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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
 FORM 10K þ
    
    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 For the fiscal year ended December 31, 2004 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 Commission file number 0-8679 BAYLAKE CORP.  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)Registrants telephone number, including area code:
    
    
    920/743-5551Securities registered pursuant to Section 12(b) of the Act:

        
    NoneSecurities registered pursuant to Section 12(g) of the Act:
    
    
    Common Stock $5 Par
Value
 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for
such shorter period that the registrant was required to file such reports) and (2) has been subject
to such filing requirements for the past 90 days.
Yes þ No o Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is
not contained herein, and will not be contained, to the best of the registrants knowledge, in
definitive proxy or information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. o Indicate by check mark whether the registrant is an accelerated filed (as defined in Rule 12b-2 of
the Act).
Yes þ No o As of March 1, 2005, 7,697,777 shares of Common Stock were outstanding. As of June 30, 2004, (the
last business day of the Registrants most recently completed second fiscal quarter) the aggregate
market value of the shares of the Common Stock (based upon the $15.50 reported bid price on that
date) held by non-affiliates (excludes a total of 964,854 shares reported as beneficially owned by
directors and executive officers  does not constitute an admission as to affiliate status) was
approximately $103,670,557. DOCUMENTS INCORPORATED BY REFERENCE Part of Form 10-K Into WhichDocument
    
    Portions of Document are IncorporatedDefinitive Proxy Statement for 2005 Annual Meeting of
    
    Part IIIShareholders to be filed within 120 days of the fiscal yearended December 31, 2004
   1




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2004 FORM 10-K
TABLE OF CONTENTS DESCRIPTION
    

PAGE NO.PART IITEM 1. Business
    
    
    3ITEM 2. Properties
    
    
    9ITEM 3. Legal Proceedings
    
    
    9ITEM 4. Submission of Matters to a Vote of Security Holders
    
    
    9PART IIITEM 5. Market for Registrants Common Equity, Related
Stockholder Matters and Issuer Purchase of Equity
Securities
    
    
    9ITEM 6. Selected Financial Data
    
    
    10ITEM 7. Managements Discussion and Analysis of Financial
Condition and Results of Operations
    
    
    13ITEM 7A. Quantitative and Qualitative Disclosures about Market
Risk
    
    
    45ITEM 8. Financial Statements and Supplementary Data
    
    
    45ITEM 9. Changes and Disagreements with Accountants on Accounting and
Financial Disclosure.
    
    
    81ITEM 9A Controls and Procedures
    
    
    81ITEM 9B Other Information
    
    
    81PART IIIITEM 10. Directors and Executive Officers of the Registrant
    
    
    82ITEM 11. Executive Compensation
    
    
    82ITEM 12. Security Ownership of Certain Beneficial Owners and Management
    
    
    83ITEM 13. Certain Relationships and Related Transactions
    
    
    83ITEM 14. Principal Accountant Fees and Services
    
    
    83PART IVITEM 15. Exhibits and Financial Statement Schedules
    
    
    83Signatures
    
    
    85Supplemental Executive Retirement PlanComputation of RatiosSubsidiariesConsent of Independent Registered Public Accounting FirmConsent of Independent Registered Public Accounting FirmSection 302 Certification of CEOSection 302 Certification of CFOSection 906 Certification of CEOSection 906 Certification of CFO
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Special Note Regarding
Forward-Looking Statements The statements contained in this report, including the discussion and analysis of financial
condition and results of operations, that are not historical facts are forward-looking statements
within the meaning of the Private Securities Litigation Reform Act of 1995 and are intended to be
covered by the safe-harbor provisions for forward-looking statements contained in that Act. For
example, all statements regarding our expected financial position, business and strategies are
forward-looking statements. The words anticipates, believes, estimates, seeks, expects,
plans, intends, and similar expressions, as they relate to Baylake or its management, are also
intended to identify forward-looking statements. Forward-looking statements are made based upon
managements current expectations and beliefs concerning future developments and their potential
effects upon Baylake or the Bank. Although we believe that the expectations reflected in these
forward-looking statements are reasonable, and have based these expectations on our beliefs as well
as assumptions we have made as part of the conduct of our business, these expectations may prove to
be incorrect. Actual results may differ materially from those included in the forward-looking
statements. Important factors that could cause actual results to differ materially from our
expectations include, without limitation, the failure of a significant number of borrowers to repay
their loans (the level of non-performing loans), general changes in economic conditions (including
those related to tourism) and changes in interest rates, including the effects of the current
increasing interest rate environment on loan demand, collateral value and lending margins, as well
as restrictions imposed on us by regulations or regulators of the banking industry. Many of these
factors are not within the control of Baylake or management. Baylake undertakes no obligation to
update or revise any forward-looking information, whether as a result of new information, future
developments or otherwise. 
 ITEM 1. BUSINESS General Baylake Corp., a Wisconsin corporation organized in 1976, (Baylake or the Company), is a
registered bank holding company under the Federal Bank Holding Company Act of 1956, as amended.
Baylakes primary activities consist of holding indirectly the stock of Baylake Bank (Bank), and
providing a wide range of banking and related business activities, through the Bank and its other
subsidiaries. Baylake has elected to become a financial holding company under the Gramm-Leach
Bliley Act of 1999 (GLB Act). Baylake Bank The Bank is a Wisconsin state bank originally chartered in 1876. The Bank conducts its community
banking business through 27 full-service financial centers located throughout Northeast Wisconsin,
in Brown, Door, Green Lake, Kewaunee, Manitowoc, Outagamie, Waupaca, and Waushara Counties. The
Bank has eight financial centers in Door County, which is known for its tourism related services.
The Bank has seven financial centers in Brown County, which includes the city of Green Bay and has
a broader range of service, manufacturing and retail job segments in its market. The balance of
the Banks financial centers are located in the remaining locations, which include a combination of
small cities and smaller communities. Other principal industries in Banks market area include
light industry and manufacturing, agriculture, food related products, and to a lesser degree,
lumber and furniture. The Bank is an independent community bank offering a full range of financial services primarily to
small businesses and individuals located in its market area. To complement the Banks traditional
banking products, such as demand deposit accounts, various savings account plans, certificates of
deposit and real estate, consumer, commercial/industrial and agricultural loans, the Bank offers
its customers a variety of services. These services include transfer agency, personal and
corporate trust, insurance agency, brokerage, financial planning, cash management and electronic
banking services. Subsidiaries In addition to its banking operations, the Bank owns three non-bank subsidiaries: Baylake
Investments, Inc., located in Las Vegas, Nevada, which holds and manages an investment and loan
portfolio; Baylake City Center LLC (which owns real property in Green Bay and currently renovating
a building, a substantial portion which will be used for a branch 3




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office); and Baylake Insurance
Agency, Inc., which offers various types of insurance products to the general public as an
independent agent. The Bank also owns a minority interest (49.8% of the outstanding common stock)
in United Financial Services, Inc. (UFS), a data processing services company, located in Grafton,
Wisconsin, that provides data processing services to approximately 26 banks (including the Bank)
and ATM processing services to 50 banks. In September 2004, in a tax-free internal
reorganization, the Bank merged its wholly-owned subsidiaries, Bank of Sturgeon Bay Building
Corporation (which owned Banks main office
building in Sturgeon Bay, Wisconsin and nearby conference center and underlying real property) and
Cornerstone Financial, Inc. (which managed the conference center facilities) into the Bank. At December 31, 2004, the Company had total assets of $1.0 billion. For additional financial
information, see the Consolidated Financial Statements and Notes beginning at Item 8 of this Form
10-K. Corporate Governance Matters Baylake maintains a website
at www.baylake.com. The Company makes available through that website,
free of charge, copies of our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current
Reports on Form 8-K, and amendments to those reports, as soon as reasonably practical after Baylake
electronically files those materials with, or furnishes them to, the Securities and Exchange
Commission (SEC). The Companys SEC reports can be accessed through the Baylake Corp link of our
website. The SEC also maintains a website at www.sec.gov that contains reports, proxy statements
and other information regarding SEC registrants. Lending The Company offers short-term and long-term loans on a secured and unsecured basis for business and
personal purposes. It makes real estate, commercial/industrial, agricultural and consumer loans, in
accordance with the basic lending policies established by its board of directors. The Company
focuses lending activities on individuals and small businesses in its market area. Lending has
been primarily within the State of Wisconsin. The Company does not conduct any substantial
business with foreign obligors. The markets served by the Company include a wide variety of
industries, including a limited concentration in tourism related industries, directly and
indirectly. Loans to customers in the restaurant and lodging business totaled $131.4 million at
the end of 2004, or 17.6% of our loans at that date. Although competitive and economic pressures
exist in this segment, business remains strong in the markets served by the Company. However, any
general weakness in the economy of Northeastern Wisconsin (as a result, for example, of a decline
in its manufacturing or tourism industries or otherwise) could have a material adverse effect on
the business and operations of Baylake. In particular, a decline in the Door County tourism
business would not only affect our customers in the restaurant and lodging business, and therefore
loans to them as described above, but could also affect loans and other business relationships with
persons employed in that industry and real estate values (including collateral values) in the area. The Companys total outstanding loans as of December 31, 2004 amounted to approximately $757.3
million, consisting of 56.1% commercial real estate loans, 17.7% residential real estate loans,
10.6% construction and land development real estate loans, 11.1% commercial and industrial loans,
1.8% installment and 2.7% municipal loans. Investments The Company maintains a portfolio of investments, primarily consisting of U.S. Treasury securities,
U.S. Government Agency securities, mortgage-backed securities, and obligations of states and their
political subdivisions. The Company attempts to balance its portfolio to manage interest rate
risks, maximize tax advantages and meet its liquidity needs while endeavoring to maximize
investment income. Deposits The Company offers a broad range of depository products, including non-interest bearing demand
deposits, interest-bearing demand deposits, various savings and money market accounts and
certificates of deposit. Deposits at 4




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the Company are insured by the Bank Insurance Fund of the
Federal Deposit Insurance Corporation (FDIC) up to statutory limits. At December 31, 2004, the
Companys total deposits amounted to $844.5 million, including interest bearing deposits of $724.0
million and non-interest bearing deposits of $120.5 million. Other Customer Services and Products Other services and products offered by the Company include transfer agency, safe deposit box
services, personal and corporate trust services, conference center facilities, insurance agency and
brokerage services, cash management, private banking, financial planning and electronic banking
services, including eBanc, an Internet banking product for its customers. Seasonality The tourism industry, particularly in the Door County market, substantially affects our business
with our customers, particularly those customers in the restaurant and lodging business. The
tourist business of Door County is seasonal, with the season
beginning in early spring and continuing until late fall. The seasonal nature of the tourist
business tends to result in increased demands for loans shortly before and during the tourist
season and causes reduced deposits shortly before and during the early part of the tourist season,
nonetheless, the financial needs of those involved in the delivery of tourist related services is a
year around concern. The Companys expansion into other market areas has reduced the concentration level of
tourism-related business, but these types of businesses still remain an important element of the
core business served by the Company. Competition The financial services industry is highly competitive. The Company competes with other financial
institutions and businesses in both attracting and retaining deposits and making loans in all of
its principal markets. The primary factors in competing for deposits are interest rates,
personalized services, the quality and range of financial services, convenience of office locations
and office hours. Competition for deposit products comes primarily from other commercial banks,
savings banks, credit unions and non-bank competitors, including insurance companies, money market
and mutual funds, and other investment alternatives. The primary factors in competing for loans
are interest rates, loan origination fees, the quality and range of lending services and
personalized services. Competition for loans comes primarily from other commercial banks, savings
banks, mortgage banking firms, credit unions, finance companies, leasing companies, and other
financial intermediaries. The Company also faces direct competition from members of bank holding
company systems that have greater assets and resources than those of the Company. Regulation and Supervision The banking industry is highly regulated by both federal and state regulatory authorities.
Regulation includes, among other things, capital and reserve requirements, dividend limitations,
limitations on products and services offered, geographical limits, consumer credit regulations,
community reinvestment requirements and restrictions on transactions with affiliated parties. The
system of supervision and regulation applicable to Baylake and the Bank establishes a comprehensive
framework for our respective operations and is intended primarily for the protection of the FDICs
deposit funds, the depositors of the Bank and the public, rather than shareholders of the Bank or
Baylake. Any change in government regulation may have a material adverse effect on the business of
Baylake and the Bank. Baylake Corp.As a financial holding company, Baylake is subject to regulation by the Federal
Reserve Board under the Bank Holding Company Act of 1956 (BHCA). Under the BHCA, Baylake is
subject to examination by the Board of Governors of the Federal Reserve System (the FRB) and is
required to file reports of its operations and such additional information as the FRB may require.
Baylake is also subject to supervision and examination by the Wisconsin Department of Financial
Institutions under Wisconsin law. Under FRB policy, Baylake is expected to act as a source of
financial strength to the Bank and to commit resources to support the Bank in circumstances where
Baylake might not do so, absent such policy. 5




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Any loans by a bank holding company to a subsidiary bank are subordinate in right of payment to
deposits and to certain other indebtedness of such subsidiary bank. In the event of a bank holding
companys bankruptcy, any commitment by the bank holding company to a federal bank regulatory
agency to maintain the capital of a subsidiary bank will be assumed by the bankruptcy trustee and
entitled to a priority of payment. With certain limited exceptions, the BHCA prohibits bank holding companies from acquiring direct or
indirect ownership or control of voting shares or assets of any company other than a bank, unless
the company involved is engaged solely in one or more activities which the FRB has determined to be
financial in nature, and the extent to which state laws will apply to managing or controlling
activities of banks as to be incidental to these operations. The FRB uses capital adequacy guidelines in its examination and regulation of bank holding
companies. If capital falls below minimum guidelines, a bank holding company may, among other
things, be denied approval to acquire or establish banks or non-bank businesses. The FRB has issued a policy statement on the payment of cash dividends by bank holding companies,
which expresses the FRBs view that a bank holding company should pay cash dividends only to the
extent that the Companys net income for the past year is sufficient to cover both the cash
dividend and a rate of retention consistent with the Companys needs. The FRB also indicated that
it would be inappropriate for a company experiencing serious financial problems to borrow to pay
dividends. In addition, compliance with capital adequacy guidelines at both the Bank and the
Company could affect the Companys ability to pay dividends, if the Companys capital levels were
to decrease. The Sarbanes-Oxley Act of 2002 (SOA), addresses, among other issues, director and officer
responsibilities for proper corporate governance of publicly traded companies, including the
establishment of audit committees, certification of financial
statements, auditor independence and accounting standards, executive compensation, insider loans,
whistleblower protection, and enhanced and timely disclosure of corporate information. In general,
SOA is intended to allow stockholders to monitor more effectively the performance of publicly
traded companies and their management. The Securities and Exchange Commission has enacted rules to
implement various provisions of SOA which affect the Company as a publicly-held entity. The
federal banking regulators also have adopted generally similar requirements concerning the
certification of financial statements. Among these requirements is the identification of a
company-wide code of conduct of the Bank. The SOA also imposes additional corporate governance
requirements on publicly-held companies, particularly relating to the functioning of its audit
committee. Beginning the fiscal year ended December 31, 2004, the Company has become subject to
the requirement of annual attestation and review of its internal control on financial reporting.
The Company is taking advantage of the delay granted by the SEC which permits the deferral for 45
days of filing the related reports. See Item 9A. Baylake Bank.As a FRB member Wisconsin-chartered bank, the Bank is subject to supervision and
regulation by the Wisconsin Department of Financial Institutions (the WDFI), the Board of
Governors of the Federal Reserve System and the FDIC. Federal law and regulations establish
supervisory standards applicable to the lending activities of the Bank, including internal
controls, credit underwriting, loan documentation and loan-to-value ratios for loans secured by
real property. The Bank is subject to federal and state statutory and regulatory restrictions on any extension of
credit to Baylake or its subsidiaries, on investments in the stock or other securities of Baylake
or its subsidiaries, on the payment of dividends to Baylake, and on the acceptance of the stock or
other securities of Baylake or its subsidiaries as collateral for loans to any person. Limitations
and reporting requirements are also placed on extension of credit by the Bank to its directors and
officers, to directors and officers of us and our subsidiaries, to principal shareholders of us,
and to related interests of such directors, officers and principal shareholders. In addition,
such legislation and regulations may affect the terms upon which any person becoming a director or
officer of us or one of our subsidiaries or a principal shareholder of us may obtain credit from
banks with which we maintain a correspondent relationship. The FDIC and the FRB have published guidelines establishing operational and managerial standards to
promote the safety and soundness of federally insured depository institutions. The guidelines
establish standards for internal 6




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controls, information systems, internal audit systems, loan
documentation, credit underwriting, interest rate exposure, asset growth, and compensation, fees
and benefits. In general, the guidelines prescribe the goals to be achieved in each area, and each
institution will be responsible for establishing its own procedures to achieve those goals. If an
institution fails to comply with any of the standards set forth in the guidelines, the
institutions primary federal bank regulator may require the institution to submit a plan for
achieving and maintaining compliance. The preamble to the guidelines state that the agencies
expect to require a compliance plan from an institution whose failure to meet one or more of the
standards is of such severity that it could threaten the safe and sound operation of the
institution. Failure to submit an acceptable compliance plan, or failure to adhere to a compliance
plan that has been accepted by the appropriate regulator, would constitute grounds for further
enforcement action. The Banks business includes making a variety of types of loans to individuals. In making these
loans, the Bank is subject to state usury and regulatory laws and to various federal statutes, such
as the Equal Credit Opportunity Act, the Fair Credit Reporting Act, the Truth in Lending Act, the
Real Estate Settlement Procedures Act and the Home Mortgage Disclosure Act, and the regulations
promulgated thereunder, which prohibit discrimination, specify disclosures to be made to borrowers
regarding credit and settlement costs and regulate the mortgage loan servicing activities of the
Bank, including the maintenance and operation of escrow accounts and the transfer of mortgage loan
servicing. The Riegle Act imposed new escrow requirements on depository and non-depository
mortgage lenders and services under the National Flood Insurance Program. In receiving deposits,
the Bank is subject to extensive regulation under state and federal law and regulations, including
the Truth in Savings Act, the Expedited Funds Availability Act, the Bank Secrecy Act, the
Electronic Funds Transfer Act, and the Federal Deposit Insurance Act. Violation of these laws
could result in the imposition of significant damages and fines upon the Bank, its directors and
officers. Under the Community Reinvestment Act, or CRA, and the implementing regulations, the Bank has a
continuing and affirmative obligation to help meet the credit needs of its local community
including low and moderate-income neighborhoods, consistent with the safe and sound operation of
the institution. The CRA requires the board of directors of financial institutions, such as the
Bank, to adopt a CRA statement for each assessment area that, among other things, describes its
efforts to help meet community credit needs and the specific types of credit that the institution
is willing to extend. The Banks service area is designated and comprised of the eight counties
within the geographic area of Central and Northeast, Wisconsin. The Banks board of directors is
required to review the appropriateness of this delineation at least annually. Financial institution regulation has been the subject of significant legislation in recent years
and may be the subject of further significant legislation in the future. This regulation
substantially affects the business and financial results of all financial institutions and holding
companies, including Baylake and its subsidiaries. As an example, Baylake is subject to the
capital and leverage guidelines of the FRB, which requires that Baylakes capital to asset ratio
meet certain minimum standards. For a
discussion of the Federal Reserve Boards guidelines and the Companys applicable ratios, see the
section entitled Capital Resources under Item 7: Managements Discussion and Analysis of
Financial Condition and Results of Operation. Under the Graham Leach Bliley (GLB) Act, all financial institutions, including the Company and
the Bank, are required to adopt privacy policies, restrict the sharing of nonpublic customer data
with nonaffiliated parties at the customers request, and establish procedures and practices to
protect customer data from unauthorized access. The Company has developed such policies and
procedures for itself and the Bank, and believes it is in compliance with all privacy provisions of
the GLB Act. Under Title III of the USA PATRIOT Act (PATRIOT), also known as the International Money
Laundering Abatement and Anti-Terrorism Financing Act of 2001, all financial institutions,
including the Company and Bank, are required to take certain measures to identify customers,
prevent money laundering, monitor certain customer transactions and report suspicious activity to
U.S. law enforcement agencies, and scrutinize or prohibit altogether certain transactions of
special concern. Financial institutions are also required to respond to requests for information
from federal banking regulatory agencies and law enforcement agencies concerning their customers
and their transactions. Information sharing among financial institutions concerning terrorist or
money laundering activities is encouraged by an exemption provided from the privacy provisions of
GLB Act and other laws. The effectiveness of a financial institution in 7




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combating money laundering
activities is a factor to be considered in any application submitted by the financial institution
under the Bank Merger Act, which applies to Bank, or the BHC Act, which applies to Company. The
Company has in place a Bank Secrecy Act compliance program, and it engages in very few transactions
of any kind with foreign financial institutions or foreign persons. The deposits of Baylake Bank are currently insured to the maximum provided by law through the FDIC.
All insured banks are required to pay semi-annual deposit insurance premium assessments to the
FDIC. The FDICIA included provisions to reform the Federal Deposit Insurance System, including the
implementation of risk-based deposit insurance premiums. The FDICIA also permits the FDIC to make
special assessments on insured depository institutions in amounts determined by the FDIC to be
necessary to give its adequate assessment income to repay amounts borrowed from the U.S. Treasury
and other sources, or for any other purpose the FDIC deems necessary. The FDIC has implemented a
risk-based insurance premium system under which banks are assessed insurance premiums based on the
level of risk they present to the FDIC. Banks with higher levels of capital and lower degrees of
supervisory concern are assessed lower premiums than banks with lower levels of capital or a higher
degree of supervisory concern. In addition to general requirements that banks retain specified levels of capital and otherwise
conduct their business in a safe and sound manner, Wisconsin law requires that dividends of
Wisconsin banks declared and paid without approval of the WDFI be paid out of current earnings or,
no more than once within the immediate preceding two years, out of undivided profits in the event
that there have been insufficient net profits. Any other dividends require the prior written
consent of the WDFI. The Bank is in compliance with all applicable capital requirements and may pay
dividends to Baylake. Federal law provides that adequately managed bank holding companies from any state may acquire
banks and bank holding companies located in any other state, subject to certain conditions.
Wisconsin law generally permits establishment of full service bank branch offices statewide. In addition to the matters discussed above, the Bank is subject to numerous other federal and state
laws and regulations which affect its business and operations. Among other things, these laws and
regulations govern transactions with affiliates, prohibitions against tying arrangements, consumer
lending, customer privacy, fair lending standards and other safety and soundness standards.
Financial institution regulatory agencies are given substantial powers to take corrective actions,
which may include restrictions on methods of doing business and the prohibition of certain actions. Employees At December 31, 2004, Baylake and its subsidiaries had 308 full-time equivalent employees. Baylake
considers the relationship with its employees to be good. 8




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ITEM 2. PROPERTIES Baylake does not directly own any real property of any kind. However, the Bank owns twenty-five
branches. The Bank leases its remaining two offices from third parties. The main office building located in Sturgeon Bay serves as headquarters for Baylake as well as the
main banking office of the Bank. The main office also accommodates the expanded business of the
Bank, primarily an insurance agency (Baylake Insurance Agency) and financial services. The
twenty-six branches owned or leased by the Bank are in good condition and considered adequate for
present and near term requirements. In addition, the Bank owns other real property that, when
considered in the aggregate, is not material to its financial position. At December 31, 2004, the properties and equipment of the Company had an aggregate net book value
of approximately $21.6 million. 
 ITEM 3. LEGAL PROCEEDINGS Baylake and its subsidiaries may be involved from time to time in various routine legal proceedings
incidental to its business. Neither Baylake nor any of its subsidiaries is currently engaged in
any legal proceedings that are expected to have a material adverse effect on the results of
operations or financial position of Baylake. 
 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS There were no matters submitted to a vote of security holders during the fourth quarter of fiscal
year 2004. 
 PART II 
 ITEM 5. MARKET FOR THE REGISTRANTS COMMON EQUITY AND RELATED SECURITY HOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES Historically, trading in shares of the Companys Common Stock has been limited. Since mid-1993,
Baylake Common Stock has been listed on the OTC Bulletin Board (Trading symbol: bylk.ob), an
electronic interdealer quotation system providing real-time quotations on eligible securities.
Trading in Baylake Common Stock has been conducted principally by certain brokerage and investment
firms with offices in Door County, Wisconsin that have provided price quotations, and have assisted
individual holders of Baylake Common Stock who wish to purchase or sell shares. In addition,
prices for Baylake Common Stock are reported regularly in The Milwaukee Journal Sentinel
based on information provided by a local brokerage firm. The following table summarizes high and low bid prices and cash dividends paid for the Baylake
Common Stock for the periods indicated. Bid prices are as reported from the OTC Bulletin Board.
The reported high and low prices represent interdealer bid prices, without retail mark-up,
mark-downs or commission, and may not necessarily represent actual transactions. 9




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Calendar period
    
    
    High
    
    
    Low
    
    
    Cash dividends per2003
    
    1st Quarter
    
    $
    14.00
    
    
    $
    13.30
    
    
    $
    0.132nd Quarter
    
    $
    15.00
    
    
    $
    13.10
    
    
    $
    0.133rd Quarter
    
    $
    15.00
    
    
    $
    13.50
    
    
    $
    0.134th Quarter
    
    $
    14.89
    
    
    $
    13.80
    
    
    $
    0.142004
    
    1st Quarter
    
    $
    15.00
    
    
    $
    13.90
    
    
    $
    0.142nd Quarter
    
    $
    16.00
    
    
    $
    14.10
    
    
    $
    0.143rd Quarter
    
    $
    16.00
    
    
    $
    14.20
    
    
    $
    0.144th Quarter
    
    $
    18.55
    
    
    $
    14.30
    
    
    $
    0.15
 Baylake had approximately 1,793 shareholders of record at December 31, 2004. The number of
shareholders does not reflect persons or entities that hold their stock in nominee or street name
through various brokerage firms. Dividends on Baylake Common Stock have historically been paid in cash on a quarterly basis in
March, June, September and January, and Baylake expects to continue this practice for the immediate
future. The holders of Baylake Common Stock are entitled to receive such dividends when and as
declared by Baylakes Board of Directors. In determining the payment of cash dividends, the Board
of Directors of Baylake considers the earnings, capital and debt servicing requirements, financial
ratio guidelines issued by the FRB and other banking regulators, financial conditions of Baylake
and the Bank, and other relevant factors. The ability of Baylake to pay dividends is dependent upon receipt by Baylake of dividends from the
Bank, which is subject to regulatory restrictions. Such restrictions, which govern state chartered
banks, generally limit the payment of dividends on bank stock to the Banks undivided profits after
all payments of all necessary expenses, provided that the Banks surplus equals or exceeds its
capital, as discussed further in Item 7. Management Discussion and Analysis of Financial Condition
and Results of Operation-Capital Resources. In addition, under the terms of Baylakes 10.00%
Junior Subordinated Debentures due 2031, Baylake would be precluded from paying dividends on the
Common Stock if it was in default under the Debentures, if it exercised its right to defer payments
of interest on the Debentures, or if certain related defaults occurred. Baylake maintains a dividend reinvestment plan enabling participating shareholders to elect to
purchase shares of Baylake Common Stock in lieu of receiving cash dividends. Such shares may be
newly issued securities or acquired in the market and will be purchased on behalf of participating
shareholders at their then fair market value. No shares were repurchased by Baylake in the fourth
quarter of 2004. 
 ITEM 6. SELECTED FINANCIAL DATA BAYLAKE CORP.
FIVE YEAR SELECTED CONSOLIDATED FINANCIAL DATA Year Ended December 31,2004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000(dollars in thousands, except per share data)Results of operations:Interest and dividend income
    
    $
    50,362
    
    
    $
    47,474
    
    
    $
    51,564
    
    
    $
    59,023
    
    
    $
    56,036Interest expense
    
    
    16,357
    
    
    
    18,416
    
    
    
    22,188
    
    
    
    32,053
    
    
    
    32,099Net interest income
    
    
    34,005
    
    
    
    29,058
    
    
    
    29,376
    
    
    
    26,970
    
    
    
    23,937Provision for loan losses
    
    
    1,599
    
    
    
    5,650
    
    
    
    5,700
    
    
    
    2,880
    
    
    
    545Net interest income after
provision for loan losses
    
    
    32,406
    
    
    
    23,408
    
    
    
    23,676
    
    
    
    24,090
    
    
    
    23,392
 10




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##### Table of Contents



Year Ended December 31,2004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000(dollars in thousands, except per share data)Other income:Gain on sale of loans
    
    
    1,372
    
    
    
    2,449
    
    
    
    1,733
    
    
    
    1,273
    
    
    
    455Fees from loan servicing
    
    
    1,079
    
    
    
    1,470
    
    
    
    1,279
    
    
    
    1,265
    
    
    
    723Fees from fiduciary
activities
    
    
    703
    
    
    
    677
    
    
    
    637
    
    
    
    664
    
    
    
    517Fees for other services to
customers
    
    
    3,226
    
    
    
    2,857
    
    
    
    2,853
    
    
    
    1,836
    
    
    
    1,489Securities gains, net
    
    
    
    
    
    
    
    
    
    
    509
    
    
    
    
    
    
    
    Other
    
    
    3,158
    
    
    
    3,188
    
    
    
    4,002
    
    
    
    1,473
    
    
    
    1,603Total other income
    
    
    9,538
    
    
    
    10,641
    
    
    
    11,013
    
    
    
    6,511
    
    
    
    4,787Non-interest expense:Salaries and employee
benefits
    
    
    15,283
    
    
    
    14,183
    
    
    
    13,743
    
    
    
    11,923
    
    
    
    10,353Occupancy and equipment
expense, net
    
    
    3,529
    
    
    
    3,525
    
    
    
    3,585
    
    
    
    3,235
    
    
    
    3,047Data processing
    
    
    1,125
    
    
    
    1,087
    
    
    
    1,040
    
    
    
    986
    
    
    
    932Other operating expenses
    
    
    5,955
    
    
    
    4,859
    
    
    
    4,820
    
    
    
    4,583
    
    
    
    4,381Operation of other real
estate
    
    
    599
    
    
    
    378
    
    
    
    203
    
    
    
    248
    
    
    
    (22
    )Total non-interest expense
    
    
    26,491
    
    
    
    24,032
    
    
    
    23,391
    
    
    
    20,975
    
    
    
    18,691Income before income tax
    
    
    15,453
    
    
    
    10,017
    
    
    
    11,298
    
    
    
    9,626
    
    
    
    9,488Income tax provision
    
    
    4,680
    
    
    
    2,060
    
    
    
    2,575
    
    
    
    2,091
    
    
    
    2,778Net income
    
    $
    10,773
    
    
    $
    7,957
    
    
    $
    8,723
    
    
    $
    7,535
    
    
    $
    6,710Per Share Data:(1)Net income per share (basic)
    
    $
    1.41
    
    
    $
    1.06
    
    
    $
    1.17
    
    
    $
    1.01
    
    
    $
    0.90Net income per share
(diluted)
    
    
    1.40
    
    
    
