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EX-32.1 - EXHIBIT 32.1 - NICOLET BANKSHARES INCt1600692_ex32-1.htm
EX-32.2 - EXHIBIT 32.2 - NICOLET BANKSHARES INCt1600692_ex32-2.htm
EX-31.2 - EXHIBIT 31.2 - NICOLET BANKSHARES INCt1600692_ex31-2.htm
EX-31.1 - EXHIBIT 31.1 - NICOLET BANKSHARES INCt1600692_ex31-1.htm

 

 

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

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

 

For the quarterly period ended September 30, 2016

 

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

 

For the transition period from…………to………………

 

Commission file number 001-37700

NICOLET BANKSHARES, INC.

(Exact name of registrant as specified in its charter)

 

WISCONSIN   47-0871001
(State or other jurisdiction of incorporation or organization)   (I.R.S. Employer Identification No.)

 

111 North Washington Street

Green Bay, Wisconsin 54301

(920) 430-1400

(Address, including zip code, and telephone number, including area code, of
Registrant’s principal executive offices)

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Date File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨

 

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

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

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x

 

As of October 31, 2016 there were 8,547,004 shares of $0.01 par value common stock outstanding.

 

 

 

 

 

 

Nicolet Bankshares, Inc.

 

TABLE OF CONTENTS

 

PART I FINANCIAL INFORMATION PAGE
     
  Item 1. Financial Statements:  
       
    Consolidated Balance Sheets
September 30, 2016 (unaudited) and December 31, 2015
3
       
    Consolidated Statements of Income
Three Months and Nine Months Ended September 30, 2016 and 2015 (unaudited)
4
       
    Consolidated Statements of Comprehensive Income
Three Months and Nine Months Ended September 30, 2016 and 2015 (unaudited)
5
       
    Consolidated Statement of Changes in Stockholders’ Equity
Nine Months Ended September 30, 2016 (unaudited)
6
       
    Consolidated Statements of Cash Flows
Nine Months Ended September 30, 2016 and 2015 (unaudited)
7
       
    Notes to Unaudited Consolidated Financial Statements 8-30
       
  Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 31-55
       
  Item 3. Quantitative and Qualitative Disclosures About Market Risk 55
       
  Item 4. Controls and Procedures 56
       
PART II OTHER INFORMATION  
     
  Item 1. Legal Proceedings 57
       
  Item 1A. Risk Factors 57
       
  Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 57
       
  Item 3. Defaults Upon Senior Securities 57
       
  Item 4. Mine Safety Disclosures 57
       
  Item 5. Other Information 57
       
  Item 6. Exhibits 58
       
    Signatures 58-62

 

2 

 

 

PART I – FINANCIAL INFORMATION

 

Item 1. FINANCIAL STATEMENTS:

 

NICOLET BANKSHARES, INC. AND SUBSIDIARIES

Consolidated Balance Sheets
(In thousands, except share and per share data)

 

  

September 30, 2016

(Unaudited)

   December 31, 2015
(Audited)
 
Assets          
Cash and due from banks  $63,990   $11,947 
Interest-earning deposits   39,654    70,755 
Federal funds sold   727    917 
Cash and cash equivalents   104,371    83,619 
Certificates of deposit in other banks   5,177    3,416 
Securities available for sale (“AFS”)   366,316    172,596 
Other investments   18,297    8,135 
Loans held for sale   8,312    4,680 
Loans   1,554,124    877,061 
Allowance for loan losses   (11,481)   (10,307)
Loans, net   1,542,643    866,754 
Premises and equipment, net   47,038    29,613 
Bank owned life insurance (“BOLI”)   53,730    28,475 
Goodwill and other intangibles   89,100    3,793 
Accrued interest receivable and other assets   34,503    13,358 
Total assets  $2,269,487   $1,214,439 
           
Liabilities and Stockholders’ Equity          
Liabilities:          
Demand  $485,421   $226,554 
Money market and NOW accounts   902,427    486,677 
Savings   222,887    136,733 
Time   323,347    206,453 
Total deposits   1,934,082    1,056,417 
Notes payable   1,000    15,412 
Junior subordinated debentures   24,623    12,527 
Subordinated notes   11,876    11,849 
Accrued interest payable and other liabilities   21,275    8,547 
Total liabilities   1,992,856    1,104,752 
           
Stockholders’ Equity:          
Preferred equity   -    12,200 
Common stock   86    42 
Additional paid-in capital   211,073    45,220 
Retained earnings   62,801    51,059 
Accumulated other comprehensive income (“AOCI”)   2,309    980 
Total Nicolet Bankshares, Inc. stockholders’ equity   276,269    109,501 
Noncontrolling interest   362    186 
Total stockholders’ equity and noncontrolling interest   276,631    109,687 
Total liabilities, noncontrolling interest and stockholders’ equity  $2,269,487   $1,214,439 
Preferred shares authorized (no par value)   10,000,000    10,000,000 
Preferred shares issued and outstanding   -    12,200 
Common shares authorized (par value $0.01 per share)   30,000,000    30,000,000 
Common shares outstanding   8,582,425    4,154,377 
Common shares issued   8,632,240    4,191,067 

 

See accompanying notes to unaudited consolidated financial statements.

 

3 

 

 

ITEM 1. Financial Statements Continued:

 

NICOLET BANKSHARES, INC. AND SUBSIDIARIES

Consolidated Statements of Income

(In thousands, except share and per share data) (Unaudited)

 

   Three Months Ended
September 30,
   Nine Months Ended
September 30,
 
   2016   2015   2016   2015 
Interest income:                    
Loans, including loan fees  $21,049   $11,159   $49,455   $33,921 
Investment securities:                    
Taxable   902    339    2,068    1,098 
Non-taxable   493    253    1,146    788 
Other interest income   351    108    906    327 
Total interest income   22,795    11,859    53,575    36,134 
Interest expense:                    
Money market and NOW accounts   631    569    1,726    1,693 
Savings and time deposits   719    732    2,102    2,225 
Short-term borrowings   -    2    5    2 
Notes payable   6    158    230    488 
Junior subordinated debentures   376    222    926    658 
Subordinated notes   159    159    477    335 
Total interest expense   1,891    1,842    5,466    5,401 
Net interest income   20,904    10,017    48,109    30,733 
Provision for loan losses   450    450    1,350    1,350 
Net interest income after provision for loan losses   20,454    9,567    46,759    29,383 
Noninterest income:                    
Service charges on deposit accounts   1,051    631    2,514    1,752 
Trust services fee income   1,373    1,196    4,000    3,636 
Mortgage income, net   2,010    811    3,713    2,670 
Brokerage fee income   992    170    2,090    509 
Bank owned life insurance   318    252    880    749 
Rent income   285    324    820    890 
Investment advisory fees   146    98    341    301 
Gain on sale or writedown of assets, net   453    91    548    1,042 
Other income   1,904    612    3,874    1,600 
Total noninterest income   8,532    4,185    18,780    13,149 
Noninterest expense:                    
Salaries and employee benefits   10,516    5,637    24,748    16,996 
Occupancy, equipment and office   3,018    1,745    7,324    5,263 
Business development and marketing   985    549    2,353    1,584 
Data processing   1,831    864    4,408    2,585 
FDIC assessments   247    142    629    469 
Intangibles amortization   1,172    248    2,295    783 
Other expense   1,250    664    4,799    1,695 
Total noninterest expense   19,019    9,849    46,556    29,375 
                     
Income before income tax expense   9,967    3,903    18,983    13,157 
Income tax expense   3,438    1,281    6,432    4,452 
Net income   6,529    2,622    12,551    8,705 
Less: net income attributable to noncontrolling interest   65    28    176    96 
Net income attributable to Nicolet Bankshares, Inc.   6,464    2,594    12,375    8,609 
Less: preferred stock dividends   247    60    633    182 
Net income available to common shareholders  $6,217   $2,534   $11,742   $8,427 
                     
Basic earnings per common share  $0.72   $0.64   $1.76   $2.11 
Diluted earnings per common share  $0.69   $0.58   $1.67   $1.93 
Weighted average common shares outstanding:                    
Basic   8,607,719    3,961,004    6,689,367    3,999,641 
Diluted   8,969,735    4,397,906    7,024,169    4,358,082 

 

See accompanying notes to unaudited consolidated financial statements.

 

4 

 

 

ITEM 1. Financial Statements Continued:

 

NICOLET BANKSHARES, INC. AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income

(In thousands) (Unaudited)

 

   Three Months Ended
September 30,
   Nine Months Ended
September 30,
 
   2016   2015   2016   2015 
Net income  $6,529   $2,622   $12,551   $8,705 
Other comprehensive income, net of tax:                    
Unrealized gains (losses) on securities AFS:                    
Net unrealized holding gains (losses) arising during the period   (984)   1,143    2,257    1,058 
Reclassification adjustment for net gains included in net income   (37)   -    (77)   (630)
Income tax benefit (expense)   397    (446)   (851)   (167)
Total other comprehensive income (loss)   (624)   697    1,329    261 
Comprehensive income  $5,905   $3,319   $13,880   $8,966 

 

See accompanying notes to unaudited consolidated financial statements.

