BAYLAKE CORP - FORM 10-Q

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Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549





	FORM 10-Q



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

For the quarterly period ended March 31, 2011

OR

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

For the transition period from _________________to ________________

Commission file number 001-16339



BAYLAKE CORP.
(Exact name of registrant as specified in its charter)


Wisconsin	39-1268055
(State or other jurisdiction of	(I.R.S. Employer Identification No.)
incorporation or organization)

217 North Fourth Avenue, Sturgeon Bay, WI	54235
(Address of principal executive offices)	(Zip Code)

(920) 743-5551 (Registrant’s telephone number, including area code)

None Former name, former address and former fiscal year, if changed since last report

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

Yes x No o

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

Yes o No o

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

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

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

Yes o No x

Number of outstanding shares of common stock, $5.00 par value per share, as of May 6, 2011: 7,911,539 shares

BAYLAKE CORP. AND SUBSIDIARIES

INDEX


		PAGE NO.
PART I - FINANCIAL INFORMATION

ITEM 1 -	FINANCIAL STATEMENTS	3

ITEM 2 -	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	28

ITEM 3 -	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	45

ITEM 4 -	CONTROLS AND PROCEDURES	46

PART II - OTHER INFORMATION

ITEM 1 -	LEGAL PROCEEDINGS	46

ITEM 1A -	RISK FACTORS	46

ITEM 2 -	UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	46

ITEM 3 -	DEFAULTS UPON SENIOR SECURITIES	46

ITEM 5 -	OTHER INFORMATION	46

ITEM 6 -	EXHIBITS	47

Table of Contents

PART I - FINANCIAL INFORMATION
Item 1. Financial Statements

BAYLAKE CORP.
CONSOLIDATED BALANCE SHEETS
March 31, 2011 (Unaudited) and December 31, 2010
(Dollar amounts in thousands)


	March 31, 2011			December 31, 2010
ASSETS
Cash and due from financial institutions	$	46,441		$	54,555
Federal funds sold		6			1
Cash and cash equivalents		46,447			54,556
Securities available for sale		263,864			266,760
Loans held for sale		—			6,400
Loans, net of allowance of $12,098 and $11,502 at March 31, 2011 and December 31, 2010, respectively		608,630			618,389
Cash value of life insurance		22,904			24,472
Premises and equipment, net		23,429			23,604
Federal Home Loan Bank stock		6,792			6,792
Foreclosed properties, net		13,725			15,952
Goodwill		6,641			6,641
Deferred income taxes		8,689			9,202
Accrued interest receivable		4,593			4,165
Other assets		13,356			15,520
Total Assets	$	1,019,070		$	1,052,453

LIABILITIES AND STOCKHOLDERS’ EQUITY
Deposits
Non-interest-bearing	$	85,558		$	84,552
Interest-bearing		738,343			768,014
Total Deposits		823,901			852,566
Federal Home Loan Bank advances		55,000			70,000
Repurchase agreements		27,021			19,236
Subordinated debentures		16,100			16,100
Convertible promissory notes		9,450			9,450
Accrued expenses and other liabilities		8,631			8,034
Total Liabilities		940,103			975,386

Common stock, $5 par value, authorized 50,000,000 shares; Issued-8,132,552 shares at March 31, 2011 and December 31, 2010; Outstanding-7,911,539 shares at March 31, 2011 and December 31, 2010		40,662			40,662
Additional paid-in capital		11,989			11,980
Retained earnings		27,616			26,965
Treasury stock (221,013 shares at March 31, 2011 and December 31, 2010)		(3,549	)		(3,549	)
Accumulated other comprehensive income		2,249			1,009
Total Stockholders’ Equity		78,967			77,067
Total Liabilities and Stockholders’ Equity	$	1,019,070		$	1,052,453

See accompanying Notes to Unaudited Consolidated Financial Statements.

Table of Contents

BAYLAKE CORP.
CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
Three months ended March 31, 2011 and 2010
(Dollar amounts in thousands, except per share data)


	Three months ended March 31,
	2011			2010
INTEREST AND DIVIDEND INCOME
Loans, including fees	$	8,482		$	9,084
Taxable securities		1,751			1,864
Tax exempt securities		380			367
Federal funds sold		21			32
Total Interest and Dividend Income		10,634			11,347
INTEREST EXPENSE
Deposits		1,956			2,829
Repurchase agreements		22			29
Federal Home Loan Bank advances and other debt		314			556
Subordinated debentures		67			64
Convertible promissory notes		245			147
Total Interest Expense		2,604			3,625
Net interest income		8,030			7,722
Provision for loan losses		1,300			1,050
Net interest income after provision for loan losses		6,730			6,672
NONINTEREST INCOME
Fees from fiduciary activities		283			216
Fees from loan servicing		190			157
Fees for other services to customers		1,251			1,198
Net gain on sale of loans		386			168
Net gain/(loss) in mortgage servicing rights		(30	)		6
Net gain on sale of securities		125			—
Net gain on sale of premises and equipment		8			—
Increase in cash surrender value of life insurance		130			83
Income in equity of UFS subsidiary		231			161
Other income		40			22
Total Noninterest Income		2,614			2,011
NONINTEREST EXPENSE
Salaries and employee benefits		4,556			4,262
Occupancy expense		605			611
Equipment expense		280			326
Data processing and courier		208			225
FDIC insurance expense		731			461
Operation of other real estate		1,038			425
Provision for impairment of standby letters of credit		7			87
Loan and collection expense		168			151
Other outside services		165			183
Other operating expenses		956			988
Total Noninterest Expense		8,714			7,719
Income before provision for income taxes		630			964
Provision for/(benefit from) income taxes		(21	)		147
Net Income	$	651		$	817

Basic earnings per share	$	0.08		$	0.10
Diluted earnings per share	$	0.08		$	0.10

See accompanying Notes to Unaudited Consolidated Financial Statements.

Table of Contents

BAYLAKE CORP.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY AND COMPREHENSIVE
INCOME (Unaudited)
Three months ended March 31, 2011
(Dollar amounts in thousands, except share data)


												Accumulated
					Additional							Other
	Common Stock				Paid-in		Retained		Treasury			Comprehensive			Stockholders’
	Shares		Amount		Capital		Earnings		Stock			Income			Equity

Balance, January 1, 2011		7,911,539	$	40,662	$	11,980	$	26,965	$	(3,549	)	$	1,009		$	77,067
Net income for the period		—		—		—		651		—			—			651
Net changes in unrealized gain on securities available for sale		—		—		—		—		—			2,176			2,176
Reclassification adjustment for net gains realized in income													(125	)		(125	)
Tax effect													(811	)		(811	)
Total comprehensive income																1,240
Stock compensation expense						9										9

Balance, March 31, 2011		7,911,539	$	40,662	$	11,989	$	27,616	$	(3,549	)	$	2,249		$	78,967

See accompanying Notes to Unaudited Consolidated Financial Statements.

Table of Contents

BAYLAKE CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
Three months ended March 31, 2011 and 2010
(Dollar amounts in thousands)


	2011			2010

CASH FLOWS FROM OPERATING ACTIVITIES
Reconciliation of net income to net cash provided by operating activities:
Net Income	$	651		$	817
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		325			332
Amortization of debt issuance costs		9			8
Amortization of core deposit intangible		—			13
Provision for losses on loans		1,300			1,050
Provision for impairment of letters of credit		7			51
Net amortization of premium/discount on securities		745			293
Increase in cash surrender value of life insurance		(130	)		(83	)
Net realized gain on sale of securities		(125	)		—
Net gain on sale of loans		(386	)		(168	)
Proceeds from sale of loans held for sale		31,918			13,153
Origination of loans held for sale		(25,189	)		(10,880	)
Net change in valuation of mortgage servicing rights		33			(6	)
Provision for valuation allowance on foreclosed properties		682			180
Net gain on sale of premises and equipment		(8	)		—
Net gain on disposals of foreclosed properties		(83	)		(17	)
Provision/(benefit) for deferred tax expense		(297	)		49
Stock option compensation expense recognized		8			—
Income in equity of UFS subsidiary		(231	)		(161	)
Changes in assets and liabilities:
Accrued interest receivable and other assets		3,493			2,349
Payment to reduce LOC valuation allowance		—			(2,980	)
Accrued expenses and other liabilities		590			719
Net cash flows provided by operating activities		13,312			4,719
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from sale of securities available for sale		16,226			—
Principal payments on securities available for sale		12,924			39,707
Purchase of securities available for sale		(24,823	)		(63,953	)
Proceeds from sale of foreclosed properties		2,872			314
Proceeds from sale of premises and equipment		11			—
Loan originations and payments, net		7,215			6,699
Additions to premises and equipment		(153	)		(336	)
Proceeds from life insurance surrender		1,698			—
Rabbi Trust initial funding		(1,626	)		—
Net change in federal funds sold		(5	)		—
Dividend from UFS Subsidiary		115			—
Net cash provided by (used in) investing activities		14,454			(17,569	)

See accompanying Notes to Unaudited Consolidated Financial Statements.

Table of Contents

BAYLAKE CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
Three months ended March 31, 2011 and 2010
(Dollar amounts in thousands)


	2011			2010
CASH FLOWS FROM FINANCING ACTIVITIES
Net change in deposits	$	(28,665	)	$	(18,235	)
Net change in federal funds purchased and repurchase agreements		7,785			3,541
Repayments on Federal Home Loan Bank advances		(15,000	)		(10,000	)
Proceeds from issuance of convertible promissory notes		—			1,300
Net cash used in financing activities		(35,880	)		(23,394	)
Net change in cash and cash equivalents		(8,114	)		(36,244	)

Beginning cash and cash equivalents		54,555			86,526
Ending cash and cash equivalents	$	46,441		$	50,282
Supplemental cash flow information:
Interest paid	$	2,312		$	3,597
Income taxes refunded		3,046			2,415
Supplemental noncash disclosure:
Transfers from loans to foreclosed properties	$	1,244		$	1,393
Mortgage servicing rights resulting from sale of loans		57			12

See accompanying Notes to Unaudited Consolidated Financial Statements.

Table of Contents

BAYLAKE CORP.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2011


1.	The accompanying interim consolidated financial statements should be read in conjunction with our 2010 Annual Report on Form 10-K. The accompanying consolidated financial statements are unaudited. These interim consolidated financial statements are prepared in accordance with the requirements of Form 10-Q, and accordingly do not include all of the information and footnotes required by U.S. generally accepted accounting principles (“GAAP”) for complete financial statements. In the opinion of management, the unaudited consolidated financial information included in this report reflects all adjustments, consisting of normal recurring accruals of operations for the three month period ending March 31, 2011 and 2010. The consolidated results of operations for the three months ended March 31, 2011 are not necessarily indicative of results to be expected for the entire year. We have evaluated all subsequent events through May 6, 2011, the date the interim consolidated financial statements were issued.

2.	Use of Estimates

	To prepare consolidated financial statements in conformity with GAAP, our management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the consolidated financial statements and the disclosures provided, and actual results could differ. The allowance for loan losses, foreclosed properties, mortgage servicing rights, income tax expense and fair values of financial instruments are particularly subject to change.

3.	Earnings Per Share

	Diluted earnings per share, which reflects the potential dilution that could occur if outstanding stock options were exercised and stock awards were fully vested and resulted in the issuance of common stock that then shared in our earnings, is computed by dividing net income by the weighted average number of common shares outstanding and common stock equivalents. The following table shows the computation of the basic and diluted earnings per share:

EARNINGS PER SHARE
(Dollar amounts in thousands, excluding per share data)


	Three months ended March 31,
	2011			2010
(Numerator):
Net income	$	651		$	817
(Denominator):
Weighted average number of common shares outstanding-basic		7,911,539			7,911,539
Dilutive effect of stock options		––	⁽¹⁾		––	⁽¹⁾
Dilutive effect of convertible promissory notes		––	⁽²⁾		––	⁽²⁾
Dilutive effect of restricted stock		5,845			––
Weighted average number of common shares outstanding-diluted		7,917,384			7,911,539
Basic Earnings Per Share	$	0.08		$	0.10
Diluted Earnings Per Share	$	0.08		$	0.10


	(1)	At March 31, 2011 and 2010, there were 112,600 and 49,628 outstanding stock options, respectively, which are not included in the computation of diluted earnings per share because they are considered anti-dilutive.