    1.04
    
    
    
    1.15
    
    
    
    0.99
    
    
    
    0.87Cash dividends per common
share
    
    
    0.57
    
    
    
    0.53
    
    
    
    0.49
    
    
    
    0.45
    
    
    
    0.41Book value per share
    
    
    9.91
    
    
    
    9.16
    
    
    
    8.74
    
    
    
    7.91
    
    
    
    7.14Selected Financial
Condition Data (at end of
period):Total assets
    
    $
    1,047,748
    
    
    $
    974,740
    
    
    $
    904,656
    
    
    $
    845,713
    
    
    $
    772,268Securities
    
    
    197,392
    
    
    
    176,815
    
    
    
    133,139
    
    
    
    144,895
    
    
    
    135,089Gross loans
    
    
    757,228
    
    
    
    715,022
    
    
    
    682,512
    
    
    
    627,492
    
    
    
    573,529Total deposits
    
    
    844,541
    
    
    
    783,292
    
    
    
    740,324
    
    
    
    669,812
    
    
    
    554,005Short-term borrowings (2)
    
    
    1,284
    
    
    
    23,359
    
    
    
    10,056
    
    
    
    2,837
    
    
    
    79,538Other borrowings (3)
    
    
    100,192
    
    
    
    75,092
    
    
    
    65,000
    
    
    
    90,000
    
    
    
    77,700Subordinated debentures
    
    
    16,100
    
    
    
    16,100
    
    
    
    16,100
    
    
    
    16,100
    
    
    
    0Total shareholders equity
    
    
    76,205
    
    
    
    69,628
    
    
    
    65,400
    
    
    
    59,130
    
    
    
    53,127Performance Ratios:Return on average assets
    
    
    1.07
    %
    
    
    0.87
    %
    
    
    1.00
    %
    
    
    0.93
    %
    
    
    0.95
    %Return on average total
shareholders equity
    
    
    14.88
    %
    
    
    11.86
    %
    
    
    13.82
    %
    
    
    13.37
    %
    
    
    13.76
    %Dividend payout ratio
    
    
    40.49
    %
    
    
    50.22
    %
    
    
    41.99
    %
    
    
    44.62
    %
    
    
    44.36
    %Net interest margin (4)
    
    
    3.76
    %
    
    
    3.56
    %
    
    
    3.80
    %
    
    
    3.79
    %
    
    
    3.88
    %Net interest spread (4)
    
    
    3.52
    %
    
    
    3.27
    %
    
    
    3.47
    %
    
    
    3.34
    %
    
    
    3.37
    %Non-interest income to
average assets
    
    
    0.95
    %
    
    
    1.17
    %
    
    
    1.26
    %
    
    
    0.78
    %
    
    
    0.66
    %Non-interest expense to
average assets
    
    
    2.63
    %
    
    
    2.63
    %
    
    
    2.68
    %
    
    
    2.57
    %
    
    
    2.63
    %
 11




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##### Table of Contents



Year Ended December 31,2004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000(dollars in thousands, except per share data)Net overhead ratio (5)
    
    
    1.68
    %
    
    
    1.46
    %
    
    
    1.42
    %
    
    
    1.79
    %
    
    
    1.97
    %Average loan-to-average
deposit ratio
    
    
    93.63
    %
    
    
    93.01
    %
    
    
    94.71
    %
    
    
    98.87
    %
    
    
    100.12
    %Average interest-earning
assets to average
interest-bearing
liabilities
    
    
    113.59
    %
    
    
    113.19
    %
    
    
    111.71
    %
    
    
    110.33
    %
    
    
    110.78
    %Asset Quality Ratios:(6)Non-performing loans to
total loans
    
    
    1.64
    %
    
    
    2.27
    %
    
    
    3.24
    %
    
    
    2.34
    %
    
    
    2.26
    %Allowance for loan losses
to:Total loans
    
    
    1.38
    %
    
    
    1.70
    %
    
    
    1.67
    %
    
    
    1.27
    %
    
    
    1.22
    %Non-performing loans
    
    
    83.97
    %
    
    
    74.95
    %
    
    
    51.66
    %
    
    
    54.47
    %
    
    
    53.94
    %Net charge-offs to average
loans
    
    
    0.45
    %
    
    
    0.70
    %
    
    
    0.35
    %
    
    
    0.31
    %
    
    
    0.22
    %Non-performing assets to
total assets
    
    
    1.43
    %
    
    
    1.90
    %
    
    
    2.76
    %
    
    
    1.93
    %
    
    
    1.80
    %Capital Ratios:(7)Shareholders equity to
assets
    
    
    7.27
    %
    
    
    7.14
    %
    
    
    7.23
    %
    
    
    6.99
    %
    
    
    6.88
    %Tier 1 risk-based capital
    
    
    9.75
    %
    
    
    9.53
    %
    
    
    9.74
    %
    
    
    10.10
    %
    
    
    7.77
    %Total risk-based capital
    
    
    10.95
    %
    
    
    10.78
    %
    
    
    10.99
    %
    
    
    11.29
    %
    
    
    8.92
    %Leverage ratio
    
    
    8.27
    %
    
    
    8.38
    %
    
    
    8.24
    %
    
    
    8.22
    %
    
    
    6.38
    %
   (1)
    Earnings per share are based on the weighted average number of shares outstanding for the
period.(2)
    Consists of federal funds purchased and repurchase agreements.(3)
    Consists of Federal Home Loan Bank term notes and Company borrowings from unaffiliated
correspondent bank.(4)
    Net interest margin represents net interest income as a percentage of average
interest-earning assets, and net interest rate spread represents the difference between the
weighted average yield on interest-earning assets and the weighted average cost of
interest-bearing liabilities.(5)
    Net overhead ratio represents the difference between non-interest expense and non-interest
income, divided by average assets.(6)
    Non-performing loans consist of non-accrual loans, guaranteed loans 90 days or more past due
but still accruing interest and restructured loans. Non-performing assets include
non-performing loans and foreclosed assets.(7)
    The capital ratios are presented on a consolidated basis. For information on Baylake and the
Banks regulatory capital requirements, see Item 7. Managements Discussion and Analysis of
Financial Condition and Results of Operations-Capital Resources and Item 1.
Business-Regulation and Supervision. 12




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##### Table of Contents



ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS General The following sets forth managements discussion and analysis of the consolidated financial
condition and results of operations of Baylake Corp. (Baylake or the Company), which may not be
otherwise apparent from the consolidated financial statements included in this report at Item 8.
This discussion and analysis should be read in conjunction with those financial statements, related
notes, the selected financial data and the statistical information presented elsewhere in this
report for a more complete understanding of the following discussion and analysis. Critical Accounting Policies In the course of the Companys normal business activity, management must select and apply many
accounting policies and methodologies that lead to the financial results presented in the
consolidated financial statements of the Company. Some of these policies are more critical than
others. Allowance for Loan Losses: The allowance for loan losses (ALL) represents managements
estimate of probable credit losses inherent in the loan portfolio. Estimating the amount of the
allowance for loan losses requires significant judgment and the use of estimates related to the
amount and timing of expected future cash flows on impaired loans, estimated losses on pools of
homogeneous loans based on historical loss experience, and consideration of current economic trends
and conditions, all of which may be susceptible to significant change. The loan portfolio also
represents the largest asset type on the consolidated balance sheet. Loan losses are charged off
against the allowance, while recoveries of amounts previously charged off are credited to the
allowance. A provision for loan losses is charged to operations based on managements periodic
evaluation of the factors previously mentioned, as well as other pertinent factors. The allowance for loan losses consists of an allocated component and an unallocated component. The
components of the allowance represent an estimation pursuant to either Statement of Financial
Accounting Standards No. (SFAS) 5, Accounting for Contingencies, or SFAS 114, Accounting by
Creditors for Impairment of a Loan. The allocated component of the allowance for loan losses
reflects expected losses from analyses developed through specific credit allocations for individual
loans and historical loss experience for each loan category. The specific credit allocations are
based on regular analyses of all loans over a fixed-dollar amount where the internal credit rating
is at or below a predetermined classification. These analyses involve a high degree of judgment in
estimating the amount of loss associated with specific loans, including estimating the amount and
timing of future cash flows and collateral values. The Companys historical loss experience is
updated quarterly. The allocated component of the allowance for loan losses also includes
consideration of concentrations and changes in portfolio mix and volume and other qualitative
factors. There are many factors affecting the allowance for loan losses; some are quantitative while others
require qualitative judgment. The process for determining the allowance (which management believes
adequately considers all of the potential factors which might possibly result in credit losses)
includes subjective elements and, therefore, may be susceptible to significant change. To the
extent actual outcomes differs from management estimates, additional provision for credit losses
could be required that could adversely affect the Companys earnings or financial position in
future periods. The allowance for loan losses is a valuation allowance for probable incurred credit losses. Loan
losses are charged against the allowance when management believes the uncollectibility of a loan
balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. Management
estimates the allowance balance required using past loan loss experience, the nature and volume of
the portfolio, information about specific borrower situations and the estimated collateral values,
economic conditions, and other factors. Allocations of the allowance may be made for specific
loans, but the entire allowance is available for any loan that, in managements judgment, should be
charged-off. Goodwill: The Company has goodwill assets on the books as a result of two prior
acquisitions. Goodwill is tested annually for impairment. Those tests inherently involve
managements judgment as to factors such as an estimation 13




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##### Table of Contents



of the fair value of a reporting unit;
screening for potential impairment and measuring the amount of the impairment. There was no
impairment of goodwill in 2004, 2003, or 2002. In the event of goodwill impairment, that amount
would be charged to earnings in the period in which the impairment is determined. Income tax accounting: The assessment of tax assets and liabilities involves the use of
estimates, assumptions, interpretations, and judgments concerning certain accounting pronouncements
and federal and state tax codes. There can be no assurance that future events, such as court
decisions or positions of federal and state taxing authorities, will not differ from managements
current assessment, the impact of which could be significant to the consolidated results of the
Companys operations and reported earnings. The Company believes that the tax assets and
liabilities are adequate and properly recorded in the consolidated financial statements. See Note
15-Income Tax Expense for further information. For a discussion of certain Wisconsin income tax
developments that could affect the Company, see the discussion in the Income Statement
Analysis-2004 compared to 2003-Income Taxes. Income tax expense may be affected by developments in the state of Wisconsin. Like many financial
institutions that are located in Wisconsin, a subsidiary of the Bank located in the state of Nevada
holds and manages various investment securities. Due to that fact that these subsidiaries are out
of state, income from their operations has not been subject to Wisconsin state taxation. Although
the Wisconsin Department of Revenue (Department) issued favorable tax rulings regarding Nevada
subsidiaries of Wisconsin financial institutions, the Department representatives have recently
stated that the Department intends to revoke those rulings and tax some or all these subsidiaries
income, even though there has been no intervening change in the law. The Department also
implemented a program in 2003 for the audit of Wisconsin financial institutions who have formed and
contributed assets to subsidiaries located in Nevada; to date, the Company and its subsidiaries
have not been audited on these matters. The Department sent letters in late July 2004 to financial institutions in Wisconsin, whether or
not they are undergoing an audit, reporting on settlements involving 17 banks and their
out-of-state investment subsidiaries. The letter provided a summary of currently available
settlement parameters. For periods before 2004, they include: restrictions on the types of
subsidiary income excluded from Wisconsin taxation; assessment of certain back taxes for a limited
period of time; and interest (but not penalties) on any past-due taxes. For 2004 and going forward,
there are similar provisions plus limits on the amount of subsidiaries assets as to which their
income will be excluded from Wisconsin tax. Settlement on the terms outlined would result in the
Departments rescission of related prior letter rulings, and would purport to be binding going
forward except for future legislation or change by mutual agreement. By implication, the
Department appears to accept the general proposition that some out-of-state investment subsidiary
income is not subject to Wisconsin taxes. The Company continues to believe that it has reported income and paid Wisconsin taxes correctly in
accordance with applicable tax laws and the Departments prior longstanding interpretations
thereof, including interpretations issued specifically to it. However, in view of the Departments
subsequent change in position (even if that change does not have a basis in law), the aggressive
stance now being taken by the Department, the settlements by some other banks, and the potential
effect that decisions by other similarly situated institutions may have on the Companys
alternatives going forward, the Company has determined that it would be prudent to obtain and
consider a settlement proposal from the Department; however, the Company has not yet received a
specific proposal nor has any assessment been made against the Company or its subsidiaries. The
Company will need to review any proposal in more specific detail to quantify in any definitive way
the Departments view of its exposure and to evaluate alternatives. Although there will likely be
challenges to the Departments actions and interpretations, the Banks net income would be reduced
if the Department succeeds in its actions and interpretations. The Bank could also incur costs in
the future to address any action taken against it by the Department. Overview Baylake is a full-service financial services company, providing a wide variety of loan, deposit and
other banking products and services to its business, individual or retail, and municipal customers,
as well as a full range of trust, investment and cash management services. The Company is the bank
holding company of Baylake Bank (Bank), chartered as a state bank in Wisconsin and a member bank
of the Federal Reserve and Federal Home Loan Bank. 14




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##### Table of Contents



From an industry and national perspective, the Companys profitability, like most financial
institutions, is dependent to a large extent upon net interest income. Results of operations are
also affected by the provision for loan losses, operating expenses such as salaries and employee
benefits, occupancy and other operating expenses, including income taxes, and to a lesser extent,
non-interest income such as trust revenues, loan servicing fees and service charge income derived
from deposit accounts. Economic conditions, competition and the monetary and fiscal policies of
the Federal government in general, significantly affect financial institutions, including the
Company. During the latter half of 2004, the Federal Reserve Board (FRB) steadily increased
interest rates intended to stabilize the current economy and keep inflation under control, since
the general health of the United States economy has recovered. The increasing rate environment
improved our
interest spread, and was a factor in the increase in net interest income for 2004. Lending
activities are also influenced by regional and local economic factors. Some specific factors may
include the demand for and supply of housing, competition among lenders, interest rate conditions
and prevailing market rates on competing investments, customer preferences and levels of personal
income and savings in the Companys market area. In the last several years, the Company has initiated strategic changes to its bank operations
intended to enhance the Banks utilization of resources, and the effectiveness of customer services
within its primary market area. Bank has developed an internal customer relationship management
system (CRM) to manage and to more effectively market to its internal customer base. Since the latter part of 2001, the Company has dedicated resources to its goal of improving asset
quality. Improvements have been achieved relative to collections or recoveries from the
disposition of collateral, especially related to the Companys level of non-performing commercial
loans. Credit risk has improved in the commercial loan portfolio as a result of improved
underwriting and more extensive collection efforts through the addition of legal and collection
staff. Performance Summary The following is a brief summary of some of the factors which have affected our earnings in 2004.
See the balance of this section for a more thorough discussion. The Company reported net income of $10.8 million for the year ended December 31, 2004, an increase
of $2.8 million or 35.4% compared to $8.0 million earned in 2003. Basic and diluted earnings per
share were $1.41 and $1.40, respectively, for 2004 compared to $1.06 and $1.04 for 2003. Return on
average assets for the year ended December 31, 2004 was 1.07% and 0.87% for 2003. The return on
average equity was 14.88% for 2004 and 11.86% for 2003. Cash dividends declared in 2004 increased
7.5% to $0.57 per share compared with $0.53 in 2003. Key factors behind these improved results
were:  §
    Net interest income and net interest margin were impacted in 2004 by an increasing
interest rate environment in the latter half of 2004, thereby increasing interest spread,
as we were able to increase rates on assets more quickly than on deposits.§
    Tax-equivalent net interest income was $35.1 million for 2004, an increase of $4.8
million or 15.8% higher than 2003. Tax-equivalent interest income increased $2.7 million,
while interest expense decreased $2.1 million. The increase in tax-equivalent net interest
income was attributable to favorable volume variances (with balance sheet growth and
differences in the mix of average earning assets and average interest-bearing liabilities
adding $2.7 million to tax-equivalent net interest income). In addition, favorable rate
variances added $2.1 million to tax-equivalent net interest income primarily due to the
re-pricing opportunities presented as a result of the interest rate environment. Average
earning assets increased $83.4 million to $934.6 million, while interest-bearing
liabilities increased $70.8 million to $822.8 million.§
    The net interest margin for 2004 was 3.76%, compared to 3.56% in 2003. The 20 basis
points (bps) improvement in net interest margin is the result of a 25 bps increase in
interest rate spread (the net of a 21 bps decrease in the yield on earning assets, offset
substantially by a 46 bps lower cost of interest-bearing liabilities), and a 5 bps lower
contribution from net free funds.§
    Total loans were $757.2 million at December 31, 2004, an increase of $42.2 million or
5.9%, from December 31, 2003. Commercial real estate loans increased $36.9 million (9.5%)
and represented 56% of 15




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##### Table of Contents



total loans at December 31, 2004, compared to 54% at year-end 2003.
Total deposits were $844.5 million at December 31, 2004, an increase of $61.2 million or
7.8% from year-end 2003.§
    Asset quality improved during 2004. Net loan charge-offs were $3.3 million, a decrease
of $1.6 million over 2003 results. Net loan charge-offs for commercial loans represented
$2.0 million of the total in 2004. Net loan charge-offs were 0.45% of average loans in
2004 compared to 0.70% in 2003. The provision for loan losses decreased to $1.6 million
compared to $5.7 million in 2003. The ratio of allowance for loan losses to total loans
was 1.38% and 1.70% at December 31, 2004 and 2003, respectively. Non-performing loans were
$12.5 million at December 31, 2004, representing 1.64% of total loans, compared to $16.2
million or 2.27% at year-end 2003.§
    Non-interest income was $9.5 million for 2004, a decrease of $1.1 million or 10.4% from
2003 results. A decrease in gains from sales of loans of $1.1 million, decreased fees from
loan servicing of $391,000 and a prior year gain on sale of Arborview, LLC of $538,000
offset by current year gains on sale of bank land amounting to $482,000 were primarily
attributable for the decrease in non-interest income.§
    Non-interest expense was $26.5 million, an increase of $2.5 million over 2003 results,
due to increases in personnel expense, professional services expense, charitable
contribution expense and non-employee benefit insurance costs.§
    Income tax expense increased to $4.7 million, an increase of $2.6 million from 2003.
The increase was primarily attributable to higher net income before tax. The effective
tax rate was 30.3% in 2004 compared to 20.6% in 2003 primarily related to a decrease in
non-taxable income as a percentage of net income before income tax expense. In November 2003, the Company purchased a small branch office in Kewaunee, Wisconsin, and
acquired $9.5 million in deposits and $1.0 million in loans as a result of the transaction. As
a result of the relatively small size of this transaction as compared to the Company, the
acquisition did not have a material impact on the Companys results of operations or the
composition of its balance sheet. INCOME STATEMENT ANALYSIS 2004 compared to 2003 Net Interest Income Net interest income in the consolidated statements of income (which excludes the taxable equivalent
adjustment) was $34.0 million, compared to $29.1 million in 2003. The tax equivalent adjustments
(adjustments needed to bring tax-exempt interest to a level that would yield the same after-tax
income had that income been subject to taxation using a 34% tax rate) of $1.1 million for 2004 and
$1.3 million for 2003 resulted in a tax-equivalent net interest income of $35.1 million and $30.3
million, respectively. Net interest income is impacted by the difference between rates earned on interest-earning assets
and rates paid on interest-bearing liabilities (interest rate spread) and the relative amounts of
interest-earning assets and interest-bearing liabilities. The interest income and interest expense
of financial institutions are significantly affected by general economic conditions, competition,
policies of regulatory authorities and other factors. Interest rate spread and net interest margin are utilized to measure and explain changes in net
interest income. Interest rate spread is the difference between the yield on earning assets and
the rate paid for interest-bearing liabilities that fund those assets. The net interest margin is
expressed as the percentage of net interest income to average earning assets. The net interest
margin exceeds interest rate spread because non-interest bearing sources of funds (net free
funds), principally demand deposits and stockholders equity, also support earning assets. To
compare tax-exempt asset yields to taxable yields, the yield on tax-exempt loans and securities is
computed on a tax equivalent basis. The narrative discusses net interest income, interest rate
spread and net interest margin on a tax equivalent basis. Table 1 below provides average balances of earning assets and interest-bearing liabilities,
interest income and expense, and the corresponding interest rates earned and paid, as well as net
interest income, interest spread, and net interest margin on a tax-equivalent basis for the three
years ended December 31. 16




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##### Table of Contents



Net interest income in the consolidated statements of income (including tax equivalent adjustment)
was $35.1 million in 2004, compared to $30.3 million in 2003. The increase in 2004 net interest
income of $4.8 million was a function of a higher level of earning assets, in addition to favorable
interest rate changes. The net interest margin for 2004 was 3.76% compared to 3.56% in 2003. The
20 bps increase in net interest margin is attributable to a 25 bps in interest rate spread (with a
21 bps decrease in the yield on earning assets, substantially offset by a 46 bps lower cost of
interest-bearing liabilities), and a 5 bps lower contribution from net free funds. Interest rates
were generally stable and historically low during the first half of 2004 but increased 100 bps over
the last six months of 2004 as FRB attempted to keep inflation in control. Comparatively, the
Federal funds rate at December 31, 2004, was at 2.16% compared to 1.00% at year-end 2003, while the
average Federal funds rate for 2004 was 22 bps higher than for 2003. As shown in the rate/volume analysis in Table 2, volume changes added $2.7 million to tax
equivalent net interest income in 2004, while rate changes resulted in a $2.1 million increase, for
a net increase of $4.8 million. Relative to changes in balance sheet mix, the growth and
composition change of earning assets added $2.7 million to tax equivalent net interest income in
2004. The growth and composition change of interest-bearing liabilities added an additional $2.1
million, resulting in a $4.8 million increase in tax equivalent net interest income. Rate changes
on earning assets reduced interest income by $1.4 million and was more than offset by changes in
rates on interest-bearing liabilities that lowered interest expense by $3.5 million, for a
favorable impact of $2.1 million. For 2004, the yield on earning assets fell 21 bps to 5.51%, in large part attributable to a
decrease of 18 bps in the loan yield. The average loan yield was 5.75% in 2004. Competitive
pricing on new and refinanced loans put downward pressure on loan yields in 2004. The yield on
securities and short-term investments combined was down 25 bps to 4.57%. For 2004, the cost of interest-bearing liabilities decreased 46 bps compared to 2003, to 1.99%,
aided by a historically low interest rate environment during the first half of 2004. The combined
average cost of interest-bearing deposits was 1.74%, down 47 bps
from 2003, benefiting from a larger mix of lower-cost transaction accounts, as well as re-pricing
opportunities that existed early in 2004 on higher rate time deposits that resulted in the
origination of deposits with lower rates. The cost of wholesale funding (comprised of short-term
borrowings) decreased by 92 bps to 3.21% for 2004, favorably impacted by the maturity of
higher-rate wholesale funds during the year. Average earning assets were $934.6 million in 2004, an increase of $83.4 million, or 9.8%, from
2003. Average loans outstanding grew to $740.6 million in 2004 from $695.7 million in 2003, an
increase of 6.5%. The increase in loan volume was a significant contributing factor to net interest
income. The mix of average loans to average total assets decreased to 73.4% in 2004 from 75.9% in
2003. For 2004, tax equivalent interest income on loans increased $2.6 million from growth, but
decreased $1.2 million from the impact of the interest rate and competitive environment. Balances
of securities and short-term investments increased $38.4 million on average. Tax equivalent
interest income on securities and short-term investments increased $1.5 million from volume
changes, but decreased $400,000 from the impact of the rate environment, for a net $1.4 million
increase to tax equivalent interest income. Average interest-bearing liabilities increased $70.8 million, or 9.4%, from 2003, while net free
funds (primarily demand deposits and stockholdersequity) increased $12.6 million, both supporting
the growth in earning assets. Average non-interest bearing demand deposits increased by $16.5
million, or 18.6%. Average interest-bearing deposits grew $26.6 million, or 4.0%, to $685.9
million. This growth resulted from increases in interest-bearing demand deposits, savings
accounts, and time deposits greater than $100,000 offset by a decline in time deposits less than
$100,000. Interest expense on interest-bearing deposits decreased $3.0 million from the impact of
the rate environment and increased $387,000 from volume and mix changes resulting in a decrease of
$2.6 million in interest expense. Average wholesale-funding sources increased by $44.2 million
during 2004. For 2004, interest expense on wholesale funding sources increased by $1.0 million due
to volume changes and decreased by $505,000 from lower rates, for a net increase of $558,000 versus
2003. We would not expect the impact of lower rates to continue in light of the recent FRB interest
rate increases. Table 1: Average Balances and Interest Rates (interest and rates on a tax-equivalent basis) 17




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##### Table of Contents



Year ended December 31, 2004
    
    
    
    
    
    
    
    
    
    
    
    
    
    2003
    
    
    
    
    
    
    
    
    
    
    
    
    
    2002Average
    
    
    
    
    
    
    
    
    Average
    
    
    
    Average
    
    
    
    
    
    
    
    
    Average
    
    
    
    Average
    
    
    
    
    
    
    
    
    AverageBalance
    
    
    
    Interest
    
    
    
    Rate
    
    
    
    Balance
    
    
    
    Interest
    
    
    
    Rate
    
    
    
    Balance
    
    
    
    Interest
    
    
    
    Rate(dollars in thousands)ASSETS:Earning AssetsLoans (1)(2)(3)
    
    
    $
    740,605
    
    
    
    
    42,583
    
    
    
    
    5.75
    %
    
    
    $
    695,669
    
    
    
    
    41,224
    
    
    
    
    5.93
    %
    
    
    $
    655,464
    
    
    
    
    44,339
    
    
    
    
    6.76
    %U.S. Treasuries
    
    
    
    195
    
    
    
    
    9
    
    
    
    
    4.62
    
    
    
    
    825
    
    
    
    
    51
    
    
    
    
    6.18
    
    
    
    
    1,235
    
    
    
    
    77
    
    
    
    
    6.23Agencies
    
    
    
    148,874
    
    
    
    
    5,922
    
    
    
    
    3.98
    
    
    
    
    102,323
    
    
    
    
    4,115
    
    
    
    
    4.02
    
    
    
    
    97,684
    
    
    
    
    5,239
    
    
    
    
    5.36State and Municipal
obligations (1)
    
    
    
    31,974
    
    
    
    
    2,252
    
    
    
    
    7.04
    
    
    
    
    35,981
    
    
    
    
    2,601
    
    
    
    
    7.23
    
    
    
    
    37,605
    
    
    
    
    2,650
    
    
    
    
    7.05Other Securities
    
    
    
    10,649
    
    
    
    
    664
    
    
    
    
    6.24
    
    
    
    
    10,063
    
    
    
    
    668
    
    
    
    
    6.64
    
    
    
    
    7,671
    
    
    
    
    510
    
    
    
    
    6.65Federal funds sold
    
    
    
    170
    
    
    
    
    4
    
    
    
    
    2.35
    
    
    
    
    1,669
    
    
    
    
    20
    
    
    
    
    1.20
    
    
    
    
    1,132
    
    
    
    
    19
    
    
    
    
    1.68Other money market
Instruments
    
    
    
    2,148
    
    
    
    
    24
    
    
    
    
    1.12
    
    
    
    
    4,718
    
    
    
    
    38
    
    
    
    
    0.81
    
    
    
    
    10,043
    
    
    
    
    149
    
    
    
    
    1.48Total earning assets
    
    
    $
    934,615
    
    
    
    $
    51,458
    
    
    
    
    5.51
    %
    
    
    $
    851,248
    
    
    
    $
    48,717
    
    
    
    
    5.72
    %
    
    
    $
    810,834
    
    
    
    $
    52,983
    
    
    
    
    6.53
    %Non-interest
earning Assets
    
    
    
    73,919
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    64,892
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    62,240Total assets
    
    
    
    1,008,534
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    916,140
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    873,074LIABILITIES AND
STOCKHOLDERS
EQUITYInterest bearing
LiabilitiesNOW accounts
    
    
    $
    89,648
    
    
    
    $
    782
    
    
    
    
    0.87
    %
    
    
    $
    74,998
    
    
    
    $
    674
    
    
    
    
    0.90
    %
    
    
    $
    53,170
    
    
    
    $
    526
    
    
    
    
    0.99
    %Savings accounts
    
    
    
    199,942
    
    
    
    
    1,875
    
    
    
    
    0.94
    
    
    
    
    196,598
    
    
    
    
    1,763
    
    
    
    
    0.90
    
    
    
    
    201,344
    
    
    
    
    3,038
    
    
    
    
    1.51Time deposits>
$100M
    
    
    
    207,750
    
    
    
    
    4,983
    
    
    
    
    2.40
    
    
    
    
    179,557
    
    
    
    
    5,626
    
    
    
    
    3.13
    
    
    
    
    169,395
    
    
    
    
    6,495
    
    
    
    
    3.83Time
deposits<$100M
    
    
    
    188,571
    
    
    
    
    4,328
    
    
    
    
    2.30
    
    
    
    
    208,160
    
    
    
    
    6,523
    
    
    
    
    3.13
    
    
    
    
    192,160
    
    
    
    
    7,276
    
    
    
    
    3.79Total
interest-bearing
Deposits
    
    
    
    685,911
    
    
    
    
    11,968
    
    
    
    
    1.74
    
    
    
    
    659,313
    
    
    
    
    14,586
    
    
    
    
    2.21
    
    
    
    
    616,069
    
    
    
    
    17,335
    
    
    
    
    2.81Federal funds
Purchased
    
    
    
    24,402
    
    
    
    
    388
    
    
    
    
    1.59
    
    
    
    
    10,141
    
    
    
    
    137
    
    
    
    
    1.35
    
    
    
    
    18,708
    
    
    
    
    375
    
    
    
    
    2.00Repurchase
Agreements
    
    
    
    1,127
    
    
    
    
    13
    
    
    
    
    1.15
    
    
    
    
    1,202
    
    
    
    
    12
    
    
    
    
    1.00
    
    
    
    
    2,332
    
    
    
    
    38
    
    
    
    
    1.63FHLB advances
    
    
    
    95,291
    
    
    
    
    2,293
    
    
    
    
    2.41
    
    
    
    
    65,250
    
    
    
    
    2,034
    
    
    
    
    3.12
    
    
    
    
    72,534
    
    
    
    
    2,790
    
    
    
    
    3.85Subordinated
Debentures
    
    
    
    16,100
    
    
    
    
    1,695
    
    
    
    
    10.53
    
    
    
    
    16,100
    
    
    
    
    1,645
    
    
    
    
    10.22
    
    
    
    
    16,100
    
    
    
    
    1,645
    
    
    
    
    10.22Long term debt
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    53
    
    
    
    
    2
    
    
    
    
    3.77
    
    
    
    
    106
    
    
    
    
    5
    
    
    
    
    4.72Total
interest-bearing
Liabilities
    
    
    $
    822,831
    
    
    
    $
    16,357
    
    
    
    
    1.99
    %
    
    
    $
    752,059
    
    
    
    $
    18,416
    
    
    
    
    2.45
    %
    
    
    $
    725,849
    
    
    
    $
    22,188
    
    
    