 

5 

 

 

ITEM 1. Financial Statements Continued:

 

NICOLET BANKSHARES, INC. AND SUBSIDIARIES

Consolidated Statement of Stockholders’ Equity

(In thousands) (Unaudited)

 

   Nicolet Bankshares, Inc. Stockholders’ Equity         
   Preferred
Equity
   Common
Stock
   Additional
Paid-In
Capital
   Retained
Earnings
   Accumulated
Other
Comprehensive
Income
   Noncontrolling
Interest
   Total 
Balance December 31, 2015  $12,200   $42   $45,220   $51,059   $980   $186   $109,687 
Comprehensive income:                                   
Net income   -    -    -    12,375    -    176    12,551 
Other comprehensive income   -    -    -    -    1,329    -    1,329 
Stock compensation expense   -    -    1,123    -    -    -    1,123 
Exercise of stock options, net   -    -    1,502    -    -    -    1,502 
Issuance of common stock   -    1    100    -    -    -    101 
Issuance of common stock in acquisitions, net of capitalized issuance costs of $260   -    44    164,991    -    -    -    165,035 
Purchase and retirement of common stock   -    (1)   (3,045)   -    -    -    (3,046)
Equity awards assumed in acquisition   -    -    1,182    -    -    -    1,182 
Redemption of preferred stock   (12,200)   -    -    -    -    -    (12,200)
Preferred stock dividends   -    -    -    (633)   -    -    (633)
Balance, September 30, 2016  $-   $86   $211,073   $62,801   $2,309   $362   $276,631 

 

See accompanying notes to unaudited consolidated financial statements.

 

6 

 

 

ITEM 1. Financial Statements Continued:

 

NICOLET BANKSHARES, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

(In thousands) (Unaudited)

 

   Nine Months Ended September 30, 
   2016   2015 
Cash Flows From Operating Activities, net of effects of business combinations:          
Net income  $12,551   $8,705 
Adjustments to reconcile net income to net cash provided by operating activities:          
Depreciation, amortization, and accretion   4,227    3,083 
Provision for loan losses   1,350    1,350 
Increase in cash surrender value of life insurance   (880)   (749)
Stock compensation expense   1,123    907 
Gain on sale or writedown of assets, net   (548)   (1,042)
Gain on sale of loans held for sale, net   (3,713)   (2,670)
Income from branch sale   -    (123)
Proceeds from sale of loans held for sale   179,967    149,509 
Origination of loans held for sale   (179,581)   (142,759)
Net change in:          
Accrued interest receivable and other assets   1,182    (244)
Accrued interest payable and other liabilities   (3,888)   2,330 
Net cash provided by operating activities   11,790    18,297 
Cash Flows From Investing Activities, net of effects of business combinations:          
Net decrease in certificates of deposit in other banks   239    6,226 
Net decrease (increase) in loans   15,582    (14,388)
Purchases of securities AFS   (57,510)   (34,238)
Proceeds from sales of securities AFS   30,319    13,883 
Proceeds from calls and maturities of securities AFS   22,962    17,643 
Purchase of other investments   (3,745)   (61)
Net increase in premises and equipment   (3,802)   (478)
Proceeds from sales of other real estate and other assets   1,661    2,470 
Net cash used in branch sale   -    (19,865)
Purchase of BOLI   (20,000)   - 
Proceeds from redemption of BOLI   21,549    - 
Net cash received in business combination   66,517    - 
Net cash provided (used) by investing activities   73,772    (28,808)
Cash Flows From Financing Activities, net of effects of business combinations:          
Net increase (decrease) in deposits   55,332    (13,728)
Net decrease in short-term borrowings   (49,087)   - 
Repayments of notes payable   (56,519)   (5,695)
           
Proceeds from issuance of subordinated notes, net   -    11,820 
Redemption of preferred stock   (12,200)   (12,200)
Purchase and retirement of common stock   (3,046)   (4,278)
Capitalized issuance costs, net   (260)   - 
Proceeds from issuance of common stock   101    122 
Proceeds from exercise of common stock options, net   1,502    610 
Cash dividends paid on preferred stock   (633)   (213)
Net cash used by financing activities   (64,810)   (23,562)
Net increase (decrease) in cash and cash equivalents   20,752    (34,073)
Cash and cash equivalents:          
Beginning  $83,619   $68,708 
Ending  $104,371   $34,635 
Supplemental Disclosures of Cash Flow Information:          
Cash paid for interest  $5,787   $5,458 
Cash paid for taxes   7,150    2,430 
Transfer of loans and bank premises to other real estate owned   33    870 
Acquisitions          
Fair value of assets acquired   1,035,517     
Fair value of liabilities assumed   936,621     
Net assets acquired   98,896     

 

See accompanying notes to unaudited consolidated financial statements.

 

7 

 

 

NICOLET BANKSHARES, INC. AND SUBSIDIARIES

 

Notes to Unaudited Consolidated Financial Statements

 

Note 1 – Basis of Presentation

 

General

 

In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments necessary to present fairly Nicolet Bankshares, Inc. (the “Company”) and its subsidiaries, consolidated balance sheets, statements of income, comprehensive income, changes in stockholders’ equity and cash flows for the periods presented, and all such adjustments are of a normal recurring nature. All material intercompany transactions and balances are eliminated. The results of operations for the interim periods are not necessarily indicative of the results to be expected for the entire year.

 

These interim consolidated financial statements have been prepared according to the rules and regulations of the Securities and Exchange Commission and, therefore, certain information and footnote disclosures normally presented in accordance with generally accepted accounting principles in the United States of America (“U.S. GAAP”) have been omitted or abbreviated. These consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements and footnotes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015.

 

Critical Accounting Policies and Estimates

 

Preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying disclosures. These estimates are based on management’s best knowledge of current events and actions the Company may undertake in the future. Estimates are used in accounting for, among other items, the allowance for loan losses, useful lives for depreciation and amortization, fair value of financial instruments, deferred tax assets, uncertain income tax positions and contingencies. Estimates that are particularly susceptible to significant change for the Company include the determination of the allowance for loan losses, the assessment of deferred tax assets and liabilities, and the valuation of loans acquired in acquisitions; therefore, these are critical accounting policies. Factors that may cause sensitivity to the aforementioned estimates include but are not limited to: external market factors such as market interest rates and employment rates, changes to operating policies and procedures, changes in applicable banking regulations, and changes to deferred tax estimates. Actual results may ultimately differ from estimates, although management does not generally believe such differences would materially affect the consolidated financial statements in any individual reporting period presented.

 

There have been no material changes or developments with respect to the assumptions or methodologies that the Company uses when applying what management believes are critical accounting policies and developing critical accounting estimates as disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015.

 

Recent Accounting Developments Adopted

 

The Company has implemented all new accounting pronouncements that are in effect and that may impact its consolidated financial statements or results of operations.

 

Operating Segment

 

While the chief decision makers monitor the revenue streams of the various products and services, and evaluate costs, balance sheet positions and quality, all such products, services and activities are directly or indirectly related to the business of community banking, with no regular, formal or material segment delineations. Operations are managed and financial performance is evaluated on a company-wide basis, and accordingly, all the financial service operations are considered by management to be aggregated in one reportable operating segment.

 

Reclassifications

 

Certain amounts in the 2015 consolidated financial statements have been reclassified to conform to the 2016 presentation.

 

8 

 

 

Note 2 – Acquisitions

 

On April 29, 2016, the Company consummated its merger with Baylake Corp. (“Baylake”), pursuant to the Agreement and Plan of Merger by and between the Company and Baylake dated September 8, 2015, (the “Merger Agreement”), whereby Baylake was merged with and into the Company, and Baylake Bank, Baylake’s wholly owned commercial bank subsidiary serving northeastern Wisconsin, was merged with and into Nicolet National Bank. The system integration was completed, and 21 branches of Baylake opened, on May 2, 2016, as Nicolet National Bank branches, expanding its presence into Door, Kewaunee, and Manitowoc Counties, Wisconsin. Concurrently, Nicolet closed one of its Brown County locations, bringing the Bank’s footprint to 42 branches as of September 30, 2016.

 

The purpose of the merger was for strategic reasons beneficial to the Company. The acquisition is consistent with its plan to drive growth and efficiency through increased scale, leverage the strengths of each bank across the combined customer base, enhance profitability, and add liquidity and shareholder value.

