71,000 from the sale of five commercial properties and two
residential properties. Various operating expenses, net of income, of other real
estate totaling $245,000 occurred in 2002. Other real estate owned expenses
resulted in net expense of $248,000 in 2001. Gains of $23,000 were realized from
lot sales of Idlewild Valley, Inc., in 2001. 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.
During 2002, the Company adopted Statement of Financial Accounting Standards
("SFAS") No. 142, "Goodwill and Other Intangibles," which requires that goodwill
no longer be amortized but, instead, tested annually for impairment. There was
no impairment of goodwill in 2002. Prior to 2002, goodwill was being amortized
on a straight-line basis over 15 years. Amortization expense was $486,000 for
2001, unchanged from 2000 results.
Other operating expenses in 2002 increased $548,000 or 24.3%, including $129,000
in expenses related to the Arborview operation. Loan and collection expenses
increased $176,000 for 2002 compared to 2001. Additionally other losses
increased $178,000 for 2002. Included in other losses were losses taken on the
disposal of fixed assets amounting to $107,000. Other operating expenses in 2001
increased $142,000 or 6.7% compared to 2000, primarily the result of an increase
of $108,000 related to other outside service expense, such as consulting fees
and payroll service expenses.
The overhead ratio, which is computed by subtracting non-interest income from
non-interest expense and dividing by average total assets was 1.42% for 2002
compared to 1.79% for 2001 and 1.97% for 2000.
Income Taxes
Income tax expense for the Company in 2002 was $2.6 million, an increase of
$484,000 or 23.1% compared to 2001. The higher tax expense in 2002 reflected the
Company's increase in before tax earnings offset by an increase in tax-exempt
interest income. This followed a decrease of $687,000 or 24.7% in 2001 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.
The Company's effective tax rate, income tax expense divided by income before
taxes, was 22.8% in 2002 compared with 21.7% in 2001 and 29.3% in 2000. Of the
22.8% effective tax rate for 2002, the federal effective tax rate was 20.0%
while the Wisconsin State effective tax rate was 2.8%.
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
23
Total loans outstanding grew to $664.3 million at December 31, 2002, a 9.7%
increase from the end of 2001. This follows a 9.0% increase at December 31, 2001
over 2000 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 $516.3 million at year end 2002 and comprised 77.7% of the loan
portfolio compared with 73.5% of the portfolio at the end of 2001. Loans in
these classifications grew $71.3 million or 16.0% during 2002. Loans of this
type are in a broad range of industries. The credit risk related to these types
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:
TABLE 8: LOAN COMPOSITION
(dollars in thousands)
2002 2001 2000
Amount % of Total Amount % of Total Amount % of Total
Amount of loans by type
Real estate-
mortgage
Commercial $351,425 52.9% $288,385 47.6% $251,971 45.4%
1-4 Family residential
First liens 86,161 13.0 96,626 16.0 109,173 19.7
Junior liens 21,789 3.3 24,748 4.1 26,513 4.8
Home equity 25,415 3.8 22,374 3.7 24,464 4.4
Commercial,financial
and agricultural 89,207 13.4 88,649 14.6 83,897 15.1
Real estate-construction 75,688 11.4 67,939 11.2 41,524 7.5
Installment
Credit cards and related
plans 2,057 0.3 2,145 0.4 2,140 0.4
Other 12,859 1.9 14,745 2.4 15,785 2.8
Less: deferred fees, net
of costs 316 0.0 324 0.1 360 0.1
Total loans (net of
unearned income) $664,285 100.0% $605,287 100.0% $555,107 100.0%
======== ======== ========
1999 1998
Amount % of Total Amount % of Total
Amount of loans by type
Real estate-
mortgage
Commercial $201,301 45.0% $178,846 43.9%
1-4 Family residential
First liens 95,255 21.3 101,391 24.9
Junior liens 23,811 5.3 17,122 4.2
24
Home equity 18,963 4.3 18,051 4.4
Commercial,financial
and agricultural 66,159 14.8 67,550 16.6
Real estate-construction 26,535 5.9 9,553 2.3
Installment
Credit cards and related
plans 1,810 0.4 1,809 0.4
Other 13,636 3.1 14,105 3.5
Less: deferred fees, net
Of costs 451 0.1 779 0.2
Total loans (net of
unearned income) $447,019 100.0% $407,648 100.0%
======== ========
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 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, 2002, there existed no industry group concentration
in the Company's loans that exceeded 10% of total loans.