    
    3.06
    %Demand deposits
    
    
    
    105,134
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    88,642
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    76,030Accrued expenses
and other
liabilities
    
    
    
    8,182
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    8,322
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    8,069Stockholders equity
    
    
    
    72,387
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    67,117
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    63,126Total liabilities
and Stockholders
equity
    
    
    
    1,008,534
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    916,140
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    873,074Net interest income
and rate spread
    
    
    
    
    
    
    
    $
    35,101
    
    
    
    
    3.52
    %
    
    
    
    
    
    
    
    $
    30,301
    
    
    
    
    3.27
    %
    
    
    
    
    
    
    
    $
    30,795
    
    
    
    
    3.47
    %Net interest margin
    
    
    
    
    
    
    
    
    
    
    
    
    
    3.76
    %
    
    
    
    
    
    
    
    
    
    
    
    
    
    3.56
    %
    
    
    
    
    
    
    
    
    
    
    
    
    
    3.80
    %
 18




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##### Table of Contents



(1)
    
    The yield on tax exempt loans and securities is computed on a tax-equivalent basis
using a tax rate of 34% for all periods presented.(2)
    
    Nonaccrual loans and loans held for sale have been included in the average balances.(3)
    
    Interest income includes loan fees, net of amortization. Table 2: Rate/Volume Analysis (1) 2004 compared to 2003
    
    
    
    2003 compared to 2002Increase (Decrease) due to
    
    
    
    Increase (Decrease) due toVolume
    
    
    
    Rate
    
    
    
    Net
    
    
    
    Volume
    
    
    
    Rate
    
    
    
    Net(dollars in thousands)Interest income:Loans (2)
    
    
    $
    2,609
    
    
    
    $
    (1,250
    )
    
    
    $
    1,359
    
    
    
    $
    2,580
    
    
    
    $
    (5,695
    )
    
    
    $
    (3,115
    )U.S. treasuries
    
    
    
    (32
    )
    
    
    
    (10
    )
    
    
    
    (42
    )
    
    
    
    (25
    )
    
    
    
    (1
    )
    
    
    
    (26
    )Agencies
    
    
    
    1,852
    
    
    
    
    (45
    )
    
    
    
    1,807
    
    
    
    
    239
    
    
    
    
    (1,363
    )
    
    
    
    (1,124
    )State and
municipal
obligations (2)
    
    
    
    (284
    )
    
    
    
    (65
    )
    
    
    
    (349
    )
    
    
    
    (116
    )
    
    
    
    67
    
    
    
    
    (49
    )Other securities
    
    
    
    38
    
    
    
    
    (42
    )
    
    
    
    (4
    )
    
    
    
    159
    
    
    
    
    (1
    )
    
    
    
    158Federal funds sold
    
    
    
    (26
    )
    
    
    
    10
    
    
    
    
    (16
    )
    
    
    
    7
    
    
    
    
    (6
    )
    
    
    
    1Other money market
instruments
    
    
    
    (25
    )
    
    
    
    11
    
    
    
    
    (14
    )
    
    
    
    (60
    )
    
    
    
    (51
    )
    
    
    
    (111
    )Total earning assets
    
    
    $
    4,132
    
    
    
    $
    (1,391
    )
    
    
    $
    2,741
    
    
    
    $
    2,784
    
    
    
    $
    (7,050
    )
    
    
    $
    (4,266
    )Interest expense:NOW accounts
    
    
    $
    128
    
    
    
    $
    (20
    )
    
    
    $
    108
    
    
    
    $
    200
    
    
    
    $
    (52
    )
    
    
    $
    148Savings accounts
    
    
    
    30
    
    
    
    
    82
    
    
    
    
    112
    
    
    
    
    (70
    )
    
    
    
    (1,205
    )
    
    
    
    (1,275
    )Time deposits
    
    
    
    229
    
    
    
    
    (3,067
    )
    
    
    
    (2,838
    )
    
    
    
    944
    
    
    
    
    (2,566
    )
    
    
    
    (1,622
    )Federal funds
purchased
    
    
    
    223
    
    
    
    
    28
    
    
    
    
    251
    
    
    
    
    (139
    )
    
    
    
    (99
    )
    
    
    
    (238
    )Repurchase
agreements
    
    
    
    (1
    )
    
    
    
    2
    
    
    
    
    1
    
    
    
    
    (14
    )
    
    
    
    (12
    )
    
    
    
    (26
    )FHLB advances
    
    
    
    794
    
    
    
    
    (535
    )
    
    
    
    259
    
    
    
    
    (262
    )
    
    
    
    (494
    )
    
    
    
    (756
    )Subordinated
debentures
    
    
    
    
    
    
    
    
    50
    
    
    
    
    50
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Long term debt
    
    
    
    (2
    )
    
    
    
    
    
    
    
    
    (2
    )
    
    
    
    (2
    )
    
    
    
    (1
    )
    
    
    
    (3
    )Total
interest-bearing
liabilities
    
    
    $
    1,401
    
    
    
    $
    (3,460
    )
    
    
    $
    (2,059
    )
    
    
    $
    657
    
    
    
    $
    (4,429
    )
    
    
    $
    (3,772
    )Net interest income
    
    
    $
    2,731
    

    
    
    $
    2,069
    
    
    
    $
    4,800
    
    
    
    $
    2,127
    
    
    
    $
    (2,621
    )
    
    
    $
    (494
    )
   (1)
    
    The change in interest due to both rate and volume has been allocated proportional to
the relationship to the dollar amounts of the change in each.(2)
    
    The yield on tax-exempt loans and securities is computed on an FTE basis using a tax
rate of 34% for all periods presented. TABLE 3: Interest Rate Spread and Interest Margin (on a tax equivalent basis) 19




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##### Table of Contents



2004 average
    
    
    
    2003 average
    
    
    
    2002 average% of
    
    
    
    
    
    
    
    
    
    
    
    % of
    
    
    
    
    
    
    
    
    
    
    
    % ofEarning
    
    
    
    
    
    
    
    
    
    
    
    
    
    Earning
    
    
    
    
    
    
    
    
    
    
    
    
    
    EarningBalance
    
    
    
    Assets
    
    
    
    Yield/Rate
    
    
    
    Balance
    
    
    
    Assets
    
    
    
    Yield/Rate
    
    
    
    Balance
    
    
    
    Assets
    
    
    
    Yield/Rate($ in Thousands)Earning assets
    
    
    
    934,615
    
    
    
    
    100.0
    %
    
    
    
    5.51
    %
    
    
    
    851,248
    
    
    
    
    100.0
    %
    
    
    
    5.72
    %
    
    
    
    810,834
    
    
    
    
    100.0
    %
    
    
    
    6.53
    %Financed by:Interest
- bearing
funds
    
    
    
    822,831
    
    
    
    
    88.0
    %
    
    
    
    1.99
    %
    
    
    
    752,059
    
    
    
    
    88.3
    %
    
    
    
    2.45
    %
    
    
    
    725,849
    
    
    
    
    89.5
    %
    
    
    
    3.06
    %Non
-  interest
bearing - funds
    
    
    
    111,784
    
    
    
    
    12.0
    %
    
    
    
    
    
    
    
    
    99,189
    
    
    
    
    11.7
    %
    
    
    
    
    
    
    
    
    84,985
    
    
    
    
    10.5
    %Total fund sources
    
    
    
    934,615
    
    
    
    
    100.0
    %
    
    
    
    1.75
    %
    
    
    
    851,248
    
    
    
    
    100.0
    %
    
    
    
    2.16
    %
    
    
    
    810,834
    
    
    
    
    100.0
    %
    
    
    
    2.77
    %Interest rate
spread
    
    
    
    
    
    
    
    
    
    
    
    
    
    3.52
    %
    
    
    
    
    
    
    
    
    
    
    
    
    
    3.27
    %
    
    
    
    
    
    
    
    
    
    
    
    
    
    3.47
    %Contribution from
net free funds
    
    
    
    
    
    
    
    
    
    
    
    
    
    0.24
    %
    
    
    
    
    
    
    
    
    
    
    
    
    
    0.29
    %
    
    
    
    
    
    
    
    
    
    
    
    
    
    0.33
    %Net interest
margin
    
    
    
    
    
    
    
    
    
    
    
    
    
    3.76
    %
    
    
    
    
    
    
    
    
    
    
    
    
    
    3.56
    %
    
    
    
    
    
    
    
    
    
    
    
    
    
    3.80
    %Average prime
rate *
    
    
    
    
    
    
    
    
    
    
    
    
    
    4.34
    %
    
    
    
    
    
    
    
    
    
    
    
    
    
    4.12
    %
    
    
    
    
    
    
    
    
    
    
    
    
    
    4.67
    %Average federal
funds rate *
    
    
    
    
    
    
    
    
    
    
    
    
    
    1.35
    %
    
    
    
    
    
    
    
    
    
    
    
    
    
    1.13
    %
    
    
    
    
    
    
    
    
    
    
    
    
    
    1.67
    %Average spread
    
    
    
    
    
    
    
    
    
    
    
    
    299 bps
    
    
    
    
    
    
    
    
    
    
    
    
    299 bps
    
    
    
    
    
    
    
    
    
    
    
    
    300 bps
   *
    
    Source: Federal Reserve Table 4: Selected Average Balances 20




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##### Table of Contents



Percent
    
    
    
    2004 as % of
    
    
    
    2003 as % of2004
    
    
    
    2003
    
    
    
    Change
    
    
    
    Total Assets
    
    
    
    Total Assets(dollars in thousands)ASSETSLoans, net of
non - accrual loans
    
    
    $
    740,605
    
    
    
    $
    695,669
    
    
    
    
    6.5
    %
    
    
    
    73.4
    %
    
    
    
    75.9
    %Investment securitiesTaxable
    
    
    
    159,718
    
    
    
    
    113,211
    
    
    
    
    41.1
    %
    
    
    
    15.8
    
    
    
    
    12.4Tax exempt
    
    
    
    31,974
    
    
    
    
    35,981
    
    
    
    
    ( 11.1
    %)
    
    
    
    3.2
    
    
    
    
    3.9Short
- term investments
    
    
    
    2,318
    
    
    
    
    6,387
    
    
    
    
    ( 63.7
    %)
    
    
    
    0.2
    
    
    
    
    0.7Total earning assets
    
    
    
    934,615
    
    
    
    
    851,248
    
    
    
    
    9.8
    %
    
    
    
    92.6
    
    
    
    
    92.9Other assets
    
    
    
    73,919
    
    
    
    
    64,892
    
    
    
    
    13.9
    %
    
    
    
    7.4
    
    
    
    
    7.1Total assets
    
    
    $
    1,008,534
    
    
    
    $
    916,140
    
    
    
    
    10.1
    %
    
    
    
    100.0
    %
    
    
    
    100.0
    %LIABILITIES AND
STOCKHOLDERS EQUITYInterest
- bearing
deposits
    
    
    $
    685,911
    
    
    
    $
    659,313
    
    
    
    
    4.0
    %
    
    
    
    68.0
    %
    
    
    
    72.0
    %Short
- term borrowings
    
    
    
    25,529
    
    
    
    
    11,343
    
    
    
    
    125.1
    %
    
    
    
    2.5
    
    
    
    
    1.2Federal Home Loan Bank
Advances
    
    
    
    95,291
    
    
    
    
    65,250
    
    
    
    
    46.0
    %
    
    
    
    9.4
    
    
    
    
    7.1Subordinated debentures
    
    
    
    16,100
    
    
    
    
    16,100
    
    
    
    
    0.0
    %
    
    
    
    1.6
    
    
    
    
    1.8Long
- term debt
    
    
    
    
    
    
    
    
    53
    
    
    
    
    (100.0
    %)
    
    
    
    0.0
    
    
    
    
    0.0Total
interest - bearing
Liabilities
    
    
    
    822,831
    
    
    
    
    752,059
    
    
    
    
    9.4
    %
    
    
    
    81.6
    
    
    
    
    82.1Demand deposits
    
    
    
    105,134
    
    
    
    
    88,642
    
    
    
    
    18.6
    %
    
    
    
    10.4
    
    
    
    
    9.7Accrued expenses
    
    
    
    8,182
    
    
    
    
    8,322
    
    
    
    
    (1.7
    %)
    
    
    
    0.8
    
    
    
    
    0.9Stockholders equity
    
    
    
    72,387
    
    
    
    
    67,117
    
    
    
    
    7.9
    %
    
    
    
    7.2
    
    
    
    
    7.3Total liabilities and
Stockholdersequity
    
    
    $
    1,008,534
    
    
    
    $
    916,140
    
    
    
    
    10.1
    %
    
    
    
    100.0
    %
    
    
    
    100.0
    %
 Provision for Loan Losses The provision for loan losses (PFLL) is the periodic cost of providing an allowance for probable
incurred losses. Prior to the third quarter of 2004, the Company determined the allowance by risk
rating loans that were classified as substandard or doubtful thru a grading process that was
predicated on various risk rating matrices and the assignment of potential loss based on those
ratings. In addition, the remaining loans in the portfolio were assigned risk weightings based on
their various classifications. In the third quarter of 2004, the Company further enhanced its
methodologies to individually review substandard and doubtful loans for impairment and bring other
factors into the process to evaluate the ALL. As previously discussed, the allowance consists of specific and general components. The specific
component relates to loans that are individually classified as impaired or loans otherwise
classified as substandard or doubtful. The general component covers non-classified loans and is
based on historical loss experience adjusted for current factors. These current factors, include
loan growth, net charge-offs, changes in the composition of the loan portfolio, delinquencies,
managements evaluation of loan quality, general economic factors and collateral values. The PFLL in 2004 was $1.6 million. The PFLL in each of 2003 and 2002 was $5.7 million. At
December 31, 2004, the allowance for loan losses was $10.4 million, compared to $12.2 million at
December 31, 2003 and $11.4 million at December 31, 2002. Net charge-offs were $3.3 million for
2004, compared to $4.9 million for 2003 and $2.3 million for 2002. Net charge-offs as a percent of
average loans were 0.45%, 0.70%, and 0.35% for 2004, 2003, and 21




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##### Table of Contents



2002, respectively. The ratio of the allowance for loan losses (ALL) to total loans was 1.38% at
December 31, 2004, compared to 1.70% at December 31, 2003 and 1.67% at December 31, 2002.
Non-performing loans at December 31, 2004, were $12.5 million, compared to $16.2 million at
December 31, 2003 and $22.1 million at December 31, 2002. Management believes that the current provision conforms to the Companys loan loss reserve policy
and is adequate in view of the present condition of the Companys loan portfolio. However, 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
allowance. If there are significant charge-offs against the allowance, or we otherwise determine
that the allowance is inadequate, we will need to make higher provisions in the future. See Risk
Management and the Allowance for Loan Losses below for more information related to non-performing
loans. Non-Interest Income Total non-interest income for 2004 was $9.5 million, a $1.1 million decrease from 2003, or 10.4%.
The non-interest income to average assets ratio was 0.95% for the year ended December 31, 2004
compared to 1.17% for the same period in 2003. Trust service fees, fees from loan servicing, gains
from sales of loans and service charges continue to be the primary components of non-interest
income as evidenced in Table 5. Table 5: Other Income Years ended December 31,

    
    
    % Change from prior year2004
    
    
    
    2003
    
    
    
    2002
    
    
    
    2004
    
    
    
    2003(dollars in thousands)Fees from fiduciary
Activities
    
    
    $
    703
    
    
    
    $
    677
    
    
    
    $
    637
    
    
    
    
    3.8
    %
    
    
    
    6.3
    %Fees from loan servicing
    
    
    $
    1,079
    
    
    
    $
    1,470
    
    
    
    $
    1,279
    
    
    
    
    (26.6
    %)
    
    
    
    14.9
    %Gains from sale of loans
    
    
    $
    1,372
    
    
    
    $
    2,449
    
    
    
    $
    1,733
    
    
    
    
    (44.0
    %)
    
    
    
    41.3
    %Service charges on
deposit accounts
    
    
    $
    3,226
    
    
    
    $
    2,857
    
    
    
    $
    2,853
    
    
    
    
    12.9
    %
    
    
    
    0.1
    %Other fee income
    
    
    $
    675
    
    
    
    $
    669
    
    
    
    $
    720
    
    
    
    
    0.9
    %
    
    
    
    (  7.1
    %)Financial service income
    
    
    $
    707
    
    
    
    $
    527
    
    
    
    $
    575
    
    
    
    
    34.2
    %
    
    
    
    (  8.3
    %)Increase in cash surrender
value of life insurance
    
    
    $
    772
    
    
    
    $
    821
    
    
    
    $
    450
    
    
    
    
    (6.0
    %)
    
    
    
    82.4
    %Death benefit of life
insurance
    
    
    $
    0
    
    
    
    $
    0
    
    
    
    $
    754
    
    
    
    NM
    
    
    NMRental income
    
    
    $
    0
    
    
    
    $
    67
    
    
    
    $
    705
    
    
    
    NM
    
    
    NMGain
on sale - bank assets
    
    
    $
    484
    
    
    
    $
    0
    
    
    
    $
    107
    
    
    
    NM
    
    
    NMGain
on sale - Arborview LLC
    
    
    $
    0
    
    
    
    $
    538
    
    
    
    $
    0
    
    
    
    NM
    
    
    NMSecurities gains, net
    
    
    $
    0
    
    
    
    $
    0
    
    
    
    $
    509
    
    
    
    NM
    
    
    NMOther income
    
    
    $
    520
    
    
    
    $
    566
    
    
    
    $
    691
    
    
    
    
    (  8.1
    %)
    
    
    
    (18.1
    %)Total other income
    
    
    $
    9,538
    
    
    
    $
    10,641
    
    
    
    $
    11,013
    
    
    
    
    (10.4
    %)
    
    
    
    ( 3.4
    %)
 In 2004, gains from sales of loans were affected by a slowdown in refinancing activity throughout
the industry due to higher mortgage rates. In comparison, 2003 (and to a lesser extent 2002) saw
high levels of loan refinancing as a result of the historically low interest rate environment.
Loan servicing fees decreased $391,000 and gains from sales of loans decreased $1.1 million between
the comparable periods of 2004 and 2003. The decrease was driven primarily by secondary market
mortgage and commercial loan production (loan production to be sold to the secondary market) and
resulting sales. As interest rates have increased over the year, the Company has continued to
experience a decrease in the number of loan applications. Secondary loan production declined 54.2%
between the comparable twelve-month periods ($63.4 million in of 2004 versus $138.5 million in
2003). 22




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##### Table of Contents



The 2004 increase of $369,000 in service charges on deposit accounts was due in part to the
implementation of an overdraft privilege program started in the third quarter of 2004 and other
price increases implemented during the latter part of 2004. Financial service income increased $180,000 as a result of additional business generated and aided
by favorable market conditions. Revenues generated from the operation of Arborview LLC (Arborview) (a subsidiary formed in 2002
to manage a community based residential facility and sold in the first quarter of 2003) decreased
as a result of the sale to $0 and $67,000 in 2004 and 2003, respectively. The subsidiary was sold
in February 2003 with a gain on sale amounting to $538,000. For 2004 non-interest income included a gain recognized on the sale of bank land located at one of
the Banks branch locations in the Green Bay market area totaling $484,000. The sale of property
occurred as a result of a purchase of 19.2 acres by the Department of Transportation to facilitate
its highway expansion efforts in the Green Bay market. We do not expect the sale to substantially
affect the operations at that location. Non-Interest Expense Non-interest expense in 2004 increased to $26.5 million, a $2.5 million, or 10.2% increase compared
to 2003 results, primarily as a result of increased personnel, charitable contributions,
professional services and other operating expense. This followed a $641,000 or 2.7% increase in
2003 as compared to 2002. Primary categories impacting the change between 2004 and 2003 are noted
in Table 6 below. Table 6: Non-interest Expense Years ended December 31,
    
    % Change from prior year(dollars in thousands)2004
    
    
    
    2003
    
    
    
    2002
    
    
    
    2004
    
    
    
    2003Salaries and employee benefits
    
    
    $
    15,283
    
    
    
    $
    14,183
    
    
    
    $
    13,743
    
    
    
    
    7.8
    %
    
    
    
    3.2
    %Occupancy
    
    
    $
    2,156
    
    
    
    $
    2,087
    
    
    
    $
    2,163
    
    
    
    
    3.3
    %
    
    
    
    (3.5
    %)Equipment
    
    
    $
    1,373
    
    
    
    $
    1,438
    
    
    
    $
    1,422
    
    
    
    
    (4.5
    %)
    
    
    
    1.1
    %Data processing and courier
    
    
    $
    1,125
    
    
    
    $
    1,087
    
    
    
    $
    1,040
    
    
    
    
    3.5
    %
    
    
    
    4.5
    %Business development
and advertising
    
    
    $
    742
    
    
    
    $
    737
    
    
    
    $
    628
    
    
    
    
    0.7
    %
    
    
    
    17.4
    %Charitable contributions
    
    
    $
    582
    
    
    
    $
    303
    
    
    
    $
    228
    
    
    
    
    92.1
    %
    
    
    
    32.9
    %Stationery and supplies
    
    
    $
    513
    
    
    
    $
    499
    
    
    
    $
    611
    
    
    
    
    2.8
    %
    
    
    
    (18.3
    %)Director fees
    
    
    $
    293
    
    
    
    $
    263
    
    
    
    $
    266
    
    
    
    
    11.4
    %
    
    
    
    (1.1
    %)FDIC insurance
    
    
    $
    113
    
    
    
    $
    115
    
    
    
    $
    116
    
    
    
    
    (1.7
    %)
    
    
    
    (0.9
    %)Mortgage servicing rights
Amortization
    
    
    $
    273
    
    
    
    $
    411
    
    
    
    $
    260
    
    
    
    
    (33.6
    %)
    
    
    
    58.1
    %Legal and professional
    
    
    $
    481
    
    
    
    $
    250
    
    
    
    $
    230
    
    
    
    
    92.4
    %
    
    
    
    8.7
    %Operation of other real estate
    
    
    $
    599
    
    
    
    $
    378
    
    
    
    $
    203
    
    
    
    
    58.5
    %
    
    
    
    86.2
    %Other operating expense
    
    
    $
    2,958
    
    
    
    $
    2,281
    
    
    
    $
    2,481
    
    
    
    
    29.7
    %
    
    
    
    (8.1
    %)Total noninterest expense
    
    
    $
    26,491
    
    
    
    $
    24,032
    
    
    
    $
    23,391
    
    
    
    
    10.2
    %
    
    
    
    2.7
    %
 Salaries and employee benefits expense is the largest component of non-interest expense and totaled
$15.3 million in 2004, an increase of $1.1 million, or 7.8%, as compared to 2003 results. The
increase in 2004 primarily resulted from staffing increases, increased benefit costs, bonus expense
and normal salary increases. Salary costs increased $374,000, or 3.6%, for 2004 compared to 2003
results as a result of increased staffing and normal salary increases, offset by the elimination of
Arborview related expenses which were over $100,000. Bonus expense increased $612,000 to $852,000
for 2004 compared to 2003 as a result of various profit improvement and growth results 23




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##### Table of Contents



achieved during the year. The number of full-time equivalent employees increased to 308 in 2004
from 302 in 2003, an increase of 2.0%. Net occupancy expense for 2004 showed an increase of $69,000 as compared to 2003 for a total of
$2.2 million. An increase in depreciation expense and real estate tax expense accounted for the
increase in 2004. Equipment expense for 2004 decreased $65,000 compared to 2003. The decrease was primarily due to a
decrease in depreciation expense and a reduction in maintenance contract costs. Data processing and courier expense in 2004 increased $38,000 due to an increase in the volume of
transaction activity processed and technology enhancements. Management estimates that data
processing expense should show minimal increases in the next several years with adjustments related
only to any volume increases incurred by the Company. Charitable contribution expense increased $279,000 in 2004. The increase was related to long-term
commitments made in the fourth quarter of 2004 for local community renovation projects. Legal and professional expense for 2004 increased substantially, by $231,000, to $481,000. The
increase was the result of increased costs relative to SEC compliance as a result of enhanced
requirements imposed by the Sarbanes-Oxley Act of 2002 and related SEC actions. Other real estate expenses are netted against income received in the determination of net other
real estate owned expense (income). Other real estate owned showed net expense of $599,000 in
2004. Gains of $131,000 from five commercial property sales and $148,000 from nine residential
property sales were realized in 2004. These were offset by losses of $80,000 from the sale of
seven commercial properties and $29,000 from four residential properties. Various operating
expenses, net of income, of other real estate totaling $769,000 occurred in 2004. Other operating expenses in 2004 increased $677,000, or 29.7%, to $3.0 million as compared to $2.3
million in 2003. Costs of $305,000 related to non-employee benefit insurance expense primarily
accounted for the increase in other operating expense for 2004. In addition, consulting fees of
$143,000 for profit improvement programs were expensed in 2004 and also contributed to the increase
in other operating expense. The overhead efficiency ratio, which is computed by subtracting non-interest income from
non-interest expense and dividing by average total assets was 1.68% for 2004 compared to 1.46% for
2003 and 1.42% for 2002. The overhead efficiency ratio reflects the extent to which non-interest
expenses are recovered through non-interest income. A higher ratio indicates lower appropriation
of net interest income to meet non-interest expenses. Income Taxes Income tax expense for the Company was $4.7 million in 2004, an increase of $2.6 million compared
to 2003 results. The higher tax expense in 2004 reflected the Companys increase in income before
income tax expense in addition to a decrease in tax-exempt interest income. The Companys effective tax rate, income tax expense divided by income before taxes, was 30.3% in
2004 compared with 20.6% in 2003. Of the 30.3% effective tax rate for 2004, the federal effective
tax rate was 25.1% while the Wisconsin state effective tax rate was 5.2%. For 2003, the federal
effective tax rate was 19.0% while the Wisconsin state effective tax rate was 1.6%. Taxable income
increased while tax-exempt interest income from municipal investments and income from BOLI did not
increase in a like manner. See Note 1, Summary of Significant Accounting Policies, of the notes to consolidated financial
statements for a further discussion of income tax accounting. Income tax expense recorded in the
consolidated statements of income involves interpretation and application of certain accounting
pronouncements and federal and state tax codes, and is, therefore, considered a critical accounting
policy. The Company undergoes examination by various taxing authorities. Such taxing authorities
may require that changes in the amount of tax expense or valuation allowance be recognized when
their interpretations differ from those of management, based on their judgments about information 24




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##### Table of Contents



available to them at the time of their examinations. See Note 15, Income Tax Expense, of the
notes to consolidated financial statements for more discussion. 2003 compared to 2002 General The Company reported net income of $8.0 million in 2003 compared to $8.7 million for 2002. Basic
and diluted earnings per share were $1.06 and $1.04, respectively, for 2003 compared to $1.17 and
$1.15 for 2002. Return on average assets for the year ended December 31, 2003 was 0.87% and 1.00%
for 2002. The return on average equity was 11.86% for 2003 and 13.82% for 2002. Cash dividends
declared in 2003 increased 8.2% to $0.53 per share compared with $0.49 in 2002. Net Interest Income The Company earned net interest income of $29.0 million and $29.4 million in 2003 and 2002,
respectively. The continuing national trend of historically low interest rates produced a decrease
in net interest income of 1.3% in 2003 from 2002 despite the increase in average balances. The
changes in the loan and security portfolios, discussed later, generally reflect downward trends in
rates associated with lower risk assets in addition to the current market rates. The year 2003 saw a decrease of the interest rate spread for the Company in spite of a lower
interest rate environment. The interest rate spread decreased 20 basis points in 2003 to 3.27%
from 3.47% in 2002, as the average yield on earning assets decreased 81 basis points while the
average rate paid on interest-bearing liabilities decreased 61 basis points over the same period.
The decrease in the Companys earning assets yield reflects a lower rate environment impacting
rates on the variable priced loans and re-pricing fixed rate loans (for competitive reasons) for
the year 2003. Decreased investment interest income, which resulted from an increased investment
portfolio, offset by lower yields on the investment portfolio, have contributed to some of the
decrease in the yields on interest earning assets. A lower rate environment also affected the
funding side of the balance sheet. Yields on interest-paying liabilities decreased 60 basis
points. Decreased interest costs resulted from a lower rate environment offset to a lesser extent
by increased competition for retail deposits and increased balances in time deposit accounts.
Yields on interest bearing deposits decreased 60 basis points to 2.21% in 2003 from 2.81% in 2002. The lower rate environment also had an effect in reducing yields on the wholesale funding side of
the balance sheet. Yields on short-term borrowings decreased 65 basis points in 2003 compared to
2002, while yields on other borrowings decreased 73 basis points to 3.12% in 2003 from 3.85% in
2002. The net interest margin for 2003 was 3.60% compared to 3.87% in 2002. The decrease in net interest
margin was in part related to a general decline in the interest rate environment offset slightly by
an increase in the free funds ratio and a decrease in non-accrual loans. The steady decrease in
general interest rates, including the Companys commercial loan Prime Rate, which commenced during
2001, provided the general low interest rate environment that continued to drive the yield on
commercial and other variable type loans lower into the year 2003. Increased competition,
especially as it relates to the commercial loan portfolio, negatively affected net interest margin.
The free funds ratio, or the level of non-interest bearing funds that support earning assets,
improved to 19.5% from 18.5% in 2002. Provision for Loan Losses The provision for loan losses in 2003 and 2002 were $5.7 million. The provisions reflected the
increases in net loan charge-offs, the high level of non-performing loans, risk levels inherent in
the loan portfolio and the changing mix of the overall loan portfolio. Non-Interest Income 25