 

Pursuant to the terms of the Merger Agreement, Baylake shareholders received 0.4517 shares of the Company’s common stock for each outstanding share of Baylake common stock (except for Baylake shares pre-owned by the Company at the time of the merger), and cash in lieu of any fractional share. Pre-existing Baylake equity awards (restricted stock units and stock options) immediately vested upon consummation of the merger. The Company issued 0.4517 shares of its common stock for each vesting Baylake restricted stock unit, and Nicolet assumed, after appropriate adjustment by the 0.4517 exchange ratio, all pre-existing Baylake stock options. As a result, the Company issued 4,344,243 shares of the Company’s common stock, for common stock consideration of $163.3 million (based on $37.58 per share, the volume weighted average closing price of the Company’s common stock over the preceding 20 trading day period, and recorded an additional $1.2 million consideration for the assumed stock options. Approximately $0.3 million in direct stock issuance costs for the merger were incurred and charged against additional paid in capital, bringing the total purchase price to $164.2 million.

 

The Company accounted for the transaction under the acquisition method of accounting, and thus, the financial position and results of operations of Baylake prior to the consummation date were not included in the accompanying consolidated financial statements. The accounting required assets purchased and liabilities assumed to be recorded at their respective fair values at the date of acquisition. The Company determined the fair value of core deposit intangibles, securities, premises and equipment, loans, OREO, BOLI and other assets, deposits, debt and deferred taxes with the assistance of third party valuations, appraisals, and third party advisors. The estimated fair values will be subject to refinement as additional information relative to the closing date fair values becomes available through the measurement period of approximately one year from consummation.

 

The fair value of the assets acquired and liabilities assumed on April 29, 2016 was as follows:

 

(in millions)  As recorded by
Baylake Corp
   Fair Value
Adjustments
   As Recorded
by Nicolet
 
Cash, cash equivalents and securities available for sale  $262   $1   $263 
Loans   710    (19)   691 
Other real estate owned   3    (2)   1 
Core deposit intangible   1    16    17 
Fixed assets and other assets   71    (8)   63 
Total assets acquired  $1,047   $(12)  $1,035 
                
Deposits  $822   $-   $822 
Junior subordinated debentures, borrowings and other liabilities   116    (1)   115 
Total liabilities acquired  $938   $(1)  $937 
                
Excess of assets acquired over liabilities acquired  $109   $(11)  $98 
Less: purchase price             164 
Goodwill            $66 

 

9 

 

 

Note 2 – Acquisitions, continued

 

The following unaudited pro forma information presents the results of operations for three months and nine months ended September 30, 2016 and 2015, as if the acquisition had occurred January 1 of each period. The Company expects to achieve further operating cost savings and other business synergies as a result of the acquisition which are not reflected in the pro forma amounts. These unaudited pro forma results are presented for illustrative purposes and are not intended to represent or be indicative of the actual results of operations of the combined company that would have been achieved had the acquisition occurred at the beginning of each period presented, nor are they intended to represent or be indicative of future results of operations.

 

   Three Months Ended   Nine Months Ended 
   September 30,
2016
   September 30,
2015
   September 30,
2016
   September 30,
2015
 
(in thousands, except per share data)                
Total revenues, net of interest expense  $29,436   $25,433   $82,870   $78,118 
Net income   6,827    5,237    17,042    16,637 
Diluted earnings per share   0.74    0.57    1.85    1.86 

 

During the first quarter of 2016, Nicolet agreed in a private transaction to hire a select group of financial advisors and purchase their respective books of business, as well as their operating platform, to enhance the leadership and future growth of the Company’s wealth management business. The transaction was effected in phases and completed April 1, 2016. The Company paid $4.9 million total initial consideration, including $0.8 million cash, $2.6 million of Nicolet common stock, and recorded a $1.5 million earn-out liability payable to one principal in the future (which may require adjustment based on change in initial business purchased over a period, but not contingent upon the principal’s employment). The Company initially recorded $0.4 million of goodwill, $0.2 million of fixed assets, and $4.3 million of customer relationship intangibles (a portion amortizing straight-line over 10 years and a portion over 15 years). The transaction will impact the income statement primarily within brokerage income, personnel expense, and intangibles amortization.

 

Note 3 – Earnings per Common Share

 

Basic earnings per common share are calculated by dividing net income available to common shareholders by the weighted average number of common shares outstanding during the period. Diluted earnings per share is calculated by dividing net income available to common shareholders by the weighted average number of shares adjusted for the dilutive effect of common stock awards (outstanding stock options and unvested restricted stock), if any. Presented below are the calculations for basic and diluted earnings per common share.

 

   Three Months Ended
September 30,
   Nine Months Ended
September 30,
 
   2016   2015   2016   2015 
(In thousands except per share data)                
Net income, net of noncontrolling interest  $6,464   $2,594   $12,375   $8,609 
Less: preferred stock dividends   247    60    633    182 
Net income available to common shareholders  $6,217   $2,534   $11,742   $8,427 
Weighted average common shares outstanding   8,608    3,961    6,689    4,000 
Effect of dilutive stock instruments   362    437    335    358 
Diluted weighted average common shares outstanding   8,970    4,398    7,024    4,358 
Basic earnings per common share*  $0.72   $0.64   $1.76   $2.11 
Diluted earnings per common share*  $0.69   $0.58   $1.67   $1.93 

 

*Cumulative quarterly per share performance may not equal annual per share totals due to the effects of the amount and timing of capital increases. When computing earnings per share for an interim period, the denominator is based on the weighted-average shares outstanding during the interim period, and not on an annualized weighted-average basis. Accordingly, the sum of the quarters' earnings per share data will not necessarily equal the year to date earnings per share data.

 

No shares were outstanding at September 30, 2016 which were excluded from the calculation of diluted earnings per common share as anti-dilutive. Options to purchase approximately 0.2 million shares were outstanding at September 30, 2015, but were excluded from the calculation of diluted earnings per common share as the effect would have been anti-dilutive.

 

10 

 

 

Note 4 – Stock-based Compensation

 

A Black-Scholes model is utilized to estimate the fair value of stock options and the market price of the Company’s stock at the date of grant is used to estimate the value of restricted stock awards. The weighted average assumptions used in the model for valuing option grants were as follows:

 

   Nine months ended
September 30, 2016
       Year ended
December 31, 2015
 
Dividend yield   0%   0%
Expected volatility   25%   25%
Risk-free interest rate   1.52%   1.68%
Expected average life   7 years    7 years 
Weighted average per share fair value of options  $11.04   $8.11 

 

Activity in the Company’s Stock Incentive Plans is summarized in the following tables:

 

Stock Options  Weighted-
Average Fair
Value of Options
Granted
   Option Shares
Outstanding
   Weighted-
Average
Exercise Price
   Exercisable
Shares
 
Balance – December 31, 2014        967,859   $19.30    630,121 
Granted  $8.11    162,000    26.66      
Exercise of stock options*        (381,505)   18.00      
Forfeited        (2,350)   19.61      
Balance – December 31, 2015        746,004    21.56    325,979 
Granted  $11.04    170,500    36.86      
Options assumed in acquisition        91,701    21.03      
Exercise of stock options*        (72,783)   20.90      
Forfeited        (1,456)   21.71      
Balance – September 30, 2016        933,966   $24.35    407,779 

 

*The terms of the stock option agreements permit having a number of shares of stock withheld, the fair market value of which as of the date of exercise is sufficient to satisfy the exercise price and/or tax withholding requirements.

 

Options outstanding at September 30, 2016 are exercisable at option prices ranging from $9.19 to $38.10. There are 304,393 options outstanding in the range from $9.19 - $20.00, 260,489 in the range from $20.01 - $25.00, 162,211 in the range from $25.01 - $30.00, and 206,873 options outstanding in the range from $30.01 - $38.10. At September 30, 2016, the exercisable options have a weighted average remaining contractual life of approximately 5 years and a weighted average exercise price of $19.60.

 

Intrinsic value represents the amount by which the fair market value of the underlying stock exceeds the exercise price of the stock options. The total intrinsic value of options exercised in the first nine months of 2016, and full year of 2015 was approximately $1.1 million and $5.2 million, respectively.

 

Restricted Stock  Weighted-
Average Grant
Date Fair Value
   Restricted
Shares
Outstanding
 
Balance – December 31, 2014  $18.62    66,231 
Granted   -    - 
Vested*   19.26    (29,261)
Forfeited   16.50    (280)
Balance – December 31, 2015   18.70    36,690 
Granted   31.33    25,202 
Vested *   20.01    (12,077)
Forfeited   -    - 
Balance – September 30, 2016  $24.77    49,815 

 

*The terms of the restricted stock agreements permit the surrender of shares to the Company upon vesting in order to satisfy applicable tax withholding requirements at the minimum statutory withholding rate, and accordingly 3,653 shares were surrendered during the nine months ended September 30, 2016 and 7,715 shares were surrendered during the twelve months ended December 31, 2015.

 

11 

 

 

Note 4 – Stock-based Compensation, continued

 

The Company recognized approximately $1.1 million and $0.9 million of stock-based employee compensation expense during the nine months ended September 30, 2016 and 2015, respectively, associated with its stock equity awards. As of September 30, 2016, there was approximately $4.7 million of unrecognized compensation cost related to equity award grants. The cost is expected to be recognized over the weighted average remaining vesting period of approximately three years.