	(2)	At March 31, 2011, we had $9.45 million of outstanding Convertible Promissory Notes (the “Convertible Notes”). The Convertible Notes are convertible into shares of our common stock at a conversion ratio of one share of common stock for each $5.00 in aggregate principal amount held on the record date of the conversion subject to certain adjustments as described in the Convertible Notes. On October 1, 2014, one-half of the original principal amount of the Convertible Notes is mandatorily convertible at the conversion ratio if conversion has not occurred. The mandatorily convertible principal of the Convertible Notes represents 945,000 shares, which are not included in the computation of diluted earnings per share because they are considered anti-dilutive. The remaining half of the principal amount of Convertible Notes is convertible into an additional 945,000 common shares at the discretion of the respective holders. These shares have not been included because of their anti-dilutive effect, if converted.

Table of Contents

BAYLAKE CORP.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2011


4.	Recent Accounting Pronouncements

	In April 2011, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (“ASU”) No. 2011-02, Receivables (“Topic 310”): A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring. The ASU will improve financial reporting by creating greater consistency in the way GAAP is applied for various types of debt restructurings. The ASU clarifies which loan modifications constitute troubled debt restructurings. It is intended to assist creditors in determining whether a modification of the terms of a receivable meets the criteria to be considered a troubled debt restructuring, both for purposes of recording an impairment loss and for disclosure of troubled debt restructurings. The new guidance is effective for interim and annual periods beginning on or after June 15, 2011, and applies retrospectively to restructurings occurring on or after the beginning of the fiscal year of adoption. The provisions of this guidance are not expected to have a significant impact on our consolidated financial condition, results of operation or liquidity.

	In May 2011, the FASB issued ASU No. 2011-03, Transfers and Servicing (Topic 860): Reconsideration of Effective Control for Repurchase Agreements. The ASU is intended to improve financial reporting of repurchase agreements (“repos”) and other agreements that both entitle and obligate a transferor to repurchase or redeem financial assets before their maturity. The amendments to the Codification in this ASU are intended to improve the accounting for these transactions by removing from the assessment of effective control the criterion requiring the transferor to have the ability to repurchase or redeem the financial assets. The guidance in the ASU is effective for the first interim or annual period beginning on or after December 15, 2011. The provisions of this guidance are not expected to have a significant impact on the Company’s consolidated financial condition, results of operation or liquidity.

5.	Fair Value

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


		Level 1:		Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

		Level 2:		Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

		Level 3:		Significant unobservable inputs that reflect a reporting entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

The fair value of securities available for sale is determined by obtaining quoted prices on nationally recognized securities exchanges (Level 1 inputs) or matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities (Level 2 inputs).

Table of Contents

BAYLAKE CORP.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2011


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

	The fair value of foreclosed properties is determined using a variety of market information including but not limited to appraisals, professional market assessments and real estate tax assessment information (Level 2 inputs).

	The fair value of impaired loans is determined based on either the present value of expected future cash flows discounted at the loan’s effective interest rate, the market price of the loan or, if the loan is collateral dependent, the fair value of the underlying collateral less the estimated costs to sell. Impaired loans do not require an allowance if the fair value of the expected repayments or collateral exceed the investments in such loans. Impaired loans are carried at the lower of amortized cost or fair value (Level 3 inputs).

ASSETS MEASURED ON A RECURRING BASIS
(Dollar amounts in thousands)

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


	March 31, 2011		Quoted Prices in Active Markets For Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
Securities available for sale:
U.S. government-sponsored agency securities	$	28,111	$	—	$	28,111	$	—
Mortgage-backed securities		161,493		—		161,493		—
Asset-backed securities		5,880		—		5,880		—
Obligations of states and political subdivisions		53,158		—		53,158		—
Private placement and corporate bonds		12,474		—		12,474		—
Other securities		2,748		—		2,748		—
Total securities available for sale		263,864		—		263,864		—
Mortgage servicing rights		770		—		770		—
Foreclosed properties		13,725		—		13,725		—
Total	$	278,359	$	—	$	278,359	$	—

Table of Contents

BAYLAKE CORP.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2011


	December 31, 2010		Quoted Prices in Active Markets For Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
Securities available for sale:
U.S. government-sponsored agency securities	$	33,753	$	—	$	33,753	$	—
Mortgage-backed securities		159,646		—		159,646		—
Asset-backed securities		5,536				5,536
Obligations of states and political subdivisions		52,853		—		52,853		—
Private placement and corporate bonds		12,537		—		12,537		—
Other securities		2,435		—		2,435		—
Total securities available for sale		266,760		—		266,760		—
Mortgage servicing rights		746		—		746		—
Foreclosed properties		15,952		—		15,952		—
Total	$	283,458	$	—	$	283,458	$	—

ASSETS MEASURED ON A NON-RECURRING BASIS
(Dollar amounts in thousands)

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


	March 31, 2011		Quoted Prices in Active Markets For Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
Impaired loans	$	7,274	$	—	$	—	$	7,274


	December 31, 2010		Quoted Prices in Active Markets For Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
Impaired loans	$	7,676	$	—	$	—	$	7,676

Required Financial Disclosures about Fair Value of Financial Instruments

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

Table of Contents

BAYLAKE CORP.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2011


	(Dollar amounts in thousands)
	March 31, 2011				December 31, 2010
	Carrying Amount		Fair Value		Carrying Amount		Fair Value
FINANCIAL ASSETS
Cash and cash equivalents	$	46,441	$	46,441	$	54,555	$	54,555
Federal funds sold		6		6		1		1
Securities available for sale		263,864		263,864		266,760		266,760
Loans held for sale		—		—		6,400		6,488
Loans, net		608,630		608,981		618,389		622,273
Cash value of life insurance		22,904		22,904		24,472		24,472
Federal Home Loan Bank stock		6,792		6,792		6,792		6,792
Accrued interest receivable		4,593		4,593		4,165		4,165
FINANCIAL LIABILITIES
Deposits	$	823,901	$	825,293	$	852,566	$	854,598
Repurchase agreements		27,021		27,021		19,236		19,236
Federal Home Loan Bank advances		55,000		55,778		70,000		71,525
Subordinated debentures		16,100		16,100		16,100		16,100
Convertible promissory notes		9,450		9,640		9,450		9,224
Accrued interest payable		1,531		1,531		1,239		1,239

Off-balance sheet credit related items:
Letters of credit	$	744	$	744	$	737	$	737

The methods and assumptions used to estimate fair value are described as follows:

(a) Cash and Cash Equivalents

Due to their short-term nature, the carrying amount of cash and cash equivalents approximates fair value.

(b) Securities Available for Sale

Fair values for securities available for sale are based on market prices or other inputs that are observable or can be corroborated by observable market data.

(c) Loans Held for Sale

The fair value of loans held for sale is based on actual market quotes from third party investors.

(d) Loans, net

For variable-rate loans that reprice frequently, fair values are based on carrying value. Fair values for other loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms. Impaired loans are valued at the lower of cost or fair value. Fair value is measured based on the value of the underlying collateral securing those loans less the cost of sale. This evaluation may include obtaining supplemental market data and/or routine site visits to offer support to the valuation process.

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BAYLAKE CORP.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2011

(e) Cash Value of Life Insurance

The fair value of life insurance approximates the carrying amount, because upon liquidation of these investments, we would receive the cash surrender value, which equals the carrying amount.

(f) Federal Home Loan Bank Stock

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

(g) Accrued Interest Receivable

The carrying amount of accrued interest receivable approximates fair value.

(h) Deposits

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

(i) Repurchase Agreements

The carrying amount of repurchase agreements approximates fair value.

(j) Federal Home Loan Bank Advances

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

(k) Subordinated Debentures

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

(l) Convertible Promissory Notes

The fair value of fixed rate convertible promissory notes is based on discounted cash flows using current market interest rates.

(m) Accrued Interest Payable

The carrying amount of accrued interest payable approximates fair value.

(n) Off Balance Sheet Credit Related Items-Letters of Credit

The carrying amount of the off balance sheet letters of credit approximates fair value based on management’s evaluation of the factors affecting the letters of credit.

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BAYLAKE CORP.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2011


6.	Investments

INVESTMENT SECURITY ANALYSIS
(Dollar amounts in thousands)

The fair value of securities available for sale and the related unrealized gains and losses as of March 31, 2011 and December 31, 2010 are as follows:


	March 31, 2011
	Fair Value		Gross Unrealized Gains		Gross Unrealized Losses
U.S. government-sponsored agency securities	$	28,111	$	137	$	(33	)
Obligations of states and political subdivisions		53,158		1,342		(112	)
Mortgage-backed securities		161,493		2,602		(444	)
Asset-backed securities		5,880		170		(379	)
Private placement and corporate bonds		12,474		435		—
Other securities		2,748		—		—
Totals	$	263,864	$	4,686	$	(968	)


	December 31, 2010
	Fair Value		Gross Unrealized Gains		Gross Unrealized Losses
U.S. government-sponsored agency securities	$	33,753	$	80	$	(35	)
Obligations of states and political subdivisions		52,853		863		(284	)
Mortgage-backed securities		159,646		2,074		(866	)
Asset-backed securities		5,536		175		(841	)
Private placement and corporate bonds		12,537		534		(33	)
Other securities		2,435		—		—
Totals	$	266,760	$	3,726	$	(2,059	)

Securities with unrealized losses at March 31, 2011 and December 31, 2010, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, are as follows (dollar amounts in thousands):


	March 31, 2011
	Less than 12 Months					12 Months or More					Total
Description of Securities	Fair Value		Unrealized Loss			Fair Value		Unrealized Loss			Fair Value		Unrealized Loss
U.S. government-sponsored agency securities	$	4,962	$	(33	)	$	—	$	—		$	4,962	$	(33	)
Obligations of states and political subdivisions		7,886		(89	)		227		(23	)		8,113		(112	)
Mortgage-backed securities		42,884		(444	)		—		—			42,884		(444	)
Asset-backed securities		—		—			4,252		(379	)		4,252		(379	)
Total temporarily impaired	$	55,732	$	(566	)	$	4,479	$	(402	)	$	60,211	$	(968	)

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BAYLAKE CORP.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2011


	December 31, 2010
	Less than 12 Months					12 Months or More					Total
Description of Securities	Fair Value		Unrealized Loss			Fair Value		Unrealized Loss			Fair Value		Unrealized Loss
U.S. government-sponsored agency securities	$	4,960	$	(35	)	$	—	$	—		$	4,960	$	(35	)
Obligations of states and political subdivisions		15,177		(284	)		—		—			15,177		(284	)
Mortgage-backed securities		53,582		(838	)		5,500		(28	)		59,082		(866	)
Asset-backed securities		3,889		(841	)		—		—			3,889		(841	)
Private placement and corporate bonds		—		—			4,967		(33	)		4,967		(33	)
Total temporarily impaired	$	77,608	$	(1,998	)	$	10,467	$	(61	)	$	88,075	$	(2,059	)

At March 31, 2011, the obligations of state and political subdivisions category with continuous unrealized losses for twelve months or more comprises one security. The asset-backed securities category with continuous unrealized losses for twelve months or more comprises two securities.

At December 31, 2010, the mortgage-backed securities category with continuous unrealized losses for twelve months or more and the private placement and corporate bond category with continuous unrealized losses for twelve months or more each comprise one security.