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##### Table of Contents



Non-interest income during 2003 decreased $372,000 or 3.4% when compared to 2002. The primary
factors decreasing non-interest income were a reduction in fees for other services to customers, a
decrease in securities gains and a decrease in other income. These decreases were offset by an
increase in fiduciary fees, an increase in loan servicing fee income and increased gains on sales
of loans. Death benefits recognized in 2002 and gross revenues from bank subsidiaries realized in
2002 accounted for much of the difference in other income for 2003 relative to 2002. Revenues
generated from the operation of Arborview LLC (Arborview) (a subsidiary formed in 2002 to manage
a community based residential facility and sold in the first quarter of 2003) decreased as a result
of the sale to $67,000 in 2003 from $705,000 in 2003. The subsidiary was sold in February 2003
with a gain on sale amounting to $538,000. Non-Interest Expense Non-interest expense increased $641,000 during 2003, or 2.7% over 2002 levels. Factors
contributing to the increase were increased personnel and benefits expenses and increased expenses
related to the operation of other real estate owned. Increases in these expenses were offset by a
$710,000 decrease in expenses related to our former Arborview subsidiary as a result of its sale in
early 2003. Income Taxes Income tax expense for the Company was $2.1 million in 2003, $2.6 million in 2002. The lower tax
expense in 2003 reflected the Companys decrease in before tax earnings in addition to a decrease
in tax-exempt interest income. The Companys effective tax rate, income tax expense divided by income before taxes, was 20.6% in
2003 compared with 22.8% in 2002. Of the 20.6% effective tax rate for 2003, the federal effective
tax rate was 19.0% while the Wisconsin State effective tax rate was 1.6%. Balance Sheet Items Average loans outstanding grew to $695.7 million in 2003 from $655.5 million in 2002, an increase
of 6.1%. The increase in loan volume was a significant contributing factor to net interest income.
The mix of average loans to average total assets increased to 75.9% in 2003 from 75.1% in 2002.
The relationship of a higher volume of loans as a percentage of the asset mix has provided a source
of higher yielding assets, which has contributed to net interest income. Total loans outstanding grew to $715.0 million at December 31, 2003, a 4.8% increase from the end
of 2002. Commercial loans and commercial real estate loans (including construction loans) totaled
$556.2 million at year end 2003 and comprised 79.9% of the loan portfolio compared with 77.7% of
the portfolio at the end of 2002. Loans in these classifications grew $39.9 million or 7.7% during
2003. At December 31, 2003, deposits were $783.3 million, an increase of $43.0 million or 5.8% from
$740.3 million recorded at December 31, 2002. Brokered deposits decreased $800,000 to $97.8
million at year-end 2003 from $98.6 million at year end 2002. Average total deposits for 2003
were $748.0 million, an increase of 8.1% over 2002. Included in these results was an increase in
average brokered deposits to $98.2 million in 2003 from $87.1 million in 2002. The increase in
brokered time deposits occurred principally in the first half of 2003, and reflects the Companys
use of such instruments to provide incremental funding to meet cash flow needs. The acquisition of
brokered time deposits was accomplished generally at funding rates encountered by the Company in
its own market area. The ALL at December 31, 2003 was $12.2 million compared with $11.4 million at the end of 2002.
Loans increased 4.8% in 2003, while the allowance as a percent of total loans increased as a result
of a loan loss provision (offset by net charge-offs) increased to 1.70% from 1.67% at year-end
2002. Based on managements analysis of the loan portfolio risk at December 31, 2003, a provision
expense of $5.7 million was recorded for the year ended December 31, 2003, a decrease of $50,000
compared to the same period in 2002. Factors evaluated were primarily based upon calculations made
as a result of various loss risk percentages applied to various problem and watch type 26




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##### Table of Contents



credits. The trend indicated a slight increase in risk relative to the loan portfolio at year-end
2003 compared to year-end 2002. Net loan charge-offs of $4.9 million occurred in 2003, and the
ratio of net charge-offs to average loans for the period ended December 31, 2003 was 0.70% compared
to 0.35% at December 31, 2002. Commercial loan charge-offs represented 69.8% of the total net
charge-offs for the year 2003, primarily the result of a previously discussed $2.6 million loan
charge-off taken in the fourth quarter of 2003. Real estate-mortgage charge-offs represented 25.0%
of the total net charge-offs for the year 2003. Commercial mortgage loan charge-offs accounted for
$542,000 of the mortgage total and residential mortgage loan charge-offs totaled $683,000. BALANCE SHEET ANALYSIS Loans Gross loans outstanding grew to $757.2 million at December 31, 2004, a 5.9% increase from the end
of 2003. This follows a 4.8% increase from the end of 2002. Table 7 reflects composition (mix) of the loan portfolio at December 31: Table 7: Loan Composition (dollars in thousands)2004
    
    
    
    
    
    
    2003
    
    
    
    
    
    
    2002Amount
    
    
    % of Total
    
    
    Amount
    
    
    % of Total
    
    
    Amount
    
    
    % of TotalAmount of loans by type
Real estate-mortgageCommercial
    
    $
    424,712
    
    
    
    56.1
    %
    
    $
    387,778
    
    
    
    54.2
    %
    
    $
    351,425
    
    
    
    51.5
    %1-4 Family residential
    
    
    134,350
    
    
    
    17.7
    
    
    
    125,700
    
    
    
    17.6
    
    
    
    133,365
    
    
    
    19.5Construction
    
    
    80,384
    
    
    
    10.6
    
    
    
    77,350
    
    
    
    10.8
    
    
    
    75,688
    
    
    
    11.1Commercial,financial
and agricultural
    
    
    83,787
    
    
    
    11.1
    
    
    
    91,051
    
    
    
    12.7
    
    
    
    89,207
    
    
    
    13.1Consumer
    
    
    13,936
    
    
    
    1.8
    
    
    
    14,460
    
    
    
    2.0
    
    
    
    14,916
    
    
    
    2.2Tax exempt
    
    
    20,457
    
    
    
    2.7
    
    
    
    19,032
    
    
    
    2.7
    
    
    
    18,227
    
    
    
    2.7Less: deferred fees,
net
of costs
    
    
    (398
    )
    
    
    0.0
    
    
    
    (349
    )
    
    
    0.0
    
    
    
    (316
    )
    
    
    0.0Total loans (net of
unearned income)
    
    $
    757,228
    
    
    
    100.0
    %
    
    $
    715,022
    
    
    
    100.0
    %
    
    $
    682,512
    
    
    
    100.0
    %
 2001
    
    
    
    
    
    
    2000Amount
    
    
    % of Total
    
    
    Amount
    
    
    % of TotalAmount of loans by type
Real estate mortgageCommercial
    
    $
    288,385
    
    
    
    46.0
    %
    
    $
    251,971
    
    
    
    43.9
    %1-4 Family residential
    
    
    143,748
    
    
    
    22.9
    
    
    
    160,150
    
    
    
    28.0Construction
    
    
    67,939
    
    
    
    10.8
    
    
    
    41,524
    
    
    
    7.2Commercial,financial
and agricultural
    
    
    88,649
    
    
    
    14.1
    
    
    
    83,897
    
    
    
    14.6Consumer
    
    
    16,890
    
    
    
    2.7
    
    
    
    17,925
    
    
    
    3.1Tax exempt
    
    
    22,205
    
    
    
    3.5
    
    
    
    18,422
    
    
    
    3.2Less: deferred fees, net
of costs
    
    
    (324
    )
    
    
    0.0
    
    
    
    (360
    )
    
    
    0.0Total loans (net of
unearned income)
    
    $
    627,492
    
    
    
    100.0
    %
    
    $
    573,529
    
    
    
    100.0
    %
 27




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##### Table of Contents



Commercial real estate loans totaled $424.7 million at year-end 2004 and comprised 56.1% of the
loan portfolio compared with 54.2% of the portfolio at the end of 2003. Loans in these
classifications grew $36.9 million or 9.5% during 2004. Loans of this type are in a broad range of
industries. Commercial real estate includes loans secured by farmland, multifamily properties, and
nonfarm/nonresidential real estate properties. Loans of this type are mainly for business
properties, multifamily properties, and community purpose properties. The credit risk related to
these types of loans is greatly influenced by general economic conditions, especially those
applicable to the Northeast Wisconsin market area, and the resulting impact on a borrowers
operations. Credit risk is managed by employing sound underwriting guidelines, lending to
borrowers in local markets and businesses, and formally reviewing the borrowers financial
soundness and relationship on an ongoing basis. Many times, the Company will take additional real
estate collateral to further secure the overall lending relationship. A substantial portion of our
commercial real estate loans are secured by real estate in Door County, Wisconsin, which is heavily
influenced by the tourism trade. A decline in the tourism industry, or other economic effects,
(such as increased interest rates affecting demand for real estate) could affect both our lending
opportunities in this area as well as potentially affect the value of collateral held for these
loans. Commercial, financial and agricultural loans totaled $83.8 million at the end of 2004, down $7.3
million or 8.0% since year-end 2003. The commercial, financial, and agricultural loan
classification primarily consists of commercial loans to small businesses. Loans of this type are
in a broad range of industries and include service, retail, wholesale, and manufacturing concerns.
Agricultural loans are made principally to farmers engaged in dairy, cherry and apple production.
Borrowers are primarily concentrated in Door, Brown, Outagamie, Waupaca, Waushara and Kewaunee
Counties, Wisconsin. The origination of commercial and commercial real estate loans was primarily
from the Companys market area in Brown County. Growth in tourism related business in Door County
slowed in 2004 compared to growth experienced in prior years. The credit risk related to
commercial loans made is largely influenced by general economic conditions, especially those
applicable to the Northeast Wisconsin market area, and the resulting impact on a borrowers
operations. These types of loans are generally higher in risk than residential real estate loans. Management uses an active credit risk management process for commercial loans to ensure that sound
and consistent credit decisions are made. Management attempts to control credit risk by adhering
to detailed underwriting procedures, performing comprehensive loan administration, and undertaking
periodic review of borrowers outstanding loans and commitments. Borrower relationships are
formally reviewed periodically during the life of the loan. Further analyses by customer,
industry, and location are performed to monitor trends, financial performance and concentrations. Real estate construction loans grew $3.0 million or 3.9% to $80.4 million at December 31, 2004.
Loans in this classification are primarily short-term interim loans that provide financing for the
acquisition or development of commercial real estate, such as multifamily or other commercial
development projects. Real estate construction loans are made to developers who are well known to
the Company, have prior experience, and are well capitalized. Construction projects undertaken by
these developers are carefully reviewed by the Company to ensure the economic feasibility. The
credit risk related to real estate construction loans is generally limited to specific geographic
areas, but it is also influenced by general economic conditions. The Company controls the credit
risk on these types of loans by making loans to developers in familiar markets, reviewing the
merits of the individual project, controlling loan structure and monitoring project progress and
advances of construction proceeds. The Companys loan portfolio is diversified by types of borrowers and industry groups within the
market areas that it serves. Significant loan concentrations are considered to exist for a
financial entity when such amounts are loans to a multiple of borrowers engaged in similar
activities that cause them to be similarly impacted by economic or other conditions. The Company
has identified certain industry groups within its market area, including lodging, restaurants,
retail shops, small manufacturing, real estate rental properties and real estate development. At
December 31, 2004, there existed several industry group concentrations in the Companys loans that
exceeded 10% of total loans. At year-end 2004, loans to real estate developers totaled $80.9
million, real estate rental property loans totaled $75.9 million and lodging represented $75.1
million in loans and are located in various areas of the Banks market area. 28




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##### Table of Contents



In addition, loans to tourism related businesses remain a significant part of the business and
loans in other sectors are affected by the tourism driven economy of Door County. As a result, a
decrease in tourism could adversely affect one or more industry groups in the Companys loan
portfolio, which could have a corresponding adverse effect on the Companys earnings.
Additionally, a decline in tourism has an indirect effect in that other types of business (grocery
and convenience stores, for example) rely on the tourism to provide cash flow to their operations.
Loans to individuals who are employed by tourism related business could also be affected in the
event of a downturn in the market. Although growth was somewhat flat in 2004 for tourism business in the Door County market,
management believes that business activity still appears to remain adequate to service debt of the
customers and for customers in general to make improvements to their operations. To date, these
types of loans have had little downgrade in loss potential relative to credit risk. At the end of 2004, residential real estate mortgage loans totaled $134.4 million and comprised
17.7% of the loan portfolio. These loans increased $8.7 million or 6.9% during 2004. The
historically low interest rate environment during the first half of 2004 caused consumer preference
to remain with fixed-rate residential loans. Loans were originated or refinanced at lower fixed
rates as consumers looked to lock in to the attractive financing rates. Refinancing activity has
slowed considerably in the last half of 2004 compared to 2003, as interest rates have increased.
The Company expects the trend to continue into 2005, and given current trends, growth in mortgage
loans would decline. Residential real estate loans consist of conventional home mortgages,
adjustable indexed interest rate mortgage loans, home equity loans, and secondary home mortgages.
Loans are primarily for properties within the market areas served by the Company. Residential real
estate loans generally contain a limit for the maximum loan to collateral value of 75% to 80% of
fair market value. Private mortgage insurance may be required when the loan to value exceeds these
limits. The Company offers adjustable rate mortgage loans based upon market demands. At year-end 2004,
those loans totaled $25.1 million dollars, an increase of $1.3 million dollars. Adjustable rate
mortgage loans contain an interest rate adjustment provision tied to the weekly average yield on
U.S. Treasury securities adjusted to a constant maturity of one year (the index), plus an
additional mark-up of 2.75% which varies with the mortgage loan product. Interest rates on indexed
mortgage loans are adjusted, up or down, on predetermined dates fixed by contract, in relation to
and based on the index or market interest rates as of a predetermined time prior to the adjustment
date. Adjustable rate mortgage loans have an initial period, ranging from one or three years, during
which the interest rate is fixed, with adjustments permitted thereafter, subject to annual and
lifetime interest rate caps which vary with the product. Annual limits on interest rate changes
are 2% while aggregate lifetime interest rate increases over the term of the loan are currently at
6% above the original mortgage loan interest rate. The Company also participates in a fixed rate
mortgage program under the Federal Home Loan Mortgage Corporation (FHLMC) guidelines. These
loans are sold in the secondary market and the Company retains servicing rights. At December 31,
2004, these loans totaled $117.3 million compared to $116.5 million at December 31, 2003. The Company also offers fixed rate mortgages through participation in fixed rate mortgage programs
under private investors. These loans also are sold in the secondary market with servicing rights
released to the buyer. In 2004, the Company sold $63.4 million in mortgage loans through the secondary programs
compared to $138.5 million in 2003. Installment loans to individuals totaled $13.9 million, or 1.8%, of the total loan portfolio at
December 31, 2004 compared to $14.5 million, or 2.0%, at end of 2003. Installment loans include
short-term installment loans, direct and indirect automobile loans, recreational vehicle loans,
credit card loans, and other personal loans. Individual borrowers may be required to provide
collateral or a satisfactory endorsement or guaranty from another party, depending upon the
specific type of loan and the creditworthiness of the borrower. Loans are made to individual
borrowers located in the market areas served by the Company. Credit risks for loans of this type
are generally influenced by general economic conditions (especially in the market areas served),
the characteristics of individual borrowers and the nature of the loan collateral. Credit risk is
primarily controlled by reviewing the creditworthiness of the borrowers as well as taking the
appropriate collateral and guaranty positions on such loans. 29




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##### Table of Contents



Tax-exempt loans totaled $20.5 million at December 31, 2004 compared to $19.0 million at year-end
2003. Tax- exempt loans are short or long term loans to municipalities for the funding of various
projects. The proceeds of these loans are collateralized by the backing of the taxing authority and
can be used for general or revenue producing projects. Table 8: Loan Maturity and Interest Rate Sensitivity MaturityDecember 31, 2004
    
    
    Within 1 Year
    
    
    
    1-5 Years
    
    
    
    After 5 Years
    
    
    
    Total(dollars in thousands)Loans secured
primarily by real
estate:Secured by 1 to 4
family residential
properties
    
    
    $
    39,385
    
    
    
    $
    56,144
    
    
    
    $
    38,821
    
    
    
    $
    134,350Construction
    
    
    
    37,429
    
    
    
    
    41,385
    
    
    
    
    1,570
    
    
    
    
    80,384Commercial real
estate
    
    
    
    131,355
    
    
    
    
    195,227
    
    
    
    
    97,732
    
    
    
    
    424,314Commercial and
Industrial
    
    
    
    15,703
    
    
    
    
    52,664
    
    
    
    
    14,783
    
    
    
    
    83,150Tax-exempt
    
    
    
    5,213
    
    
    
    
    7,651
    
    
    
    
    7,593
    
    
    
    
    20,457Loans to consumers
    
    
    
    4,228
    
    
    
    
    9,690
    
    
    
    
    18
    
    
    
    
    13,936All other loans
    
    
    
    385
    
    
    
    
    252
    
    
    
    
    0
    
    
    
    
    637Total
    
    
    $
    233,698
    
    
    
    $
    363,013
    
    
    
    $
    160,517
    
    
    
    $
    757,228
 Interest sensitivityFixed rate
    
    
    
    Variable rateDue after one year
    
    
    $
    154,624
    
    
    
    $
    368,906
 Critical factors in the overall management of credit quality are sound loan underwriting and
administration, systematic monitoring of existing loans and commitments, effective loan review on
an ongoing basis, adequate allowance for loan losses, and conservative non-accrual and charge-off
policies. Risk Management and the Allowance for Loan Losses The loan portfolio is the Companys primary asset subject to credit risk. To reflect this credit
risk, the Company sets aside an allowance for probable incurred credit losses through periodic
charges to earnings. These charges are shown in the Companys consolidated income statement as
provision for loan losses. See Provision for Loan Losses above. Credit risk is controlled and
monitored through the use of lending standards, a thorough review of potential borrowers, and an
ongoing review of payment performance. Asset quality administration, including early
identification of problem loans and timely resolution of problems, further enhances management of
credit risk and minimization of loan losses. All specifically identifiable and quantifiable losses
are charged off against the allowance. Charged-off loans are subject to periodic review, and
specific efforts are taken to achieve maximum recovery of principal and interest. As Table 9 indicates, the ALL at December 31, 2004 was $10.4 million compared with $12.2 million at
the end of 2003. Loans increased 5.9% in 2004, while the allowance as a percent of total loans
decreased to 1.38% from 1.70% at year-end 2003. Based on managements analysis of the loan
portfolio risk at December 31, 2004, a provision expense of $1.6 million was recorded for the year
ended December 31, 2004, a decrease of $4.1 million compared to the same period in 2003. The
provision for loan losses is predominately a function of managements evaluation of the loan
portfolio, with particular emphasis directed toward non-performing and other potential problem
loans. During these evaluations, consideration is also given to such factors as managements
evaluation of specific loans, the level and composition of impaired loans, other non-performing
loans, historical loss experience, 30




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##### Table of Contents



results of examinations by regulatory agencies and various other
factors. The trend indicated a reduction in risk relative to the loan portfolio at year-end 2004 compared to year-end 2003. Net loan charge-offs
of $3.3 million occurred in 2004, and the ratio of net charge-offs to average loans for the period
ended December 31, 2004 was 0.45% compared to 0.70% at December 31, 2003. Commercial loan
charge-offs represented 61.6% of the total net charge-offs for the year 2004, primarily the result
of a $1.6 million loan charge-off taken in the fourth quarter of 2004. This was the remaining
amount left on a commercial credit that experienced a $2.6 million charge-off in 2003. Real
estate-mortgage charge-offs represented 33.4% of the total net charge-offs for the year 2004.
Commercial mortgage loan charge-offs accounted for $960,000 of the mortgage total and residential
mortgage loan charge-offs totaled $147,000. Loans charged-off are subject to periodic review and
specific efforts are taken to achieve maximum recovery of principal, accrued interest and related
expenses. Table 9. Loan Loss Experience Years Ended December 31,2004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000(dollars in thousands)Daily average amount of loans
    
    $
    740,605
    
    
    $
    695,669
    
    
    $
    655,464
    
    
    $
    607,097
    
    
    $
    523,743Loans, end of period
    
    $
    757,228
    
    
    $
    715,022
    
    
    $
    682,512
    
    
    $
    627,492
    
    
    $
    573,529ALL, at beginning of year
    
    $
    12,159
    
    
    $
    11,410
    
    
    $
    7,992
    
    
    $
    7,006
    
    
    $
    7,611Loans charged off:Real estate-mortgage
    
    
    226
    
    
    
    946
    
    
    
    178
    
    
    
    334
    
    
    
    745Real estate-construction
    
    
    3
    
    
    
    79
    
    
    
    
    
    
    
    
    

    
    
    Real estate-commercial
    
    
    1,039
    
    
    
    649
    
    
    
    1,681
    
    
    
    1,239
    
    
    
    839Commercial/agricultural loans
    
    
    2,781
    
    
    
    4,369
    
    
    
    789
    
    
    
    983
    
    
    
    367Consumer loans
    
    
    240
    
    
    
    302
    
    
    
    407
    
    
    
    173
    
    
    
    123Lease
financing/other loans
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total loans charged off
    
    $
    4,289
    
    
    $
    6,345
    
    
    $
    3,055
    
    
    $
    2,729
    
    
    $
    2,074Recoveries of loans previously charged off:Real estate-mortgage
    
    
    79
    
    
    
    263
    
    
    
    126
    
    
    
    173
    
    
    
    205Real estate-construction
    
    
    1
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2Real estate-commercial
    
    
    79
    
    
    
    107
    
    
    
    49
    
    
    
    159
    
    
    
    85Commercial/agricultural loans
    
    
    741
    
    
    
    950
    
    
    
    524
    
    
    
    428
    
    
    
    568Consumer loans
    
    
    76
    
    
    
    124
    
    
    
    74
    
    
    
    75
    
    
    
    64Lease
financing/other loans
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total loans recovered
    
    
    976
    
    
    
    1,444
    
    
    
    773
    
    
    
    835
    
    
    
    924Net loans charged off (NCOs)
    
    
    3,313
    
    
    
    4,901
    
    
    
    2,282
    
    
    
    1,894
    
    
    
    1,150Additions to allowance for loan losses
charged
to operating expense
    
    $
    1,599
    
    
    $
    5,650
    
    
    $
    5,700
    
    
    $
    2,880
    
    
    $
    545Allowance to related assets acquired
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    ALL, at end of year
    
    $
    10,445
    
    
    $
    12,159
    
    
    $
    11,410
    
    
    $
    7,992
    
    
    $
    7,006Ratio of NCOs during period to average
loans
outstanding
    
    
    0.45
    %
    
    
    0.70
    %
    
    
    0.35
    %
    
    
    0.31
    %
    
    
    0.22
    %Ratio of ALL to NCOs
    
    
    3.2
    
    
    
    2.5
    
    
    
    5.0
    
    
    
    4.2
    
    
    
    6.1Ratio of ALL to total loans end of period
    
    
    1.38
    %
    
    
    1.70
    %
    
    
    1.67
    %
    
    
    1.27
    %
    
    
    1.22
    %
 The change in ALL is a function of a number of factors, including but not limited to changes in the
loan portfolio, net charge-offs, and non-performing loans. On a quarterly basis, management reviews the adequacy of the ALL. Commercial credits are graded by
the loan officers and the loan review function validates the officers grades. In the event that
the loan review function downgrades the loan, it is included in the allowance analysis at the lower
grade. The grading system is in compliance with the regulatory classifications and the allowance
is allocated to the loans based on the regulatory 31




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grading, except in instances where there are know
differences (i.e., collateral value is nominal, etc.). To establish
 the appropriate level of the allowance, a sample of loans (including impaired and non-performing
loans) are reviewed and classified as to potential loss exposure. Based on an estimation computed pursuant to the requirements of Financial Accounting Standards
Board (FASB) Statement No. 5, Accounting for Contingencies, and FASB Statements No. 114 and
118, Accounting by Creditors for Impairment of a Loan, the analysis of the ALL consists of two
components: (i) specific credit allocation established for expected losses resulting from analysis
developed through specific credit allocations on individual loans for which the recorded investment
in the loan exceeds its fair value; (ii) general portfolio allocation based on historical loan loss
experience for each loan category and adjusted for economic conditions as well as specific and
other factors in the markets in which the Company operates. In prior years the Company did not consistently use subject reserves based on general economic
conditions and specific economic factors as a component of the ALL analysis, but rather used the
unallocated portion of the ALL to recognize this inherent factor. In the current year the Company
refined their calculation to use the subjective factors and thus the previously unallocated portion
was allocated to the various loan categories. Management believes that there would be no change in
the balance of the ALL if this approach was used in all of the years presented. The specific credit allocation of the ALL is based on a regular analysis of loans over a
fixed-dollar amount where the internal credit rating is at or below a predetermined classification.
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 cost of sale. The general portfolio allocation component of the ALL is determined statistically using a loss
migration analysis that examines historical loan loss experience. The loss migration analysis is
performed quarterly and loss factors are updated regularly based on actual experience. The general
portfolio allocation element of the ALL also includes consideration of the amounts necessary for
concentrations and changes in portfolio mix and volume. The ALL is based on estimates, and ultimate losses will vary from current estimates. These
estimates are reviewed monthly, and as adjustments, either positive or negative, become necessary,
a corresponding increase or decrease is made in the provision for loan losses. The composition of
the loan portfolio has not significantly changed since year-end 2003. Management remains watchful of credit quality issues and believes that issues within the portfolio
are reflective of the challenging economic environment experienced over the past few years. Should
the economic climate deteriorate from current levels, borrowers may experience difficulty, and the
level of non-performing loans, charge-offs and delinquencies could rise and require further
increases in the provision. Table 10 shows the amount of the ALL allocated for the time periods indicated to each loan type as
described. It also shows the percentage of balances for each loan type to total loans. In
general, it would be expected that those types of loans which have historically more loss
associated with them will have a proportionally larger amount of the allowance allocated to them
than do loans that have less risk. Consideration for making such allocations is consistent with the factors discussed above, and all
of the factors are subject to change; thus, the allocation is not necessarily indicative of the
loan categories in which future loan losses will occur. It would also be expected that the amount
allocated for any particular type of loan will increase or decrease proportionately to both the
changes in the loan balances and to increases or decreases in the estimated loss in loans of that
type. In other words, changes in the risk profile of the various parts of the loan portfolio
should be reflected in the allowance allocated. Table 10: Allocation of the Allowance for Loan Losses 32




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As of December 31,(dollars in thousands)2004
    

2003
    

2002% of total
    
    
    
    
    
    
    
    
    % of total
    
    
    
    
    
    
    
    
    % of totalAmount
    
    
    
    loans
    
    
    
    Amount
    
    
    
    loans
    
    
    
    Amount
    
    
    
    loansCommercial,
financial
& agricultural
    
    
    $
    1,982
    
    
    
    
    11.1
    %
    
    
    $
    2,386
    
    
    
    
    12.7
    %
    
    
    $
    3,679
    
    
    
    
    13.0
    %Commercial real
estate
    
    
    
    6,374
    
    
    
    
    56.1
    
    
    
    
    6,772
    
    
    
    
    54.2
    
    
    
    
    4,639
    
    
    
    
    51.5Real estateConstruction
    
    
    
    998
    
    
    
    
    10.6
    
    
    
    
    702
    
    
    
    
    10.8
    
    
    
    
    814
    
    
    
    
    11.1Residential
    
    
    
    460
    
    
    
    
    13.0
    
    
    
    
    1,246
    
    
    
    
    13.2
    
    
    
    
    1,467
    
    
    
    
    15.8Home equity lines
    
    
    
    79
    
    
    
    
    4.7
    
    
    
    
    79
    
    
    
    
    4.4
    
    
    
    
    228
    
    
    
    
    3.7Consumer
    
    
    
    198
    
    
    
    
    1.8
    
    
    
    
    346
    
    
    
    
    2.0
    
    
    
    
    222
    
    
    
    
    2.2Tax exempt loans
    
    
    
    
    
    
    
    
    2.7
    
    
    
    
    
    
    
    
    
    2.7
    
    
    
    
    
    
    
    
    
    2.7Not specifically
Allocated
    
    
    
    354
    
    
    
    
    
    
    
    
    
    628
    
    
    
    
    
    
    
    
    
    361Total allowance
    
    
    $
    10,445
    
    
    
    
    

    
    
    
    $
    12,159
    
    
    
    
    
    
    
    
    $
    11,410
 The reduction in allocation of ALL for residential real estate relates to the improvement in the
performance of several non-performing loans in those categories and subsequent reduction of the ALL
relative to those loans. As of December 31,(dollars in thousands)2001
    

2002% of total
    
    
    
    
    
    
    
    
    % of totalAmount
    
    
    
    loans
    
    
    
    Amount
    
    
    
    loansCommercial,
financial
& agricultural
    
    
    $
    972
    
    
    
    
    14.1
    %
    
    
    $
    1,073
    
    
    
    
    14.6
    %Commercial real
estate
    
    
    
    4,158
    
    
    
    
    46.0
    
    
    
    
    2,993
    
    
    
    
    43.9Real estateConstruction
    
    
    
    503
    
    
    
    
    10.8
    
    
    
    
    302
    
    
    
    
    7.2Residential
    
    
    
    1,078
    
    
    
    
    19.3
    
    
    
    
    1,395
    
    
    
    
    23.7Home equity lines
    
    
    
    178
    
    
    
    
    3.6
    
    
    
    
    148
    
    
    
    
    4.3Consumer
    
    
    
    255
    
    
    
    
    2.7
    
    
    
    
    208
    
    
    
    
    3.1Tax exempt loans
    
    
    
    
    
    
    
    
    3.5
    
    
    
    
    
    
    
    
    
    3.2Not specifically
Allocated
    
    
    
    848
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    887Total allowance
    
    
    $
    7,992
    
    
    
    
    100.0
    %
    
    
    $
    7,006
    
    
    
    
    100.0
    %
 While there exists probable asset quality problems in the loan portfolio, management believes
sufficient reserves have been provided in the ALL to absorb probable losses in the loan portfolio
at December 31, 2004. Ongoing efforts are being made to collect these loans, and the Company
involves the legal process when it believes it necessary to minimize the risk of further
deterioration of these loans for full collection. While management uses available information to recognize losses on loans, future adjustments to the
ALL may be necessary based on changes in economic conditions and the impact of such change on the
Companys borrowers. As an integral part of their examination process, various regulatory agencies
also review the ALL. Such agencies may require that changes in the ALL be recognized when their
credit evaluations differ from those of management, based on their judgments about information
available to them at the time of their examination. Non-Performing Loans, Potential Problem Loans and Other Real Estate Management encourages early identification of non-accrual and problem loans in order to minimize
the risk of loss. Non-performing loans remain a leading indicator of future loan loss potential. Non-performing
loans are defined as non-accrual loans, loans 90 days or more past due but still accruing, and
restructured loans. Additionally, whenever management becomes aware of facts or circumstances that
may adversely impact on the collection of principal or interest on loans, it is the practice of
management to place such loans on non-accrual status immediately rather than 33




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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. When interest accruals are discontinued, interest
credited to income is reversed. If collection is in doubt, cash receipts on non-accrual loans are used to
reduce principal rather than recorded as interest income.

Restructuring loans involve the granting of some concession to the borrower involving a loan
modification, such as payment schedule or interest rate changes.

