UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10–K

For the fiscal year ended December 31, 2004

Commission file number 0-8679

BAYLAKE CORP.

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 þ No o

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 the 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. o

Indicate by check mark whether the registrant is an accelerated filed (as defined in Rule 12b-2 of the Act).
Yes þ No o

As of March 1, 2005, 7,697,777 shares of Common Stock were outstanding. As of June 30, 2004, (the last business day of the Registrant’s most recently completed second fiscal quarter) the aggregate market value of the shares of the Common Stock (based upon the $15.50 reported bid price on that date) held by non-affiliates (excludes a total of 964,854 shares reported as beneficially owned by directors and executive officers – does not constitute an admission as to affiliate status) was approximately $103,670,557.

DOCUMENTS INCORPORATED BY REFERENCE

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2004 FORM 10-K
TABLE OF CONTENTS

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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 also 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 as part of the conduct of our business, 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 (the level of non-performing loans), general changes in economic conditions (including those related to tourism) and changes in interest rates, including the effects of the current increasing interest rate environment on loan demand, collateral value and lending margins, 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. Baylake has elected to become a “financial holding company” under the Gramm-Leach Bliley Act of 1999 (“GLB Act”).

Baylake Bank

The Bank is a Wisconsin state bank originally chartered in 1876. The Bank conducts its community banking business through 27 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 tourism related services. The Bank has seven financial centers in Brown County, which includes the city of Green Bay and has a broader range of service, manufacturing and retail job segments in its market. The balance of the Bank’s financial centers are located in the remaining locations, which include a combination of small cities and smaller communities. 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.

Subsidiaries

In addition to its banking operations, the Bank owns three non-bank subsidiaries: Baylake Investments, Inc., located in Las Vegas, Nevada, which holds and manages an investment and loan portfolio; Baylake City Center LLC (which owns real property in Green Bay and currently renovating a building, a substantial portion which will be used for a branch

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office); 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 26 banks (including the Bank) and ATM processing services to 50 banks. In September 2004, in a tax-free internal reorganization, the Bank merged its wholly-owned subsidiaries, Bank of Sturgeon Bay Building Corporation (which owned Bank’s main office building in Sturgeon Bay, Wisconsin and nearby conference center and underlying real property) and Cornerstone Financial, Inc. (which managed the conference center facilities) into the Bank.

At December 31, 2004, the Company had total assets of $1.0 billion. 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 makes 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.

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 been primarily 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, including a limited concentration in tourism related industries, directly and indirectly. Loans to customers in the restaurant and lodging business totaled $131.4 million at the end of 2004, or 17.6% of our loans at that date. Although competitive and economic pressures exist in this segment, business remains strong in the markets served by the Company. However, any general weakness in the economy of Northeastern Wisconsin (as a result, for example, of a decline in its manufacturing or tourism industries or otherwise) could have a material adverse effect on the business and operations of Baylake. In particular, a decline in the Door County tourism business would not only affect our customers in the restaurant and lodging business, and therefore loans to them as described above, but could also affect loans and other business relationships with persons employed in that industry and real estate values (including collateral values) in the area.

The Company’s total outstanding loans as of December 31, 2004 amounted to approximately $757.3 million, consisting of 56.1% commercial real estate loans, 17.7% residential real estate loans, 10.6% construction and land development real estate loans, 11.1% commercial and industrial loans, 1.8% installment and 2.7% municipal loans.

Investments

The Company maintains a portfolio of 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

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the Company are insured by the Bank Insurance Fund of the Federal Deposit Insurance Corporation (“FDIC”) up to statutory limits. At December 31, 2004, the Company’s total deposits amounted to $844.5 million, including interest bearing deposits of $724.0 million and non-interest bearing deposits of $120.5 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, private banking, financial planning and electronic banking services, including eBanc, an Internet banking product for its customers.

Seasonality

The tourism industry, particularly in the Door County market, substantially affects our business with our customers, particularly those customers in the restaurant and lodging business. The tourist business of Door County is seasonal, with the season beginning in early spring and continuing until late fall. The seasonal nature of the tourist business tends to result in increased demands for loans shortly before and during the tourist season and causes reduced deposits shortly before and during the early part of the tourist season, nonetheless, the financial needs of those involved in the delivery of tourist related services is a year around concern.

The Company’s expansion into other market areas has reduced the concentration level of tourism-related business, but these types of businesses still remain an important element of the core business served by the Company.

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 financial holding company, Baylake is subject to regulation by the Federal Reserve Board under the Bank Holding Company Act of 1956 (“BHCA”). Under the BHCA, Baylake is subject to examination by the Board of Governors of the Federal Reserve System (the “FRB”) and is required to file reports of its operations and such additional information as the FRB may require. Baylake is also subject to supervision and examination by the Wisconsin Department of Financial Institutions under Wisconsin law. Under FRB 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.

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Any loans by a bank holding company to a subsidiary bank are subordinate in right of payment to deposits and to certain other indebtedness of such subsidiary bank. In the event of a bank holding company’s bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of a subsidiary bank will be assumed by the bankruptcy trustee and entitled to a priority of payment.