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

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BAYLAKE CORP.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2011


7.	Loans

	Loans held for investment are summarized as follows (dollar amounts in thousands):


	March 31, 2011			December 31, 2010

Real Estate-Commercial	$	330,226		$	344,263
Real Estate-Residential		130,322			129,449
Real Estate-Construction		53,298			55,467
Commercial Loans		81,688			73,928
Consumer Loans		9,576			10,225
Obligations of States and Political Subdivisions		15,960			16,892
Gross Loans		621,070			630,224
Less: Deferred Origination Fees, net of costs		(342	)		(333	)
Less: Allowance for Loan Losses		(12,098	)		(11,502	)
Total	$	608,630		$	618,389

Loans having carrying value of $90,260 and $86,744 are pledged as collateral for borrowings from the Federal Home Loan Bank at March 31, 2011 and December 31, 2010, respectively.

A summary of the activity in the allowance for loan losses by class of loan is as follows (dollar amounts in thousands):


	Construction Loans			Real Estate- Mortgage			Real Estate- Commercial			Commercial			Consumer			Municipal		Not Specifically Allocated			Total

Allowance for Loan Losses:

Balance January 1, 2011	$	1,424		$	2,103		$	6,355		$	1,189		$	391		$	—	$	40		$	11,502


Charge-offs		(62	)		(393	)		(222	)		(21	)		(157	)		—		—			(855	)

Recoveries		50			2			71			15			13			—		—			151

Provision		(36	)		678			(23	)		(161	)		142			—		700			1,300

Balance March 31, 2011	$	1,376		$	2,390		$	6,181		$	1,022		$	389		$	—	$	740		$	12,098
Ending balance individually evaluated for impairment	$	116		$	771		$	945		$	199		$	154		$	—	$	—		$	2,185
Ending balance collectively evaluated for impairment	$	1,260		$	1,619		$	5,236		$	823		$	235		$	—	$	740		$	9,913

Loans:
Balance March 31, 2011	$	53,298		$	130,322		$	329,908		$	81,664		$	9,576		$	15,960	$	—		$	620,728

ALL		1,376			2,390			6,181			1,022			389			—		740			12,098
Recorded investment	$	51,922		$	127,932		$	323,727		$	80,642		$	9,187		$	15,960	$	(740	)	$	608,630
Ending balance individually evaluated for impairment	$	118		$	2,196		$	4,472		$	474		$	15		$	—	$	—		$	7,275
Ending balance collectively evaluated for impairment	$	51,804		$	125,736		$	319,255		$	80,168		$	9,172		$	15,960	$	(740	)	$	601,355

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BAYLAKE CORP.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2011


	Construction Loans			Real Estate- Mortgage			Real Estate- Commercial			Commercial			Consumer			Municipal		Not Specifically Allocated			Total

Allowance for Loan Losses:

Balance January 1, 2010	$	1,184		$	1,452		$	4,558		$	1,497		$	375		$	—	$	534		$	9,600

Charge-offs		(1,837	)		(156	)		(5,443	)		(1,030	)		(123	)		—		—			(8,589	)

Recoveries		5			206			1,316			1,553			61			—		—			3,141

Provision		2,072			601			5,924			(831	)		78			—		(494	)		7,350

Balance, December 31, 2010	$	1,424		$	2,103		$	6,355		$	1,189		$	391		$	—	$	40		$	11,502
Ending balance individually evaluated for impairment	$	168		$	717		$	1,236		$	528		$	189		$	—	$	—		$	2,838
Ending balance collectively evaluated for impairment	$	1,256		$	1,386		$	5,119		$	661		$	202		$	—	$	40		$	8,664

Loans:
Balance December 31, 2010	$	55,467		$	129,448		$	343,955		$	73,904		$	10,225		$	16,892	$	—		$	629,891

ALL		(1,424	)		(2,103	)		(6,355	)		(1,189	)		(391	)		—		(40	)		(11,502	)

Recorded investment	$	54,043		$	127,345		$	337,600		$	72,715		$	9,834		$	16,892	$	(40	)	$	618,389
Ending balance individually evaluated for impairment	$	3,959		$	4,178		$	23,883		$	1,174		$	7		$	—	$	—		$	33,201
Ending balance collectively evaluated for impairment	$	50,084		$	123,167		$	313,717		$	71,541		$	9,827		$	16,892	$	(40	)	$	585,188

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BAYLAKE CORP.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2011

A summary of past due loans at March 31, 2011 and December 31, 2010 is as follows (dollar amounts in thousands):


	March 31, 2011
	30-89 Days Past Due (accruing)		90 Days & Over or on non-accrual		Total

Construction	$	325	$	5,856	$	6,181
Real estate – mortgage		2,337		3,804		6,141
Real estate – commercial		4,953		6,593		11,546
Commercial		1,937		745		2,682
Consumer		54		194		273
Municipal		—		—		—

Total	$	9,606	$	17,192	$	26,823

	December 31, 2010
	30-89 Days Past Due (accruing)		90 Days & Over or on non-accrual		Total

Construction	$	586	$	4,066	$	4,652
Real estate – mortgage		1,311		4,845		6,156
Real estate – commercial		3,531		6,360		9,891
Commercial		289		973		1,262
Consumer		95		256		351
Municipal		—		—		—

Total	$	5,812	$	16,500	$	22,312

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BAYLAKE CORP.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2011

Credit Quality: We utilize a risk grading matrix on each of our commercial loans. Loans are graded on a scale of 1 to 7. A description of the loan grades is as follows:

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

0002 Very Good Risk. Good ratios in all areas. High quality borrower. Normally quite liquid. Differs slightly from a one rated customer.

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

0004 Better than Average Risk. Adequate ratios, fair liquidity, desirable customer. Proactive management. Performance trends are positive. Any deviations are limited and temporary as a historical trend.

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

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

0006 B Have weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or in the Bank’s collateral position at some future date. Loans rated 6B are not adversely classified and do not expose the Bank to sufficient risk to warrant adverse classification.

0007 Well defined weaknesses and trends that jeopardize the repayment of loans. Ranging from workout to legal. Includes loans that are 90 days and over past due.

Below is a breakdown of loans by risk grading as of March 31, 2011(dollar amounts in thousands):


	0001-0005		0006A		0006B		0007		Total

Commercial Loans	$	69,926	$	5,506	$	3,649	$	2,607	$	81,688
Real Estate - Commercial		231,938		34,781		24,338		39,169		330,226
Real Estate - Construction		36,359		6,288		3,278		7,373		53,298
		338,223		46,575		31,265		49,149		465,212
Real Estate - Residential		122,572		672		1,012		6,066		130,322
Consumer Loans		9,370		—		—		206		9,576
Obligations of States and Political Subdivisions		15,960		—		—		—		15,960
		147,902		672		1,012		6,272		155,858
	$	486,125	$	47,247	$	32,277	$	55,421	$	621,070
Deferred origination Fees, net of costs										(342	)
Total									$	620,728

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BAYLAKE CORP.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2011

Below is a breakdown of loss by risk grading as of December 31, 2010:


	0001-0005		0006A		0006B		0007		Total

Commercial Loans	$	61,733	$	5,964	$	3,590	$	2,641	$	73,928
Real Estate – Commercial		240,368		33,604		35,763		34,528		344,263
Real Estate – Construction		37,990		6,587		5,308		5,582		55,467
		340,091		46,155		44,661		42,751		473,658
Real Estate - Residential		120,529		715		1,846		6,359		129,449
Consumer Loans		9,985		—		—		240		10,225
Obligations of States and Political Subdivisions		16,892		—		—		—		16,892
		147,406		715		1,846		6,599		156,566
	$	487,497	$	46,870	$	46,507	$	49,350		630,224
Deferred Origination Fees, net of costs										(333	)
Total									$	629,891


8.	Allowance For Loan Losses (“ALL”)

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

	The ALL consists of specific reserves on certain impaired loans and general reserves for non-impaired loans. Specific reserves reflect estimated losses on impaired loans from analyses developed through specific credit allocations for individual loans. The specific credit allocations are based on regular analyses of all impaired non-homogenous loans. These analyses involve a high degree of judgment in estimating the amount of loss associated with specific loans, including estimating the amount and timing of future cash flows and collateral values. The general reserve is based on the Bank’s historical loss experience which is updated quarterly. The general reserve portion of the ALL also includes consideration of certain qualitative factors such as 1) changes in the nature, volume and terms of loans, 2) changes in lending personnel, 3) changes in the quality of the loan review function, 4) changes in nature and volume of past-due, nonaccrual and/or classified loans, 5) changes in concentration of credit risk, 6) changes in economic and industry conditions, 7) changes in legal and regulatory requirements, 8) unemployment and inflation statistics, and 9) changes in underlying collateral values.

	There are many factors affecting the ALL; some are quantitative while others require qualitative judgment. The process for determining the ALL (which management believes adequately considers potential factors which might possibly result in credit losses) includes subjective elements and, therefore, may be susceptible to significant change. To the extent actual outcomes differ from management estimates, additional PFLL could be required that could adversely affect our earnings or financial position in future periods. Allocations of the ALL may be made for specific loans but the entire ALL is available for any loan that, in management’s judgment, should be charged-off or for which an actual loss is realized. As an integral part of their examination process, various regulatory agencies review the ALL as well. Such agencies may require that changes in the ALL be recognized when such regulators’ credit evaluations differ from those of management based on information available to the regulators at the time of their examinations.

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BAYLAKE CORP.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2011

Changes in the ALL were as follows (dollar amounts in thousands):

ALLOWANCE FOR LOAN LOSSES


	For the three months ended March 31,
		2011			2010

Balance at beginning of period	$	11,502		$	9,600
Provision for loan losses		1,300			1,050
Charge-offs		(855	)		(1,939	)
Recoveries		151			1,424
Balance at end of period	$	12,098		$	10,135
Net charge-offs	$	(704	)	$	(515	)

Information regarding impaired loans is as follows (dollar amounts in thousands):

IMPAIRED LOANS AND ALLOCATED ALLOWANCE


March 31, 2011	Construction Loans		Real Estate- Mortgage		Real Estate- Commercial		Commercial		Consumer		Municipal		Not Specifically Allocated		Total
With an allowance recorded:
Recorded investment	$	117	$	2,196	$	4,472	$	474	$	15	$	—	$	—	$	7,274
Unpaid principal balance		234		2,967		5,417		673		169		—		—		9,460
Related allowance		117		771		945		199		154		—		—		2,186

With no related allowance recorded:
Recorded investment	$	5,572	$	929	$	23,364	$	73	$	571	$	—	$	—	$	30,509
Unpaid principal balance		5,572		929		23,364		73		571		—		—		30,509
Related allowance		—		—		—		—		—		—		—		—

Total:
Recorded investment	$	5,689	$	3,125	$	27,836	$	547	$	586	$	—	$	—	$	37,783
Unpaid principal balance		5,806		3,896		28,781		746		740		—		—		39,969
Related allowance		117		771		945		199		154		—		—		2,186

Average recorded investment during quarter	$	4,768	$	3,630	$	5,399	$	483	$	53	$	—	$	—	$	14,333

Interest income recognized while impaired	$	—	$	1	$	—	$	—	$	—	$	—	$	—	$	1

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BAYLAKE CORP.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2011


December 31, 2010	Construction Loans		Real Estate - Mortgage		Real Estate- Commercial		Commercial		Consumer		Municipal		Not Specifically Allocated		Total
With an allowance recorded:
Recorded investment	$	288	$	3,097	$	4,174	$	110	$	7	$	—	$	—	$	7,676
Unpaid principal balance		456		3,814		5,410		638		196		—		—		10,514
Related allowance		168		717		1,236		528		189		—		—		2,838

With no related allowance recorded:
Recorded investment	$	3,559	$	1,125	$	13,637	$	695	$	60	$	—	$	—	$	19,076
Unpaid principal balance		3,559		1,125		13,637		695		60		—		—		19,076
Related allowance		—		—		—		—		—		—		—		—

Total:
Recorded investment	$	3,847	$	4,222	$	17,811	$	805	$	67	$	—	$	—	$	26,752
Unpaid principal balance		4,015		4,939		19,047		1,333		256		—		—		29,590
Related allowance		168		717		1,236		528		189		—		—		2,838

Average recorded investment during quarter	$	4,100	$	2,885	$	7,113	$	426	$	51	$	—	$	—	$	14,575