Table 11: Nonperforming Loans and Other Real Estate Owned

Years Ended December 31,2004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000(dollars in thousands)Nonaccrual loans
    
    $
    5,920
    
    
    $
    11,079
    
    
    $
    12,244
    
    
    $
    9,929
    
    
    $
    8,479Accruing loans past due 90 days or more
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Restructured loans
    
    
    6,531
    
    
    
    5,144
    
    
    
    9,844
    
    
    
    4,744
    
    
    
    4,510Total non-performing loans (NPLs)
    
    $
    12,451
    
    
    $
    16,223
    
    
    $
    22,088
    
    
    $
    14,673
    
    
    $
    12,989Other real estate owned/operating subsidiaries
    
    
    2,572
    
    
    
    2,271
    
    
    
    2,890
    
    
    
    1,673
    
    
    
    877Total non-performing assets (NPAs)
    
    $
    15,023
    
    
    $
    18,494
    
    
    $
    24,978
    
    
    $
    16,346
    
    
    $
    13,866Ratios:NPLs to total loans
    
    
    1.64
    %
    
    
    2.27
    %
    
    
    3.24
    %
    
    
    2.34
    %
    
    
    2.26
    %NPAs to total assets
    
    
    1.43
    %
    
    
    1.90
    %
    
    
    2.76
    %
    
    
    1.93
    %
    
    
    1.80
    %ALL to NPLs
    
    
    83.97
    %
    
    
    74.95
    %
    
    
    51.66
    %
    
    
    54.47
    %
    
    
    53.94
    %


Non-performing loans at December 31, 2004 were $12.5 million compared to $16.2 million at December
31, 2003. Impacting the decrease in non-performing loans in 2004 was a loan charge-off of $1.6
million in restructured loans and a shifting, as a result of foreclosure, of approximately $3.3
million in loans to other real estate owned during 2004 offset by a net increase in non-performing
loans totaling $1.1 million in 2004. Non-accrual loans represented $5.9 million of the total of
non-performing loans. Real estate non-accrual loans account for $5.2 million of the total, of
which $868,000 was residential real estate and $4.4 million was commercial real estate, while
commercial and industrial non-accruals account for $512,000. Management believes collateral is
sufficient to offset losses in the event additional legal action would be warranted to collect
these non-accrual loans. Restructured loans were $6.5 million at December 31, 2004 compared with
$5.1 million at year-end 2003. The change in restructured loans resulted from the charge-off of
$1.6 million in loans which were considered restructured loans at year-end 2003 and net loan
principal increases on various other restructured loans totaling $3.0 million during 2004. Of the
restructured loans at December 31, 2004, approximately $4.5 million consisted of one commercial
real estate credit as to which the bank has granted various concessions as a result of the
borrowers past cash flow problems. This credit was current at December 31, 2004. Because
management believes that collateral for this loan may not be generally sufficient if there were to
be a default, management has allocated $2.4 million of the ALL to this credit. As a result of
the cash flow problems of the debtor, management is continuing to specially monitor this loan on a
monthly basis and is working with the borrower to minimize any additional loss exposure. As a
result the ratio of non-performing loans to total loans at the end of 2004 was 1.6% compared to
2.3% at end of year 2003. The Companys ALL was 84.0% of total non-performing loans at December
31, 2004 compared to 75.0% at end of year 2003.

The following table shows, for those loans accounted for on a non-accrual basis for the years ended
as indicated, the gross interest that would have been recorded if the loans had been current in
accordance with their original terms and the amount of interest income that was included in
interest income for the period.

34



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Table 12: Foregone Loan Interest Years
ended December 31,2004
    
    
    
    2003
    
    
    
    2002(dollars in thousands)Interest income in accordance with
original terms
    
    
    $
    688
    
    
    
    $
    996
    
    
    
    $
    1,639Interest income recognized
    
    



(383
    )
    
    
    
    (352
    )
    
    
    
    (357
    )Reduction in interest income
    
    
    $
    305
    
    
    
    $
    644
    
    
    
    $
    1,282
 Potential problem loans are currently performing loans that management needs to be more vigilant in
its efforts to oversee the loans and recognize that a higher degree of risk is associated with
these potential problem loans. Managements decision to place loans in this category does not
necessarily mean that the Company expects to take losses on such loans. At December 31, 2004,
potential problem loans amounted to a total of $9.3 million compared to a total of $5.7 million at
end of 2003. Of the problem loans, a total of $4.8 million stem from two commercial borrowers
which are currently experiencing cash flow concerns. Noting the exceptions above, potential
problem loans are not concentrated in a particular industry but rather cover a diverse range of
businesses. Management does not presently expect significant losses from credits in the potential
problem loan category. Other real estate owned, which represents property that the Company acquired through foreclosure or
in satisfaction of debt, consisted of sixteen properties totaling $2.6 million at end of year 2004.
This compared to nineteen properties totaling $2.3 million at end of year 2003. Management
actively seeks to ensure that properties held are administered to minimize any risk of loss. The net cost of operation of other real estate for 2004, 2003, and 2002 consists of the following
and are shown in Table 13: Table 13: Other Real Estate Operation Summary 2004
    
    
    2003
    
    
    2002(dollars in thousands)Loss on disposition of properties and
other costs
    
    $
    1,044
    
    
    $
    511
    
    
    $
    341Gains on disposition of properties
and expense recoveries
    
    $
    (445
    )
    
    $
    (133
    )
    
    $
    (138
    )Net losses
    
    $
    599
    
    
    $
    378
    
    
    $
    203
 Investment Portfolio The investment portfolio is intended to provide the Company with adequate liquidity, flexibility in
asset/liability management and, lastly, its earning potential. Table 14: Investment Portfolio 2004
    
    
    
    2003
    
    
    
    2002(dollars in thousands)Securities Available for Sale (AFS):U.S. Treasury and other agency
Securities
    
    
    $
    58,796
    
    
    
    $
    37,942
    
    
    
    $
    38,379Obligations of states and political
Subdivisions
    
    
    
    32,417
    
    
    
    
    32,848
    
    
    
    
    35,840Mortgage-backed securities
    
    
    
    99,964
    
    
    
    
    99,970
    
    
    
    
    49,968
 35




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##### Table of Contents



2004
    
    
    
    2003
    
    
    
    2002(dollars in thousands)Private placement
    
    
    
    994
    
    
    
    
    991
    
    
    
    
    Other equity securities
    
    
    

3,442
    
    
    
    
    1,886
    
    
    
    
    4,019Total amortized cost
    
    
    $
    195,613
    
    
    
    $
    173,637
    
    
    
    $
    128,206Total fair value and carrying value
    
    
    $
    197,392
    
    
    
    $
    176,815
    
    
    
    $
    133,139
 Securities are classified as available for sale. The Company determined at year end 2004 that all
of its taxable securities, including U.S. Treasury, U.S. Agency securities and municipal bond
securities purchased in 2004 were to be classified as available for sale. Gains or losses on
disposition are based on the net proceeds and the adjusted carrying amount of the securities sold,
using the specific identification method. Securities classified as available for sale are those securities which the Company has determined
might be sold to manage interest rates or in response to changes in interest rates or other
economic factors. While the Company has no current intention of selling those securities, they may
not be held to maturity. Investment securities available for sale are carried at market value.
Adjustments up or down to market value at December 31, 2004 and 2003 are recorded as a separate
component of equity, net of tax. Premium amortization and discount accretion are recognized as
adjustments to interest income using the interest method. Realized gains or losses on disposition
are based on the net proceeds and the adjusted carrying amount of the securities sold using the
specific identification method. Table 15: Securities Portfolio Maturity Distribution(dollars in thousands) Securities AFS  maturity distribution and weighted average yieldAfter one year
    
    
    
    After five yearsBut within five
    
    
    
    But within tenWithin one year
    
    
    
    years
    
    
    
    years
    
    
    
    After ten years
    
    
    
    TotalAmount
    
    
    
    Yield
    
    
    
    Amount
    
    
    
    Yield
    
    
    
    Amount
    
    
    
    Yield
    
    
    
    Amount
    
    
    
    Yield
    
    
    
    Amount
    
    
    
    YieldTreasury
    
    
    $
    
    
    
    
    
    
    
    
    
    $
    200
    
    
    
    
    4.59
    %
    
    
    $
    
    
    
    
    
    
    
    
    
    $
    
    
    
    
    
    
    
    
    
    $
    200
    
    
    
    
    4.59
    %Agencies
    
    
    
    3,588
    
    
    
    
    6.64
    %
    
    
    
    55,759
    
    
    
    
    4.12
    %
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    59,347
    
    
    
    
    4.27
    %Mortgage-backed
securities
    
    
    
    9,520
    
    
    
    
    3.37
    %
    
    
    
    86,387
    
    
    
    
    3.97
    %
    
    
    
    3,453
    
    
    
    
    4.52
    %
    
    
    
    
    
    
    
    
    
    
    
    
    
    99,360
    
    
    
    
    3.93
    %Obligations of
states and
political
subdivisions
    
    
    
    2,797
    
    
    
    
    7.10
    %
    
    
    
    8,179
    
    
    
    
    7.37
    %
    
    
    
    11,873
    
    
    
    
    7.67
    %
    
    
    
    11,124
    
    
    
    
    6.68
    %
    
    
    
    33,973
    
    
    
    
    7.23
    %Private placement
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,070
    
    
    
    
    8.29
    %
    
    
    
    1,070
    
    
    
    
    8.29
    %Total
carrying Value
    
    
    $
    15,905
    
    
    
    
    4.76
    %
    
    
    $
    150,525
    
    
    
    
    4.21
    %
    
    
    $
    15,326
    
    
    
    
    6.96
    %
    
    
    $
    12,194
    
    
    
    
    6.82
    %
    
    
    
    193,950
    
    
    
    
    4.63
    %
 At December 31, 2004 and 2003, mortgage-backed securities represented 50.3% and 56.1%, respectively
of total investments based on carrying value. The fair value of mortgage-backed securities are
subject to inherent risks based upon the future performance of the underlying collateral (i.e.
mortgage loans) for these securities, such as prepayment risk and interest rate changes. At December 31, 2004 and 2003, the Companys investment portfolio did not contain, other than U.S.
treasury and federal agencies, securities of any single issuer that were payable from and secured
by the same source of revenue of taxing authority where the aggregate book value of such securities
exceed 10% of stockholders equity. Securities averaged $193.8 million in 2004 compared with $153.9 million in 2003. In 2004, taxable
securities comprised approximately 83.5% of the total average investments compared to 76.6% in
2003. Tax-exempt securities on average for 2004 accounted for 16.5% of the total average
investments compared to 23.4% in 2003. Deposits 36




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##### Table of Contents



Deposits are the Companys largest source of funds. At December 31, 2004, deposits were $844.5
million, an increase of $61.2 million or 7.8% from $783.3 million recorded at December 31, 2003.
Brokered deposits increased $77.6 million to $175.4 million at year-end 2004 from $97.8 million at year-end 2003.
Average total deposits for 2004 were $791.0 million, an increase of 5.8% over 2003. Included in
these results was an increase in average brokered deposits to $132.6 million in 2004 from $98.2
million in 2003. The increase in brokered time deposits occurred principally in the first half of
2004, and reflects the Companys continuing use of such instruments to provide incremental funding
to meet cash flow needs. The acquisition of brokered time deposits was accomplished generally at
funding rates that the Company encounters in its own market area. Although the use of brokered
deposits has continued to increase in the last year, Management views these as a stable source of
funds. If liquidity concerns arose, the Company believes (but cannot assure) that it has
alternative sources of funds such as lines with correspondent banks and borrowing arrangements with
FHLB should the need present itself. Typically, overall deposits for the first six months tend to
decline slightly as a result of the seasonality of the Companys customer base as customers draw
down deposits during the early first half of the year in anticipation of the summer tourist season. Table 16: Average Deposits Distribution 2004
    
    
    
    2003
    
    
    
    2002Amount
    
    
    
    % of Total
    
    
    
    Amount
    
    
    
    % of Total
    
    
    
    Amount
    
    
    
    % of Total(dollars in thousands)Noninterest-bearing
Demand deposits
    
    
    $
    105,134
    
    
    
    
    13
    %
    
    
    $
    88,642
    
    
    
    
    12
    %
    
    
    $
    76,030
    
    
    
    
    11
    %Interest-bearing demand
Deposits
    
    
    
    89,648
    
    
    
    
    11
    %
    
    
    
    74,998
    
    
    
    
    10
    %
    
    
    
    53,170
    
    
    
    
    8
    %Savings deposits
    
    
    
    199,942
    
    
    
    
    25
    %
    
    
    
    196,598
    
    
    
    
    26
    %
    
    
    
    201,344
    
    
    
    
    29
    %Other time deposits
    
    
    
    188,571
    
    
    
    
    24
    %
    
    
    
    208,160
    
    
    
    
    28
    %
    
    
    
    192,160
    
    
    
    
    28
    %Time deposits $100,000
and over (excluding
brokered deposits)
    
    
    
    75,177
    
    
    
    
    10
    %
    
    
    
    81,342
    
    
    
    
    11
    %
    
    
    
    82,287
    
    
    
    
    12
    %Brokered certificates of
Deposit
    
    
    

132,573
    
    
    
    
    17
    %
    
    
    
    98,215
    
    
    
    
    13
    %
    
    
    
    87,108
    
    
    
    
    12
    %Total deposits
    
    
    $
    791,045
    
    
    
    
    100
    %
    
    
    $
    747,955
    
    
    
    
    100
    %
    
    
    $
    692,099
    
    
    
    
    100
    %
 Table 17: Maturity Distribution-Certificates of Deposit and Other Time Deposits of $100,000 or
More December 31, 2004Certificates of DepositThree months or less
    
    
    $
    45,306Over three months through six months
    
    
    
    52,648Over six months through twelve months
    
    
    
    90,557Over twelve months
    
    
    
    47,497Total
    
    
    $
    236,008
 As shown in Table 16, non-interest bearing demand deposits in 2004 averaged $105.1 million, up
18.6% from $88.6 million recorded in 2003. This $16.5 million increase is attributable to
improvement in the seasonal increases in these funds throughout the year along with an emphasis of
attracting new customer relationships and selling more services to existing customers. At December
31, 2004, non-interest-bearing demand deposits were $120.5 million compared with $106.6 million at
year-end 2003. Interest bearing deposits generally consist of interest-bearing checking, savings deposits, money
market accounts, individual retirement accounts (IRAs) and certificates of deposit (CDs). In
2004, interest-bearing deposits 37




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##### Table of Contents



averaged $685.9 million, an increase of 4.0%. Within the category
of interest bearing deposits, savings deposits, including money market accounts, increased $18.0
million or 6.6% as a result of customer preference to stay liquid in a rising interest rate
environment. During the same period, time deposits, including CDs and IRAs (other than
brokered time and time over $100,000) decreased in average deposits $19.6 million or 9.4%,
primarily the result of a shift in customer preferences. Average time deposits over $100,000 other
than brokered time deposits decreased by $6.2 million or 7.6%. Time deposits greater than $100,000
and brokered time deposits were priced within the framework of the Companys rate structure and did
not materially increase the average rates on deposit liabilities. Increased competition for
consumer deposits and customer awareness of interest rates continue to limit the Companys core
deposit growth in these types of deposits. Emphasis will be placed on generating additional core deposits in 2005 through competitive pricing
of deposit products and through the branch delivery systems that have already been established.
The Company will also attempt to attract and retain core deposit accounts through new product
offerings and customer service. The Company also may continute to increase brokered CDs during
the year 2005 as an additional source of funds to provide for loan growth in the event that core
deposit growth goals would not be accomplished. Under that scenario, the Company will continue to
look at other wholesale sources of funds, if the brokered CD market became illiquid or more costly
in terms of rate. Other funding sources Total other funding sources, including short-term borrowings, Federal Home Loan Bank Advances and
subordinated debentures, were $117.6 million at December 31, 2004, an increase of $3.0 million, or
2.6%, from $114.6 million at December 31, 2003. For the illustration depicted in Table 18
short-term borrowings consist of federal funds purchased, securities under agreements to
repurchases and Federal Home Loan Bank Advances. As indicated in Table 19, average 2004 short-term
borrowings were $120.8 million compared to $86.4 million during 2003. The increase of $34.4
million occurred as a result of increased loan demand, increased investment balances offset to a
lesser extent by growth in core deposit, an increase in non-core funding sources such as brokered
time deposits and time deposits greater than $100,000, but also reflected reduced federal funds
purchased at year-end. Table 18: Short-term Borrowings December 31,2004
    
    
    
    2003
    
    
    
    2002(dollars in thousands)Federal funds purchased and repurchase
agreements:Balance end of year
    
    
    $
    1,284
    
    
    
    $
    23,359
    
    
    
    $
    10,056Average amounts outstanding during year
    
    
    $
    25,529
    
    
    
    $
    11,343
    
    
    
    $
    21,040Maximum month-end amounts outstanding
    
    
    $
    44,600
    
    
    
    $
    32,641
    
    
    
    $
    38,197Average interest rates on amounts
Outstanding at end of year
    
    
    
    1.88
    %
    
    
    
    1.23
    %
    
    
    
    1.37
    %Average interest rates on amounts
Outstanding during year
    
    
    
    1.57
    %
    
    
    
    1.32
    %
    
    
    
    1.94
    %Federal Home Loan Bank advances:Balance end of year
    
    
    $
    100,192
    
    
    
    $
    75,092
    
    
    
    $
    65,000Average amounts outstanding during year
    
    
    $
    95,291
    
    
    
    $
    65,250
    
    
    
    $
    72,534Maximum month-end amounts outstanding
    
    
    
    100,196
    
    
    
    
    75,093
    
    
    
    
    100,000Average interest rates on amounts
outstanding at end of year
    
    
    
    2.88
    %
    
    
    
    2.41
    %
    
    
    
    3.44
    %Average interest rates on amounts
outstanding during year
    
    
    
    2.41
    %
    
    
    
    3.12
    %
    
    
    
    3.85
    %
 38




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##### Table of Contents



Federal funds are purchased from money center banks and correspondent banks at prevailing overnight
interest rates. Securities are sold to bank customers under repurchase agreements at prevailing
market rates. Borrowings with the FHLB are secured by one to four family residential mortgages and eligible investment
securities allowing the Company to use it for additional funding purposes. FHLB advances are
included as short-term borrowings. Long-term Debt In connection with the issuance of Trust Preferred Securities in 2001 (see Capital Resources),
the Company issued long-term subordinated debentures to Baylake Capital Trust I, a Delaware
Business Trust subsidiary of the Company. Subordinated debentures were at $16.1 million at
December 31, 2004 and 2003. For additional details, please make reference to the Consolidated
Financial Statements and Note 10 in the accompanying footnotes. Off-Balance Sheet Obligations As of December 31, 2004 the Company has the following commitments, which do not appear on its
balance sheet: Table 19: Commitments 2004(dollars in thousands)Commitments to fund home equity line loans
    
    
    $
    45,101Commitments to fund residential real estate construction
    
    
    
    5,314Commitments unused on various other lines of credit loans
    
    
    

135,889Total commitments to extend credit
    
    
    $
    186,304Financial standby letters of credit
    
    
    $
    23,428
 Further discussion of these commitments is included in Note 13, Financial Instruments with
Off-Balance Sheet Risk of the notes to consolidated financial statements. See also Contractual
Obligations below. Contractual Obligations As of December 31, 2004, the Company is contractually obligated under long-term agreements as
follows: Table 20: Contractual Obligations Payments due by period(dollars in
    
    
    
    
    
    
    
    Less than 1
    
    
    
    
    
    
    
    
    
    
    
    
    
    More than 5thousands)
    
    
    Total
    
    
    
    year
    
    
    
    1 to 3 years
    
    
    
    3 to 5 years
    
    
    
    yearsSubordinated
debentures
    
    
    $
    16,100
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    16,100FHLB advances
    
    
    
    100,192
    
    
    
    
    75,000
    
    
    
    
    
    
    
    
    
    192
    
    
    
    
    25,000Purchase
obligations-facilities
    
    
    
    4,000
    
    
    
    
    4,000Operating leases
    
    
    

554
    
    
    
    
    125
    
    
    
    
    246
    
    
    
    
    183
    
    
    
    
    Totals
    
    
    $
    120,846
    
    
    
    $
    79,125
    
    
    
    $
    246
    
    
    
    $
    375
    
    
    
    $
    41,100
 Further discussion of these contractual obligations is included in Note 4,  Bank Premises and
Equipment and Note 10, Subordinated Debentures of the notes to consolidated financial
statements. 39




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##### Table of Contents



Liquidity Liquidity management refers to the ability of the Company to ensure that cash is available in a
timely manner 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. The Company and the Bank have different liquidity considerations. The Companys primary sources of funds are dividends from the Bank; investment income, and net
proceeds from borrowings and the offerings of subordinated debentures, in addition to the issuance
of its common stock securities. The Company manages its liquidity position in order to provide
funds necessary to pay dividends to its shareholders. Dividends received from Bank totaled $4.6
million in 2004 and will continue to be the Companys main source of liquidity. The dividends from
the Bank were sufficient to pay cash dividends to the Companys shareholders of $3.9 million in
2004. The Bank meets its cash flow needs by having funding sources available to it to satisfy the credit
needs of customers as well as having available funds to satisfy deposit withdrawal requests.
Liquidity at the Bank is derived from deposit growth, maturing loans, the maturity of the
investment portfolio, access to other funding sources, marketability of certain of their assets;
the ability to use its loan and investment portfolios as collateral for secured borrowings and
strong capital positions. Maturing investments have been a primary source of liquidity at the Bank. Principal payments on
investments totaling $16.9 million were made in 2004. $39.4 million in investments were purchased
in 2004. This resulted in net cash of $22.5 million used in investing activities for 2004. At
December 31, 2004, the carrying or book value of investment securities maturing within one year
amounted to $17.8 million or 9.0% of the total investment securities portfolio. This compares to a
6.1% level for investment securities with one year or less maturities as of December 31, 2003.
Within the investing activities of the statement of cash flows, sales and maturities of investment
securities during 2004 totaled $16.9 million. At the end of 2004, the investment portfolio
contained $158.9 million of U.S. Treasury and federal agency backed securities representing 80.5%
of the total investment portfolio. These securities tend to be highly marketable and had a market
value above amortized cost at end of year 2004 amounting to $147,000. Deposit growth is another source of liquidity for the Bank. As a financing activity reflected in
2004 Consolidated Statements of Cash Flows, deposits provided $61.2 million in cash inflow during
2004. The Companys overall average deposit base grew $61.2 million or 7.8% during 2004. Deposit
growth is the most stable source of liquidity for the Bank, although brokered deposits are
inherently less stable than locally generated core deposits. 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 would require the Bank to develop alternative sources of
funds which may not be as liquid and potentially a more costly alternative. Federal funds sold averaged $170,000 in 2004 compared to $1.7 million in 2003. Funds provided from
the maturity of these assets typically are used as funding sources for seasonal loan growth, which
typically have higher yields. Short-term and liquid by nature, federal funds sold generally
provide a yield lower than other earning assets. The Bank has a strategy of maintaining a
sufficient level of liquidity to accommodate fluctuations in funding sources and will at times take
advantage of specific opportunities to temporarily invest excess funds at narrower than normal rate
spreads while still generating additional interest revenue. At December 31, 2004, the Bank had
federal funds sold of $5.4 million. The scheduled maturity of loans can provide a source of additional liquidity. The Bank has $233.7
million of loans maturing within one year, or 30.9% of total loans. Factors affecting liquidity
relative to loans are loan origination volumes, loan prepayment rates and the maturity structure of
existing loans. The Banks liquidity position is influenced by changes in interest rates, economic
conditions and competition. Conversely, loan demand as a need for liquidity will cause the Company
to acquire other sources of funding which could be harder to find and, therefore, more costly to
acquire. 40




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##### Table of Contents



Within the classification of short-term borrowings at year-end 2004, federal funds purchased
and securities sold under agreements to repurchase totaled $1.3 million compared with $23.3 million
at the end of 2003. Federal funds are purchased from various upstream correspondent banks while
securities sold under agreements to repurchase are obtained from a base of business customers.
FHLB Advances, short-term or term, are another source of funds. They totaled $100.2 million at end
of year 2004. The Banks liquidity resources were sufficient in 2004 to fund the growth in loans and investments,
increase the volume of interest earning assets and meet other cash needs when necessary. Management expects that deposit growth will continue to be the primary funding source of the Banks
liquidity on a long-term basis, along with a stable earnings base, the resulting cash generated by
operating activities, and a strong capital position. Although federal funds purchased and
borrowings from the FHLB provided funds in 2004, management expects deposit growth, including
brokered CDs, to be a reliable funding source in the future as a result of branch expansion
efforts and marketing efforts to attract and retain core deposits. Shorter-term liquidity needs
will mainly be derived from growth in short-term borrowings, maturing federal funds sold and
portfolio investments, loan maturities and access to other funding sources. In assessing liquidity, historical information such as seasonality (loan demands affect on
liquidity which starts before and during the tourist season and deposit draw down which affects
liquidity shortly before and during the early part of the tourist season), local economic cycles
and the economy in general are considered along with the current ratios, management goals and the
unique characteristics of the Company. Management believes that, in the current economic
environment, the Companys and the Banks liquidity position is adequate. To managements
knowledge, there are no known trends nor any known demands, commitments, events or uncertainties
that will result or are reasonably likely to result in a material increase or decrease in the
Banks or the Companys liquidity. Interest Rate Sensitivity Management The business of the Company and the composition of its balance sheet consist of investments in
interest-earning assets (primarily loans and securities) which are primarily funded by
interest-bearing liabilities (deposits and borrowings). All of the financial instruments of the
Company are for other than trading purposes. Such financial instruments have varying levels of
sensitivity to changes in market rates of interest. The operating income and net income of the
Company depends, to a substantial extent, on rate differentials, i.e., the differences between
the income the Company receives from loans, securities, and other earning assets and the interest
expense they pay to obtain deposits and other liabilities. These rates are highly sensitive to
many factors that are beyond the control of the Company, including general economic conditions and
the policies of various governmental and regulatory authorities. The Company measures its overall interest rate sensitivity through a net interest income analysis.
The net interest income analysis measures the changes in net interest income in the event of
hypothetical changes in interest rates. This analysis assesses the risk of changes in net interest
income in the event of a sudden and sustained 100 to 200 bps increase in market interest rates or a
100 bps to 200 bps decrease in market rates. The interest rates scenarios are used for analytical
purposes and do not necessarily represent managements view of future market movements. The tables
below present the Companys projected changes in net interest income for 2004 and 2003 for the
various rate shock levels. Table 21: Net Interest Income Sensitivity Analysis Net Interest IncomePotential Change in Net
    
    
    
    Potential Change in NetInterest Income ($)
    
    
    
    Interest Income (%)December 31, 2004
    
    
    Amount
    
    
    
    (Dollars in thousands)+ 200 bps
    
    
    $
    40,100
    
    
    
    $
    2,357
    
    
    
    
    6.3
    %+ 100 bps
    
    
    $
    38,834
    
    
    
    $
    1,092
    
    
    
    
    2.9
    %Base
    
    
    $
    37,743
    
    
    
    
    
    
    
    
    
    - 100 bps
    
    
    $
    35,987
    
    
    
    ($
    1,756
    )
    
    
    
    (4.7
    %)- 200 bps
    
    
    $
    34,086
    
    
    
    ($
    3,656
    )
    
    
    
    (9.7
    %)
 41




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##### Table of Contents



Based on the Companys model at December 31, 2004, the effect on an immediate 100 bps increase in
interest rates would increase the Companys net interest income by 2.9% or approximately $1.1
million. The effect of an immediate 100 bps decrease in rates would decrease the Companys net
interest income by 4.7% or approximately $1.8 million. Net Interest IncomeAmount
    
    
    
    Change ($)
    
    
    
    Change (%)December 31, 2003
    
    
    (Dollars in thousands)+ 200 bps
    
    
    $
    37,310
    
    
    
    $
    1,743
    
    
    
    
    4.9
    %+ 100 bps
    
    
    $
    36,598
    
    
    
    $
    1,031
    
    
    
    
    2.9
    %Base
    
    
    $
    35,567
    
    
    
    
    
    
    
    
    
    - 100 bps
    
    
    $
    34,322
    
    
    
    
    ($1,245
    )
    
    
    
    (3.5
    %)
 Based on the Companys model at December 31, 2003, the effect on an immediate 100 bps increase in
interest rates would increase the Companys net interest income by 2.9% or approximately $1.0
million. The effect of an immediate 100 bps decrease in rates would decrease the Companys net
interest income by 3.5% or approximately $1.2 million. For the year ended December 31, 2003, the
Company did not present an immediate 200 bps decrease in its Asset Liability model due to the
abnormally low prevailing interest rate environment. In order to limit exposure to interest rate risk, the Company has developed strategies to manage
its liquidity, shorten the effective maturities of certain interest-earning assets, and increase
the effective maturities of certain interest-bearing liabilities. The origination of floating rate
loans such as business, construction and other prime based loans is emphasized. The vast majority
of fixed rate loans have re-pricing periods less than five years. The mix of floating and fixed
rate assets is designed to mitigate the impact of rate changes on the Companys net interest
income. Virtually all fixed rate residential mortgage loans with maturities greater than five
years are sold into the secondary market. There can be no assurance that the results of operations would be impacted as indicated if interest
rates did move by the amounts discussed above. Management continually reviews its interest risk
position through the ALCO process. Managements philosophy is to maintain relatively matched rate
sensitive asset and liability positions within the range described above in order to provide
earnings stability in the event of significant interest rate changes. Capital Resources Stockholders equity at December 31, 2004 increased $6.6 million or 9.5% to $76.2 million, compared
with $69.6 million at end of year 2003. The increase in stockholders equity in 2004 was primarily
composed of the retention of earnings and proceeds from the exercise of stock options with
offsetting decreases to stockholders equity from the payment of cash dividends. Additionally,
stockholders equity decreased by $916,000 during 2004 resulting in $1.2 million of accumulated
other comprehensive income, related to unrealized gains on securities. At December 31, 2003,
stockholders equity included $2.1 million of comprehensive income related to unrealized gains on
securities. Stockholders equity to assets at December 31, 2004 was 7.27%, compared to 7.14% at
the end of 2003. In 2001, the Company formed Baylake Capital Trust I (the Trust) as a statutory business
trust organized for the sole purpose of issuing trust preferred securities and investing the
proceeds thereof in junior subordinated debentures of the Company, the sole asset of the Trust.
The trust preferred securities enhanced regulatory capital and added liquidity. The common
securities of the Trust are wholly-owned by the Company. The trust preferred securities and common
securities of the trust represent preferred undivided beneficial interests as the assets of Baylake
Capital Trust I, and the holder of the preferred securities will be entitled to a preference over
the common securities of the Trust upon an event of default with respect to distributions and
amounts payable on redemption or liquidation. These trust preferred securities are tax-advantaged
issues for the Company that qualify for Tier 1 capital treatment to 42