With certain limited exceptions, the BHCA prohibits bank holding companies from acquiring direct or indirect ownership or control of voting shares or assets of any company other than a bank, unless the company involved is engaged solely in one or more activities which the FRB has determined to be financial in nature, and the extent to which state laws will apply to managing or controlling activities of banks as to be incidental to these operations.

The FRB 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.

The FRB has issued a policy statement on the payment of cash dividends by bank holding companies, which expresses the FRB’s view that a bank holding company should pay cash dividends only to the extent that the Company’s net income for the past year is sufficient to cover both the cash dividend and a rate of retention consistent with the Company’s needs. The FRB also indicated that it would be inappropriate for a company experiencing serious financial problems to borrow to pay dividends. In addition, compliance with capital adequacy guidelines at both the Bank and the Company could affect the Company’s ability to pay dividends, if the Company’s capital levels were to decrease.

The Sarbanes-Oxley Act of 2002 (“SOA”), addresses, among other issues, director and officer responsibilities for proper corporate governance of publicly traded companies, including the establishment of audit committees, certification of financial statements, auditor independence and accounting standards, executive compensation, insider loans, whistleblower protection, and enhanced and timely disclosure of corporate information. In general, SOA is intended to allow stockholders to monitor more effectively the performance of publicly traded companies and their management. The Securities and Exchange Commission has enacted rules to implement various provisions of SOA which affect the Company as a publicly-held entity. The federal banking regulators also have adopted generally similar requirements concerning the certification of financial statements. Among these requirements is the identification of a company-wide code of conduct of the Bank. The SOA also imposes additional corporate governance requirements on publicly-held companies, particularly relating to the functioning of its audit committee. Beginning the fiscal year ended December 31, 2004, the Company has become subject to the requirement of annual attestation and review of its internal control on financial reporting. The Company is taking advantage of the delay granted by the SEC which permits the deferral for 45 days of filing the related reports. See Item 9A.

Baylake Bank. As a FRB member Wisconsin-chartered 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 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 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. 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 and the FRB have published guidelines establishing operational and managerial standards to promote the safety and soundness of federally insured depository institutions. The guidelines establish standards for internal

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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 state that the agencies expect to require a compliance plan from an institution whose failure to meet one or more of the standards is of such severity that it could threaten the safe and sound operation of the institution. Failure to submit an acceptable compliance plan, or failure to adhere to a compliance plan that has been accepted by the appropriate regulator, would constitute grounds for further enforcement action.

The Bank’s business includes making a variety of types of loans to individuals. In making these loans, the Bank is subject to state usury and regulatory laws and to various federal statutes, such as the Equal Credit Opportunity Act, the Fair Credit Reporting Act, the Truth in Lending Act, the Real Estate Settlement Procedures Act and the Home Mortgage Disclosure Act, and the regulations promulgated thereunder, which prohibit discrimination, specify disclosures to be made to borrowers regarding credit and settlement costs and regulate the mortgage loan servicing activities of the Bank, including the maintenance and operation of escrow accounts and the transfer of mortgage loan servicing. The Riegle Act imposed new escrow requirements on depository and non-depository mortgage lenders and services under the National Flood Insurance Program. In receiving deposits, the Bank is subject to extensive regulation under state and federal law and regulations, including the Truth in Savings Act, the Expedited Funds Availability Act, the Bank Secrecy Act, the Electronic Funds Transfer Act, and the Federal Deposit Insurance Act. Violation of these laws could result in the imposition of significant damages and fines upon the Bank, its directors and officers.

Under the Community Reinvestment Act, or CRA, and the implementing regulations, the Bank has a continuing and 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 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.”

Under the Graham Leach Bliley (“GLB”) Act, all financial institutions, including the Company and the Bank, are required to adopt privacy policies, restrict the sharing of nonpublic customer data with nonaffiliated parties at the customer’s request, and establish procedures and practices to protect customer data from unauthorized access. The Company has developed such policies and procedures for itself and the Bank, and believes it is in compliance with all privacy provisions of the GLB Act.

Under Title III of the USA PATRIOT Act (“PATRIOT”), also known as the International Money Laundering Abatement and Anti-Terrorism Financing Act of 2001, all financial institutions, including the Company and Bank, are required to take certain measures to identify customers, prevent money laundering, monitor certain customer transactions and report suspicious activity to U.S. law enforcement agencies, and scrutinize or prohibit altogether certain transactions of special concern. Financial institutions are also required to respond to requests for information from federal banking regulatory agencies and law enforcement agencies concerning their customers and their transactions. Information sharing among financial institutions concerning terrorist or money laundering activities is encouraged by an exemption provided from the privacy provisions of GLB Act and other laws. The effectiveness of a financial institution in

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combating money laundering activities is a factor to be considered in any application submitted by the financial institution under the Bank Merger Act, which applies to Bank, or the BHC Act, which applies to Company. The Company has in place a Bank Secrecy Act compliance program, and it engages in very few transactions of any kind with foreign financial institutions or foreign persons.