 

Note 5 – Securities Available for Sale

 

Amortized costs and fair values of securities available for sale are summarized as follows:

 

   September 30, 2016 
(in thousands)  Amortized Cost  

Gross

Unrealized

Gains

   Gross
Unrealized
Losses
   Fair Value 
U.S. government sponsored enterprises  $1,985   $9   $-   $1,994 
State, county and municipals   186,025    1,567    100    187,492 
Mortgage-backed securities   161,448    1,602    124    162,926 
Corporate debt securities   10,442    248    -    10,690 
Equity securities   2,631    583    -    3,214 
   $362,531   $4,009   $224   $366,316 

 

   December 31, 2015 
(in thousands)  Amortized Cost   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
   Fair Values 
U.S. government sponsored enterprises  $287   $7   $-   $294 
State, county and municipals   104,768    497    244    105,021 
Mortgage-backed securities   61,600    418    554    61,464 
Corporate debt securities   1,140    -    -    1,140 
Equity securities   3,196    1,504    23    4,677 
   $170,991   $2,426   $821   $172,596 

 

12 

 

 

Note 5 – Securities Available for Sale, continued

 

The following table represents gross unrealized losses and the related fair value of investment securities available for sale, aggregated by investment category and length of time individual securities have been in a continuous unrealized loss position, at September 30, 2016 and December 31, 2015.

 

   September 30, 2016 
   Less than 12 months   12 months or more   Total 
(in thousands)  Fair
Value
   Unrealized
Losses
   Fair
Value
   Unrealized
Losses
   Fair
Value
   Unrealized
Losses
 
State, county and municipals  $42,144   $94   $1,306   $6   $43,450   $100 
Mortgage-backed securities   16,761    79    3,290    45    20,051    124 
   $58,905   $173   $4,596   $51   $63,501   $224 

 

   December 31, 2015 
   Less than 12 months   12 months or more   Total 
(in thousands)  Fair
Value
   Unrealized
Losses
   Fair
Value
   Unrealized
Losses
   Fair
Value
   Unrealized
Losses
 
State, county and municipals  $34,283   $112   $12,702   $132   $46,985   $244 
Mortgage-backed securities   22,228    167    13,750    387    35,978    554 
Equity securities   408    23    -    -    408    23 
   $56,919   $302   $26,452   $519   $83,371   $821 

 

At September 30, 2016 the Company had $0.2 million of gross unrealized losses related to 152 securities. As of September 30, 2016, the Company does not consider securities with unrealized losses to be other-than-temporarily impaired as the unrealized losses in each category have occurred as a result of changes in interest rates, market spreads and market conditions subsequent to purchase. The Company has the ability and intent to hold its securities to maturity. There were no other-than-temporary impairments charged to earnings during the nine-month periods ending September 30, 2016 or September 30, 2015.

 

The amortized cost and fair values of securities available for sale at September 30, 2016 by contractual maturity are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Fair values of securities are estimated based on financial models or prices paid for the same or similar securities. It is possible interest rates could change considerably, resulting in a material change in estimated fair value.

 

   September 30, 2016 
(in thousands)  Amortized Cost   Fair Value 
Due in less than one year  $10,673   $10,675 
Due in one year through five years   80,933    81,499 
Due after five years through ten years   98,176    99,029 
Due after ten years   8,670    8,973 
    198,452    200,176 
Mortgage-backed securities   161,448    162,926 
Equity securities   2,631    3,214 
Securities available for sale  $362,531   $366,316 

 

Proceeds from sales of securities available for sale during the first nine months of 2016 and 2015 were approximately $30.3 million and $13.9 million, respectively. Gross gains of approximately $0.1 million and $0.6 million were realized during the first nine months of 2016 and 2015, respectively. Gross losses of approximately $13,000 were realized on sales of securities during the first nine months of 2016. No losses were realized on sales of securities during the first nine months of 2015.

 

13 

 

 

Note 6 – Loans, Allowance for Loan Losses, and Credit Quality

 

The loan composition as of September 30, 2016 and December 31, 2015 is summarized as follows.

 

   Total 
   September 30, 2016   December 31, 2015 
(in thousands)  Amount  

% of

Total

   Amount   % of
Total
 
Commercial & industrial  $423,790    27.3%  $294,419    33.6%
Owner-occupied commercial real estate (“CRE”)   362,554    23.3    185,285    21.1 
Agricultural (“AG”) production   34,077    2.2    15,018    1.7 
AG real estate   45,671    2.9    43,272    4.9 
CRE investment   197,884    12.7    78,711    9.0 
Construction & land development   68,161    4.4    36,775    4.2 
Residential construction   27,331    1.8    10,443    1.2 
Residential first mortgage   284,653    18.3    154,658    17.6 
Residential junior mortgage   95,901    6.2    51,967    5.9 
Retail & other   14,102    0.9    6,513    0.8 
Loans   1,554,124    100.0%   877,061    100.0%
Less allowance for loan losses   11,481         10,307      
Loans, net  $1,542,643        $866,754      
Allowance for loan losses to loans   0.74%        1.18%     

 

   Originated 
   September 30, 2016   December 31, 2015 
(in thousands)  Amount  

% of

Total

   Amount   % of
Total
 
Commercial & industrial  $321,522    37.7%  $284,023    38.4%
Owner-occupied CRE   181,107    21.3    153,563    20.7 
AG production   8,857    1.0    6,849    0.9 
AG real estate   18,222    2.1    25,464    3.4 
CRE investment   72,182    8.5    58,949    8.0 
Construction & land development   34,916    4.1    27,231    3.7 
Residential construction   20,964    2.5    10,443    1.4 
Residential first mortgage   138,103    16.2    122,373    16.5 
Residential junior mortgage   47,346    5.5    44,889    6.1 
Retail & other   9,179    1.1    6,351    0.9 
Loans   852,398    100.0%   740,135    100.0%
Less allowance for loan losses   8,988         8,714      
Loans, net  $843,410        $731,421      
Allowance for loan losses to loans   1.05%        1.18%     

 

   Acquired 
   September 30, 2016   December 31, 2015 
(in thousands)  Amount  

% of

Total

   Amount   % of
Total
 
Commercial & industrial  $102,268    14.6%  $10,396    7.6%
Owner-occupied CRE   181,447    25.9    31,722    23.2 
AG production   25,220    3.6    8,169    6.0 
AG real estate   27,449    3.9    17,808    13.0 
CRE investment   125,702    17.9    19,762    14.4 
Construction & land development   33,245    4.7    9,544    7.0 
Residential construction   6,367    0.9    -    - 
Residential first mortgage   146,550    20.9    32,285    23.5 
Residential junior mortgage   48,555    6.9    7,078    5.2 
Retail & other   4,923    0.7    162    0.1 
Loans   701,726    100.0%   136,926    100.0%
Less allowance for loan losses   2,493         1,593      
Loans, net  $699,233        $135,333      
Allowance for loan losses to loans   0.36%        1.16%     

 

14 

 

 

Note 6 – Loans, Allowance for Loan Losses, and Credit Quality, continued

 

Practically all of the Company’s loans, commitments, financial letters of credit and standby letters of credit have been granted to customers in the Company’s market area. Although the Company has a diversified loan portfolio, the credit risk in the loan portfolio is largely influenced by general economic conditions and trends of the counties and markets in which the debtors operate, and the resulting impact on the operations of borrowers or on the value of underlying collateral, if any.

 

The allowance for loan and lease losses (“ALLL”) represents management’s estimate of probable and inherent credit losses in the Company’s loan portfolio at the balance sheet date. In general, estimating the amount of the ALLL is a function of a number of factors, including but not limited to changes in the loan portfolio, net charge-offs, trends in past due and impaired loans, and the level of potential problem loans, all of which may be susceptible to significant change. To the extent actual outcomes differ from management estimates, additional provisions for loan losses could be required that could adversely affect our earnings or financial position in future periods. Allocations to the ALLL may be made for specific loans but the entire ALLL is available for any loan that, in management’s judgment, should be charged-off or for which an actual loss is realized.

 

The allocation methodology used by the Company includes specific allocations for impaired loans evaluated individually for impairment based on collateral values and for the remaining loan portfolio collectively evaluated for impairment primarily based on historical loss rates and other qualitative factors. Loan charge-offs and recoveries are based on actual amounts charged-off or recovered by loan category. Management allocates the ALLL by pools of risk within each loan portfolio.