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##### Table of Contents



the Company. Distributions on
these securities are included in interest expense on subordinated debentures. The preferred
securities are traded on the American Stock Exchange under the symbol BYL_p. Prior to 2003, the trust was consolidated in the Companys financial statements, with the trust
preferred securities issued by the trust reported in liabilities as guaranteed preferred
beneficial interests and the subordinated debentures eliminated in consolidation. Under new
accounting guidance, FASB Interpretation No. 46, as revised in December 2003, the trust is no
longer consolidated with the Company. Accordingly, the Company does not report the securities
issued by the trust as liabilities, and instead reports as liabilities the subordinated debentures
issued by the Company and held by the trust, as these are no longer eliminated in consolidation.
Amounts previously reported as guaranteed preferred beneficial interests in liabilities have been
recaptioned subordinated debentures and continue to be presented in liabilities on the balance
sheet. The effect of no longer consolidating the trust does not change significantly the amounts
reported as the Companys assets, liabilities, equity, or interest expense. Under applicable regulatory guidelines, the Trust Preferred Securities qualify as Tier 1 capital up
to a maximum of 25% of Tier 1 capital. Any additional portion of Trust Preferred Securities would
qualify as Tier 2 capital. As of December 31, 2004, all $16.1 million of the Trust Preferred
Securities qualify as Tier 1 Capital. Cash dividends paid in 2004 were $0.57 per share compared with $0.53 in 2003. The Company provided
a 7.5% increase in normal dividends per share in 2004 over 2003 as a result of earnings for 2004. In 1997, the Companys Board of Directors authorized management to repurchase up to 7,000 shares of
the Companys common stock each calendar quarter in the market. The shares repurchased would be
used to fill its needs for the dividend reinvestment program, any future benefit plans, and the
Companys stock purchase plan. Shares repurchased are held as treasury stock and, accordingly, are
accounted for as a reduction of stockholders equity. The Company did not repurchase any of its
common shares in 2004. The adequacy of the Companys capital is regularly reviewed to ensure that sufficient capital is
available for 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. Management is confident that because of current capital levels
and projected earnings levels, capital levels are more than adequate to meet the ongoing and future
concerns of the Company. The Federal Reserve Board 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 the 8% required, at least
half must be comprised of core capital elements defined as Tier 1 capital. The federal banking
agencies also have adopted leverage capital guidelines which banking organizations 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 ratio
of at least 4% to 5%. Failure to meet minimum capital requirements can initiate certain mandatory
-and possible additional discretionary- actions by regulators that, if undertaken, could have a
direct material effect on the consolidated financial statements. At December 31, 2004 and 2003, the Company was categorized as well capitalized under the
regulatory framework for prompt corrective action. There are no conditions or events since that
notification that management believes have changed the Companys 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%. The following table presents the Companys and the Banks capital ratios as of December 31 for each
of the previous two years. Table 22: Capital 43




---



##### Table of Contents



To Be Well CapitalizedUnder PromptFor Capital Adequacy
    
    
    
    Corrective ActionActual
    
    
    
    Purposes
    
    
    
    Provisions(dollars in thousands)At December 31, 2004:Total capital (to risk
weighted assets):The Company
    
    
    $
    95,433
    
    
    
    
    10.95
    %
    
    
    $
    69,791
    
    
    
    
    8.00
    %
    
    
    
    N/A
    
    
    
    
    N/AThe Bank
    
    
    $
    91,521
    
    
    
    
    10.53
    %
    
    
    $
    69,580
    
    
    
    
    8.00
    %
    
    
    $
    86,975
    
    
    
    
    10.00
    %Tier 1 capital (to risk
Weighted assets):The Company
    
    
    $
    84,988
    
    
    
    
    9.75
    %
    
    
    $
    34,895
    
    
    
    
    4.00
    %
    
    
    
    N/A
    
    
    
    
    N/AThe Bank
    
    
    $
    81,076
    
    
    
    
    9.33
    %
    
    
    $
    34,790
    
    
    
    
    4.00
    %
    
    
    $
    52,185
    
    
    
    
    6.00
    %Tier 1 capital (to average
assets):The Company
    
    
    $
    84,988
    
    
    
    
    8.27
    %
    
    
    $
    41,129
    
    
    
    
    4.00
    %
    
    
    
    N/A
    
    
    
    
    N/AThe Bank
    
    
    $
    81,076
    
    
    
    
    7.91
    %
    
    
    $
    41,025
    
    
    
    
    4.00
    %
    
    
    $
    51,282
    
    
    
    
    5.00
    %At December 31, 2003:Total capital (to risk
weighted assets):The Company
    
    
    $
    88,493
    
    
    
    
    10.78
    %
    
    
    $
    65,650
    
    
    
    
    8.00
    %
    
    
    
    N/A
    
    
    
    
    N/AThe Bank
    
    
    $
    84,771
    
    
    
    
    10.33
    %
    
    
    $
    65,631
    
    
    
    
    8.00
    %
    
    
    $
    82,038
    
    
    
    
    10.00
    %Tier 1 capital (to risk
Weighted assets):The Company
    
    
    $
    78,212
    
    
    
    
    9.53
    %
    
    
    $
    32,825
    
    
    
    
    4.00
    %
    
    
    
    N/A
    
    
    
    
    N/AThe Bank
    
    
    $
    74,493
    
    
    
    
    9.08
    %
    
    
    $
    32,815
    
    
    
    
    4.00
    %
    
    
    $
    49,223
    
    
    
    
    6.00
    %Tier 1 capital (to average
assets):The Company
    
    
    $
    78,212
    
    
    
    
    8.38
    %
    
    
    $
    37,331
    
    
    
    

    4.00
    %
    
    
    
    N/A
    
    
    
    
    N/AThe Bank
    
    
    $
    74,493
    
    
    
    
    7.98
    %
    
    
    $
    37,331
    
    
    
    
    4.00
    %
    
    
    $
    46,664
    
    
    
    
    5.00
    %
 Management believes that 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. The Companys 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. Management
actively reviews capital strategies for the Company to ensure that capital levels are appropriate
based on the perceived business risks, further growth opportunities, industry standards, and
regulatory requirements. Table 23: Selected Quarterly Financial Data The following is selected financial data summarizing the results of operations for each quarter in
the years ended December 31, 2004 and 2003: 2004 Quarter EndedMarch 31
    
    
    
    June 30
    
    
    
    September 30
    
    
    
    December 31(In thousands, except per share data)Interest income
    
    
    $
    11,861
    
    
    
    $
    12,239
    
    
    
    $
    12,752
    
    
    
    $
    13,510Interest expense
    
    
    
    4,033
    
    
    
    
    3,887
    
    
    
    
    3,991
    
    
    
    
    4,446Net interest income
    
    
    
    7,828
    
    
    
    
    8,352
    
    
    
    
    8,761
    
    
    
    
    9,064Provision for loan losses
    
    
    
    775
    
    
    
    
    724
    
    
    
    
    70
    
    
    
    
    30Net interest income after
PLL
    
    
    
    7,053
    
    
    
    
    7,628
    
    
    
    
    8,691
    
    
    
    
    9,034Non-interest income
    
    
    
    1,982
    
    
    
    
    2,675
    
    
    
    
    2,416
    
    
    
    
    2,465Non-interest expense
    
    
    
    6,372
    
    
    
    
    6,512
    
    
    
    
    6,575
    
    
    
    
    7,032
 44




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##### Table of Contents



2004 Quarter EndedMarch 31
    
    
    
    June 30
    
    
    
    September 30
    
    
    
    December 31(In thousands, except per share data)Income before income tax
Expense
    
    
    
    2,663
    
    
    
    
    3,791
    
    
    
    
    4,532
    
    
    
    
    4,467Provision for income tax
    
    
    
    767
    
    
    
    
    1,198
    
    
    
    
    1,458
    
    
    
    
    1,257Net income
    
    
    
    1,896
    
    
    
    
    2,593
    
    
    
    
    3,074
    
    
    
    
    3,210Basic earnings per share
    
    
    $
    0.25
    
    
    
    $
    0.34
    
    
    
    $
    0.40
    
    
    
    $
    0.42Diluted earnings per share
    
    
    
    0.25
    
    
    
    
    0.33
    
    
    
    
    0.39
    
    
    
    
    0.41
 2003 Quarter EndedMarch 31
    
    
    
    June 30
    
    
    
    September 30
    
    
    
    December 31(In thousands, except per share data)Interest income
    
    
    $
    11,898
    
    
    
    $
    11,864
    
    
    
    $
    11,951
    
    
    
    $
    11,761Net interest income
    
    
    
    6,811
    
    
    
    
    6,896
    
    
    
    
    7,610
    
    
    
    
    7,741Net interest income after
PLL
    
    
    
    5,918
    
    
    
    
    5,864
    
    
    
    
    6,398
    
    
    
    
    5,228Net income
    
    
    
    1,826
    
    
    
    
    1,867
    
    
    
    
    2,241
    
    
    
    
    2,023Basic earnings per share
    
    
    $
    0.24
    
    
    
    $
    0.25
    
    
    
    $
    0.30
    
    
    
    $
    0.27Diluted earnings per share
    
    
    
    0.24
    
    
    
    
    0.24
    
    
    
    
    0.29
    
    
    
    
    0.26
 Recent Accounting Pronouncements FAS 123R requires all public companies to record compensation cost for stock options provided to
employees in return for employee service. The cost is measured at the fair value of the options
when granted, and this cost is expensed over the employee service period, which is normally the
vesting period of the options. This will apply to awards granted or modified after the first
quarter or year beginning after June 15, 2005. Compensation cost will also be recorded for prior
option grants that vest after the date of the adoption. The effect on results of operations will
depend on the level of future option grants and the calculation of the fair value of the options
granted at such future date, as well as the vesting periods provided, and so cannot currently be
predicted. The Company has ceased issuing stock options under the current plan and thus expects no
further grants. Existing options that will vest after adoption date are expected to result in
additional compensation expense during 2005 through 2008. SOP 03-3 requires that a valuation allowance for loans acquired in a transfer, including in a
business combination, reflect only losses incurred after acquisition and should not be recorded at
acquisition. It applies to any loan acquired in a transfer that showed evidence of credit quality
deterioration since it was made. The effect of these new standards on the Companys financial position and results of operations is
not expected to be material upon adoption. 
 Item 7 A. Quantitative and Qualitative Disclosure about Market Risk. Information required by this item is set forth in Item 7 under the caption Interest Rate
Sensitivity Management and is incorporated in this schedule by reference. 
 Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The Companys Consolidated Financial Statements and notes to related statements thereto are set
forth on the following pages. 45




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##### Table of Contents



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Baylake Corp. and Subsidiaries
Sturgeon Bay, Wisconsin We have audited the accompanying balance sheet of Baylake Corp. and Subsidiaries (the Company) as
of December 31, 2004, and the related statements of income, changes in stockholders equity, and
cash flows for the year then ended. These financial statements are the responsibility of the
Companys management. Our responsibility is to express an opinion on these financial statements
based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the
financial statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall financial statement
presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material
respects, the financial position of the Company as of December 31, 2004 and the results of its
operations and its cash flows for the year then ended, in conformity with U.S. generally accepted
accounting principles. /s/ Crowe Chizek and Company LLC Crowe Chizek and Company LLC Oak Brook, Illinois
March 2, 2005 46




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##### Table of Contents



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Shareholders and Board of Directors
Baylake Corp.
Sturgeon Bay, Wisconsin We have audited the accompanying consolidated balance sheet of Baylake Corp. and subsidiaries
as of December 31, 2003, and the related consolidated statements of income, changes in stockholder
equity, and cash flows for each of the two years in the period ended December 31, 2003. These
financial statements are the responsibility of the companys management. Our responsibility is to
express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a reasonable basis for our
opinion. In our opinion, the financial statements referred to above present fairly the consolidated
financial position of Baylake Corp. and subsidiaries at December 31, 2003, and the results of its
operations and cash flows for each of the two years in the period ended December 31, 2003, in
conformity with U.S. generally accepted accounting principles. Madison,
Wisconsin
January 21, 2004
    
    /s/ Smith & Gesteland, LLPSMITH & GESTELAND, LLP
 47




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##### Table of Contents



BAYLAKE CORP. AND SUBSIDIARIES 
  2004
    
    
    2003ASSETSCash and due from financial institutions
    
    $
    20,727
    
    
    $
    24,226Federal funds sold
    
    
    5,445
    
    
    
    Cash and cash equivalents
    
    
    26,172
    
    
    
    24,226Securities available for sale
    
    
    197,392
    
    
    
    176,815Loans held for sale
    
    
    1,349
    
    
    
    165Loans, net of allowance after $10,445 and $12,159
    
    
    746,783
    
    
    
    702,863Cash value of life insurance
    
    
    21,561
    
    
    
    20,789Premises and equipment, net
    
    
    24,777
    
    
    
    21,958Federal Home Loan Bank stock
    
    
    7,697
    
    
    
    7,247Foreclosed assets, net
    
    
    2,572
    
    
    
    2,271Goodwill
    
    
    5,723
    
    
    
    4,969Accrued interest receivable
    
    
    4,330
    
    
    
    3,997Other assets
    
    
    9,392
    
    
    
    9,440Total assets
    
    $
    1,047,748
    
    
    $
    974,740LIABILITIES AND STOCKHOLDERS EQUITYDepositsNon-interest-bearing
    
    $
    120,511
    
    
    $
    106,642Interest-bearing
    
    
    724,030
    
    
    
    676,650Total deposits
    
    
    844,541
    
    
    
    783,292Federal Home Loan Bank advances
    
    
    100,192
    
    
    
    75,092Federal funds purchased and repurchase agreements
    
    
    1,284
    
    
    
    23,359Subordinated debentures
    
    
    16,100
    
    
    
    16,100Accrued expenses and other liabilities
    
    
    8,272
    
    
    
    6,208Dividends payable
    
    
    1,154
    
    
    
    1,061Total liabilities
    
    
    971,543
    
    
    
    905,112Common stock, $5 par value, authorized 50,000,000; issued-
7,715,936 shares in 2004, 7,628,136 shares in 2003; outstanding-
7,692,777 shares in 2004, 7,604,977 shares in 2003
    
    
    38,580
    
    
    
    38,141Additional paid-in capital
    
    
    8,806
    
    
    
    8,163Retained earnings
    
    
    28,275
    
    
    
    21,864Treasury stock (23,159 shares in 2004 and 2003)
    
    
    (625
    )
    
    
    (625
    )Accumulated other comprehensive income
    
    
    1,169
    
    
    
    2,085Total stockholders equity
    
    
    76,205
    
    
    
    69,628Total liabilities and stockholder equity
    
    $
    1,047,748
    
    
    $
    974,740
 See accompanying notes to consolidated financial statements. 48




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##### Table of Contents



BAYLAKE CORP. AND SUBSIDIARIES 
 2004
    
    
    2003
    
    
    2002Interest and dividend incomeLoans, including fees
    
    $
    42,254
    
    
    $
    40,852
    
    
    $
    43,825Taxable securities
    
    
    6,594
    
    
    
    4,857
    
    
    
    5,958Tax exempt securities
    
    
    1,486
    
    
    
    1,689
    
    
    
    1,754Federal funds sold and other
    
    
    28
    
    
    
    76
    
    
    
    27Total interest and dividend income
    
    
    50,362
    
    
    
    47,474
    
    
    
    51,564Interest expenseDeposits
    
    
    11,968
    
    
    
    14,585
    
    
    
    17,335Federal funds purchased and repurchase agreements
    
    
    401
    
    
    
    150
    
    
    
    413Federal Home Loan Bank advances and other debt
    
    
    2,293
    
    
    
    2,036
    
    
    
    2,795Subordinated debentures
    
    
    1,695
    
    
    
    1,645
    
    
    
    1,645Total interest expense
    
    
    16,357
    
    
    
    18,416
    
    
    
    22,188Net interest income
    
    
    34,005
    
    
    
    29,058
    
    
    
    29,376Provision for loan losses
    
    
    1,599
    
    
    
    5,650
    
    
    
    5,700Net interest income after provision for loan losses
    
    
    32,406
    
    
    
    23,408
    
    
    
    23,676Other incomeFees from fiduciary activities
    
    
    703
    
    
    
    677
    
    
    
    637Fees from loan servicing
    
    
    1,079
    
    
    
    1,470
    
    
    
    1,279Fees for other services to customers
    
    
    4,608
    
    
    
    4,053
    
    
    
    4,148Gains from sales of loans
    
    
    1,372
    
    
    
    2,449
    
    
    
    1,733Securities gains, net
    
    
    
    
    
    
    
    
    
    
    509Increase in cash surrender value of life insurance
    
    
    772
    
    
    
    821
    
    
    
    450Gain on sale of Arborview, LLC
    
    
    
    
    
    
    538
    
    
    
    Rental income
    
    
    
    
    
    
    67
    
    
    
    705Death benefit of life insurance
    
    
    
    
    
    
    
    
    
    
    754Other income
    
    
    1,004
    
    
    
    566
    
    
    
    798Total other income
    
    
    9,538
    
    
    
    10,641
    
    
    
    11,013Noninterest expensesSalaries and employee benefits
    
    
    15,283
    
    
    
    14,183
    
    
    
    13,743Occupancy expense
    
    
    2,156
    
    
    
    2,087
    
    
    
    2,163Equipment expense
    
    
    1,373
    
    
    
    1,438
    
    
    
    1,422Data processing and courier
    
    
    1,125
    
    
    
    1,087
    
    
    
    1,040Operation of other real estate
    
    
    599
    
    
    
    378
    
    
    
    203Other operating expenses
    
    
    5,955
    
    
    
    4,859
    
    
    
    4,820Total other expenses
    
    
    26,491
    
    
    
    24,032
    
    
    
    23,391Income before income tax expense
    
    
    15,453
    
    
    
    10,017
    
    
    
    11,298Income tax expense
    
    
    4,680
    
    
    
    2,060
    
    
    
    2,575Net income
    
    $
    10,773
    
    
    $
    7,957
    
    
    $
    8,723Basic earnings per common share
    
    $
    1.41
    
    
    $
    1.06
    
    
    $
    1.17Diluted earnings per common share
    
    $
    1.40
    
    
    $
    1.04
    
    
    $
    1.15
 See accompanying notes to consolidated financial statements. 49




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##### Table of Contents



BAYLAKE CORP. AND SUBSIDIARIES 
 AccumulatedAdditional
    
    
    
    
    
    
    
    
    
    
    OtherCommon Stock
    
    
    Paid-in
    
    
    Retained
    
    
    Treasury
    
    
    Comprehensive
    
    
    TotalShares
    
    
    Amount
    
    
    Capital
    
    
    Earnings
    
    
    Stock
    
    
    Income
    
    
    EquityBalance, January 1, 2002
    
    
    7,471,577
    
    
    $
    37,474
    
    
    $
    7,319
    
    
    $
    12,843
    
    
    $
    (625
    )
    
    $
    2,119
    
    
    $
    59,130Net income for the year
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    8,723
    
    
    
    
    
    
    
    
    
    
    
    8,723Net changes in unrealized gain (loss) on securities
available for sale, net of $570 deferred taxes
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,098
    
    
    
    1,098Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    9,821Stock options exercised
    
    
    11,700
    
    
    
    58
    
    
    
    23
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    81Tax benefit from exercise of stock options
    
    
    
    
    
    
    
    
    
    
    31
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    31Cash dividends declared ($0.49 per share)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (3,663
    )
    
    
    
    
    
    
    
    
    
    
    (3,663
    )Balance, December 31, 2002
    
    
    7,483,277
    
    
    
    37,532
    
    
    
    7,373
    
    
    
    17,903
    
    
    
    (625
    )
    
    
    3,217
    
    
    
    65,400Net income for the year
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    7,957
    
    
    
    
    
    
    
    
    
    
    
    7,957Net changes in unrealized gain (loss) on securities
available for sale, net of $622 deferred taxes
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,132
    )
    
    
    (1,132
    )Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6,825Stock options exercised
    
    
    121,700
    
    
    
    609
    
    
    
    611
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,220Tax benefit from exercise of stock options
    
    
    
    
    
    
    
    
    
    
    179
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    179Cash dividends declared ($0.53 per share)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (3,996
    )
    
    
    
    
    
    
    
    
    
    
    (3,996
    )Balance, December 31, 2003
    
    
    7,604,977
    
    
    
    38,141
    
    
    
    8,163
    
    
    
    21,864
    
    
    
    (625
    )
    
    
    2,085
    
    
    
    69,628Net income for the year
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    10,773
    
    
    
    
    
    
    
    
    
    
    
    10,773Net changes in unrealized gain (loss) on securities
available for sale, net of $483 deferred taxes
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (916
    )
    
    
    (916
    )Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    9,857Stock options exercised
    
    
    87,800
    
    
    
    439
    
    
    
    499
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    938Tax benefit from exercise of stock options
    
    
    
    
    
    
    
    
    
    
    144
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    144Cash dividends declared ($0.57 per share)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (4,362
    )
    
    
    
    
    
    
    
    
    
    
    (4,362
    )Balance, December 31, 2004
    
    
    7,692,777
    
    
    $
    38,580
    
    
    $
    8,806
    
    
    $
    28,275
    
    
    $
    (625
    )
    
    $
    1,169
    
    
    $
    76,205
 See accompanying notes to consolidated financial statements. 50




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##### Table of Contents



BAYLAKE CORP. AND SUBSIDIARIES 
 2004
    
    
    2003
    
    
    2002Cash flows from operating activities:Reconciliation of net income to net cash provided by
operating activities:Net income
    
    $
    10,773
    
    
    $
    7,957
    
    
    $
    8,723Adjustments to reconcile net income to net cash
provided to operating activities:Depreciation and amortization
    
    
    1,531
    
    
    
    1,434
    
    
    
    1,460Provision for losses on loans
    
    
    1,599
    
    
    
    5,650
    
    
    
    5,700Net amortization of securities
    
    
    567
    
    
    
    620
    
    
    
    135Increase in cash surrender value of life insurance
    
    
    (772
    )
    
    
    (821
    )
    
    
    (450
    )Federal Home Loan Bank stock dividend
    
    
    (450
    )
    
    
    (533
    )
    
    
    (337
    )Net realized gain on sale of securities
    
    
    
    
    
    
    
    
    
    
    (509
    )Net gain on sale of loans
    
    
    (1,372
    )
    
    
    (2,449
    )
    
    
    (1,733
    )Proceeds from sale of loans held for sale
    
    
    63,204
    
    
    
    141,877
    
    
    
    110,056Origination of loans held for sale
    
    
    (63,410
    )
    
    
    (138,530
    )
    
    
    (107,805
    )Net gain from disposal of other real estate
    
    
    (173
    )
    
    
    (65
    )
    
    
    (42
    )Gain on sale of Arborview, LLC
    
    
    
    
    
    
    (538
    )
    
    
    Net gain from disposal of premises and equipment
    
    
    (475
    )
    
    
    (535
    )
    
    
    Provision for deferred tax expense
    
    
    119
    
    
    
    156
    
    
    
    1,063Changes in assets and liabilities:Accrued interest receivable and other assets
    
    
    617
    
    
    
    1,602
    
    
    
    (1,712
    )Accrued expenses and other liabilities
    
    
    2,117
    
    
    
    (309
    )
    
    
    (117
    )Net cash provided by operating activities
    
    
    13,875
    
    
    
    15,516
    
    
    
    14,432Cash flows from investing activities:Proceeds from sale of securities available-for-sale
    
    
    
    
    
    
    
    
    
    
    8,506Principal payments on securities available-for-sale
    
    
    16,859
    
    
    
    68,096
    
    
    
    79,777Purchase of securities available-for-sale
    
    
    (39,402
    )
    
    
    (114,953
    )
    
    
    (70,506
    )Proceeds from sale of other real estate owned
    
    
    2,992
    
    
    
    2,219
    
    
    
    5,608Proceeds from sale of subsidiary assets
    
    
    
    
    
    
    2,595
    
    
    
    Cash paid in completion of acquisition
    
    
    (754
    )
    
    
    
    
    
    
    Proceeds from sale of premises and equipment
    
    
    774
    
    
    
    
    
    
    
    Loan originations and payments, net
    
    
    (48,688
    )
    
    
    (40,169
    )
    
    
    (67,969
    )Additions to premises and equipment
    
    
    (4,600
    )
    
    
    (2,001
    )
    
    
    (1,206
    )Investment in bank-owned life insurance
    
    
    
    
    
    
    (4,000
    )
    
    
    (13,000
    )Net cash used in investing activities
    
    
    (72,819
    )
    
    
    (88,213
    )
    
    
    (58,790
    )
 (Continued) 51




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##### Table of Contents



BAYLAKE CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended December 31, 2004, 2003, and 2002
(Amounts in thousands of dollars) 2004
    
    
    2003
    
    
    2002Cash flows from financing activities:Net change in deposits
    
    $
    61,249
    
    
    $
    42,968
    
    
    $
    70,513Net change in federal funds purchased and
repurchase agreements
    
    
    (22,075
    )
    
    
    13,303
    
    
    
    7,220Proceeds from Federal Home Loan Bank advances
    
    
    125,105
    
    
    
    80,093
    
    
    
    30,000Repayments on Federal Home Loan Bank advances
    
    
    (100,005
    )
    
    
    (70,001
    )
    
    
    (55,000
    )Payments on other borrowings and long-term debt
    
    
    (53
    )
    
    
    (53
    )
    
    
    (53
    )Proceeds from exercise of stock options
    
    
    938
    
    
    
    1,220
    
    
    
    81Cash dividends paid
    
    
    (4,269
    )
    
    
    (3,907
    )
    
    
    (3,588
    )Net cash provided by financing activities
    
    
    60,890
    
    
    
    63,623
    
    
    
    49,173Net change in cash and cash equivalents
    
    
    1,946
    
    
    
    (9,074
    )
    
    
    4,815Beginning cash and cash equivalents
    
    
    24,226
    
    
    
    33,300
    
    
    
    28,485Ending cash and cash equivalents
    
    $
    26,172
    
    
    $
    24,226
    
    
    $
    33,300Supplemental cash flow information:Interest paid
    
    $
    16,078
    
    
    $
    19,147
    
    
    $
    22,618Income taxes paid
    
    
    3,405
    
    
    
    2,019
    
    
    
    2,626Supplemental noncash disclosures:Transfers from loans to repossessed assets
    
    
    3,120
    
    
    
    3,549
    
    
    
    6,697
 See accompanying notes to consolidated financial statements. 52




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##### Table of Contents



BAYLAKE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004, 2003 and 2002
(Amounts in thousands of dollars)  NOTE 1 - NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES The consolidated financial statements of Baylake Corp. (the Company) include the accounts of
the Company, its wholly owned subsidiary Baylake Bank, (the Bank), and the Banks wholly owned
subsidiaries: Baylake Investments, Inc., Baylake Insurance Agency, Inc., and Baylake City Center.
Prior to 2004, the financial statements also included the accounts of Kewaunee County Banc Shares,
Bank of Sturgeon Bay Building Corporation, and Cornerstone Financial Inc. These companies were
merged into the Bank in the third quarter of 2004. Additionally, prior to 2003, the financial
statements included the accounts of Arborview LLC, which was sold in 2003. As discussed in Note
10, a trust that had previously been consolidated in the Company is now reported separately. All
significant intercompany items and transactions have been eliminated. The Bank owns a 49% interest in United Financial Services, Inc., (UFS) a data processing service.
In addition to the ownership interest, UFS and the Company have a common member on each 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. Income recognized by
the Company was $387, $377, and $383 for 2004, 2003, and 2002, respectively. Amounts paid to UFS
for data processing services for Baylake Bank were $992, $962, and $909, in 2004, 2003, and 2002,
respectively. At December 31, 2004 and 2003, Baylake Bank had loans of $100 and $350,
respectively, to UFS. Baylake Bank makes commercial, mortgage, and installment loans to customers substantially all of
whom are located in Door, Brown, Kewaunee, Manitowoc, Waushara, Outagamie, Green Lake, and Waupaca
Counties of Wisconsin. Although Baylake Bank has a diversified portfolio, a substantial portion of
its debtors ability to honor their contracts is dependent upon the economic condition of the local
industrial businesses, as well as commercial, agricultural and tourism industries. Use of Estimates: To prepare financial statements in conformity with U.S. generally
accepted accounting principles, management makes estimates and assumptions based on available
information. These estimates and assumptions affect the amounts reported in the financial
statements and the disclosures provided, and actual results could differ. The allowance for loan
losses, foreclosed assets, and fair values of financial instruments are particularly subject to
change. Cash Flows: Cash and cash equivalents includes cash, deposits with other financial
institutions, and federal funds sold. Net cash flows are reported for customer loan and deposit
transactions, and federal funds purchased and repurchase agreements. (Continued) 53




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BAYLAKE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004, 2003 and 2002
(Amounts in thousands of dollars)  NOTE 1 - NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES(Continued) Securities: Debt securities are classified as available for sale when they might be
sold before maturity. Equity securities with readily determinable fair values are classified as
available for sale. Securities available for sale are carried at fair value, with unrealized
holding gains and losses reported in other comprehensive income, net of tax. Other securities such
as Federal Home Loan Bank stock are carried at cost. Interest income includes amortization of purchase premium or discount. Premiums and discounts on
securities are amortized on the level-yield method without anticipating prepayments. Gains and
losses on sales are recorded on the trade date and determined using the specific identification
method. Declines in the fair value of securities below their cost that are other than temporary are
reflected as realized losses. In estimating other-than-temporary losses, management considers: (1)
the length of time and extent that fair value has been less than cost, (2) the financial condition
and near-term prospects of the issuer, and (3) the Companys ability and intent to hold the
security for a period sufficient to allow for any anticipated recovery in fair value. Loans Held for Sale: Mortgage loans originated and intended for sale in the secondary
market are carried at the lower of aggregate cost or market, as determined by outstanding
commitments from investors. Net unrealized losses, if any, are recorded as a valuation allowance
and charged to earnings. Mortgage loans held for sale may be sold with servicing rights retained. The carrying value of
mortgage loans sold is reduced by the cost allocated to the servicing right. Gains and losses on
sales of mortgage loans are based on the difference between the selling price and the carrying
value of the related loan sold. Loans: Loans that management has the intent and ability to hold for the foreseeable future
or until maturity or payoff are reported at the principal balance outstanding, net of unearned
interest, deferred loan fees and costs, and an allowance for loan losses. Interest income is
accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination
costs, are deferred and recognized in interest income using the level-yield method without
anticipating prepayments. Interest income on mortgage and commercial loans is discontinued at the time the loan is 90 days
delinquent. Past due status is based on the contractual terms of the loan. In all cases, loans
are
placed on nonaccrual or charged off at an earlier date if collection of principal or interest is
considered doubtful. (Continued) 54




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BAYLAKE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004, 2003 and 2002
(Amounts in thousands of dollars)  NOTE 1 - NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES(Continued) All interest accrued but not received for loans placed on nonaccrual is reversed against
interest income. Interest received on such loans is accounted for on the cash-basis or
cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status
when all the principal and interest amounts contractually due are brought current and future
payments are reasonably assured. Allowance for Loan Losses: The allowance for loan losses is a valuation allowance for
probable incurred credit losses. Loan losses are charged against the allowance when management
believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are
credited to the allowance. Management estimates the allowance balance required using past loan loss
experience, the nature and volume of the portfolio, information about specific borrower situations
and estimated collateral values, economic conditions, and other factors. Allocations of the
allowance may be made for specific loans, but the entire allowance is available for any loan that,
in managements judgment, should be charged-off. The allowance consists of specific and general components. The specific component relates to loans
that are individually classified as impaired or loans otherwise classified as substandard or
doubtful. The general component covers non-classified loans and is based on historical loss
experience adjusted for current factors. A loan is impaired when full payment under the loan terms is not expected. Commercial and
commercial real estate loans are individually evaluated for impairment. If a loan is impaired, a
portion of the allowance is allocated so that the loan is reported, net, at the present value of
estimated future cash flows using the loans existing rate or at the fair value of collateral if
repayment is expected solely from the collateral. Large groups of smaller balance homogeneous
loans, such as consumer and residential real estate loans, are collectively evaluated for
impairment, and accordingly, they are not separately identified for impairment disclosures. Servicing Rights: Servicing rights represent the allocated value of retained servicing
rights on loans sold. Servicing assets are expensed in proportion to, and over the period of,
estimated net servicing revenues, with adjustments for prepayments recognized on a loan-by-loan
basis. (Continued) 55