Interest income recognized while impaired	$	3	$	—	$	2	$	—	$	—	$	—	$	—	$	5

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

Nonperforming loans are as follows (dollar amounts in thousands):

NONPERFORMING LOANS


	March 31, 2011		December 31, 2010		September 30, 2010		June 30, 2010		March 31, 2010
Nonaccrual loans	$	17,027	$	15,877	$	18,339	$	23,550	$	16,969
Loans restructured in a troubled debt restructuring		165		623		586		160		386
Total nonperforming loans (“NPL”)	$	17,192	$	16,500	$	18,925	$	23,710	$	17,355

Restructured loans, accruing	$	22,777	$	13,090	$	11,416	$	9,845	$	9,809

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BAYLAKE CORP.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2011


9.	Foreclosed Properties, Net

	Foreclosed properties are summarized as follows (dollar amounts in thousands):


	For the three months ended March 31,
	2011			2010

Beginning balance	$	19,934		$	17,768
Transfer of net realizable value to foreclosed properties		1,244			1,393
Sale proceeds, net		(2,872	)		(314	)
Net gain from sale of foreclosed properties		83			17
Valuation allowance related to properties disposed		(572	)		(147	)
Total foreclosed properties		17,817			18,717
Valuation write-downs		(4,092	)		(2,806	)
Total foreclosed properties, net	$	13,725		$	15,911


	Changes in the valuation allowance for losses on foreclosed properties were as follows (dollar amounts in thousands):


	For the three months ended March 31,
	2011			2010

Beginning balance	$	3,982		$	2,773
Provision charged to operations		682			180
Amounts related to properties disposed		(572	)		(147	)
Balance at end of period	$	4,092		$	2,806


10.	Income Taxes

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

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

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BAYLAKE CORP.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2011


	We regularly review the carrying amount of our deferred tax assets to determine if the establishment of a valuation allowance is necessary. If, based on the available evidence, it is more likely than not that all or a portion of our deferred tax assets will not be realized in future periods, a deferred tax valuation allowance would be established. Consideration is given to various positive and negative factors that could affect the realization of the deferred tax assets. In evaluating available evidence, management considers, among other things, historical financial performance, expectation of future earnings, the ability to carry back losses to recoup taxes previously paid, length of statutory carry forward periods, experience with operating loss and tax credit carry forwards not expiring unused, tax planning strategies and timing of reversals of temporary differences. Significant judgment is required in assessing future earning trends and the timing of reversals of temporary differences. Our evaluation is based on current tax laws as well as management’s expectations of future performance. Management has concluded that there is no need for a valuation allowance as of March 31, 2011 or December 31, 2010.

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

	Changes in the deferred income tax balances were as follows (dollar amounts in thousands):

	Deferred taxes – Available for sale securities


	For the three months ended March 31,
	2011			2010

Balances at beginning of period	$	(659	)	$	(333	)
Net change during period		(810	)		(514	)
Balances at end of period	$	(1,469	)	$	(847	)


	Deferred taxes – Other than available for sale securities


	For the three months ended March 31,
	2011		2010

Balances at beginning of period	$	9,861	$	8,523
Net change during period		297		(49	)
Balances at end of period	$	10,158	$	8,474

Table of Contents

BAYLAKE CORP.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2011


11.	Equity Investment

	Baylake Bank owns a 49.8% interest (500 shares) in United Financial Services, Inc. (“UFS”), a data processing service. In addition to the ownership interest, we and UFS have a common member on each of our respective Board of Directors. The investment in this entity is carried under the equity method of accounting and the pro rata share of its income is included in other income. On June 27, 2006, UFS amended an earlier employment agreement with one of its key employees that provided the individual the option to purchase up to 20%, or 240 shares, of the authorized shares of UFS common stock. The option price was $1,000 per share, less dividends or distributions to owners. During 2007, options for 120 shares were exercised by the key employee. The remaining options were exercised in 2010. The current book value of UFS is approximately $8,087 per share.

12.	Mortgage Servicing Rights

	We have obligations to service residential first mortgage loans and commercial loans that have been sold in the secondary market. Mortgage servicing rights (“MSRs”) are recorded when loans are sold in the secondary market with servicing retained. On a quarterly basis MSRs are valued based on a valuation model that calculates the present value of estimated servicing income. The valuation model incorporates assumptions that market participants would use in estimating future net servicing income.

	Changes in the carrying value of MSRs are as follows (dollar amounts in thousands):

MORTGAGE SERVICING RIGHTS


	For the three months ended March 31,
	2011			2010

Balance at beginning of period	$	746		$	609
Additions from loans sold with servicing retained		57			12
Changes in valuation		18			27
Loan payments and payoffs		(51	)		(21	)
Fair value of MSRs at the end of period	$	770		$	627


13.	Promissory Notes

	During 2009 and 2010, we issued 10% Convertible Notes due June 30, 2017 (the “Convertible Notes”) totaling $9.45 million. The Convertible Notes were offered and sold in reliance on the exemption from registration under Section 4(2) of the Securities Act of 1933 and Rule 506 promulgated there under.

	The Convertible Notes accrue interest at a fixed rate of 10% per annum upon issuance and until maturity or earlier conversion or redemption. Interest is payable quarterly, in arrears, on January 1, April 1, July 1, and October 1 of each year. The Convertible Notes are convertible into shares of our common stock at a conversion ratio of one share of common stock for each $5.00 in aggregate principal amount held on the record date of the conversion, subject to certain adjustments as described in the Convertible Notes. Prior to October 1, 2014, each holder of the Convertible Notes may convert up to 100% (at the discretion of the holder) of the original principal amount into shares of our common stock at the conversion ratio. On October 1, 2014, one-half of the original principal amounts are mandatorily convertible into common stock at the conversion ratio if voluntary conversion has not occurred. The principal amount, along with accrued but unpaid interest, of any Convertible Note that has not been converted will be payable at maturity on June 30, 2017. We are not obligated to register the common stock issued on the conversion of the Convertible Notes.

	During 2009 and 2010 the Company incurred debt issuance costs of $0.2 million. These costs were capitalized and are being amortized to interest expense using the effective interest method over the initial conversion term, which ends October 1, 2014.

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BAYLAKE CORP.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2011


14.	Troubled Debt Restructuring

	A troubled debt restructuring (“TDR”) includes a loan modification where a borrower is experiencing financial difficulty and we grant a concession to that borrower that we would not otherwise consider except for the borrower’s financial difficulties. A TDR may be either accrual or nonaccrual status based upon the performance of the borrower and management’s assessment of collectability. If a TDR is placed on nonaccrual status, it remains there until a sufficient period of performance under the restructured terms has occurred at which time it is returned to accrual status, generally six months.

	(Dollar amounts in thousands)


	Construction Loans		Real Estate- Mortgage			Real Estate- Commercial			Commercial		Consumer		Municipal		Total

Accruing

January 1, 2011	$	—	$	44		$	12,661		$	386	$	—	$	—	$	13,091

Principal payments		—		(1	)		(25	)		—		—		—		(26	)
Charge-offs		—		—			—			—		—		—		—
Advances		—		—			25			—		—		—		25
New restructured		—		—			9,687			—		—		—		9,687
Class transfers		—		—			(160	)		160		—		—		—
Transfers between nonaccrual		—		—			—			—		—		—		—
March 31, 2011	$	—	$	43		$	22,188		$	546	$	—	$	—	$	22,777

Nonaccrual

January 1, 2011	$	—	$	—		$	586		$	18	$	20	$	—	$	624

Principal payments		—		—			(296	)		—		—		—		(296	)
Charge-offs		—		—			(172	)		—		—		—		(172	)
Advances		—		—			9			—		—		—		9
New Restructured		—		—			—			—		—		—		—
Class transfers		—		—			—			—		—		—		—
Transfers between accruing		—		—			—			—		—		—		—
March 31, 2011	$	—	$	—		$	127		$	18	$	20	$	—	$	165

Totals
January 1, 2011	$	—	$	44		$	13,247		$	404	$	20	$	—	$	13,715

Principal payments		—		(1	)		(321	)		—		—		—		(322	)
Charge-offs		—		—			(172	)		—		—		—		(172	)
Advances		—		—			34			—		—		—		34
New Restructured		—		—			9,687			—		—		—		9,687
Class transfers		—		—			(160	)		160		—		—		—
Transfers between accruing		—		—			—			—		—		—		—
March 31, 2011	$	—	$	43		$	22,315		$	564	$	20	$	—	$	22,942

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BAYLAKE CORP.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2011

A summary of troubled debt restructurings as of March 31, 2011 and December 31, 2010 is as follows (dollar amounts in thousands):


	March 31, 2011				December 31, 2010
	Number of Modifications		Recorded Investment		Number of Modifications		Recorded Investment

Construction		—	$	—		—	$	—
Real estate – mortgage		1		43		1		43
Real estate – commercial		22		22,316		19		13,247
Commercial		3		563		2		404
Consumer		1		20		1		19
Municipal		—		—		—		—
Total		27	$	22,942		23	$	13,713

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

General

Baylake Corp. is a Wisconsin corporation that is registered with the Board of Governors of the Federal Reserve (the “Federal Reserve”) as a bank holding company under the Bank Holding Company Act of 1956, as amended. Our wholly-owned banking subsidiary, Baylake Bank, is a Wisconsin state-chartered bank that provides a wide variety of loan, deposit and other banking products and services to its business, retail, and municipal customers, as well as a full range of trust, investment and cash management services. Baylake Bank is a member of the Federal Reserve and the Federal Home Loan Bank of Chicago.

The following sets forth management’s discussion and analysis of our consolidated financial condition at March 31, 2011 and December 31, 2010 and our consolidated results of operations for the three months ended March 31, 2011 and 2010. This discussion and analysis should be read together with the consolidated financial statements and accompanying notes contained in Part I of this Form 10-Q, as well as our Annual Report on Form 10-K for the year ended December 31, 2010.

Forward-Looking Information

This discussion and analysis of consolidated financial condition and results of operations, and other sections of this report, may contain forward-looking statements that are based on the current expectations of management. Such expressions of expectations are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Words such as “anticipates,” “believes,” “estimates,” “expects,” “forecasts,” “intends,” “is likely,” “plans,” “projects,” and other such words are intended to identify such forward-looking statements. The statements contained herein and in such forward-looking statements involve or may involve certain assumptions, risks and uncertainties, many of which are beyond our control that may cause actual future results to differ materially from what may be expressed or forecasted in such forward-looking statements. Readers should not place undue expectations on any forward-looking statements. In addition to the assumptions and other factors referenced specifically in connection with such statements, the following factors could cause actual results to differ materially from the forward-looking statements: the factors described under “Risk Factors” in Item 1A of this Quarterly Report on Form 10-Q and of our Annual Report on Form 10-K for the year ended December 31, 2010, which are incorporated herein by reference, and other risks that may be identified or discussed in this Form 10-Q.

The Dodd-Frank Wall Street Reform and Consumer Protection Act

On July 21, 2010, President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”) into law. This legislation makes extensive changes to the laws regulating financial services firms and requires significant rule-making. In addition, the legislation mandates multiple studies, which could result in additional legislative or regulatory action. While the full effects of the legislation on us and Baylake Bank cannot yet be determined, this legislation is generally perceived as negatively impacting the banking industry. This legislation may result in higher compliance and other costs, reduced revenues and higher capital and liquidity requirements, among other things, which could adversely affect our business and the business of Baylake Bank.

Critical Accounting Policies

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

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

The ALL consists of specific reserves on certain impaired loans and general reserves for non-impaired loans. Specific reserves reflect estimated losses on impaired loans from analyses developed through specific credit allocations for individual loans. The specific credit allocations are based on regular analyses of all impaired non-homogenous loans. These analyses involve a high degree of judgment in estimating the amount of loss associated with specific loans, including estimating the amount and timing of future cash flows and collateral values. The general reserve is based on our historical loss experience which is updated quarterly. The general reserve portion of the ALL also includes consideration of certain qualitative factors such as 1) changes in the nature, volume and terms of loans, 2) changes in lending personnel, 3) changes in the quality of the loan review function, 4) changes in nature and volume of past-due, nonaccrual and/or classified loans, 5) changes in concentration of credit risk, 6) changes in economic and industry conditions, 7) changes in legal and regulatory requirements, 8) unemployment and inflation statistics, and 9) changes in underlying collateral values.