 

The following tables present the balance and activity in the ALLL by portfolio segment and the recorded investment in loans by portfolio at or for the nine months ended September 30, 2016:

 

   TOTAL – Nine Months Ended September 30, 2016 
(in thousands)
ALLL:
  Commercial
& industrial
   Owner-
occupied
CRE
   AG
production
   AG real
estate
   CRE
investment
   Construction
& land
development
   Residential
construction
   Residential
first
mortgage
   Residential
junior
mortgage
   Retail
& other
   Total 
Beginning balance  $3,721   $1,933   $85   $380   $785   $1,446   $147   $1,240   $496   $74   $10,307 
Provision   745    710    40    (77)   23    (586)   176    188    42    89    1,350 
Charge-offs   (279)   (61)   -    -    -    -    -    -    (53)   (39)   (432)
Recoveries   17    3    -    -    221    -    -    5    7    3    256 
Net charge-offs   (262)   (58)   -    -    221    -    -    5    (46)   (36)   (176)
Ending balance  $4,204   $2,585   $125   $303   $1,029   $860   $323   $1,433   $492   $127   $11,481 
As percent of ALLL   36.6%   22.5%   1.1%   2.6%   9.0%   7.5%   2.8%   12.5%   4.3%   1.1%   100.0%
                                                        
ALLL:                                                       
Individually evaluated  $96   $-   $-   $-   $-   $-   $-   $-   $-   $-   $96 
Collectively evaluated   4,108    2,585    125    303    1,029    860    323    1,433    492    127    11,385 
Ending balance  $4,204   $2,585   $125   $303   $1,029   $860   $323   $1,433   $492   $127   $11,481 
                                                        
Loans:                                                       
Individually evaluated  $662   $2,666   $53   $240   $13,466   $722   $287   $2,303   $181   $-   $20,580 
Collectively evaluated   423,128    359,888    34,024    45,431    184,418    67,439    27,044    282,350    95,720    14,102    1,533,544 
Total loans  $423,790   $362,554   $34,077   $45,671   $197,884   $68,161   $27,331   $284,653   $95,901   $14,102   $1,554,124 
                                                        
Less ALLL  $4,204   $2,585   $125   $303   $1,029   $860   $323   $1,433   $492   $127   $11,481 
Net loans  $419,586   $359,969   $33,952   $45,368   $196,855   $67,301   $27,008   $283,220   $95,409   $13,975   $1,542,643 

 

15 

 

 

Note 6 – Loans, Allowance for Loan Losses, and Credit Quality, continued

 

   Originated – Nine Months Ended September 30, 2016 
(in thousands)
ALLL:
  Commercial
& industrial
   Owner-
occupied
CRE
   AG
production
   AG real
estate
   CRE
investment
   Construction
& land
development
   Residential
construction
   Residential
first
mortgage
   Residential
junior
mortgage
   Retail
& other
   Total 
Beginning balance  $3,135   $1,567   $71   $299   $646   $1,381   $147   $987   $418   $63   $8,714 
Provision   426    408    29    (73)   (70)   (633)   130    85    16    80    398 
Charge-offs   (262)   (3)   -    -    -    -    -    -    (53)   (38)   (356)
Recoveries   -    3    -    -    221    -    -    -    6    2    232 
Net charge-offs   (262)   -    -    -    221    -    -    -    (47)   (36)   (124)
Ending balance  $3,299   $1,975   $100   $226   $797   $748   $277   $1,072   $387   $107   $8,988 
As percent of ALLL   36.7%   22.0%   1.1%   2.5%   8.9%   8.3%   3.1%   11.9%   4.3%   1.2%   100.0%
                                                        
ALLL:                                                       
Individually evaluated  $96   $-   $-   $-   $-   $-   $-   $-   $-   $-   $96 
Collectively evaluated   3,203    1,975    100    226    797    748    277    1,072    387    107    8,892 
Ending balance  $3,299   $1,975   $100   $226   $797   $748   $277   $1,072   $387   $107   $8,988 
                                                        
Loans:                                                       
Individually evaluated  $319   $-   $-   $-   $-   $-   $-   $-   $-   $-   $319 
Collectively evaluated   321,203    181,107    8,857    18,222    72,182    34,916    20,964    138,103    47,346    9,179    852,079 
Total loans  $321,522   $181,107   $8,857   $18,222   $72,182   $34,916   $20,964   $138,103   $47,346   $9,179   $852,398 
                                                        
Less ALLL  $3,299   $1,975   $100   $226   $797   $748   $277   $1,072   $387   $107   $8,988 
Net loans  $318,223   $179,132   $8,757   $17,996   $71,385   $34,168   $20,687   $137,031   $46,959   $9,072   $843,410 

 

   Acquired – Nine Months Ended September 30, 2016 
(in thousands)
ALLL:
  Commercial
& industrial
   Owner-
occupied
CRE
   AG
production
   AG real
estate
   CRE
investment
   Construction
& land
development
   Residential
construction
   Residential
first
mortgage
   Residential
junior
mortgage
   Retail
& other
   Total 
Beginning balance  $586   $366   $14   $81   $139   $65   $-   $253   $78   $11   $1,593 
Provision   319    302    11    (4)   93    47    46    103    26    9    952 
Charge-offs   (17)   (58)   -    -    -    -    -    -    -    (1)   (76)
Recoveries   17    -    -    -    -    -    -    5    1    1    24 
Net charge-offs   -    (58)   -    -    -    -    -    5    1    -    (52)
Ending balance  $905   $610   $25   $77   $232   $112   $46   $361   $105   $20   $2,493 
As percent of ALLL   36.3%   24.5%   1.0%   3.1%   9.3%   4.5%   1.8%   14.5%   4.2%   0.8%   100.0%
                                                        
Loans:                                                       
Individually evaluated  $343   $2,666   $53   $240   $13,466   $722   $287   $2,303   $181   $-   $20,261 
Collectively evaluated   101,925    178,781    25,167    27,209    112,236    32,523    6,080    144,247    48,374    4,923    681,465 
Total loans  $102,268   $181,447   $25,220   $27,449   $125,702   $33,245   $6,367   $146,550   $48,555   $4,923   $701,726 
                                                        
Less ALLL  $905   $610   $25   $77   $232   $112   $46   $361   $105   $20   $2,493 
Net loans  $101,363   $180,837   $25,195   $27,372   $125,470   $33,133   $6,321   $146,189   $48,450   $4,903   $699,233 

 

16 

 

 

Note 6 – Loans, Allowance for Loan Losses, and Credit Quality, continued

 

The following table presents the balance and activity in the ALLL by portfolio segment and the recorded investment in loans by portfolio at or for the nine months ended September 30, 2015.

 

   TOTAL – Nine Months Ended September 30, 2015 
(in thousands)
ALLL:
  Commercial
& industrial
   Owner-
occupied
CRE
   AG
production
   AG real
estate
   CRE
investment
   Construction
& land
development
   Residential
construction
   Residential first
mortgage
   Residential
junior
mortgage
   Retail
& other
   Total 
Beginning balance  $3,191   $1,230   $53   $226   $511   $2,685   $140   $866   $337   $49   $9,288 
Provision   781    682    31    76    227    (975)   (34)   291    244    27    1,350 
Charge-offs   (305)   (219)   -    -    -    -    -    (60)   (104)   (29)   (717)
Recoveries   37    3    -    -    13    -    -    18    1    12    84 
Net charge-offs   (268)   (216)   -    -    13    -    -    (42)   (103)   (17)   (633)
Ending balance  $3,704   $1,696   $84   $302   $751   $1,710   $106   $1,115   $478   $59   $10,005 
As percent of ALLL   37.0%   17.0%   0.8%   3.0%   7.5%   17.1%   1.1%   11.1%   4.8%   0.6%   100%
                                                        
ALLL:                                                       
Individually evaluated  $-   $-   $-   $-   $-   $-   $-   $-   $-   $-   $- 
Collectively evaluated   3,704    1,696    84    302    751    1,710    106    1,115    478    59    10,005 
Ending balance  $3,704   $1,696   $84   $302   $751   $1,710   $106   $1,115   $478   $59   $10,005 
                                                        
Loans:                                                       
Individually evaluated  $147   $1,224   $39   $392   $982   $686   $-   $627   $144   $-   $4,241 
Collectively evaluated   304,711    178,345    15,670    39,323    82,296    38,801    8,106    152,935    54,026    5,994    880,207 
Total loans  $304,858   $179,569   $15,709   $39,715   $83,278   $39,487   $8,106   $153,562   $54,170   $5,994   $884,448 
                                                        
Less ALLL  $3,704   $1,696   $84   $302   $751   $1,710   $106   $1,115   $478   $59   $10,005 
Net loans  $301,154   $177,873   $15,625   $39,413   $82,527   $37,777   $8,000   $152,447   $53,692   $5,935   $874,443 

 

   Originated – Nine Months Ended September 30, 2015 
(in thousands)
ALLL:
  Commercial
& industrial
   Owner-
occupied
CRE
   AG
production
   AG real
estate
   CRE
investment
   Construction
& land
development
   Residential
construction
   Residential first
mortgage
   Residential
junior
mortgage
   Retail
& other
   Total 
Beginning balance  $3,191   $1,230   $53   $226   $511   $2,685   $140   $866   $337   $49   $9,288 
Provision   160    260    15    4    79    (1,045)   (34)   41    149    17    (354)
Charge-offs   (305)   (157)   -    -    -    -    -    (60)   (91)   (29)   (642)
Recoveries   37    3    -    -    13    -    -    15    -    12    80 
Net charge-offs   (268)   (154)   -    -    13    -    -    (45)   (91)   (17)   (562)
Ending balance  $3,083   $1,336   $68   $230   $603   $1,640   $106   $862   $395   $49   $8,372 
As percent of ALLL   36.8%   16.0%   0.8%   2.7%   7.2%   19.6%   1.3%   10.3%   4.7%   0.6%   100%
                                                        
