8.Allowance For Loan Losses (“ALL”)

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

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

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

BAYLAKE CORP.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2014

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

IMPAIRED LOANS AND ALLOCATED ALLOWANCE


June 30, 2014		Construction						Real Estate- Residential				Real Estate- Commercial			Commercial		Consumer		Tax Exempt		Not Specifically Allocated		Totals
With an allowance recorded:
Recorded investment	$		649		$				282	$			805	$	–	$	–	$	–	$	–	$	1,736
Unpaid principal balance			660						386				1,230		652		–		–		–		2,928
Related allowance			11						104				425		652		–		–		–		1,192
With no related allowance recorded:
Recorded investment	$		–			$			223	$			12,126	$	235	$	10	$	–	$	–	$	12,594
Unpaid principal balance			–						223				12,126		235		10		–		–		12,594
Related allowance			–						–				–		–		–		–		–		–
Total:
Recorded investment	$			649			$		505		$		12,931	$	235	$	10	$	–	$	–	$	14,330
Unpaid principal balance				660					609				13,356		887		10		–		–		15,522
Related allowance				11					104				425		652		–		–		–		1,192
Average recorded investment during quarter	$			703			$		534		$		14,631	$	310	$	16	$	–	$	–	$	16,194
Interest income recognized while impaired during the period	$			–			$		4		$		170	$	–	$	–	$	–	$	–	$	174

December 31, 2013	Construction						Real Estate- Residential					Real Estate- Commercial			Commercial			Consumer			Tax Exempt			Not Specifically Allocated			Totals
With an allowance recorded:
Recorded investment	$	—			$				201		$	1,032		$		19	$		—	$		—	$	—	$	1,252
Unpaid principal balance		—							277			1,569				49			—			—		—		1,895
Related allowance		—							76			537				30			—			—		—		643
With no related allowance recorded:
Recorded investment	$	660				$			263		$	12,611		$		218	$		21	$		—	$	—	$	13,773
Unpaid principal balance		660							263			12,611				218			21			—		—		13,773
Related allowance		—							—			—				—			—			—		—		—
Total:
Recorded investment	$		660	$				464		$		13,643	$		237		$		21	$		—	$	—	$	15,025
Unpaid principal balance			660					540				14,180			267				21			—		—		15,668
Related allowance			—					76				537			30				—			—		—		643
Average recorded investment during quarter	$		767	$				434		$		13,503	$		227		$		31	$		—	$	—	$	14,962
Interest income recognized while impaired during the period	$		3	$				8		$		316	$		—		$		—	$		—	$	—	$	329

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

BAYLAKE CORP.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2014

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

NONPERFORMING LOANS

		June 30, 2014		March 31, 2014		December 31, 2013		September 30, 2013		June 30, 2013
Nonaccrual loans	$	6,794	$	6,686	$	6,403	$	6,215	$	8,231
Loans restructured in a troubled debt restructuring, nonaccrual		256		255		255		299		114
Total nonperforming loans (“NPLs”)	$	7,050	$	6,941	$	6,658	$	6,514	$	8,345

Restructured loans, accruing	$	8,472	$	8,370	$	9,009	$	9,020	$	3,959

During the quarter ended June 30, 2014, $0.1 million of nonaccrual loans were brought current, $0.1 million were charged off, $0.1 million were transferred to other real estate, and $0.4 million of pay downs were received on nonaccrual loans. Offsetting those decreases were $0.8 million of additions to nonaccrual loans. Restructured loans accruing interest increased during the second quarter of 2014 due to one loan of $0.1 million being restructured during the quarter involving a reduction of interest rate terms.