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

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

Foreclosed Properties: Foreclosed properties acquired through or in lieu of loan foreclosure are initially recorded at the lower of carrying cost or fair value, less estimated costs to sell, establishing a new cost basis. Fair value is determined using a variety of market information including but not limited to appraisals, professional market assessments and real estate tax assessment information. If fair value declines subsequent to foreclosure, a valuation allowance is recorded through expense. Costs incurred after acquisition are expensed.

Provision for Impairment of Standby Letters of Credit: The provision for losses on standby letters of credit represents management’s estimate of probable incurred losses with respect to off-balance sheet standby letters of credit which are used to support our customers’ business arrangements with an unrelated third party. In the event of further impairment, a provision for impairment of standby letters of credit is charged to operations based on management’s periodic evaluation of the factors affecting the standby letters of credit.

Income Tax Accounting: The assessment of income tax assets and liabilities involves the use of estimates, assumptions, interpretations, and judgments concerning certain accounting pronouncements and federal and state tax codes. There can be no assurance that future events, such as court decisions or positions of federal and state taxing authorities, will not differ from management’s current assessment, the impact of which could be significant to the consolidated results of our operations and reported earnings. We believe that the deferred income tax assets on our March 31, 2011 balance sheet are recoverable, and the deferred income tax liabilities are adequate and fairly stated in the consolidated financial statements.

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Goodwill: Goodwill is not amortized but is subject to impairment tests on an annual basis or more frequently if deemed appropriate. During 2010, we, with the assistance of a third party valuation firm determined an estimated cash fair value of our common stock. Consideration was given to our nature and history, the competitive and economic outlook for our trade area and for the banking industry in general, our book value and financial condition, our future earnings and dividend paying capacity, the size of the block valued, and the prevailing market prices of bank stocks. The following valuation methodologies were considered: 1) net asset value – defined as our net worth, 2) market value – defined as the price at which knowledgeable buyers and sellers would agree to buy and sell our common stock, and 3) investment value – defined as an estimate of the present value of the future benefits, usually earnings, cash flow, or dividends, that will accrue to our common stock. When consideration was given to the three valuation methodologies, as well as all other relevant valuation variables and factors, the fully-diluted cash fair value range of our common shares was considered to be in excess of the book value and therefore, management concluded that goodwill was not impaired. As of March 31, 2011, there are no conditions that would require us to recognize goodwill impairment.

Results of Operations

The following table sets forth our results of operations and related summary information for the three month periods ended March 31, 2011 and 2010.

SUMMARY RESULTS OF OPERATIONS
(Dollar amounts in thousands, except per share data)


	Three months ended March 31,
	2011			2010
Net income, as reported	$	651		$	817
Earnings per share-basic, as reported	$	0.08		$	0.10
Earnings per share-diluted, as reported	$	0.08		$	0.10
Cash dividends declared	$	—		$	—

Return on average assets		0.28	%		0.32	%
Return on average equity		3.40	%		4.40	%
Efficiency ratio ⁽¹⁾		80.85	%		77.31	%


⁽¹⁾	Noninterest expense divided by the sum of taxable equivalent net interest income plus noninterest income, excluding net investment securities gains and excluding net gains on the sale of fixed assets. A lower ratio indicates greater efficiency.

Net income of $0.7 million for the three months ended March 31, 2011 decreased from net income of $0.8 million for the comparable period in 2010. Net interest income increased $0.3 million for the quarter ended March 31, 2011 versus the comparable quarter last year resulting from a $1.0 million reduction in interest expense partially offset by a $0.7 million reduction in interest income. A PFLL of $1.3 million was charged to operations for the first quarter of 2011, which is $0.2 million higher than the $1.1 million PFLL taken during the comparable quarter of 2010. Noninterest expense increased $1.0 million, which was partially offset by a $0.6 million increase in noninterest income in the first quarter of 2011 compared to the similar period in 2010. Refer to the “Net Interest Income,” “Provision for Loan Losses,” “Noninterest Expense” and “Noninterest Income” sections below for additional details.

Net Interest Income:

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

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Interest rate spread is the difference between the interest rate earned on average interest-earning assets and the rate paid on average interest-bearing liabilities. Interest rate spread increased 9 bps to 3.46% for the first quarter of 2011 compared to the same period in 2010, resulting primarily from a 45 bps decrease in the cost of interest-bearing liabilities from 1.67% to 1.22%, partially offset by a 36 bps decrease in the yield on interest-earning assets from 5.04% to 4.68%. We continue to be positively impacted by the interest rate floors on a large number of loans on our balance sheet, which has resulted in the recognition of a greater amount of interest income than would have been recognized had the floors not existed.

Net interest income on a tax-equivalent basis was $8.3 million for the three months ended March 31, 2011 compared to $8.0 million for the same period in 2010. The increase for the first quarter of 2011 resulted primarily from a decrease in funding costs on liabilities attributable to both a decline in interest rates and a reduction in average interest-bearing liabilities, partially offset by a decrease in interest income on loans, due to a reduction in average loans. Contributing to the improved net interest income was a $16.0 million increase in average noninterest-bearing demand deposits, from $71.8 million during the first quarter of 2010 to $87.8 million for the comparable period in 2011.

Net interest margin represents net interest income expressed as an annualized percentage of average interest-earning assets. Net interest margin exceeds the interest rate spread because of the use of noninterest-bearing sources of funds (demand deposits and equity capital) to fund a portion of earning assets. Net interest margin for the first quarter of 2011 was 3.56%, up 10 bps from 3.46% for the comparable period in 2010.

For the three months ended March 31, 2011, average interest-earning assets increased $11.0 million (1.2%) from the same period in 2010. Increases in average taxable securities of $51.9 million (28.9%) and in tax exempt securities of $2.3 million (6.2%) were partially offset by a $16.3 million (2.5%) decrease in loans and a $26.9 million decrease (41.7%) in federal funds sold and interest-bearing due from bank balances.

NET INTEREST INCOME ANALYSIS ON A TAX-EQUIVALENT BASIS
(Dollar amounts in thousands)


	Three months ended March 31, 2011							Three months ended March 31, 2010
	Average Balance		Interest Income/ Expense		Average Yield/ Rate			Average Balance		Interest Income/ Expense		Average Yield/ Rate
ASSETS
Average Earning Assets:
Loans, net^1,2	$	632,415	$	8,553		5.49	%	$	648,674	$	9,146		5.72	%
Taxable securities		231,109		1,751		3.03	%		179,239		1,864		4.16	%
Tax exempt securities ¹		39,974		575		5.76	%		37,643		556		5.91	%
Federal funds sold and interest-bearing due from banks		37,689		21		0.22	%		64,594		32		0.20	%
Total earning assets		941,187		10,900		4.68	%		930,150		11,598		5.04	%
Noninterest earning assets		101,603							105,979
Total Assets	$	1,042,790						$	1,036,129

LIABILITIES AND STOCKHOLDERS’ EQUITY
Average Interest-bearing liabilities:
Total interest-bearing deposits	$	746,393	$	1,956		1.06	%	$	751,234	$	2,829		1.53	%
Short-term borrowings		1		—		0.65	%		12		—		1.67	%
Customer repurchase agreements		28,440		22		0.32	%		23,247		29		0.50	%
Federal Home Loan Bank advances		68,611		314		1.86	%		84,111		556		2.68	%

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	Three months ended March 31, 2011							Three months ended March 31, 2010
	Average Balance		Interest Income/ Expense		Average Yield/ Rate			Average Balance		Interest Income/ Expense		Average Yield/ Rate
Convertible promissory notes	$	9,450	$	245		10.37	%	$	5,555	$	147		10.48	%
Subordinated debentures		16,100		67		1.65	%		16,100		64		1.60	%
Total interest-bearing liabilities		868,995		2,604		1.22	%		880,259		3,625		1.67	%
Demand deposits		87,828							71,831
Accrued expenses and other liabilities		8,464							8,669
Stockholders’ equity		77,503							75,370
Total liabilities and stockholders’ equity	$	1,042,790						$	1,036,129
Net Interest Income			$	8,296						$	7,973
Interest rate spread ⁽³⁾						3.46	%						3.37	%
Net interest margin ⁽⁴⁾						3.56	%						3.46	%


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

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

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

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

RATE/VOLUME ANALYSIS ⁽¹⁾(Dollar amounts in thousands)

Three months ended March 31, 2011 compared to the three months ended March 31, 2010:


	Increase (Decrease) due to
	Volume			Rate⁽¹⁾			Net

Interest income:
Loans	$	(990	)	$	397		$	(593	)
Taxable securities		1,963			(2,076	)		(113	)
Tax exempt securities		135			(116	)		19
Federal funds sold and interest-bearing due from banks		(58	)		47			(11	)
Total interest-earning assets	$	1,050		$	(1,748	)	$	(698	)

Interest expense:
Total interest-bearing deposits	$	(549	)	$	(324	)	$	(873	)
Short term borrowings		—			—			—
Repurchase agreements		22			(29	)		(7	)
FHLB advances		(368	)		126			(242	)
Subordinated debentures		404			(306	)		98
Long term debt		—			3			3
Total interest-bearing liabilities	$	(491	)	$	(530	)	$	(1,021	)

Net interest income	$	1,541		$	(1,218	)	$	323


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

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Our management’s ability to employ overall assets for the production of interest income can be measured by the ratio of average interest-earning assets to average total assets. This ratio was 90.2% and 91.0% for the first quarter of 2011 and 2010, respectively.

Provision for Loan Losses:

The ALL consists of specific and general reserves. The PFLL is the cost of providing an allowance for probable and inherent losses in our loan portfolio. Our internal risk system is used to identify loans that meet the criteria for being “impaired” as defined by accounting guidance. Specific reserves are computed on loans that are individually classified as impaired. Loans identified as impaired are evaluated for impairment using either the discounted expected cash flows or collateral value less estimated costs to sell. When the fair value of the collateral is less than amortized cost, a specific reserve is required. The general reserve is computed on non-impaired loans and is based on historical loss experience adjusted for qualitative factors. These qualitative factors include: 1) changes in the nature, volume and terms of loans, 2) changes in lending personnel, 3) changes in the quality of the loan review function, 4) changes in nature and volume of past-due, nonaccrual and/or classified loans, 5) changes in concentration of credit risk, 6) changes in economic and industry conditions, 7) changes in legal and regulatory requirements, 8) unemployment and inflation statistics, and 9) changes in underlying collateral values. Allocations of the ALL may be made for specific loans but the entire ALL is available for any loan that, in management’s judgment, should be charged-off or for which an actual loss is realized.

The PFLL for the quarter ended March 31, 2011 was $1.3 million compared to $1.1 million for the first quarter of 2010. New impairments of $0.2 million on loans not previously identified, with associated loan balances of $1.3 million, were recorded during the first quarter of 2011.

Net loan charge-offs for each of the first three months of 2011 and 2010 were $0.7 million and $0.5 million, respectively. Net annualized charge-offs to average loans were 0.45% for the first three months of 2011 compared to 0.32% for the same period in 2010. For the three months ended March 31, 2011, nonperforming loans increased by $0.7 million (4.2%) to $17.2 million from $16.5 million at December 31, 2010. Refer to the “Financial Condition - Risk Management and the Allowance for Loan Losses” and “Financial Condition - Nonperforming Loans, Potential Problem Loans and Foreclosed Properties” sections below for more information related to nonperforming loans. Our management believes that the ALL at March 31, 2011 and the related PFLL charged to earnings for the quarter ended March 31, 2011 are appropriate in light of the present condition of the loan portfolio and the amount and quality of the collateral supporting nonperforming loans. We continue to monitor nonperforming loan relationships and will make additional provisions, as necessary, if the facts and circumstances change. In addition, a decline in the quality of our loan portfolio as a result of general economic conditions, factors affecting particular borrowers or our market area, or otherwise, could affect the adequacy of the ALL. If there are significant charge-offs against the ALL, or we otherwise determine that the ALL is inadequate or our estimates are different than our regulators’ estimates, we will need to make additional PFLLs in the future.