ALLL:                                                       
Individually evaluated  $-   $-   $-   $-   $-   $-   $-   $-   $-   $-   $- 
Collectively evaluated   3,083    1,336    68    230    603    1,640    106    862    395    49    8,372 
Ending balance  $3,083   $1,336   $68   $230   $603   $1,640   $106   $862   $395   $49   $8,372 
                                                        
Loans:                                                       
Individually evaluated  $-   $-   $-   $-   $-   $-   $-   $-   $-   $-   $- 
Collectively evaluated   294,160    146,155    7,334    21,541    59,894    28,314    8,106    119,503    47,096    5,752    737,855 
Total loans  $294,160   $146,155   $7,334   $21,541   $59,894   $28,314   $8,106   $119,503   $47,096   $5,752   $737,855 
                                                        
Less ALLL  $3,083   $1,336   $68   $230   $603   $1,640   $106   $862   $395   $49   $8,372 
Net loans  $291,077   $144,819   $7,266   $21,311   $59,291   $26,674   $8,000   $118,641   $46,701   $5,703   $729,483 

 

17 

 

 

Note 6 – Loans, Allowance for Loan Losses, and Credit Quality, continued

 

   Acquired – Nine Months Ended September 30, 2015 
(in thousands)
ALLL:
  Commercial
& industrial
   Owner-
occupied
CRE
   AG
production
   AG real
estate
   CRE
investment
   Construction
& land
development
   Residential
construction
   Residential
first
mortgage
   Residential
junior
mortgage
   Retail
& other
   Total 
Beginning balance  $-   $-   $-   $-   $-   $-   $-   $-   $-   $-   $- 
Provision   621    422    16    72    148    70    -    250    95    10    1,704 
Charge-offs   -    (62)   -    -    -    -    -    -    (13)   -    (75)
Recoveries   -    -    -    -    -    -    -    3    1    -    4 
Net charge-offs   -    (62)   -    -    -    -    -    3    (12)   -    (71)
Ending balance  $621   $360   $16   $72   $148   $70   $-   $253   $83   $10   $1,633 
As percent of ALLL   38.0%   22.0%   1.0%   4.4%   9.1%   4.3%   -%   15.5%   5.1%   0.6%   100%
                                                        
Loans:                                                       
Individually evaluated  $147   $1,224   $39   $392   $982   $686   $-   $627   $144   $-   $4,241 
Collectively evaluated   10,551    32,190    8,336    17,782    22,402    10,487    -    33,432    6,930    242    142,352 
Total loans  $10,698   $33,414   $8,375   $18,174   $23,384   $11,173   $-   $34,059   $7,074   $242   $146,593 
                                                        
Less ALLL  $621   $360   $16   $72   $148   $70   $-   $253   $83   $10   $1,633 
Net loans  $10,077   $33,054   $8,359   $18,102   $23,236   $11,103   $-   $33,806   $6,991   $232   $144,960 

 

18 

 

 

Note 6 – Loans, Allowance for Loan Losses, and Credit Quality, continued

 

The following table presents nonaccrual loans by portfolio segment in total and then as a further breakdown by originated or acquired as of September 30, 2016 and December 31, 2015.

 

   Total Nonaccrual Loans 
(in thousands)  September 30,
2016
   % to Total   December 31, 2015   % to Total 
Commercial & industrial  $680    3.2%  $204    5.8%
Owner-occupied CRE   2,986    13.9    951    26.9 
AG production   23    0.1    13    0.4 
AG real estate   208    1.0    230    6.5 
CRE investment   13,216    61.4    1,040    29.4 
Construction & land development   1,220    5.7    280    7.9 
Residential construction   287    1.3    -    - 
Residential first mortgage   2,656    12.4    674    19.1 
Residential junior mortgage   212    1.0    141    4.0 
Retail & other   -    -    -    - 
Nonaccrual loans - Total  $21,488    100.0%  $3,533    100.0%

 

   Originated 
(in thousands)  September 30,
2016
   % to Total   December 31, 2015   % to Total 
Commercial & industrial  $324    47.3%  $49    8.4%
Owner-occupied CRE   44    6.4    -    - 
AG production   8    1.2    13    2.2 
AG real estate   -    -    -    - 
CRE investment   -    -    387    66.7 
Construction & land development   -    -    -    - 
Residential construction   -    -    -    - 
Residential first mortgage   309    45.1    132    22.7 
Residential junior mortgage   -    -    -    - 
Retail & other   -    -    -    - 
Nonaccrual loans - Originated  $685    100.0%  $581    100.0%

 

   Acquired 
(in thousands)  September 30,
2016
   % to Total   December 31, 2015   % to Total 
Commercial & industrial  $356    1.7%  $155    5.3%
Owner-occupied CRE   2,942    14.1    951    32.1 
AG production   15    0.1    -    - 
AG real estate   208    1.0    230    7.8 
CRE investment   13,216    63.5    653    22.1 
Construction & land development   1,220    5.9    280    9.5 
Residential construction   287    1.4    -    - 
Residential first mortgage   2,347    11.3    542    18.4 
Residential junior mortgage   212    1.0    141    4.8 
Retail & other   -    -    -    - 
Nonaccrual loans – Acquired  $20,803    100.0%  $2,952    100.0%

 

19 

 

 

Note 6 – Loans, Allowance for Loan Losses, and Credit Quality, continued

 

The following tables present total past due loans by portfolio segment as of September 30, 2016 and December 31, 2015:

 

   September 30, 2016 
(in thousands)  30-89 Days
Past Due
(accruing)
   90 Days &
Over or non-
accrual
   Current   Total 
Commercial & industrial  $78   $680   $423,032   $423,790 
Owner-occupied CRE   -    2,986    359,568    362,554 
AG production   -    23    34,054    34,077 
AG real estate   71    208    45,392    45,671 
CRE investment   -    13,216    184,668    197,884 
Construction & land development   -    1,220    66,941    68,161 
Residential construction   -    287    27,044    27,331 
Residential first mortgage   211    2,656    281,786    284,653 
Residential junior mortgage   44    212    95,645    95,901 
Retail & other   -    -    14,102    14,102 
Total loans  $404   $21,488   $1,532,232   $1,554,124 
As a percent of total loans   0.1%   1.3%   98.6%   100.0%

 

   December 31, 2015 
(in thousands)  30-89 Days
Past Due
(accruing)
   90 Days &
Over or
nonaccrual
   Current   Total 
Commercial & industrial  $50   $204   $294,165   $294,419 
Owner-occupied CRE   -    951    184,334    185,285 
AG production   16    13    14,989    15,018 
AG real estate   -    230    43,042    43,272 
CRE investment   -    1,040    77,671    78,711 
Construction & land development   -    280    36,495    36,775 
Residential construction   -    -    10,443    10,443 
Residential first mortgage   150    674    153,834    154,658 
Residential junior mortgage   10    141    51,816    51,967 
Retail & other   12    -    6,501    6,513 
Total loans  $238   $3,533   $873,290   $877,061 
As a percent of total loans   0.1%   0.4%   99.5%   100.0%

 

A description of the loan risk categories used by the Company follows:

 

1-4 Pass: Credits exhibit adequate cash flows, appropriate management and financial ratios within industry norms and/or are supported by sufficient collateral. Some credits in these rating categories may require a need for monitoring but elements of concern are not severe enough to warrant an elevated rating.

 

5 Watch: Credits with this rating are adequately secured and performing but are being monitored due to the presence of various short-term weaknesses which may include unexpected, short-term adverse financial performance, managerial problems, potential impact of a decline in the entire industry or local economy and delinquency issues. Loans to individuals or loans supported by guarantors with marginal net worth or collateral may be included in this rating category.

 

6 Special Mention: Credits with this rating have potential weaknesses that, without the Company’s attention and correction may result in deterioration of repayment prospects. These assets are considered Criticized Assets. Potential weaknesses may include adverse financial trends for the borrower or industry, repeated lack of compliance with Company requests, increasing debt to net worth, serious management conditions and decreasing cash flow.

 

7 Substandard: Assets with this rating are characterized by the distinct possibility the Company will sustain some loss if deficiencies are not corrected. All foreclosures, liquidations, and non-accrual loans are considered to be categorized in this rating, regardless of collateral sufficiency.

 

8 Doubtful: Assets with this rating exhibit all the weaknesses as one rated Substandard with the added characteristic that such weaknesses make collection or liquidation in full highly questionable.