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 2002, residential real estate mortgage loans totaled $133.4
million and comprised 20.1% of the loan portfolio. These loans decreased $10.4
million or 7.2% during 2002. 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 2002, those loans totaled $31.2 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
25
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, 2002,
these loans totaled $72.7 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 2002, the Company sold $104.8 million in
mortgage loans through the secondary programs.
TABLE 9: LOAN MATURITY AND INTEREST RATE SENSITIVITY
Maturity
------------------------------------------------------------------
December 31, 2002 Within 1 Year 1-5 Years After 5 Years Total
------------- --------- ------------- -----
(dollars in thousands)
Loans secured
primarily by real
estate:
Secured by 1 to 4
family residential
properties $ 37,046 $ 55,470 $ 40,849 $133,365
Construction 55,525 19,540 623 75,688
Other real estate 107,261 159,398 84,766 351,425
Loans to farmers 3,106 4,183 1,034 8,323
Commercial and
industrial 21,396 19,965 38,582 79,943
Loans to consumers 3,294 10,338 1,284 14,916
All other loans 895 21 25 941
-------- -------- -------- --------
Total $228,523 $268,915 $167,163 $664,601
======== ======== ======== ========
Interest sensitivity
Fixed rate Variable rate
---------- --------------------
Due after one year $179,552 $256,526
Installment loans to individuals totaled $14.9 million, or 2.2%, of the total
loan portfolio at December 31, 2002 compared to $16.9 million, or 2.8%, at end
of 2001. 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
26
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 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. In addition to this
quarterly management review, all problem review, all problem loans are monitored
and evaluated on a monthly basis by a designated review committee. Depending on
the change in condition, loans may be reassessed concerning allocation of risk,
probable disposition, and potential loss, including changes to the Allowance for
Loan Losses.
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, 2002 was $11.4 million compared
with $8.0 million at the end of 2001. Loans increased 9.7% from December 31,
2001 to December 31, 2002, while the allowance as a percent of total loans
increased due to increased loan loss provision for the year 2002 offset by net
charge-offs for the year. The December 31, 2002 ratio of ALL to outstanding
loans was 1.72% compared with 1.32% at December 31, 2001. Based on management's
analysis of the loan portfolio risk at December 31, 2002, a provision expense of
$5.7 million was recorded for the year ended December 31, 2002, an increase of
$2.8 million compared to the same period in 2001. Net loan charge-offs of $2.3
million occurred in 2002, and the ratio of net charge-offs to average
27
loans for the period ended December 31, 2002 was 0.36% compared to 0.32% at
December 31, 2001. Real estate-mortgage charge-offs represented 73.8% of the
total net charge-offs for the year 2002. Commercial mortgage loan charge-offs
accounted for $1.6 million of the mortgage total and residential mortgage loan
charge-offs totaled $52,000. Commercial loans accounted for $265,000 or 11.6% of
the total net charge-offs for the year 2002. 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,
------------------------
2002 2001 2000 1999 1998
---- ---- ---- ---- ----
(dollars in thousands)
Daily average amount of loans $635,368 $587,995 $505,892 $ 421,541 $333,484
-------- -------- -------- --------- --------
Loans, end of period $664,285 $605,287 $555,107 $ 447,019 $407,648
-------- -------- -------- --------- --------
ALL, at beginning of year $ 7,992 $ 7,006 $ 7,611 $ 11,035 $ 3,881
Loans charged off:
Real estate-mortgage 1,859 1,573 1,584 991 355
Real estate-construction -- -- -- 40 --
Loans to farmers -- -- 24 35 --
Commercial/industrial loans 789 983 343 4,097 376
Consumer loans 407 173 123 199 114
Lease financing/other loans -- -- -- -- --
-------- -------- -------- --------- --------
Total loans charged off $ 3,055 $ 2,729 $ 2,074 $ 5,362 $ 845
Recoveries of loans previously charged off:
Real estate-mortgage 175 332 290 508 148
Real estate-construction -- -- 2 -- --
Loans to farmers -- -- 11 -- --
Commercial/industrial loans 524 428 557 1,433 186
Consumer loans 74 75 64 47 43
Lease financing/other loans -- -- -- -- --
Total loans recovered 773 835 924 1,988 377
-------- -------- -------- --------- --------
Net loans charged off ("NCOs") 2,282 1,894 1,150 3,374 468
-------- -------- ---