Noninterest Income:

The following table reflects the various components of noninterest income for the three month periods ended March 31, 2011 and 2010, respectively.

NONINTEREST INCOME
(Dollar amounts in thousands)


	Three months ended
	March 31, 2011			March 31, 2010		% Change

Fees from fiduciary services	$	283		$	216		31.3	%
Fees from loan servicing		190			157		20.8	%
Service charges on deposit accounts		795			805		(1.3	)%
Other fee income		164			189		(13.2	)%
Financial services income		292			204		43.0	%
Net gains from sales of loans		386			168		129.4	%
Net gain/(loss) in valuation of mortgage servicing rights		(30	)		6		(590.9	)%
Net gains from sale of securities		125			—		NM	%
Gains from sale of fixed assets		8			—		NM	%
Increase in cash surrender value of life insurance		130			83		56.4	%

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	Three months ended
	March 31, 2011		March 31, 2010		% Change

Equity in income of UFS subsidiary		231		161		43.8	%
Other income		40		22		81.1	%
Total Noninterest Income	$	2,614	$	2,011		30.0	%

Noninterest income increased $0.6 million (30.0%) for the three months ended March 31, 2011 versus the comparable period in 2010. This was primarily due to a $0.1 million increase in net gains from the sale of securities, a $0.2 million increase in net gains from sales of loans due to increased secondary mortgage market originations, and a $0.1 million increase in financial services income due to an increase in trading activity on behalf of our brokerage customers. Secondary mortgage market originations decreased considerably in the later part of the first quarter of 2011 and are expected to remain at lower levels as the year progresses.

Noninterest Expense:

The following table reflects the various components of noninterest expense for the three months ended March 31, 2011 and 2010, respectively.

NONINTEREST EXPENSE
(Dollar amounts in thousands)


	Three months ended
	March 31, 2011		March 31, 2010		% Change

Salaries and employee benefits	$	4,556	$	4,262		7.0	%
Occupancy		605		611		(1.1	)%
Equipment		280		326		(14.2	)%
Data processing and courier		208		225		(7.7	)%
Operation of foreclosed properties		1,038		425		144.4	%
Business development & advertising		128		179		(28.6	)%
Charitable contributions		18		27		(33.8	)%
Stationery and supplies		112		115		(2.3	)%
Director fees		93		82		12.9	%
FDIC		731		461		58.6	%
Legal and professional		193		176		9.8	%
Loan and collection		168		151		11.3	%
Other outside services		165		183		(9.8	)%
Provision for impairment of letter of credit		7		87		(92.0	)%
Other operating		412		409		0.8	%
Total Noninterest Expense	$	8,714	$	7,719		12.9	%

Total noninterest expense increased $1.0 million for the three months ended March 31, 2011 compared to the same period in 2010. The noninterest expense to average assets ratio was 3.4% for the three months ended March 31, 2011 compared to 3.0% for the same period in 2010.

Net overhead expense is total noninterest expense less total noninterest income excluding securities gains. The net overhead expense to average assets ratio was at 2.4% for the three months ended March 31, 2011 compared to 2.2% for the same period in 2010. The efficiency ratio represents total noninterest expense as a percentage of the sum of net interest income on a fully taxable equivalent basis and total noninterest income (excluding net gains on the sale of securities and premises and equipment). A lower efficiency ratio indicates a more efficient operation. The efficiency ratio increased to 80.9% for the three months ended March 31, 2011 from 77.3% for the comparable period last year. This is primarily due to an increase of $1.0 million in noninterest expense of which $0.6 million was related to operation of foreclosed properties. Partially offsetting the increase in noninterest expense was a $0.5 million increase in noninterest income and a $0.3 million increase in tax equivalent interest income.

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Expenses related to the operation of foreclosed properties held for sale by the Bank increased $0.6 million to $1.0 million for the three-month period ended March 31, 2011 compared to $0.4 million for the same period in 2010. The increase consists of a $0.5 million increase in write-downs due to the revaluation of properties held and a $0.2 million increase in operating expenses, offset by a $0.1 million increase in gain on sale of foreclosed properties. We continue to evaluate all foreclosed property values and attempt to reduce the holding periods of these properties and, as a result, the related holding costs, to the extent possible. Such expenses include but are not limited to insurance, maintenance, real estate taxes, management fees, utilities and legal fees.

Included in noninterest expense are FDIC insurance premiums of $0.7 million for the three months ended March 31, 2011 compared to $0.5 million for the same period a year ago. FDIC insurance premiums consist of two components, deposit insurance premiums and payments for servicing obligations of the Financing Corporation (“FICO”) that were issued in connection with the resolution of savings and loan associations. With the enactment in early 2006 of the Federal Deposit Insurance Reform Act of 2005, major changes were introduced in the calculation of FDIC deposit insurance premiums. Such changes were effective January 1, 2007 and included establishment by the FDIC of a target reserve ratio range for the Deposit Insurance Fund (“DIF”) of between 1.15% and 1.50%, as opposed to the prior fixed reserve ratio of 1.25%. At the same time, the FDIC adopted a new risk-based system for assessment of deposit insurance premiums under which all such institutions are required to pay minimum annual premiums. The system categorizes institutions in one of four risk categories, depending on capitalization and supervisory rating criteria. Baylake Bank’s assessment rate, like that of other financial institutions, is confidential and may not be directly disclosed, except to the extent required by law. Payments for the FICO portion will continue as long as FICO obligations remain outstanding. In February 2009, the FDIC adopted a final rule modifying the risk-based assessment system and setting initial base assessment rates beginning April 1, 2009 at between 12 bps and 45 bps. On November 12, 2009, the Board of Directors of the FDIC adopted a rule that required insured institutions to prepay their estimated quarterly risk-based assessments for the fourth quarter of 2009 and for all of 2010, 2011 and 2012. In October 2010, the FDIC Board voted to eliminate a uniform 3 bps increase in assessment rates that was to be effective January 1, 2011. We were required to prepay approximately $6.7 million in premiums in December 2009, which premiums will be taken as a charge against our operations in the period for which they apply.

On February 7, 2011, the FDIC finalized the rule to change its assessment base from total domestic deposits to average total assets minus average tangible equity, as required in the Dodd-Frank Act. The new assessment base will begin in the second quarter of 2011, with the premium payable in September 2011. The result of the change will be a reduction in future assessments.

Salaries and employee benefits increased $0.3 million (7.0%) to $4.6 million for the three months ended March 31, 2011 compared to $4.3 million for the three months ended March 31, 2010. The number of full-time equivalent employees increased from 298 at March 31, 2010 to 304 at March 31, 2011, resulting in additional salary expense of $0.2 million. Commission expense for commissioned salespersons, including financial advisors and mortgage originators, increased $0.1 million due to increased activity.

Income Taxes:

We recorded a nominal income tax benefit for the three months ended March 31, 2011 versus tax expense of $0.1 million for the same period in 2010. The decrease in tax expense is attributable to a $0.3 million year-over-year decrease in pre-tax income.

We maintain significant net deferred tax assets for deductible temporary tax differences, such as allowance for loan losses, nonaccrual loan interest, and foreclosed property valuations as well as net operating loss carryforwards. Our determination of the amount of our deferred tax asset to be realized is highly subjective and is based on several factors, including projected future income, income tax planning strategies, and federal and state income tax rules and regulations. At March 31, 2011, we determined that no valuation allowance was required to be taken against our deferred tax asset other than a valuation allowance to reduce our state net operating loss carryforwards to an amount which we believe the benefit will more likely than not be realized. We continue to assess the amount of tax benefits we may realize.

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Financial Condition

Loans:

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

LOAN PORTFOLIO ANALYSIS
(Dollar amounts in thousands)


	March 31, 2011			December 31, 2010			Percent Change

Amount of Loans by Type:
Real estate-mortgage:
Commercial	$	330,226		$	344,263			(4.1	)%
1-4 family residential
First liens		79,091			76,874			2.9	%
Junior liens		10,175			11,143			(8.7	)%
Home equity		41,056			41,432			(0.9	)%
Commercial, financial and agricultural		81,688			73,928			10.5	%
Real estate-construction		53,298			55,467			(3.9	)%
Installment
Credit cards and related plans		1,678			1,662			1.0	%
Other		7,898			8,563			(7.8	)%
Obligations of states and political subdivisions		15,960			16,892			(5.5	)%
Less: deferred origination fees, net of costs		(342	)		(333	)		2.7	%
Less: allowance for loan losses		(12,098	)		(11,502	)		5.2	%
Total	$	608,630		$	618,389			(1.6	)%

Total gross loans at March 31, 2011 decreased $9.8 million (1.6%) from $618.4 million at December 31, 2010 to $608.6 million at March 31, 2011. The decrease is primarily due to reductions in commercial real estate of $14.0 million, partially offset by an increase of $7.8 million (10.5%) in commercial, financial, and agricultural loans. We continue to reduce our exposure in the commercial real estate sector.

Risk Management and the Allowance for Loan Losses:

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

The ALL at March 31, 2011 was $12.1 million, compared to $11.5 million at December 31, 2010. On a quarterly basis, management reviews the adequacy of the ALL. The analysis of the ALL consists of three components: (i) specific reserves established for expected losses relating to impaired loans for which the recorded investment in the loans exceeds its fair value; (ii) general reserves based on historical loan loss experience for significant loan categories; and (iii) general reserves based on qualitative factors such as concentrations and changes in portfolio mix and volume. Allocations of the ALL may be made for specific loans but the entire ALL is available for any loan that, in management’s judgment, should be charged off or for which an actual loss is realized.

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On a regular basis, loan officers review all commercial credit relationships. The loan officers grade commercial credits and the loan review function validates the grades assigned. In the event that a loan review function downgrades a loan, it is included in the ALL analysis process at the lower grade. This grading system is in compliance with regulatory classifications. At least quarterly, all commercial loans that have been deemed impaired are evaluated. In compliance with accounting guidance for impaired loans, the fair value of the loan is determined based on either the present value of expected future cash flows discounted at the loan’s effective interest rate, the market price of the loan or, if the loan is collateral dependent, the fair value of the underlying collateral less the estimated costs to sell. This evaluation may include obtaining supplemental market data and/or routine site visits to offer support to the evaluation process. A specific reserve is then allocated to the loans based on this assessment. Specific reserves are reviewed by the Chief Credit Officer (“CCO”) and management familiar with the credits.

We have two other major components of the ALL that do not pertain to specific loans: “General Reserves – Historical” and “General Reserves – Other.” We determine General Reserves – Historical based on our historical recorded charge-offs of loans in particular categories, analyzed as a group. As it relates to the historical loss component, in December 2009 we reduced the historical loss look-back period from sixteen quarters to between eight and twelve quarters. This was primarily done to enable the model to provide a better reflection of the recent economic times. This resulted in increased allocations that we determined were appropriate. We determine General Reserves – Other by taking into account other factors, such as the concentration of loans in a particular industry or geographic area and adjustments for economic indicators. By nature, our general reserve changes with our fluid lending environment and the overall economic environment in which we lend. As such, we are continually attempting to enhance this portion of the allocation process to reflect anticipated losses in our portfolio driven by these changing factors. Economic statistics, specifically unemployment and inflation rates for national, state and local markets are monitored and factored into the allocation to address repayment risk. Further identification and management of portfolio concentration risks, both by loan category and by specific markets is reflected in the general allocation component. In the fourth quarter of 2009 the model was enhanced to include more specific qualitative factors, as mentioned previously, by loan type.