 

20 

 

 

Note 6 – Loans, Allowance for Loan Losses, and Credit Quality, continued

 

9 Loss: Assets in this category are considered uncollectible. Pursuing any recovery or salvage value is impractical but does not preclude partial recovery in the future.

 

The following tables present total loans by loan grade as of September 30, 2016 and December 31, 2015:

 

   September 30, 2016 
(in thousands)  Grades 1- 4   Grade 5   Grade 6   Grade 7   Grade 8   Grade 9   Total 
Commercial & industrial  $393,666   $20,566   $4,612   $4,946   $-   $-   $423,790 
Owner-occupied CRE   344,257    13,057    586    4,654    -    -    362,554 
AG production   31,649    1,861    73    494    -    -    34,077 
AG real estate   43,968    947    -    756    -    -    45,671 
CRE investment   174,264    8,153    1,096    14,371    -    -    197,884 
Construction & land development   62,217    4,516    -    1,428    -    -    68,161 
Residential construction   26,049    819    -    463    -    -    27,331 
Residential first mortgage   279,705    1,466    194    3,288    -    -    284,653 
Residential junior mortgage   95,557    -    91    253    -    -    95,901 
Retail & other   14,102    -    -    -    -    -    14,102 
Total loans  $1,465,434   $51,385   $6,652   $30,653   $-   $-   $1,554,124 
Percent of total   94.3%   3.3%   0.4%   2.0%   -    -    100.0%

 

   December 31, 2015 
(in thousands)  Grades 1- 4   Grade 5   Grade 6   Grade 7   Grade 8   Grade 9   Total 
Commercial & industrial  $278,118   $9,267   $2,490   $4,544   $-   $-   $294,419 
Owner-occupied CRE   176,371    5,072    253    3,589    -    -    185,285 
AG production   13,238    1,765    -    15    -    -    15,018 
AG real estate   39,958    2,600    -    714    -    -    43,272 
CRE investment   74,778    2,020    -    1,913    -    -    78,711 
Construction & land development   31,897    4,598    -    280    -    -    36,775 
Residential construction   9,792    651    -    -    -    -    10,443 
Residential first mortgage   151,835    860    457    1,506    -    -    154,658 
Residential junior mortgage   51,736    68    -    163    -    -    51,967 
Retail & other   6,513    -    -    -    -    -    6,513 
Total loans  $834,236   $26,901   $3,200   $12,724   $-   $-   $877,061 
Percent of total   95.0%   3.1%   0.4%   1.5%   -    -    100.0%

 

Management considers a loan to be impaired when it is probable the Company will be unable to collect all contractual principal and interest payments due in accordance with the terms of the loan agreement. For determining the adequacy of the ALLL, management defines impaired loans as nonaccrual credit relationships over $250,000, plus additional loans with impairment risk characteristics. At the time an individual loan goes into nonaccrual status, however, management evaluates the loan for impairment and possible charge-off regardless of loan size.

 

In determining the appropriateness of the ALLL, management includes allocations for specifically identified impaired loans and loss factor allocations for all remaining loans, with a component primarily based on historical loss rates and another component primarily based on other qualitative factors. Impaired loans are individually assessed and are measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate or, as a practical expedient, at the loan’s observable market price or the fair value of the collateral if the loan is collateral dependent.

 

Loans that are determined not to be impaired are collectively evaluated for impairment, stratified by type and allocated loss ranges based on the Company’s actual historical loss ratios for each strata, and adjustments are also provided for certain current environmental and qualitative factors. An internal loan review function rates loans using a grading system based on nine different categories. Loans with grades of seven or higher (“classified loans”) represent loans with a greater risk of loss and may be assigned allocations for loss based on specific review of the weaknesses observed in the individual credits if classified as impaired. Classified loans are constantly monitored by the loan review function to ensure early identification of any deterioration.

 

21 

 

 

Note 6 – Loans, Allowance for Loan Losses, and Credit Quality, continued

 

The following tables present impaired loans as of September 30, 2016 and December 31, 2015. As a further breakdown, impaired loans are also summarized by originated and acquired for the periods presented. In April 2016, the Baylake merger added purchased credit impaired loans at a fair value of $20.8 million, net of an initial $12.9 million non-accretable mark. Including these credit impaired loans acquired in the Baylake merger, total purchased credit impaired loans acquired in aggregate were initially recorded at a fair value of $37.5 million on their respective acquisition dates, net of an initial $25.1 million non-accretable mark and a zero accretable mark. At September 30, 2016, $20.0 million of the $37.5 million remain in impaired loans and $0.3 million of acquired loans have subsequently become impaired, bringing acquired impaired loans to $20.3 million.

 

   Total Impaired Loans – September 30, 2016 
(in thousands)  Recorded
Investment
   Unpaid Principal
Balance
   Related Allowance   Average Recorded
Investment
   Interest Income
Recognized
 
Commercial & industrial*  $662   $1,089   $96   $815   $82 
Owner-occupied CRE   2,666    4,772    -    2,742    252 
AG production   53    180    -    61    9 
AG real estate   240    333    -    246    25 
CRE investment   13,466    21,093    -    13,634    891 
Construction & land development   722    2,150    -    781    95 
Residential construction   287    1,374    -    300    64 
Residential first mortgage   2,303    3,860    -    2,364    178 
Residential junior mortgage   181    617    -    186    37 
Retail & Other   -    42    -    -    5 
Total  $20,580   $35,510   $96   $21,129   $1,638 

 

As a further breakdown, impaired loans as of September 30, 2016 are summarized by originated and acquired as follows:

 

   Originated – September 30, 2016 
(in thousands)  Recorded
Investment
   Unpaid Principal
Balance
   Related Allowance   Average Recorded
Investment
   Interest Income
Recognized
 
Commercial & industrial*  $319   $319   $96   $464   $19 
Owner-occupied CRE   -    -    -    -    - 
AG production   -    -    -    -    - 
AG real estate   -    -    -    -    - 
CRE investment   -    -    -    -    - 
Construction & land development   -    -    -    -    - 
Residential construction   -    -    -    -    - 
Residential first mortgage   -    -    -    -    - 
Residential junior mortgage   -    -    -    -    - 
Retail & Other   -    -    -    -    - 
Total  $319   $319   $96   $464   $19 

 

   Acquired – September 30, 2016 
(in thousands)  Recorded
Investment
   Unpaid Principal
Balance
   Related Allowance   Average Recorded
Investment
   Interest Income
Recognized
 
Commercial & industrial*  $343   $770   $-   $351   $63 
Owner-occupied CRE   2,666    4,772    -    2,742    252 
AG production   53    180    -    61    9 
AG real estate   240    333    -    246    25 
CRE investment   13,466    21,093    -    13,634    891 
Construction & land development   722    2,150    -    781    95 
Residential construction   287    1,374    -    300    64 
Residential first mortgage   2,303    3,860    -    2,364    178 
Residential junior mortgage   181    617    -    186    37 
Retail & other   -    42    -    -    5 
Total  $20,261   $35,191   $-   $20,665   $1,619 

 

*One commercial & industrial loan with a balance of $0.3 million had a specific reserve of $96,000. No other loans had a related allowance at September 30, 2016 and, therefore, the above disclosure was not expanded to include loans with and without a related allowance.

 

22 

 

 

Note 6 – Loans, Allowance for Loan Losses, and Credit Quality, continued

 

   Total Impaired Loans – December 31, 2015 
(in thousands)  Recorded
Investment
   Unpaid Principal
Balance
   Related Allowance   Average Recorded
Investment
   Interest Income
Recognized
 
Commercial & industrial  $142   $142   $-   $144   $10 
Owner-occupied CRE   950    1,688    -    1,111    135 
AG production   39    53    -    38    4 
AG real estate   252    348    -    260    27 
CRE investment   1,301    3,109    -    1,432    175 
Construction & land development   280    822    -    301    18 
Residential construction   -    -    -    -    - 
Residential first mortgage   460    1,150    -    515    79 
Residential junior mortgage   142    471    -    147    26 
Retail & Other   -    12    -    -    1 
Total  $3,566   $7,795   $-   $3,948   $475 

 

As a further breakdown, impaired loans as of December 31, 2015 are summarized by originated and acquired as follows:

 

   Originated – December 31, 2015 
(in thousands)  Recorded
Investment
   Unpaid Principal
Balance
   Related Allowance   Average Recorded
Investment
   Interest Income
Recognized
 
Commercial & industrial  $-   $-   $-   $-   $- 
Owner-occupied CRE   -    -    -    -    - 
AG production   -    -    -    -    - 
AG real estate   -    -    -    -    - 
CRE investment   387    387    -    387    29 
Construction & land development   -    -    -    -    - 
Residential construction   -    -    -    -    - 
Residential first mortgage   -    -    -    -    - 
Residential junior mortgage   -    -    -    -    - 
Retail & Other   -    -    -    -    - 
Total  $387   $387   $-   $387   $29 

 

   Acquired – December 31, 2015 
(in thousands)  Recorded
Investment
   Unpaid Principal
Balance
   Related Allowance   Average Recorded
Investment
   Interest Income
Recognized
 