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BAYLAKE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004, 2003 and 2002
(Amounts in thousands of dollars)  NOTE 1 - NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES(Continued) Servicing fee income is recorded for fees earned for servicing loans. The fees are based on a
contractual percentage of the outstanding principal and are recorded as income when earned. Loan servicing rights are carried in other assets on the balance sheet and amount to $1,187 and
$1,066 on loans serviced for others totaling $151,971 and $144,748 in 2004 and 2003, respectively.
Servicing rights capitalized totaled $394, $539, and $308, during 2004, 2003, and 2002,
respectively. Amortization of servicing rights, which is included in other expense totaled $273,
$411, and $260 during 2004, 2003, and 2002, respectively. Cash Value of Life Insurance: Life insurance is carried at the cash surrender value of the
underlying policies. Certain policies owned by the Company include provisions which could reduce
the amount of cash surrender value the Company could realize. At December 31, 2004, $5,303 of the
cash surrender value of the life insurance policies would not be realizable by the Company if the
Company did not transact a full and complete surrender for the policies and (1) conducts an IRC
1035 exchange, (2) does not surrender all other Bank-owned life insurance simultaneously, (3) does
not maintain a well-capitalized status, and (4) undergoes a change of control within 30 months
prior to the date of such surrender. Transfers of Financial Assets: Transfers of financial assets are accounted for as sales
when control over the assets has been surrendered. Control over transferred assets is deemed to be
surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains the
right (free of conditions that constrain it from taking advantage of that right) to pledge or
exchange the transferred assets, and (3) the Company does not maintain effective control over the
transferred assets through an agreement to repurchase them before their maturity. Foreclosed Assets: Assets acquired through or instead of loan foreclosure are initially
recorded at fair value when acquired, less estimated costs to sell, establishing a new cost basis.
If fair value declines subsequent to foreclosure, a valuation allowance is recorded through
expense. Costs after acquisition are expensed. Premises and Equipment: Land is carried at cost. Premises and equipment are stated at
cost less accumulated depreciation. Buildings and related components are depreciated using the
straight-line method with useful lives ranging from 5 to 40 years. Furniture, fixtures, and
equipment are depreciated using the straight-line (or accelerated) method with useful lives ranging
from 3 to 12 years. (Continued) 56




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##### Table of Contents



BAYLAKE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004, 2003 and 2002
(Amounts in thousands of dollars)  NOTE 1 - NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES(Continued) Goodwill and Other Intangible Assets: Goodwill results from business acquisitions and
represents the excess of the purchase price over the fair value of acquired tangible assets and
liabilities and identifiable intangible assets. Goodwill is assessed at least annually for
impairment, and any such impairment will be recognized in the period identified. Other intangible assets consist of core deposit intangible assets arising from a branch
acquisition. They are initially measured at fair value and then are amortized over their estimated
useful lives, which was determined to be seven years. The balance of the core deposit intangible,
which is included in other assets in the consolidated balance sheets was $304 and $355 at December
31, 2004 and 2003, respectively. Scheduled amortization expense related to the core deposit
intangible is $52 for each of the next five years. Long-Term Assets: Premises and equipment, core deposit and other intangible assets,
and other long-term assets are reviewed for impairment when events indicate that their carrying
amount may not be recoverable from future undiscounted cash flows. If impaired, the assets are
recorded at fair value. Loan Commitments and Related Financial Instruments: Financial instruments include
off-balance-sheet credit instruments, such as commitments to make loans and commercial letters of
credit, issued to meet customer financing needs. The face amount for these items represents the
exposure to loss, before considering customer collateral or ability to repay. Such financial
instruments are recorded when they are funded. Trust Fee Income: The Company provides trust services to customers and in return charges
fees using terms customary in its industry, including charging fees based on the agreed-upon
percentages of assets managed or as otherwise specified in the underlying agreements. Income from
trust services is recognized when the services are provided. Advertising Expense: The Company expenses all advertising costs as they are incurred.
Total advertising costs for the years ended December 31, 2004, 2003, and 2002 were $310, $269, and
$274, respectively. Stock Compensation: Employee compensation expense under stock options is reported using
the intrinsic value method. No stock-based compensation cost is reflected in net income, as all
options granted had an exercise price equal to or greater than the market price of the underlying
common stock at date of grant. The following table illustrates the effect on net income and
earnings per share if expense were measured using the fair value recognition provisions of FASB
Statement No. 123, Accounting for Stock-Based Compensation. (Continued) 57




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BAYLAKE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004, 2003 and 2002
(Amounts in thousands of dollars except per share data)  NOTE 1 - NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES(Continued) 2004
    
    
    2003
    
    
    2002Net incomeAs reported
    
    $
    10,773
    
    
    $
    7,957
    
    
    $
    8,723Stock-based compensation expense
determined under the fair value
based method
    
    
    110
    
    
    
    183
    
    
    
    220Pro forma
    
    $
    10,663
    
    
    $
    7,774
    
    
    $
    8,503Basic earnings per common shareAs reported
    
    $
    1.41
    
    
    $
    1.06
    
    
    $
    1.17Pro forma
    
    
    1.39
    
    
    
    1.03
    
    
    
    1.14Diluted earnings per common shareAs reported
    
    $
    1.40
    
    
    $
    1.04
    
    
    $
    1.15Pro forma
    
    
    1.38
    
    
    
    1.02
    
    
    
    1.12
 The fair value of each option granted was estimated as of the date of grant using the Black-Scholes
option pricing model. The resulting compensation cost was amortized over the vesting period. The fair values and assumptions used to determine such values are as follows: 2004
    
    
    2003
    
    
    2002Weighted average grant date fair value
    
    $
    1.53
    
    
    $
    3.28
    
    
    $
    3.15Assumptions:Risk-free interest rates
    
    
    2.25
    %
    
    
    3.73
    %
    
    
    3.78
    %Expected volatility
    
    
    17.03
    %
    
    
    25.10
    %
    
    
    30.10
    %Expected term (in years)
    
    
    6.98
    
    
    
    8.00
    
    
    
    8.00Expected dividend yield
    
    
    3.75
    %
    
    
    3.65
    %
    
    
    3.78
    %
 Income Taxes: Income tax expense is the total of the current year income tax due or
refundable and the change in deferred tax assets and liabilities. Deferred tax assets and
liabilities are the expected future tax amounts for the temporary differences between carrying
amounts and tax
basis of assets and liabilities, computed using enacted tax rates. A valuation allowance, if
needed, reduces deferred tax assets to the amount expected to be realized. (Continued) 58




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BAYLAKE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004, 2003 and 2002
(Amounts in thousands of dollars)  NOTE 1 - NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES(Continued) Earnings Per Common Share: Basic earnings per common share is net income divided by
the weighted average number of common shares outstanding during the period. Diluted earnings per
common share include the dilutive effect of additional potential common shares issuable under stock
options. Comprehensive Income: Comprehensive income consists of net income and other comprehensive
income. Other comprehensive income includes unrealized gains and losses on securities available
for sale, which are also recognized as separate components of equity. Effect of Newly Issued But Not Yet Effective Accounting Standards: FAS 123R requires all
public companies to record compensation cost for stock options provided to employees in return for
employee service. The cost is measured at the fair value of the options when granted, and this
cost is expensed over the employee service period, which is normally the vesting period of the
options. This will apply to awards granted or modified after the first quarter or year beginning
after June 15, 2005. Compensation cost will also be recorded for prior option grants that vest
after the date of adoption. The effect on results of operations will depend on the level of future
option grants and the calculation of the fair value of the options granted at such future date, as
well as the vesting periods provided, and so cannot currently be predicted. The Company has ceased
issuing stock options under the current plan and thus expects no further grants. However, the plan
is still in existence and the Company has reserved the right to grant additional options. Existing
options that will vest after adoption date are expected to result in an immaterial amount of
compensation expense during 2005 though 2008. SOP 03-3 requires that a valuation allowance for loans acquired in a transfer, including in a
business combination, reflect only losses incurred after acquisition and should not be recorded at
acquisition. It applies to any loan acquired in a transfer that showed evidence of credit quality
deterioration since it was made. The effect of these new standards on the Companys financial position and results of operations is
not expected to be material upon adoption. (Continued) 59




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BAYLAKE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004, 2003 and 2002
(Amounts in thousands of dollars)  NOTE 1 - NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES(Continued) Loss Contingencies: Loss contingencies, including claims and legal actions arising in
the ordinary course of business, are recorded as liabilities when the likelihood of loss is
probable and an amount or range of loss can be reasonably estimated. Restrictions on Cash: Cash on hand or on deposit with the Federal Reserve Bank of $6,732
and $6,190 was required to meet regulatory reserve and clearing requirements at year-end 2004 and
2003. These balances do not earn interest. Fair Value of Financial Instruments: Fair values of financial instruments are estimated
using relevant market information and other assumptions, as more fully disclosed in a separate
note. Fair value estimates involve uncertainties and matters of significant judgment regarding
interest rates, credit risk, prepayments, and other factors, especially in the absence of broad
markets for particular items. Changes in assumptions or in market conditions could significantly
affect the estimates. Dividend Reinvestment Plan: The Company administers a dividend reinvestment plan (DRIP),
whereby, the Company allocates applicable dividends to acquire, on the participants behalf, shares
of Baylake common stock. While the plan allows for additional shares to be issued, all shares are
acquired through the open market. Operating Segments: While the chief decision makers monitor the revenue streams of
the various products and services, the identifiable segments are not material and operations are
managed and financial performance is evaluated on a Company-wide basis. Accordingly, all of the
financial service operations are considered by management to be aggregated in one reportable
operating segment. Reclassifications: Some items in the prior year financial statements were reclassified to
conform to the current presentation. During the year ended December 31, 2004, the Company changed
its method of presenting the statement of cash flows for operating activities from the direct
method (which showed principal components of operating cash receipts and payments) to the indirect
method (which adjusts net income to remove the effects of non-cash operating transactions). This
change has been applied retroactively to the 2003 and 2002 statement of cash flows. (Continued) 60




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BAYLAKE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004, 2003 and 2002
(Amounts in thousands of dollars) 
 NOTE 2 - SECURITIES The fair value of securities available for sale and the related unrealized gains and losses as of
December 31, 2004 and 2003 are as follows: 2004Gross
    
    
    GrossFair
    
    
    Unrealized
    
    
    UnrealizedValue
    
    
    Gains
    
    
    LossesU.S. Treasury and other
U.S. government agencies
    
    $
    59,547
    
    
    $
    965
    
    
    $
    214Obligations of states and
political subdivisions
    
    
    33,973
    
    
    
    1,556
    
    
    
    Mortgage-backed securities
    
    
    99,360
    
    
    
    190
    
    
    
    794Private placement
    
    
    1,070
    
    
    
    76
    
    
    
    Other equity securities
    
    
    3,442
    
    
    
    
    
    
    
    $
    197,392
    
    
    $
    2,787
    
    
    $
    1,008
 2003Gross
    
    
    GrossFair
    
    
    Unrealized
    
    
    UnrealizedValue
    
    
    Gains
    
    
    LossesU.S. Treasury and other
U.S. government agencies
    
    $
    39,696
    
    
    $
    1,760
    
    
    $
    6Obligations of states and
political subdivisions
    
    
    35,015
    
    
    
    2,167
    
    
    
    Mortgage-backed securities
    
    
    99,148
    
    
    
    204
    
    
    
    1,026Private placements
    
    
    1,070
    
    
    
    79
    
    
    
    Other equity securities
    
    
    1,886
    
    
    
    
    
    
    
    $
    176,815
    
    
    $
    4,210
    
    
    $
    1,032
 Other securities consist of short-term money market mutual funds and equity securities in the
Federal Reserve Bank and other nonmarketable equity securities, which are carried at cost. A summary of sales of securities available for sale were as follows: 2004
    
    
    2003
    
    
    2002Proceeds
    
    $
    
    
    
    $
    
    
    
    $
    8,506Gross realized gains
    
    
    
    
    
    
    
    
    
    
    509Gross realized losses
    
    
    
    
    
    
    
    
    
    
    
   (Continued) 61




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BAYLAKE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004, 2003 and 2002
(Amounts in thousands of dollars) 
 NOTE 2 - SECURITIES(Continued) The estimated market value of investments at December 31, 2004, by contractual maturity, is shown
below. Expected maturities will differ from contractual maturities because borrowers may have the
right to call or prepay obligations with or without call or prepayment penalties. EstimatedMarketValueDue in one year or less
    
    $
    6,385Due after one year through five years
    
    
    64,138Due after five years through ten years
    
    
    11,873Due after ten years
    
    
    12,19494,590Other equity securities
    
    
    3,442Mortgage-backed securities
    
    
    99,360$
    197,392
 Securities pledged to secure public deposits and borrowed funds had a carrying value of $127,107
and $91,228 at December 31, 2004 and 2003, respectively. Securities with unrealized losses at year-end 2004 and 2003, aggregated by investment category and
length of time that individual securities have been in a continuous unrealized loss position, are
as follows: Less than 12 Months
    
    
    12 Months or More
    
    
    TotalFair
    
    
    Unrealized
    
    
    Fair
    
    
    Unrealized
    
    
    Fair
    
    
    UnrealizedDescription of Securities
    
    Value
    
    
    Loss
    
    
    Value
    
    
    Loss
    
    
    Value
    
    
    Loss2004U.S. government agencies
    
    $
    32,329
    
    
    $
    201
    
    
    $
    1,235
    
    
    $
    13
    
    
    $
    33,564
    
    
    $
    214Mortgage-backed securities
    
    
    16,537
    
    
    
    191
    
    
    
    55,441
    
    
    
    603
    
    
    
    71,978
    
    
    
    794Total temporarily
impaired
    
    $
    48,866
    
    
    $
    392
    
    
    $
    56,676
    
    
    $
    616
    
    
    $
    105,542
    
    
    $
    1,0082003U.S. government agencies
    
    $
    1,242
    
    
    $
    6
    
    
    $
    
    
    
    $
    
    
    
    $
    1,242
    
    
    $
    6Mortgage-backed securities
    
    
    66,173
    
    
    
    1,026
    
    
    
    
    
    
    
    
    
    
    
    66,173
    
    
    
    1,026Total temporarily
impaired
    
    $
    67,415
    
    
    $
    1,032
    
    
    $
    
    
    
    $
    
    
    
    $
    67,415
    
    

    $
    1,032
   (Continued) 62




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##### Table of Contents



BAYLAKE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004, 2003 and 2002
(Amounts in thousands of dollars) 
 NOTE 2 - SECURITIES(Continued) The Company evaluates securities for other-than-temporary impairment at least on a quarterly basis,
and more frequently when economic or market concerns warrant such evaluation. Consideration is
given to the length of time and the extent to which the fair value has been less than cost, the
financial condition and near-term prospects of the issuer, and the intent and ability of the
Company to retain its investment in the issuer for a period of time sufficient to allow for any
anticipated recovery in fair value. In analyzing an issuers financial condition, the Company may
consider whether the securities are issued by the federal government or its agencies, whether
downgrades by bond rating agencies have occurred, and the results of reviews of the issuers
financial condition. At December 31, 2004, securities with unrealized losses had depreciated in value by less than 1%,
in aggregate, from the amortized cost basis. There are no individual securities with unrealized
losses in excess of 4% of amortized cost basis. These unrealized losses related principally to
changes in interest rates. As the Company has the ability to hold these securities for the
foreseeable future, no declines were deemed to be other than temporary. NOTE 3 - LOANS Major classifications of loans as of December 31, 2004 and 2003 are as follows: 2004
    
    
    2003Commercial
    
    $
    83,787
    
    
    $
    91,051Real estateResidential
    
    
    134,350
    
    
    
    125,700Commercial
    
    
    424,712
    
    
    
    387,778Construction
    
    
    80,384
    
    
    
    77,350Consumer
    
    
    13,936
    
    
    
    14,460Tax exempt loans
    
    
    20,457
    
    
    
    19,032757,626
    
    
    
    715,371Less: Deferred loan origination fees, net of costs
    
    
    398
    
    
    
    349Allowance for loan losses
    
    
    10,445
    
    
    
    12,159Net loans
    
    $
    746,783
    
    
    $
    702,863
 Loans having a carrying value of $29,519 are pledged as collateral for borrowings from the Federal
Home Loan Bank at December 31, 2004.   (Continued) 63




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BAYLAKE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004, 2003 and 2002
(Amounts in thousands of dollars) 
 NOTE 3 - LOANS(Continued) Certain directors and officers of the Company and the Bank, including their immediate families,
companies in which they are principal owners, and trusts in which they are involved, were loan
customers of the Bank during 2004 and 2003. A summary of the changes in those loans is as follows: 2004
    
    
    2003Balance at beginning of year
    
    $
    3,311
    
    
    $
    4,978New loans made
    
    
    4,065
    
    
    
    3,156Repayments received
    
    
    (2,627
    )
    
    
    (4,524
    )Loans related to former officers and directors
    
    
    (23
    )
    
    
    (299
    )Balance at end of year
    
    $
    4,726
    
    
    $
    3,311
 Changes in the allowance for loan losses were as follows: 2004
    
    
    2003
    
    
    2002Balance at beginning of year
    
    $
    12,159
    
    
    $
    11,410
    
    
    $
    7,992Provision charged to operations
    
    
    1,599
    
    
    
    5,650
    
    
    
    5,700Recoveries
    
    
    976
    
    
    
    1,444
    
    
    
    773Loans charged off
    
    
    (4,289
    )
    
    
    (6,345
    )
    
    
    (3,055
    )Balance at end of year
    
    $
    10,445
    
    
    $
    12,159
    
    
    $
    11,410
 Information regarding impaired loans is as follows: 2004
    
    
    2003Impaired loans with no allocated allowance
for loan loss
    
    $
    12,746
    
    
    $
    Impaired loans with allocated allowance
for loan loss
    
    
    16,116
    
    
    
    60,661Allowance allocated to impaired loans
    
    
    4,169
    
    
    
    6,521
 2004
    
    
    2003
    
    
    2002Average impaired loans during the period
    
    $
    48,412
    
    
    $
    40,184
    
    
    $
    30,443Interest income recognized during
impairment
    
    
    2,338
    
    
    
    3,562
    
    
    
    1,864Cash-basis interest income recognized
    
    
    2,338
    
    
    
    3,562
    
    
    
    1,864
   (Continued) 64




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##### Table of Contents



BAYLAKE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004, 2003 and 2002
(Amounts in thousands of dollars) 
 NOTE 3 - LOANS(Continued) Nonperforming loans were as follows: 2004
    
    
    2003Loans past due over 90 days still on accrual
    
    $
    
    
    
    $
    Restructured loans
    
    
    6,531
    
    
    
    5,144Non-accrual loans
    
    
    5,920
    
    
    
    11,079Total nonperforming loans
    
    $
    12,451
    
    
    $
    16,223
 NOTE 4 - BANK PREMISES AND EQUIPMENT 2004
    
    
    2003Land
    
    $
    5,776
    
    
    $
    4,123Buildings and improvements
    
    
    21,033
    
    
    
    20,067Equipment
    
    
    10,295
    
    
    
    9,758Construction in progress
    
    
    891
    
    
    
    37,995
    
    
    
    33,948Less accumulated depreciation
    
    
    13,218
    
    
    
    11,990Bank premises and equipment
    
    $
    24,777
    
    
    $
    21,958
 Depreciation expense was $1,482, $1,428, and $1,515 for 2004, 2003, and 2002, respectively. The Company has a ten-year lease to rent space in a building in Green Bay, Wisconsin that expires
on November 30, 2009. The Company also has a seven-year lease to rent space for a branch bank
location in mall in Howard, Wisconsin that began in 2000. The Company must also pay its
proportional share of costs for common areas at the mall. Rent expense for 2004, 2003, and 2002
was $123, $120, and $117, respectively. Future minimum lease payments under these agreements are as follows: 2005
    
    $
    1252006
    
    
    1282007
    
    
    1182008
    
    
    942009
    
    
    89$
    554
   (Continued) 65




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BAYLAKE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004, 2003 and 2002
(Amounts in thousands of dollars) 
 NOTE 4 - BANK PREMISES AND EQUIPMENT(continued) At December 31, 2004, the estimated costs to complete construction in progress totaled $4.0
million. The construction project relates to an existing building that is being renovated for a
future branch location. Additional office space will be sold under a condominium arrangement. NOTE 5 - OTHER REAL ESTATE Other real estate ($2,788 in 2004, $2,318 in 2003, and $929 in 2002, net of an allowance for other
real estate losses of $216 in 2004, $47 in 2003, and $33 in 2002) is included in other assets. Net cost of operation of other real estate is summarized below: 2004
    
    
    2003
    
    
    2002Loss on disposition of properties
and other costs
    
    $
    1,044
    
    
    $
    511
    
    
    $
    341Gain on disposition of properties
and expense recoveries
    
    
    (445
    )
    
    
    (133
    )
    
    
    (138
    )Net losses
    
    $
    599
    
    
    $
    378
    
    
    $
    203
 Changes in the valuation allowance for losses on other real estate were as follows: 2004
    
    
    2003
    
    
    2002Balance at beginning of year
    
    $
    47
    
    
    $
    33
    
    
    $
    43Provision charged to operations
    
    
    196
    
    
    
    20
    
    
    
    Amounts related to properties disposed
    
    
    (27
    )
    
    
    (6
    )
    
    
    (10
    )Balance at end of year
    
    $
    216
    
    
    $
    47
    
    
    $
    33
 NOTE 6 - GOODWILL The change in balance for goodwill during the year is as follows: 2004
    
    
    2003Beginning of year
    
    $
    4,969
    
    
    $
    4,969Impairment
    
    
    
    
    
    
    Acquired goodwill
    
    
    754
    
    
    
    End of year
    
    $
    5,723
    
    
    $
    4,969
   (Continued) 66




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BAYLAKE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004, 2003 and 2002
(Amounts in thousands of dollars) 
 NOTE 6 - GOODWILL(Continued) Acquired goodwill relates to the final settlement payment made relative to the 1998 acquisition of
Evergreen Bank, N.A. NOTE 7 - DEPOSITS The following is a summary of deposits by type at December 31: 2004
    
    
    2003Non-interest-bearing demand deposits
    
    $
    120,511
    
    
    $
    106,642Interest-bearing demand deposits
    
    
    94,471
    
    
    
    92,308Savings deposits
    
    
    35,531
    
    
    
    35,572Money market deposits
    
    
    173,737
    
    
    
    168,780Time deposits $100,000 and greater
    
    
    236,008
    
    
    
    180,520Other time deposits
    
    
    184,283
    
    
    
    199,470Total deposits
    
    $
    844,541
    
    
    $
    783,292Brokered certificates of deposit included above:
    
    $
    175,357
    
    
    $
    97,840
 At December 31, 2004, the scheduled maturities of time deposits were as follows: 2005
    
    $
    329,1012006
    
    
    72,3412007
    
    
    11,0452008
    
    
    7,7792009
    
    
    Thereafter
    
    
    25$
    420,291
 Deposits from the Companys directors and officers held by the Bank at December 31, 2004 and 2003,
amounted to $3,536 and $3,280, respectively.   (Continued) 67




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BAYLAKE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004, 2003 and 2002
(Amounts in thousands of dollars) 
 NOTE 8 - FEDERAL FUND PURCHASED AND REPURCHASED AGREEMENTS Short-term borrowings consisted of the following at December 31: 2004
    
    
    2003Federal funds purchased
    
    $
    
    
    
    $
    22,386Securities sold under agreements to repurchase
    
    
    1,284
    
    
    
    973$
    1,284
    
    
    $
    23,359
 The average outstanding balance of total short-term borrowings amounted to $25,529 in 2004 and
$11,343 in 2003. The weighted-average interest rate on these borrowings was 1.57% for 2004 and
1.32% for 2003. The average outstanding balance is determined on a daily average basis and the
weighted-average interest rate is calculated by dividing the actual interest paid on all short-term
borrowings by the average balance for the year. The maximum amount outstanding at any month end was $44,600 during 2004 and $32,641 during 2003. NOTE 9 - FEDERAL HOME LOAN BANK ADVANCES A summary of Federal Home Loan Bank advances at December 31 is as follows: Weighted
    
    
    
    
    
    
    WeightedYear of
    
    
    
    
    
    Average
    
    
    
    
    
    
    AverageMaturity
    
    2004
    
    
    Rate
    
    
    2003
    
    
    Rate2004
    
    
    
    
    
    
    
    
    
    $
    50,000
    
    
    
    1.20
    %2005
    
    $
    75,000
    
    
    
    2.21
    %
    
    
    
    
    
    
    2011
    
    
    25,000
    
    
    
    4.73
    
    
    
    25,000
    
    
    
    4.73Total fixed maturity
    
    
    100,000
    
    
    
    2.84
    
    
    
    75,000
    
    
    
    3.55Amortizing
    
    
    192
    
    
    
    3.73
    
    
    
    92
    
    
    
    3.90Total
    
    $
    100,192
    
    
    
    2.84
    %
    
    $
    75,092
    
    
    
    3.55
    %
 Federal Home Loan Bank advances are secured by $29,519 of real estate mortgages and $111,861 of
mortgage-backed agency securities. Advances of $25,000 have call provisions at December 31, 2004.
All advances in the table above are at fixed rates with the exception of $50,000 due June 2005
priced at three month Libor plus 2 basis points and the interest rate is reset quarterly.   (Continued) 68




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BAYLAKE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004, 2003 and 2002
(Amounts in thousands of dollars) 
 NOTE 10 - SUBORDINATED DEBENTURES In 2001, Baylake Corp. formed Baylake Capital Trust I (the Trust) as a statutory business trust
organized for the sole purpose of issuing $16,100 of 10% fixed rate trust-preferred securities and
investing the proceeds thereof in junior subordinated debentures of the Company, the sole asset of
the Trust. The common securities of the Trust are wholly owned by the Company. The
trust-preferred securities and common securities of the Trust represent preferred undivided
beneficial interests in the assets of Baylake Capital Trust I, and the holder of the
trust-preferred securities will be entitled to a preference over the common securities of the Trust
upon an event of default with respect to distributions and amounts payable on redemption or
liquidation. These trust-preferred securities are tax-advantaged issues that qualify for Tier 1
capital treatment to the Company. Distributions on these securities are included in interest
expense. The trust-preferred securities are traded on the American Stock Exchange under the symbol
BYL_p. The Company may redeem the subordinated debentures, in whole but not in part, any time on
or after March 31, 2006 at a price of 100% of face value. The subordinated debentures must be
redeemed no later than 2031. The trusts ability to pay amounts due on the trust-preferred securities is solely dependent upon
the Company making payment on the related subordinated debentures to the trust. The Companys
obligations under the subordinated debentures constitute a full and unconditional guarantee by the
Company of the trusts obligations under the trust securities issued by the trust. NOTE 11 - CAPITAL MATTERS Banks and bank holding companies are subject to regulatory capital requirements administered by
federal banking agencies. Capital adequacy guidelines and, additionally for banks, prompt
corrective action regulations involve quantitative measures of assets, liabilities, and certain   (Continued) 69




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BAYLAKE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004, 2003 and 2002
(Amounts in thousands of dollars) 
 NOTE 11 - CAPITAL MATTERS(Continued) off-balance-sheet items calculated under regulatory accounting practices. Capital amounts and
classifications are also subject to qualitative judgments by regulators. Failure to meet capital
requirements can initiate regulatory action. Prompt corrective action regulations provide five classifications: well capitalized, adequately
capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized,
although these terms are not used to represent overall financial condition. If adequately
capitalized, regulatory approval is required to accept brokered deposits. If undercapitalized,
capital distributions are limited, as is asset growth and expansion, and capital restoration plans
are required. At year-end 2004 and 2003, the most recent regulatory notifications categorized the
Bank as well capitalized under the regulatory framework for prompt corrective action. There are no
conditions or events since that notification that management believes have changed the
institutions category. At December 31, 2004 and 2003, the Company was categorized as well capitalized under the
regulatory framework for prompt corrective action. There are no conditions or events since that
notification that management believes have changed the Companys category. The Companys and
Baylake Banks risk-based capital and leverage ratios are presented below at year-end as follows: To Be WellCapitalized UnderFor Capital
    
    
    Prompt CorrectiveActual
    
    
    Adequacy Purposes
    
    
    Action ProvisionsAmount
    
    
    Ratio
    
    
    Amount
    
    
    Ratio
    
    
    Amount
    
    
    Ratio2004Total
Capital to risk-weighted assetsConsolidated
    
    $
    95,433
    
    
    
    10.95
    %
    
    $
    69,791
    
    
    
    8.00
    %
    
    
    N/A
    
    
    
    N/ABank
    
    
    91,521
    
    
    
    10.53
    
    
    
    69,580
    
    
    
    8.00
    
    
    $
    86,975
    
    
    
    10.00
    %Tier 1
(Core) Capital to risk-weighted assetsConsolidated
    
    
    84,988
    
    
    
    9.75
    
    
    
    34,895
    
    
    
    4.00
    
    
    
    N/A
    
    
    
    N/ABank
    
    
    81,076
    
    
    
    9.33
    
    
    
    34,790
    
    
    
    4.00
    
    
    
    52,185
    
    
    
    6.00Tier 1 (Core) Capital to
average assetsConsolidated
    
    
    84,988
    
    
    
    8.27
    
    
    
    41,129
    
    
    
    4.00
    
    
    
    N/A
    
    
    
    N/ABank
    
    
    81,076
    
    
    
    7.91
    
    
    
    41,025
    
    
    
    4.00
    
    
    
    51,282
    
    
    
    5.00
   (Continued) 70




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BAYLAKE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004, 2003 and 2002
(Amounts in thousands of dollars)  NOTE 11  CAPITAL MATTERS
 To Be WellCapitalized UnderFor Capital
    
    
    Prompt CorrectiveActual
    
    
    Adequacy Purposes
    
    
    Action ProvisionsAmount
    
    
    Ratio
    
    
    Amount
    
    
    Ratio
    
    
    Amount
    
    
    Ratio2003Total Capital to risk-
weighted assetsConsolidated
    
    $
    88,493
    
    
    
    10.78
    %
    
    $
    65,650
    
    
    
    8.00
    %
    
    
    N/A
    
    
    
    N/ABank
    
    
    84,771
    
    
    
    10.33
    
    
    
    65,631
    
    
    
    8.00
    
    
    $
    82,038
    
    
    
    10.00
    %Tier 1 (Core) Capital to risk-
weighted assetsConsolidated
    
    
    78,212
    
    
    
    9.53
    
    
    
    32,825
    
    
    
    4.00
    
    
    
    N/A
    
    
    
    N/ABank
    
    
    74,493
    
    
    
    9.08
    
    
    
    32,815
    
    
    
    4.00
    
    
    
    49,223
    
    
    
    6.00Tier 1 (Core) Capital to
average assetsConsolidated
    
    
    78,212
    
    
    
    8.38
    
    
    
    37,331
    
    
    