Nonperforming Loans, Potential Problem Loans and Foreclosed Properties:

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

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NONPERFORMING ASSETS
(Dollar amounts in thousands)


	March 31, 2011			December 31, 2010
Nonperforming Assets:
Nonaccrual loans	$	17,027		$	15,877
Nonaccrual loans, restructured		165			623
Accruing loans past due 90 days or more		—			—
Total nonperforming loans (“NPLs”)	$	17,192		$	16,500
Foreclosed assets, net		13,725			15,952
Total nonperforming assets (“NPAs”)	$	30,917		$	32,452

Restructured loans, accruing⁽¹⁾	$	22,777		$	13,090

Ratios:
ALL to Net Charge-offs (“NCOs”) (annualized)		4.24	x		2.11	x
NCOs to average loans (annualized)		0.45	%		0.85	%
ALL to total loans		1.95	%		1.83	%
NPLs to total loans		2.77	%		2.62	%
NPAs to total assets		3.03	%		3.08	%
ALL to NPLs		70.37	%		69.71	%


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

Restructured nonaccrual loans at December 31, 2010 were $0.6 million. Principal payments of $0.3 million were received on those loans and $0.1 million was charged-off. As of March 31, 2011, principal balances of $0.2 million remain.

Restructured loans accruing at December 31, 2010 were $13.1 million. New restructured loans of $9.7 million were recorded during the quarter. As of March 31, 2011, $22.8 million of principal balances continue to be reported as restructured loans accruing.

Nonperforming loans increased $0.7 million (4.2%) from December 31, 2010 to March 31, 2011. The nonperforming loan relationships are secured primarily by commercial or residential real estate and, secondarily, by personal guarantees from principals of the respective borrowers.

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

PAST DUE LOANS (EXCLUDING NONACCRUALS)
30-89 DAYS PAST DUE
(Dollar amounts in thousands)


	03/31/11			12/31/10			09/30/10			06/30/10			03/31/10

Secured by Real Estate	$	7,615		$	5,428		$	6,877		$	5,474		$	6,730
Commercial and industrial loans		1,877			280			140			476			806
Loans to individuals		54			95			80			41			65
All other loans		60			9			1			149			134
Total	$	9,606		$	5,812		$	7,098		$	6,140		$	7,735

Percentage of total loans		1.55	%		0.92	%		1.12	%		0.96	%		1.20	%

As indicated above, loan balances 30 to 89 days past due have increased by $3.8 million since December 31, 2010. Since March 31, 2011, satisfactory resolution plans were formalized with customers on $3.1 million of the loans 30 to 89 days past due to bring the loans current. As the loans continue through the collection process, we anticipate the current past due levels will continue to decline.

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Information regarding foreclosed properties is as follows:

FORECLOSED PROPERTIES
(Dollar amounts in thousands)


	Three months ended March 31, 2011			Twelve months ended December 31, 2010			Three months ended March 31, 2010

Beginning Balance	$	15,952		$	14,995		$	14,995
Transfer of loans to foreclosed properties		1,244			5,587			1,393
Sales proceeds, net		(2,872	)		(2,520	)		(314	)
Net gain from sale of foreclosed properties		83			39			17
Provision for foreclosed properties		(682	)		(2,149	)		(180	)

Total Foreclosed Properties	$	13,725		$	15,952		$	15,911

Changes in the valuation allowance for losses on foreclosed properties were as follows:


	Three months ended March 31, 2011			Twelve months ended December 31, 2010			Three months ended March 31, 2010

Beginning Balance	$	3,982		$	2,773		$	2,773
Provision charged to operations		682			2,149			180
Allowance recovered on properties disposed		(572	)		(940	)		(147	)

Ending Balance	$	4,092		$	3,982		$	2,806

Investment Portfolio:

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

At March 31, 2011, the investment portfolio (comprising investment securities available for sale) decreased $2.9 million (1.1%) to $263.9 million compared to $266.8 million at December 31, 2010. At March 31, 2011, the investment portfolio represented 25.9% of total assets compared to 25.4% at December 31, 2010.

We closely monitor securities we hold in our investment portfolio that remain in an unrealized loss position for greater than twelve months. Total gross unrealized losses on these securities are $0.4 million at March 31, 2011, representing 40.0% of total gross unrealized securities losses. Based on an in-depth analysis, which may include ratings from external rating agencies and/or brokers, of the specific instruments and the creditworthiness of the related issuers, including their ability to continue payments under the terms of the security agreements, no declines were deemed to be other-than-temporary. Additionally, we do not have the intent to sell the securities and it is not more likely than not that we will be required to sell these securities before their anticipated recovery. If at any point in time any losses are considered other-than-temporary, we would be required to recognize other-than-temporary impairment. This would require us to assess the cash flows expected to be collected from the security. The difference between the present value of the cash flows expected to be collected and the amortized cost basis would result in a credit loss for the amount of the impairment. This amount would reduce our earnings. The remaining portion of the impairment related to factors other than credit loss would be recognized through other comprehensive income/(loss). At March 31, 2011 and December 31, 2010, we did not hold securities of any one issuer, other than the U.S. Government and its agencies, in an amount greater than 10% of stockholders’ equity.

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Deposits:

Total deposits at March 31, 2011 decreased $28.7 million (3.4%) to $823.9 million from $852.6 million at December 31, 2010. This decrease was a result of a decrease of $27.4 million (11.3%) in our demand deposits from $242.1 million at December 31, 2010 to $214.7 million at March 31, 2011, a $2.0 million (0.7%) decrease in our savings deposits from $277.2 million at December 31, 2010 to $275.2 million at March 31, 2011, and a decrease in our time deposits (excluding brokered time deposits) of $6.1 million (2.1%) from $287.3 million at December 31, 2010 to $281.2 million at March 31, 2011, partially offset by a $6.8 million (14.8%) increase in our brokered deposits from $46.0 million at December 31, 2010 to $52.8 million at March 31, 2011. Total interest-bearing deposits decreased $29.7 million (3.9%) while non-interest-bearing deposits increased $1.0 million (1.2%) from December 31, 2010 to March 31, 2011.

During the first quarter of 2011, $2.5 million of new brokered certificates of deposit were originated at terms we considered favorable compared to interest rates in the retail market, further lengthening the maturities of our liabilities in a low interest rate environment.

Emphasis has been, and will continue to be, placed on generating additional core deposits in 2011 through competitive pricing of deposit products and through our existing branch delivery systems. We will also attempt to attract and retain core deposit accounts through new product offerings and quality customer service. We also may increase brokered certificates of deposit during 2011 as an additional source of funds to support loan growth or other asset and liability needs in the event that core deposit growth goals are not achieved. Under that scenario, we will continue to look at other wholesale sources of funds if the brokered certificate of deposit market were to become illiquid or more costly. If liquidity concerns arise, we have alternative sources of funds such as lines of credit with correspondent banks and borrowing arrangements with the Federal Home Loan Bank and through the discount window at the Federal Reserve.

Other Funding Sources:

Securities under agreements to repurchase increased $7.8 million (40.5%) from $19.2 million at December 31, 2010 to $27.0 million at March 31, 2011. We did not have any federal funds purchased at either March 31, 2011 or December 31, 2010.

FHLB advances were $55.0 million at March 31, 2011, compared to $70.0 million at December 31, 2010. During the first quarter of 2011, $15.0 million of borrowings matured and were paid in full. We will borrow funds if borrowing is a less costly form of funding loans than acquiring deposits or if deposit growth is not sufficient. The availability of deposits also determines the amount of funds we need to borrow in order to fund loan demand.

Long Term Debt:

In March 2006, we issued $16.1 million of variable rate, trust preferred securities (“TruPS”) and $0.5 million of trust common securities through Baylake Capital Trust II (the “Trust”) that adjust quarterly at a rate equal to 1.35% over the three month LIBOR. At March 31, 2011, the interest rate on these securities was 1.64%. These securities were issued to replace trust preferred securities issued in 2001 through Baylake Capital Trust I. For bank regulatory purposes, these securities are considered Tier 1 capital.

The Trust’s ability to pay amounts due on the TruPS is solely dependent upon us making payment on the related subordinated debentures (“Debentures”) to the Trust. Under the terms of the Debentures, we would be precluded from paying dividends on our common stock if we were in default under the Debentures, if we exercised our right to defer payment of interest on the Debentures or if certain related defaults occurred. After discussion with our regulators during the first quarter of 2011, we exercised our right to defer payment of interest on the Debentures beginning with the March 30, 2011 interest payment. The expense related to the interest payment was recorded with a corresponding liability for the interest payment amount. We will discuss with our regulators and reevaluate the continued deferral of interest payments on the TruPS quarterly as future payments come due.

During 2009 and 2010, we completed several separate closings of a private placement of Convertible Notes. The Convertible Notes were offered and sold in reliance on the exemption from registration under Section 4(2) of the Securities Act of 1933 and Rule 506 promulgated there under. The total amount of the Convertible Notes outstanding as of the date of this report is $9.45 million. The offering expired on April 30, 2010.

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The Convertible Notes accrue interest at a fixed rate of 10% per annum upon issuance and until maturity or earlier conversion or redemption. Interest is payable quarterly, in arrears, on January 1, April 1, July 1, and October 1, of each year. The Convertible Notes are convertible into shares of our common stock at a conversion ratio of one share of common stock for each $5.00 in aggregate principal amount held on the record date of the conversion subject to certain adjustments as described in the Convertible Notes. Prior to October 1, 2014, each holder of the Convertible Notes may convert up to 100% (at the discretion of the holder) of the original principal amount into shares of our common stock at the conversion ratio. On October 1, 2014, one-half of the original principal amounts are mandatorily convertible into common stock at the conversion ratio if voluntary conversion has not occurred. The principal amount of any Convertible Note that has not been converted will be payable at maturity on June 30, 2017.

Contractual Obligations:

We use a variety of financial instruments in the normal course of business to meet the financial needs of our customers. These financial instruments include commitments to extend credit, commitments to originate residential mortgage loans held for sale, commercial letters of credit, standby letters of credit, and forward commitments to sell residential mortgage loans. Please refer to our Annual Report on Form 10-K for the year ended December 31, 2010 for quantitative and qualitative disclosures about our fixed and determinable contractual obligations. Items disclosed in the 2010 Annual Report on Form 10-K have not materially changed since that Report was filed.

The following table summarizes our significant contractual obligations and commitments at March 31, 2011:

CONTRACTUAL OBLIGATIONS
(Dollar amounts in thousands)


	Within 1 Year		1-3 Years		3-5 Years		After 5 Years		Total

Certificates of deposit and other time deposit obligations	$	201,304	$	115,568	$	14,678	$	—	$	331,550
Repurchase agreements		27,021		—		—		—		27,021
Federal Home Loan Bank advances		—		30,000		25,000		—		55,000
Subordinated debentures		—		—		—		16,100		16,100
Convertible promissory notes ⁽¹⁾		—		—		4,725		4,725		9,450
Total	$	228,325	$	145,568	$	44,403	$	20,825	$	439,121


⁽¹⁾	One-half of the Convertible Notes are mandatorily converted to shares of common stock by October 1, 2014. The principal amount of any Convertible Note that has not been converted or redeemed will be payable at maturity on June 30, 2017.

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Off- Balance Sheet Arrangements:

The following is a summary of our off-balance sheet commitments, all of which were lending-related commitments:

LENDING RELATED COMMITMENTS
(Dollar amounts in thousands)


	March 31, 2011		December 31, 2010

Commitments to fund home equity line loans	$	52,580	$	51,195
Commitments to fund 1-4 family loans		2,158		1,394
Commitments to fund residential real estate construction loans		1,341		777
Commitments unused on various other lines of credit loans		128,949		133,457
Total commitments to extend credit	$	185,028	$	186,823
Financial standby letters of credit	$	10,106	$	12,448

Liquidity:

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

Our primary sources of funds are dividends from Baylake Bank, investment income, and net proceeds from borrowings. We may also undertake offerings of debt and issue our common stock if and when we deem it prudent to do so, subject to regulatory approval. We generally manage our liquidity position in order to provide funds necessary to meet interest obligations of our trust preferred securities and convertible notes, pay dividends to our shareholders, subject to regulatory restrictions, and repurchase shares. Such restrictions, which govern all state chartered banks, preclude the payment of dividends without the prior written consent of the Wisconsin Department of Financial Institutions - Division of Banking (“WDFI”) if dividends declared and paid by such bank in either of the two immediately preceding years exceeded that bank’s net income for those years. In consultation with our federal and state regulators, our Board of Directors elected to forego the dividend to our shareholders beginning in the first quarter of 2008. In addition, in order to pay dividends in the future, we will need to seek prior approval from WDFI as well as the Federal Reserve Board. There is no assurance that we would receive such approval if sought.