The deposits of Baylake Bank are currently insured to the maximum provided by law through the FDIC. All insured banks are required to pay semi-annual deposit insurance premium assessments to the FDIC. The FDICIA included provisions to reform the Federal Deposit Insurance System, including the implementation of risk-based deposit insurance premiums. The FDICIA also permits the FDIC to make special assessments on insured depository institutions in amounts determined by the FDIC to be necessary to give its adequate assessment income to repay amounts borrowed from the U.S. Treasury and other sources, or for any other purpose the FDIC deems necessary. The FDIC has implemented a risk-based insurance premium system under which banks are assessed insurance premiums based on the level of risk they present to the FDIC. Banks with higher levels of capital and lower degrees of supervisory concern are assessed lower premiums than banks with lower levels of capital or a higher degree of supervisory concern.

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.

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.

In addition to the matters discussed above, the Bank is subject to numerous other federal and state laws and regulations which affect its business and operations. Among other things, these laws and regulations govern transactions with affiliates, prohibitions against tying arrangements, consumer lending, customer privacy, fair lending standards and other safety and soundness standards. Financial institution regulatory agencies are given substantial powers to take corrective actions, which may include restrictions on methods of doing business and the prohibition of certain actions.

Employees

At December 31, 2004, Baylake and its subsidiaries had 308 full-time equivalent employees. Baylake considers the relationship with its employees to be good.

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ITEM 2. PROPERTIES

Baylake does not directly own any real property of any kind. However, the Bank owns twenty-five branches. The Bank leases its remaining two offices from third parties.

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. In addition, the Bank owns other real property that, when considered in the aggregate, is not material to its financial position.

At December 31, 2004, the properties and equipment of the Company had an aggregate net book value of approximately $21.6 million.

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 2004.

PART II

ITEM 5. MARKET FOR THE REGISTRANT’S COMMON EQUITY AND RELATED SECURITY HOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

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, prices for Baylake Common Stock are 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 as reported from the OTC Bulletin Board. 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.

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Baylake had approximately 1,793 shareholders of record at December 31, 2004. The number of shareholders does not reflect persons or entities that hold their stock in nominee or “street” name through various brokerage firms.

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. 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.

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 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. No shares were repurchased by Baylake in the fourth quarter of 2004.

ITEM 6. SELECTED FINANCIAL DATA

BAYLAKE CORP.
FIVE YEAR SELECTED CONSOLIDATED FINANCIAL DATA

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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 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.

Critical Accounting Policies

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

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

The allowance for loan losses consists of an allocated component and an unallocated component. The components of the allowance represent an estimation pursuant to either Statement of Financial Accounting Standards No. (“SFAS”) 5, Accounting for Contingencies, or SFAS 114, Accounting by Creditors for Impairment of a Loan. The allocated component of the allowance for loan losses reflects expected losses from analyses developed through specific credit allocations for individual loans and historical loss experience for each loan category. The specific credit allocations are based on regular analyses of all loans over a fixed-dollar amount where the internal credit rating is at or below a predetermined classification. These analyses involve a high degree of judgment in estimating the amount of loss associated with specific loans, including estimating the amount and timing of future cash flows and collateral values. The Company’s historical loss experience is updated quarterly. The allocated component of the allowance for loan losses also includes consideration of concentrations and changes in portfolio mix and volume and other qualitative factors.

There are many factors affecting the allowance for loan losses; some are quantitative while others require qualitative judgment. The process for determining the allowance (which management believes adequately considers all of the potential factors which might possibly result in credit losses) includes subjective elements and, therefore, may be susceptible to significant change. To the extent actual outcomes differs from management estimates, additional provision for credit losses could be required that could adversely affect the Company’s earnings or financial position in future periods.

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

Goodwill: The Company has goodwill assets on the books as a result of two prior acquisitions. Goodwill is tested annually for impairment. Those tests inherently involve management’s judgment as to factors such as an estimation

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of the fair value of a reporting unit; screening for potential impairment and measuring the amount of the impairment. There was no impairment of goodwill in 2004, 2003, or 2002. In the event of goodwill impairment, that amount would be charged to earnings in the period in which the impairment is determined.

Income tax accounting: The assessment of tax assets and liabilities involves the use of estimates, assumptions, interpretations, and judgments concerning certain accounting pronouncements and federal and state tax codes. There can be no assurance that future events, such as court decisions or positions of federal and state taxing authorities, will not differ from management’s current assessment, the impact of which could be significant to the consolidated results of the Company’s operations and reported earnings. The Company believes that the tax assets and liabilities are adequate and properly recorded in the consolidated financial statements. See Note 15-“Income Tax Expense” for further information. For a discussion of certain Wisconsin income tax developments that could affect the Company, see the discussion in the “Income Statement Analysis-2004 compared to 2003-Income Taxes.”

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

The Department sent letters in late July 2004 to financial institutions in Wisconsin, whether or not they are undergoing an audit, reporting on settlements involving 17 banks and their out-of-state investment subsidiaries. The letter provided a summary of currently available settlement