    4.00
    
    
    
    N/A
    
    
    
    N/ABank
    
    
    74,493
    
    
    
    7.98
    
    
    
    37,331
    
    
    
    4.00
    
    
    
    46,664
    
    
    
    5.00
 NOTE 12  OTHER COMPREHENSIVE INCOME Other comprehensive income (loss) components and related tax effects were as follows: 2004
    
    
    2003
    
    
    2002Unrealized holding gains (losses) on securities
available for sale
    
    $
    (1,399
    )
    
    $
    (1,754
    )
    
    $
    2,177Reclassification adjustment for gains
realized in income
    
    
    
    
    
    
    
    
    
    
    (509
    )Net unrealized gains (losses)
    
    
    (1,399
    )
    
    
    (1,754
    )
    
    
    1,668Tax effect
    
    
    483
    
    
    
    622
    
    
    
    (570
    )Comprehensive income (loss)
    
    $
    (916
    )
    
    $
    (1,132
    )
    
    $
    1,098
 NOTE 13  FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK The Bank is party to financial instruments with off-balance-sheet risk in the normal course of
business to meet the financing needs of its customers. These financial instruments include
commitments to extend credit, standby letters of credit, and financial guarantees.   71




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BAYLAKE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004, 2003 and 2002
(Amounts in thousands of dollars)  NOTE 13  FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK
 The Banks exposure to credit loss in the event of nonperformance by the other party to the
financial instrument for commitments to extend credit and standby letters of credit is represented
by the contract or notional amount of those instruments. The Bank uses the same credit policies in
making commitments and conditional obligations as it does for on-balance-sheet instruments. Contract orNotional Amount2004
    
    
    2003Financial instruments whose contract amounts
represent credit risk:Commitments to extend credit
    
    $
    186,304
    
    
    $
    176,537Standby letters of credit
    
    
    23,428
    
    
    
    22,229
 Commitments to extend credit are agreements to lend to a customer as long as there is no violation
of any condition established in the contract. Commitments generally have fixed expiration dates or
other termination clauses and may require payment of a fee. Since many of the commitments are
expected to expire without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements. The Bank evaluates each customers creditworthiness on a
case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank upon
extension of credit, is based on managements credit evaluation of the counter-party. Collateral
held varies but may include accounts receivable; inventory; property, plant, and equipment; and
income-producing commercial properties. Standby letters of credit are conditional commitments issued by the Bank to guarantee the
performance of customers to a third party. These are primarily issued to support private borrowing
arrangements and expire in decreasing amounts through 2009. The credit risk involved in issuing
letters of credit is essentially the same as that involved in extending loan facilities to
customers. The Bank does not require collateral as support for the commitments. Collateral is
secured as commitments are funded. NOTE 14  POST-RETIREMENT PLANS The subsidiaries have 401(k) Profit Sharing Plans covering all employees who qualify as to age and
length of service. The employer contributions paid and expensed under all plans totaled $959 in
2004, $835 in 2003, and $810 in 2002.   72




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##### Table of Contents



BAYLAKE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004, 2003 and 2002
(Amounts in thousands of dollars)  NOTE 14  POST-RETIREMENT PLANS
 Certain officers and directors of the Company and its subsidiaries are covered by nonqualified
deferred compensation plans. Payments to be made under these plans are accrued over the
anticipated years of service of the individuals covered. Amounts charged to expense were $236 in
2004, $231 in 2003, and $227 in 2002. The aggregate amount of deferred compensation included in
other liabilities in the consolidated balance sheets is $1,817 and $1,720 in 2004 and 2003,
respectively. NOTE 15  INCOME TAX EXPENSE Income taxes consist of the following: 2004
    
    
    2003
    
    
    2002Taxes currently payableFederal
    
    $
    3,953
    
    
    $
    2,076
    
    
    $
    3,259State
    
    
    608
    
    
    
    140
    
    
    
    3794,561
    
    
    
    2,216
    
    
    
    3,638Deferred income taxesFederal
    
    
    80
    
    
    
    (134
    )
    
    
    (915
    )State
    
    
    39
    
    
    
    (22
    )
    
    
    (148
    )119
    
    
    
    (156
    )
    
    
    (1,063
    )Income tax expense
    
    $
    4,680
    
    
    $
    2,060
    
    
    $
    2,575
 The provision for income taxes differs from the amount of income tax determined by applying the
statutory federal income tax rate to pretax income as a result of the following differences: 2004
    
    
    2003
    
    
    2002Income tax based on statutory rate
    
    $
    5,254
    
    
    $
    3,406
    
    
    $
    3,841State income taxes net of federal tax benefit
    
    
    485
    
    
    
    93
    
    
    
    875,739
    
    
    
    3,499
    
    
    
    3,928Effect of tax-exempt interest income
    
    
    (668
    )
    
    
    (754
    )
    
    
    (842
    )Life insurance death benefit and earnings
    
    
    (262
    )
    
    
    (279
    )
    
    
    (410
    )Equity in income of service center
    
    
    (131
    )
    
    
    (128
    )
    
    
    (130
    )Other
    
    
    2
    
    
    
    (278
    )
    
    
    29Provision based on effective tax rates
    
    $
    4,680
    
    
    $
    2,060
    
    
    $
    2,575
   73




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##### Table of Contents



BAYLAKE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004, 2003 and 2002
(Amounts in thousands of dollars)  NOTE 15  INCOME TAX EXPENSE
 Deferred income taxes reflect the net tax effects of temporary differences between the carrying
amounts of assets and liabilities for financial reporting purposes and the amounts used for income
tax purposes. The following is a summary of the significant components of the Companys deferred tax assets and
liabilities as of December 31, 2004 and 2003: 2004
    
    
    2003Deferred tax assetsAllowance for loan losses
    
    $
    4,096
    
    
    $
    3,775Deferred loan fees
    
    
    157
    
    
    
    138Deferred compensation
    
    
    995
    
    
    
    915Mortgage loan servicing
    
    
    82
    
    
    
    34Nonaccrual loans
    
    
    352
    
    
    
    537Accrued vacation pay
    
    
    283
    
    
    
    257OREO property valuation
    
    
    85
    
    
    
    Donations
    
    
    184
    
    
    
    Other
    
    
    94
    
    
    
    61Gross deferred tax assets
    
    
    6,328
    
    
    
    5,717Deferred tax liabilitiesDepreciation
    
    
    1,302
    
    
    
    908FHLB stock dividends
    
    
    797
    
    
    
    463Net unrealized gain on securities
available for sale
    
    
    610
    
    
    
    1,093Prepaid expenditures
    
    
    107
    
    
    
    Other
    
    
    
    
    
    
    105Gross deferred tax liabilities
    
    
    2,816
    
    
    
    2,569Net deferred asset
    
    $
    3,512
    
    
    $
    3,148
 Income tax expense recorded in the consolidated statement of income involves the interpretation and
application of certain accounting pronouncements and federal and state tax codes. The Company
undergoes examination by various regulatory taxing agencies. Such agencies may require that
changes in the amount of tax expense be recognized when their interpretations differ from those of
management, based on their judgment about information available to them at the time of their
examination.   74




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##### Table of Contents



BAYLAKE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004, 2003 and 2002
(Amounts in thousands of dollars except per share data)  NOTE 16  EARNINGS PER SHARE
 Earnings per share are based on the weighted average number of shares outstanding for the year. A
reconciliation of the basic and diluted earnings per share amounts is as follows: 2004
    
    
    2003
    
    
    2002BasicNet income
    
    $
    10,773
    
    
    $
    7,957
    
    
    $
    8,723Weighted average common shares
outstanding
    
    
    7,657,143
    
    
    
    7,531,931
    
    
    
    7,474,819Basic earnings per common share
    
    $
    1.41
    
    
    $
    1.06
    
    
    $
    1.17DilutedNet income
    
    $
    10,773
    
    
    $
    7,957
    
    
    $
    8,723Weighted average common shares
outstanding for basic earnings
per share
    
    
    7,657,143
    
    
    
    7,531,931
    
    
    
    7,474,819Add: Dilutive effects of assumed
exercises of stock options
    
    
    41,237
    
    
    
    111,149
    
    
    
    127,164Average shares and dilutive potential
common shares
    
    
    7,698,380
    
    
    
    7,643,080
    
    
    
    7,601,983Diluted earnings per common share
    
    $
    1.40
    
    
    $
    1.04
    
    
    $
    1.15Additional common stock option
shares that have not been included
due to their antidilutive effect
    
    
    216,450
    
    
    
    216,450
    
    
    
    216,450
 NOTE 17  STOCK OPTION PLAN The Company has a non-qualified stock option plan under which certain officers and key salaried
employees may purchase shares of the Companys stock at an established exercise price. Unless
earlier terminated, these options will expire ten years from the date of grant. The options vest
over a five-year period, becoming exercisable 20% per year, commencing one year from date of grant.   75




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BAYLAKE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004, 2003 and 2002
(Amounts in thousands of dollars)  NOTE 17  STOCK OPTION PLAN
 Activity in the plan is summarized as follows: WeightedAverageNumber
    
    
    Option Price
    
    
    Exerciseof Shares
    
    
    Per share
    
    
    PriceShares under option at January 1, 2002
    
    
    703,075
    
    
    $
    4.67 - 25.00
    
    
    $
    12.19Options granted
    
    
    32,384
    
    
    
    13.00
    
    
    
    13.00Options exercised
    
    
    (11,700
    )
    
    
    4.67 -  9.50
    
    
    
    6.92Shares under option at December 31, 2002
    
    
    723,759
    
    
    $
    8.92 - 25.00
    
    
    $
    12.31Options granted
    
    
    37,260
    
    
    
    13.30
    
    
    
    13.30Options exercised
    
    
    (121,700
    )
    
    
    9.50 - 11.50
    
    
    
    10.02Shares under option at December 31, 2003
    
    
    639,319
    
    
    $
    8.92 - 25.00
    
    
    $
    12.81Options granted
    
    
    25,000
    
    
    
    14.15
    
    
    
    14.15Options exercised
    
    
    (87,800
    )
    
    
    8.92  11.50
    
    
    
    10.68Shares under option at December 31, 2004
    
    
    576,519
    
    
    $
    8.92  25.00
    
    
    $
    13.19
 The options outstanding at December 31, 2004 were: WeightedAverageWeighted-Average
    
    
    RemainingPrice
    
    
    Number of Shares
    
    
    Exercise Price
    
    
    LifeRange
    
    
    Outstanding
    
    
    Exercisable
    
    
    Outstanding
    
    
    Exercisable
    
    
    (In Years)$
    
    
    8.92  9.75
    
    
    
    264,900
    
    
    
    264,900
    
    
    $
    9.27
    
    
    $
    9.27
    
    
    
    2.213.00  15.25
    
    
    
    251,619
    
    
    
    164,991
    
    
    
    14.50
    
    
    
    14.93
    
    
    
    5.725.00
    
    
    
    60,000
    
    
    
    48,000
    
    
    
    25.00
    
    
    
    25.00
    
    
    
    5.0576,519
    
    
    
    477,891
    
    
    $
    13.19
    
    
    $
    12.80
    
    
    
    4.0
 NOTE 18  DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS The methods and assumptions used to estimate fair value are described as follows. Carrying amount is the estimated fair value for cash and cash equivalents, Federal Home Loan Bank
stock, accrued interest receivable and payable, demand deposits, short-term debt, and variable rate
loans or deposits that reprice frequently and fully. Security fair values are based   76




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BAYLAKE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004, 2003 and 2002
(Amounts in thousands of dollars)  NOTE 18  DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
 on market prices or dealer quotes and, if no such information is available, on the rate and term of
the security and information about the issuer. For fixed rate loans or deposits and for variable
rate loans or deposits with infrequent repricing or repricing limits, fair value is based on
discounted cash flows using current market rates applied to the estimated life and credit risk.
Fair values for impaired loans are estimated using discounted cash flow analysis or underlying
collateral values. Fair value of loans held for sale is based on market quotes. Fair value of
debt is based on current rates for similar financing. 2004
    
    
    2003Carrying
    
    
    Fair
    
    
    Carrying
    
    
    FairAmount
    
    
    Value
    
    
    Amount
    
    
    ValueFinancial assetsCash and cash equivalents
    
    $
    26,172
    
    
    $
    26,172
    
    
    $
    24,226
    
    
    $
    24,226Securities available for sale
    
    
    197,392
    
    
    
    197,392
    
    
    
    176,815
    
    
    
    176,815Loans held for sale
    
    
    1,349
    
    
    
    1,369
    
    
    
    165
    
    
    
    166Loans, net
    
    
    746,783
    
    
    
    745,009
    
    
    
    702,863
    
    
    
    702,590Federal Home Loan Bank stock
    
    
    7,697
    
    
    
    7,697
    
    
    
    7,247
    
    
    
    7,247Accrued interest receivable
    
    
    4,330
    
    
    
    4,330
    
    
    
    3,997
    
    
    
    3,997Financial liabilitiesDeposits
    
    
    844,541
    
    
    
    844,153
    
    
    
    783,292
    
    
    
    785,727Federal funds purchased and
repurchase agreements
    
    
    1,284
    
    
    
    1,284
    
    
    
    23,359
    
    
    
    23,359Federal Home Loan Bank
advances
    
    
    100,192
    
    
    
    100,139
    
    
    
    75,092
    
    
    
    75,123Subordinated debentures
    
    
    16,100
    
    
    
    17,549
    
    
    
    16,100
    
    
    
    18,354Accrued interest payable
    
    
    2,575
    
    
    
    2,575
    
    
    
    2,246
    
    
    
    2,246
   77




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BAYLAKE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004, 2003 and 2002
(Amounts in thousands of dollars)  NOTE 19  CONDENSED FINANCIAL INFORMATION  PARENT COMPANY ONLY
 CONDENSED BALANCE SHEETS
December 31 2004
    
    
    2003ASSETSCash in bank
    
    $
    3,111
    
    
    $
    2,665Interest receivable
    
    
    4
    
    
    
    4Receivable from subsidiary
    
    
    53
    
    
    
    134Prepaid expenses
    
    
    904
    
    
    
    989Securities available for sale
    
    
    1,070
    
    
    
    1,070Investment in subsidiaries
    
    
    88,343
    
    
    
    81,957Total assets
    
    $
    93,485
    
    
    $
    86,819LIABILITIES AND STOCKHOLDERS EQUITYLiabilitiesDividends payable
    
    $
    1,154
    
    
    $
    1,061Accrued expense
    
    
    
    
    
    
    3Debentures to subsidiary
    
    
    16,100
    
    
    
    16,100Deferred income taxes
    
    
    26
    
    
    
    27Total liabilities
    
    
    17,280
    
    
    
    17,191Stockholders equity
    
    
    76,205
    
    
    
    69,628Total liabilities and stockholders equity
    
    $
    93,485
    
    
    $
    86,819
   78




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BAYLAKE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004, 2003 and 2002
(Amounts in thousands of dollars)  NOTE 19 - CONDENSED
FINANCIAL INFORMATION - PARENT COMPANY ONLY
 CONDENSED STATEMENTS OF INCOME
Years ended December 31 2004
    
    
    2003
    
    
    2002IncomeDividends from subsidiaries
    
    $
    4,600
    
    
    $
    4,200
    
    
    $
    3,800Interest income
    
    
    113
    
    
    
    107
    
    
    
    151Total income
    
    
    4,713
    
    
    
    4,307
    
    
    
    3,951ExpensesInterestOther
    
    
    126
    
    
    
    86
    
    
    
    98Income tax benefit
    
    
    (581
    )
    
    
    (552
    )
    
    
    (559
    )Total expenses
    
    
    1,240
    
    
    
    1,179
    
    
    
    1,234Income before equity in
undistributed net income
of subsidiaries
    
    
    3,473
    
    
    
    3,128
    
    
    
    2,717Equity in undistributed net income
of subsidiaries
    
    
    7,300
    
    
    
    4,829
    
    
    
    6,006Net income
    
    $
    10,773
    
    
    $
    7,957
    
    
    $
    8,723
   79




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##### Table of Contents



BAYLAKE CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004, 2003 and 2002
(Amounts in thousands of dollars)  NOTE 19  CONDENSED FINANCIAL INFORMATION  PARENT COMPANY ONLY
  CONDENSED STATEMENT OF CASH FLOWS
Years ended December 31 2004
    
    
    2003
    
    
    2002Cash flows from operating activities:Net income
    
    $
    10,773
    
    
    $
    7,957
    
    
    $
    8,723Adjustments to reconcile net income to
net cash provided by operating activities:Undistributed earnings of subsidiary
    
    
    (7,300
    )
    
    
    (4,829
    )
    
    
    (6,006
    )Amortization of debt issue costs
    
    
    85
    
    
    
    35
    
    
    
    35Net amortization of securities
    
    
    (3
    )
    
    
    (3
    )
    
    
    (2
    )Net change in intercompany receivable
    
    
    81
    
    
    
    
    
    
    
    50Accrued expenses and other liabilities
    
    
    141
    
    
    
    181
    
    
    
    29Net cash provided by
operating activities
    
    
    3,777
    
    
    
    3,341
    
    
    
    2,829Cash flows from investing activities:Purchase of investment
    
    
    
    
    
    
    
    
    
    
    (986
    )Capital distributed to subsidiary
    
    
    
    
    
    
    
    
    
    
    Net cash used in investing activities
    
    
    
    
    
    
    
    
    
    
    (986
    )Cash flows from financing activities:Proceeds from exercise of stock options
    
    
    938
    
    
    
    1,220
    
    
    
    81Dividends paid
    
    
    (4,269
    )
    
    
    (3,907
    )
    
    
    (3,588
    )Net cash used in financing activities
    
    
    (3,331
    )
    
    
    (2,687
    )
    
    
    (3,507
    )Net change in cash and cash equivalents
    
    
    446
    
    
    
    654
    
    
    
    (1,664
    )Beginning cash and cash equivalents
    
    
    2,665
    
    
    
    2,011
    
    
    
    3,675Ending cash and cash equivalents
    
    $
    3,111
    
    
    $
    2,665
    
    
    $
    2,011
 80




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##### Table of Contents



Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE As previously reported, during fiscal 2004, Baylake changed its independent public accountants from
Smith & Gesteland LLP to Crowe Chizek and Company LLC. In 2003 and 2004 and to date in 2005,
Baylake Corp. had no disagreements with either its former or current accountants on accounting and
financial disclosures required in the annual report. 
 Item 9A. CONTROLS AND PROCEDURES Disclosures Controls and Procedures:The Companys management, with the participation of the
Companys Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of
the Companys 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 December
31, 2004. Based on such evaluation, the Companys Chief Executive Officer and Chief Financial
Officer have concluded that, as of the end of such period, the Companys disclosure controls and
procedures are effective in recording, processing, summarizing and reporting, on a timely basis,
information required to be disclosed by the Company in the reports that it files or submits under
the Exchange Act. Internal Control Over Financial Reporting:There have not been any changes in the Companys
internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f)
under the Exchange Act) subsequent to the date of the evaluation performed by the Companys Chief
Executive Officer and Chief Financial Officer. * * * For the fiscal year ended December 31, 2004, Baylake Corp. (as other accelerated filers) is
required to include in its annual report both a management report and an auditor report on the
effectiveness of Baylakes internal control over financial reporting. This report is required as a
consequence of the requirements of the Sarbanes-Oxley Act of 2002. The preparation necessary for those reports has been extensive for all companies, and remains in
process for Baylake. In recognition that relatively small accelerated filers (such as Baylake)
might encounter difficulties meeting the deadline, the Securities and Exchange Commission has
issued as general exemptive order (in Release No. 34-50754) providing small accelerated filers
with a deferral of up to 45 days in the filing of such information. Baylake Corp. is electing to avail itself of the deferral permitted by that exemptive order.
Therefore, the management report and the auditor report on the effectiveness of internal control on
financial reporting will be filed by amendment. While the related review processes continue, to
date Management has not identified, or become aware of, any material weakness which would be
required to be disclosed. 
 Item 9B. OTHER INFORMATION Not applicable. 81




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PART III 
 Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information set forth under the sections titled Proposal No. 1, Election of Directors,
Information on Executive Officers and Compliance with Section 16(a) of the Exchange Act
contained in the definitive proxy statement for the Companys 2005 Annual Meeting of Stockholders
is incorporated herein by reference. The Board of Directors has determined that, except as noted below, all of the members of the Board
are independent directors within the meaning of NASDAQ Rule 4200, although the Company is not
governed by those standards. Mr. Herlache is not considered independent because he is an executive officer of the Company and
the Bank. Mr. Braun is not considered independent because he is an executive officer of the
Company. Audit Committee Matters The company has a standing Audit Committee. The Audit Committee currently has four members: Mr.
Berg (Chairman), Mr. Parsons, Mr. Bunda; and Mr. Agnew. As of the date of this report, each of the
members of the Audit Committee is an independent director under NASDAQ Rule 4200. The Audit
Committees functions and responsibilities are described in a written policy statement and charter
that was adopted by the Companys Board of Directors. The makeup of the Audit Committee meets the
applicable standards set forth by the Securities and Exchange Commission rules through the work
experience they have accumulated and the varied background that each possess. The Board of
Directors on November 16, 2004 named Mr. Parsons as audit committee financial expert. The Corporate Governance Committee The Corporate Governance Committee met quarterly in fiscal 2004. The Corporate Governance
Committee evaluates and oversees corporate governance and related issues. The committee consists
of members of the board of directors and certain officers of the Bank. All directors of the
Corporate Governance Committee are currently independent directors. Although the Company has not
to date developed formal processes by which shareholders may communicate directly to directors, it
believes that the informal process, in which any communication sent to the board in care of the
Chief Executive Officer or corporate Secretary is forwarded to the board, has served the boards
and its shareholders needs. Code of Ethics The Company has adopted a code of ethics that all applies to all employees, as well as each member
of the Companys Board of Directors. The code of ethics is available at the Companys website at
www.baylake.com. Changes to the Code of Ethics, and any waivers from the Code of Ethics which are
granted to any directors or executive officers, will also be posted at that website. 
 Item 11. EXECUTIVE COMPENSATION The information set forth under the sections titled Director Fees and Benefits, Executive
Compensation, Board of Directors Compensation Committee Report on Management Compensation,
Compensation Committee Interlocks and Insider Participation and Performance Graph contained in
the definitive proxy statement for the Companys 2005 Annual Meeting of Stockholders is
incorporated herein by reference. 
 Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT 82




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The information set forth under the section titled Ownership of Baylake Common contained in the
definitive proxy statement for the Companys 2005 Annual Meeting of Stockholders is incorporated
herein by reference. Equity compensation plan information: The following table sets forth information regarding options and shares reserved for future
issuance under the equity compensation plans as of December 31, 2004. Number of
    
    
    
    
    
    
    
    
    Number ofsecurities to be
    
    
    
    
    
    
    
    
    securitiesissued upon
    
    
    
    
    
    
    
    remaining availableexercise of
    
    
    
    Weighted-average
    
    
    
    for future issuanceoutstanding
    
    
    
    exercise price of outstanding
    
    
    
    under equityoptions, warrants
    
    
    
    options, warrants
    
    
    
    compensation plans (excluding securitiesand rights
    
    
    
    and rights
    
    
    
    reflected in column (a)1 Plan Category
    
    
    (a)
    
    
    
    (b)
    
    
    
    ©Equity compensation
plans approved by
security holders
    
    
    
    576,519
    
    
    
    $
    13.19
    
    
    
    
    216,381Equity compensation
plans not approved
by security holders
    
    
    
    0
    
    
    
    
    0.00
    
    
    
    
    0Total
    
    
    
    576,519
    
    
    
    $
    13.19
    
    
    
    
    216,381
 
 Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Information set forth in the section titled Certain Transactions with Management in the
definitive proxy statement for the Companys 2005 Annual Meeting of Stockholders is incorporated
herein by reference. 
 Item 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES Information set forth in the section titled Principal Accountant Fees and Services in the
definitive proxy statement for the Companys 2005 Annual Meeting of Stockholders is incorporated
herein by reference. Policy on Audit Committee Pre-Approval of Audit and Non-Audit Services of Independent Auditor Consistent with Securities and Exchange Commission requirements regarding auditor independence, the
Audit Committee adopted a policy to pre-approve all audit and permissible non-audit services
provided by the independent auditor. All engagements of the independent auditor to perform any
auditor services and permissible non-audit services since November 18, 2003 have been pre-approved
by the Audit Committee in accordance with the adopted policy. Pre-approval is generally provided
for up to one year and any pre-approval is detailed as to the particular service or category of
services and is generally subject to a specific budget. The Audit Committee has not delegated a
pre-approval dollar limitation with respect to audit and non-audit services at this time. 
 PART IV 
 Item 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES 83




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##### Table of Contents



(a) 1. and 2. The consolidated financial statements and supplementary data contained in Item 8 of this report are
filed as part of this report. All schedules are omitted because of the absence of the conditions
under which they are required or because the required information is included in the consolidated
financial statements or related notes.  (a)
    3. See Item 15(b) below  (b)
    Exhibits Required by Item 601 of Regulation S-K Reference is made to the
Exhibit Index on page 86 for exhibits filed as part of this report. 84




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##### Table of Contents



SIGNATURES Pursuant to the requirements of Section 13 or 15 (d) 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.By:
    /s/ Steven D. JennerjohnSteven D. Jennerjohn TreasurerDate: March 15, 2005
 POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS, that each individual whose signature appears below hereby
designates and appoints Thomas L. Herlache and Steven D. Jennerjohn, and each of them, any one of
whom may act without the joinder of the other, as such persons true and lawful attorney-in-fact
and agents (the Attorneys-in-Fact) with full power of substitution and resubstitution, for such
person and in such persons name, place and stead, in any and all capacities, to sign any and all
amendments to this report, and to file the same, with all exhibits thereto, and other documents in
connection therewith, the Securities and Exchange Commission and any state securities commission,
granting unto said Attorneys-in-Fact and agents, and each of them, full power and authority to do
and perform each and every act and thing requisite and necessary to be done in and about the
premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying
and conforming all that said Attorneys-in-Fact and agents or any of them, or their or his
substitutes, may lawfully do or cause to be done by virtue hereof.  Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this report has
been signed by the following persons in the capacities and on these dates indicated. /s/Thomas L. Herlache
    
    
    
    /s/Richard A. BraunThomas L. Herlache
    
    
    
    Richard A. Braun, DirectorPresident, Chief Executive Officer and
    
    
    
    Vice-Chairman of the Board and ExecutiveDirector(Principal Executive Officer)
    
    
    
    Vice-President/s/ Steven D. Jennerjohn
    
    
    
    /s/ Robert W. AgnewSteven D. Jennerjohn
    
    
    
    Robert W. Agnew, DirectorTreasurer(Principal Financial and Accounting Officer)/s/ Dee Geurts-Bengtson
    
    
    
    /s/ Ronald D. BergDee Geurts-Bengtson, Director
    
    
    
    Ronald D. Berg, Director/s/ George Delveaux, Jr.John W. Bunda, Director
    
    
    
    George Delveaux, Jr., Director/s/ Roger G. Ferris
    
    
    
    /s/ Joseph J. MorganRoger G. Ferris, Director
    
    
    
    Joseph J. Morgan, Director/s/ William ParsonsWilliam Parsons, Director
    
    
    
    Paul Jay Sturm, Director
    85




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Exhibit No.
    
    Description2.1
    
    Stock Purchase Agreement, dated as of October 1, 1998, among
the Company, M&I and Evergreen (1)3.1
    
    Articles of Incorporation, as amended (2)3.2
    
    Bylaws, as amended (3)3.3
    
    Amendment to increase authorized shares of common stock of
Baylake Corp. from 10,000,000 to 50,000,000 shares (4)4.1
    
    Junior subordinated debenture dated February 16, 2002, by and
between Company and Wilmington Trust Company, as Indenture
Trustee (5)10.1
    
    Baylake Corp. 1993 Stock Option Plan* (6)10.2
    
    Baylake Banks Pay-for-Performance (bonus) program* (7)10.3
    
    Baylake Banks Deferred Compensation Program with Thomas L.
Herlache* (8)10.4
    
    Baylake Banks Agreement for Early Retirement with Ronald D.
Berg* (9)10.5
    
    Baylake Banks Deferred Compensation and Salary Continuation
Agreement with Richard A. Braun* (10)10.6
    
    Baylake Corp. Stock Purchase Plan* (11)10.7
    
    Baylake Corp. 1998 Stock Option Plan, as amended* (12)10.8
    
    Baylake Bank Supplemental Executive Retirement Plan (13)12.1
    
    Statement Re Computation of Ratios
(13)21.1
    
    List of Subsidiaries (13)23.1
    
    Consent of Crowe Chizek and Company
LLC (13)23.2
    
    Consent of Smith & Gesteland,
LLP (13)

24.1
    
    Power of Attorney (contained on the Signature Page)31.1
    
    Certification of the CEO pursuant to 18 U.S.C. Section 1350,
as adopted pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002 (13)31.2
    
    Certification of the CFO pursuant to 18 U.S.C. Section 1350,
as adopted pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002 (13)32.1
    
    Certification of the CEO pursuant to 18 U.S.C. Section 1350,
as adopted pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002 (13)32.2
    
    Certification of the CEO pursuant to 18 U.S.C. Section 1350,
as adopted pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002 (13)*Designates compensation plans or agreements
  (1)
    Incorporated by reference to Exhibit 2.1 from the Companys Current Report on Form 8-K filed
October 15, 1998.(2)
    Incorporated by reference to Exhibit 3.1 from the Companys Annual Report on Form 10-K for
the fiscal year ended December 31, 1993.(3)
    Incorporated by reference to Exhibit 3.2 from the Companys Annual Report on Form 10-K for
the fiscal year ended December 31, 1993.(4)
    Incorporated by reference to Exhibit 3.3 from the Companys Proxy Statement for the 2001
Annual Meeting of Shareholders.(5)
    Incorporated by reference to Exhibit 4.1 from the Companys Form S-3 filed February 12, 2001
for Trust Preferred Securities issued under Baylake Capital Trust I on February 16, 2001.(6)
    Incorporated by reference to Exhibit A from the Companys Proxy Statement for the 1993 Annual
Meeting of Shareholders.(7)
    Incorporated by reference to Description thereof under Board Directors/Compensation
Committee Report on Managements Compensation in the Companys Proxy Statement for the 1994
Annual Meeting of Shareholders.(8)
    Incorporated by reference to Exhibit 10.3 from the Companys Annual Report on Form 10-K for
the fiscal year ended December 31, 1993.(9)
    Incorporated by reference to Exhibit 10.4 from the Companys Annual Report on Form 10-K for
the fiscal year ended December 31, 1993.(10)
    Incorporated by reference to Exhibit 10.5 from the Companys Annual Report on Form 10-K for
the fiscal year ended December 31, 1993.(11)
    Incorporated by reference to Exhibit 4 from the Companys Form S-8 filed on February 10,
1998.(12)
    Incorporated by reference to Exhibit 99.1 from the Companys Form S-8 filed on September 21,
1998.(13)
    Filed herewith. 86