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

Maturing investments have historically been a primary source of liquidity. For the three months ended March 31, 2011, principal payments totaling $12.9 million were received on maturing investments. In addition, we received proceeds of $16.2 million from the sale of investments and we purchased $24.8 million in investments in the same period. At March 31, 2011 the investment portfolio contained $161.5 million of mortgage-backed securities issued by U.S. government sponsored agencies, representing 61.2% of the total investment portfolio. These securities tend to be highly marketable.

Deposit decreases, reflected as a financing activity in the March 31, 2011 Unaudited Consolidated Statements of Cash Flows, resulted in $28.7 million of cash outflow during the first three months of 2011. Deposit growth is generally the most stable source of liquidity, although brokered deposits, which are inherently less stable than locally-generated core deposits, are sometimes used. Our reliance on brokered deposits increased $6.8 million from $46.0 million at December 31, 2010 to $52.8 million at March 31, 2011. During the first quarter of 2011, $2.5 million of new brokered CDs were originated. Interest rates on the CDs were reflective of the low rate environment, and had a two year maturity. If at any point in the future we fall below the “well capitalized” regulatory capital threshold, it will become more difficult for us to obtain brokered deposits. Also affecting liquidity are core deposit growth levels, certificate of deposit maturity structure and retention, and characteristics and diversification of wholesale funding sources affecting the channels by which brokered deposits are acquired. Conversely, deposit outflow will cause a need to develop alternative sources of funds, which may not be as liquid and potentially a more costly alternative.

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The scheduled payments and maturities of loans can provide a source of additional liquidity. There are $246.0 million, or 39.6% of total loans, maturing within one year of March 31, 2011. Factors affecting liquidity relative to loans are loan origination volumes, loan prepayment rates and the maturity structure of existing loans. The liquidity position is influenced by changes in interest rates, economic conditions and competition. Conversely, loan demand creates a need for liquidity that may cause us to acquire other sources of funding, some of which could be more difficult to find and more costly to secure.

Within the classification of short-term borrowings at March 31, 2011, securities sold under agreements to repurchase totaled $27.0 million compared to $19.2 million at the end of 2010. Securities sold under agreements to repurchase are obtained from a base of business customers. Short-term and long-term borrowings from the FHLB are another source of funds, totaling $55.0 million at March 31, 2011 and $70.0 million at December 31, 2010. During the first quarter of 2011, we reduced our FHLB borrowings by $15.0 million.

We expect that deposit growth will be our primary source of liquidity on a long-term basis, along with a stable earnings base, the resulting cash generated by operating activities and a strong capital position. We expect deposit growth to be a reliable funding source in the future as a result of marketing efforts to attract and retain core deposits. In addition, we may acquire additional brokered deposits as funding for short-term liquidity needs. Short-term liquidity needs will also be addressed by growth in short-term borrowings, maturing federal funds sold and portfolio investments, and loan maturities and prepayments.

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

Capital Resources:

Stockholders’ equity at March 31, 2011 and December 31, 2010 was $79.0 million and $77.1 million, respectively, reflecting an increase of $1.9 million (2.5%) during the first three months of 2011. The increase in stockholders’ equity was primarily related to our net income of $0.7 million and an increase in comprehensive income of $1.2 million (as a result of an increase in unrealized gains on available-for-sale securities). The ratio of stockholders’ equity to assets was 7.8% and 7.3% at March 31, 2011 and December 31, 2010, respectively.

No cash dividends were declared during the first three months of 2011 or during all of 2010. Beginning in February 2008, our Board of Directors, in consultation with our federal and state bank regulators, elected to forego the payment of cash dividends on our common stock. We continue to monitor the payment of dividends in relationship to our financial position on a quarterly basis and our intention is to reinstate payment of dividends at the earliest appropriate opportunity, however there is no assurance if or when we will be able to do so or if we do, in what amounts. Our ability to pay dividends is subject to various factors including, among other things, sufficient earnings, available capital, board discretion and regulatory compliance. In order to pay dividends, advance approval from the WDFI as well as the Federal Reserve Board will need to be obtained. There is no assurance that we would receive such approval if sought.

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

The Federal Reserve has established capital adequacy rules which take into account risk attributable to balance sheet assets and off-balance sheet activities. All banks and bank holding companies must meet a minimum total risk-based capital ratio of 8% of which at least half must comprise core capital elements defined as Tier 1 capital. The federal banking agencies also have adopted leverage capital guidelines which banks and bank holding companies must meet. Under these guidelines, the most highly rated banking organizations must meet a leverage ratio of at least 3% Tier 1 capital to assets, while lower rated banking organizations must maintain a minimum ratio of 4% or 5%, depending on the rating. Failure to meet minimum capital requirements can initiate certain mandatory, as well as possible additional discretionary actions by regulators that, if undertaken, could have a direct material effect on our consolidated financial statements. At March 31, 2011, we were in excess of the minimum capital ratios established for “well capitalized” under the regulatory framework for the prompt corrective action categorization. There are no conditions or events since that date that we believe have changed our category. To be “well capitalized” under the regulatory framework, the Tier 1 capital ratio must meet or exceed 6%, the total capital ratio must meet or exceed 10% and the leverage ratio must meet or exceed 5%.

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Effective December 29, 2010, we and the Bank entered into a written agreement with the Federal Reserve Bank of Chicago and the State of Wisconsin Department of Financial Institutions (the “Written Agreement”). Under the terms of the Written Agreement, both we and the Bank have agreed to: (a) submit for approval plans to maintain sufficient capital; (b) comply with applicable notice provisions with respect to the appointment of new directors and senior executive officers and legal and regulatory limitations on indemnification payments and severance payments; (c) refrain from declaring or paying dividends absent prior regulatory approval. It is the intent of our Directors and senior management and the Directors and senior management of the Bank to diligently seek to comply with all requirements specified in the Written Agreement.

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

The following tables present our and Baylake Bank’s capital ratios as of March 31, 2011 and December 31, 2010:

CAPITAL RATIOS
(Dollar amounts in thousands)


	Actual					Required For Capital Adequacy Purposes					Required To Be Well Capitalized Under Prompt Corrective Action Provisions
	Amount		Ratio			Amount		Ratio			Amount		Ratio
As of March 31, 2011
Total Capital (to Risk-Weighted Assets)
Company	$	96,536		13.14	%	$	58,781		8.00	%	$	N/A		N/A
Bank		94,616		12.87	%		58,815		8.00	%		73,519		10.00	%
Tier 1 Capital (to Risk-Weighted Assets)
Company	$	77,865		10.60	%	$	29,390		4.00	%	$	N/A		N/A
Bank		85,390		11.61	%		29,408		4.00	%		44,111		6.00	%
Tier 1 Capital (to Average Assets)
Company	$	77,865		7.58	%	$	41,111		4.00	%	$	N/A		N/A
Bank		85,390		8.30	%		41,168		4.00	%		51,460		5.00	%


	Actual					Required For Capital Adequacy Purposes					Required To Be Well Capitalized Under Prompt Corrective Action Provisions
	Amount		Ratio			Amount		Ratio			Amount		Ratio
As of December 31, 2010
Total Capital (to Risk-Weighted Assets)
Company	$	96,245		12.76	%	$	60,364		8.00	%	$	N/A		N/A
Bank		94,194		12.48	%		60,394		8.00	%		75,493		10.00	%
Tier 1 Capital (to Risk-Weighted Assets)
Company	$	77,338		10.25	%	$	30,182		4.00	%	$	N/A		N/A
Bank		84,732		11.22	%		30,197		4.00	%		45,296		6.00	%
Tier 1 Capital (to Average Assets)
Company	$	77,338		7.41	%	$	41,720		4.00	%	$	N/A		N/A
Bank		84,732		8.12	%		41,237		4.00	%		52,171		5.00	%

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Item 3. Quantitative and Qualitative Disclosures about Market Risk

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

Our earnings are derived from the operations of our direct and indirect subsidiaries with particular reliance on net interest income, calculated as the difference between interest earned on loans and investments and the interest expense paid on deposits and other interest-bearing liabilities, including advances from FHLB and other subordinated debentures. Like other financial institutions, our interest income and interest expense are affected by general economic conditions and by the policies of regulatory authorities, including the monetary policies of the Federal Reserve. Changes in the economic environment may influence, among other matters, the growth rate of loans and deposits, the quality of the loan portfolio and loan and deposit pricing. Fluctuations in interest rates are not predictable or controllable.

As of March 31, 2011, we were in compliance with our management policies with respect to interest rate risk. We have not experienced any material changes to our market risk position since December 31, 2010, as described in our 2010 Annual Report on Form 10-K.

Our overall interest rate sensitivity is demonstrated by net interest income shock analysis which measures the change in net interest income in the event of hypothetical changes in interest rates. This analysis assesses the risk of change in net interest income in the event of sudden and sustained 100 bp to 200 bp increases and decreases in market interest rates. The table below presents our projected changes in net interest income for the various rate shock levels at March 31, 2011.

INTEREST SENSITIVITY
(Dollar amounts in thousands)


	Change in Net Interest Income Over One Year Horizon
	At March 31, 2011						At December 31, 2010
Change in levels of interest rates	Dollar change			Percentage change			Dollar change			Percentage change
+200 bp	$	(731	)		(2.3	)%	$	191			0.6	%
+100 bp		(841	)		(2.6	)%		(118	)		(0.4	)%
Base		—			—			—			—
-100 bp		(1,289	)		(4.0	)%		(1,468	)		(4.4	)%
-200 bp		(2,530	)		(7.9	)%		(2,622	)		(7.9	)%

As shown above, at March 31, 2011, the effect of an immediate 200 bp increase in interest rates would have decreased our net interest income by $0.7 million or 2.3%. The effect of an immediate 200 bp reduction in rates would have decreased our net interest income by $2.5 million or 7.9%. However, a 200 bp reduction in rates is not realistic given the low interest rate environment that currently exists. An interest rate floor of zero is used rather than assuming a negative interest rate.

During the first three months of 2011, Baylake Bank lengthened slightly the duration of its liabilities by issuing longer term brokered deposits. This effort has contributed to moderation of the liability sensitivity that was present at December 31, 2010.

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

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Item 4. Controls and Procedures

Disclosures Controls and Procedures: Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures, as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) as of March 31, 2011. Based on such evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, our disclosure controls and procedures are effective.

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

Internal Control Over Financial Reporting

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

PART II – OTHER INFORMATION

Item 1. Legal Proceedings

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

Item 1A. Risk Factors

See “Risk Factors” in Item 1A of our annual report on Form 10-K for the year ended December 31, 2010. There have been no material changes to the risk factors since then.

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

None.

Item 3. Defaults Upon Senior Securities

Not applicable.

Item 5. Other Information

Not applicable.

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Item 6. Exhibits

The following exhibits are furnished herewith:


Exhibit Number		Description

31.1		Certification under Section 302 of Sarbanes-Oxley by Robert J. Cera, Chief Executive Officer, is attached hereto.

31.2		Certification under Section 302 of Sarbanes-Oxley by Kevin L. LaLuzerne, Chief Financial Officer, is attached hereto.

32.1		Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of Sarbanes-Oxley is attached hereto.

32.2		Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of Sarbanes-Oxley is attached hereto.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


		BAYLAKE CORP.


Date:	May 6, 2011	/s/ Robert J. Cera
		Robert J. Cera
		President and Chief Executive Officer


Date:	May 6, 2011	/s/ Kevin L. LaLuzerne
		Kevin L. LaLuzerne
		Treasurer and Chief Financial Officer

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