Commercial & industrial  $142   $142   $-   $144   $10 
Owner-occupied CRE   950    1,688    -    1,111    135 
AG production   39    53    -    38    4 
AG real estate   252    348    -    260    27 
CRE investment   914    2,722    -    1,045    146 
Construction & land development   280    822    -    301    18 
Residential construction   -    -    -    -    - 
Residential first mortgage   460    1,150    -    515    79 
Residential junior mortgage   142    471    -    147    26 
Retail & other   -    12    -    -    1 
Total  $3,179   $7,408   $-   $3,561   $446 

 

23 

 

 

Note 6 – Loans, Allowance for Loan Losses, and Credit Quality, continued

 

Troubled Debt Restructurings

 

At September 30, 2016, there were four loans classified as troubled debt restructurings totaling $340,000. These four loans had a combined premodification balance of $468,000. There were no other loans which were modified and classified as troubled debt restructurings at September 30, 2016. There were no loans classified as troubled debt restructurings during the previous twelve months that subsequently defaulted as of September 30, 2016. Loans which were considered troubled debt restructurings by Baylake prior to the acquisition are not required to be classified as troubled debt restructurings in the Company’s consolidated financial statements unless and until such loans would subsequently meet criteria to be classified as such, since acquired loans were recorded at their estimated fair values at the time of the acquisition.

 

Note 7 – Goodwill and Intangible Assets and Mortgage Servicing Rights

 

The excess of the purchase price in an acquisition over the fair value of net assets acquired consists primarily of goodwill, core deposit intangibles and other identifiable intangibles (primarily related to customer relationships acquired). Goodwill is not amortized but is instead subject to impairment tests on at least an annual basis. Core deposit intangibles, which arise from value ascribed to the deposit base of a bank acquired, have estimated finite lives and are amortized on an accelerated basis to expense over a 10-year period. The other intangibles, which represent value ascribed to financial advisor books of business purchased in 2016 in a private transaction, have estimated finite lives and are amortized on a straight-line basis to expense over their weighted average life (of approximately 12 years for 2016).

 

Management periodically reviews the carrying value of its long-lived and intangible assets to determine if any impairment has occurred, in which case an impairment charge would be recorded as an expense in the period of impairment, or whether changes in circumstances have occurred that would require a revision to the remaining useful life which would impact expense prospectively. In making such determination, management evaluates whether there are any adverse qualitative factors indicating that an impairment may exist, as well as the performance, on an undiscounted basis, of the underlying operations or assets which give rise to the intangible. The Company’s annual assessments indicated no impairment charge on goodwill or core deposit intangible was required for 2015 or the first nine months of 2016.

 

Goodwill: Goodwill was $66.7 million at September 30, 2016 and $0.8 million at December 31, 2015. There were additions to the carrying amount of goodwill in 2016 of $0.4 million related to the acquisition of financial advisor business and of approximately $65.5 million related to the Baylake merger. See Note 2 for additional information on the 2016 acquisitions.

 

Other intangible assets: Other intangible assets, consisting of core deposit intangibles and other intangibles (related to the customer relationships acquired in connection with the 2016 acquisition of financial advisor business), are amortized over their estimated finite lives. Due to the 2016 acquisitions, there was an addition to the gross carrying amount of core deposit intangibles of $17.3 million and of other intangibles of $4.4 million. Amortization on core deposit intangibles was $1.1 million and $2.1 million for the three and nine months ended September 30, 2016, respectively, and $0.3 million and $1.0 million for the three and nine months ended September 30, 2015, respectively. Amortization on other intangible assets was $0.2 million for both the three and nine months ended September 30, 2016 and zero in 2015. See Note 2 for additional information on the 2016 acquisitions.

 

(in thousands)  September 30, 2016   December 31, 2015 
Core deposit intangibles:          
Gross carrying amount  $25,345   $8,086 
Accumulated amortization   (7,178)   (5,055)
Net book value  $18,167   $3,031 
Additions during the period  $17,259   $- 
           
Other intangibles:          
Gross carrying amount  $4,363   $- 
Accumulated amortization   (173)   - 
Net book value  $4,190   $- 
Additions during the period  $4,363   $- 

 

24 

 

 

Note 7 – Goodwill and Intangible Assets and Mortgage Servicing Rights, continued

 

Mortgage servicing rights: The Company may sell originated residential mortgage loans into the secondary market. If the Company retains the right to service these loans sold, a mortgage servicing right is capitalized upon sale (recorded in mortgage income, net, in the consolidated income statements), which represents the then-current estimated fair value of future net cash flows expected to be realized for performing the servicing activities. Mortgage servicing rights, when purchased (as in the case of the 2016 Baylake merger), are initially recorded at their then-estimated fair value. As the Company has not elected to subsequently measure any class of servicing assets under the fair value measurement method, the Company follows the amortization method. Mortgage servicing rights are amortized in proportion to and over the period of estimated net servicing income, and assessed for impairment at each reporting date, with the amortization recorded in mortgage income, net, in the consolidated income statements. Mortgage servicing rights are carried at the lower of the initial capitalized amount, net of accumulated amortization, or estimated fair value, and are included in other assets in the consolidated balance sheets.

 

(in thousands)  September 30, 2016   December 31, 2015 
Mortgage servicing rights (MSR) asset:          
MSR asset at beginning of year  $193   $- 
Additions during the period*   1,377    201 
Amortization during the period   (105)   (8)
Valuation allowance at end of period   -    - 
Net book value at end of period  $1,465   $193 
*Purchased MSR asset included in period  $885    - 
           
Fair value of MSR asset at end of period  $1,760   $249 
Residential mortgage loans serviced for others  $263,146   $34,940 

 

The Company periodically evaluates its mortgage servicing rights asset for impairment. At each reporting date, impairment is assessed based on estimated fair value using estimated prepayment speeds of the underlying mortgage loans serviced and stratifications based on the risk characteristics of the underlying loans serviced (predominantly loan type and note interest rate). A valuation allowance is established through a charge to earnings (which would be included in mortgage income, net, in the consolidated income statements) to the extent the amortized cost of the mortgage servicing rights exceeds the estimated fair value by stratification. If it is later determined that all or a portion of the temporary impairment no longer exists for a stratification, the valuation is reduced through a recovery to earnings, though not beyond the net amortized cost carried. An other-than-temporary impairment (i.e. recoverability is considered remote when considering interest rates and loan payoff activity) is recognized as a write-down of the MSR asset and the related valuation allowance (to the extent a valuation allowance is available) and then against earnings. A direct write-down permanently reduces the carrying value of the MSR asset and valuation allowance, precluding subsequent recoveries.

 

The following table shows the estimated future amortization expense for amortizing intangible assets. The projections are based on existing asset balances, the current interest rate environment and prepayment speeds as of the September 30, 2016. The actual amortization expense the Company recognizes in any given period may be significantly different depending upon acquisition or sale activities, changes in interest rates, prepayment speeds, market conditions, regulatory requirements and events or circumstances that indicate the carrying amount of an asset may not be recoverable.

 

(in thousands)  Core deposit
intangibles
   Other intangibles   MSR asset 
Year ending December 31,               
2016 (remaining three months)  $1,066   $96   $124 
2017   3,805    385    248 
2018   3,254    385    248 
2019   2,762    385    248 
2020   2,156    385    181 
Thereafter   5,124    2,554    416 
Total  $18,167   $4,190   $1,465 

 

25 

 

 

Note 8- Notes Payable

 

The Company had the following long-term notes payable:

 

(in thousands)  September 30, 2016   December 31, 2015 
Joint venture note  $-   $9,412 
Federal Home Loan Bank (“FHLB”) advances   1,000    6,000 
Notes payable  $1,000   $15,412 

 

At the completion of the construction of the Company’s headquarters building in 2005 and as part of a joint venture investment related to the building, the Company and the other joint venture partners guaranteed a joint venture note to finance certain costs of the building. The joint venture note was secured by the building, bore a fixed rate of 5.81% and required monthly principal and interest payments until its maturity on June 1, 2016. In April of 2016, this note was refinanced with Nicolet National Bank and is therefore eliminated through the consolidation process.

 

The FHLB advance bears a fixed rate, requires interest-only monthly payment, and has a maturity in February 2018. The weighted average rates of FHLB advances was 1.17% and 0.83% at September 30, 2016 and December 31, 2015, respectively. FHLB advances are collateralized by a blanket lien on qualifying first mortgages, home equity loans, multi-family loans and certain farmland loans which totaled approximately $297.8 million and $154.3 million at September 30, 2016 and December 31, 2015, respectively.

 

The following table shows the maturity schedule of the notes payable as of September 30, 2016:

 

Maturing in  (in thousands) 
2016  $- 
2017   - 
2018   1,000 
   $1,000 

 

The Company has a $10 million line of credit with a third party bank, bearing a variable rate of interest based on one-month LIBOR plus a margin, but subject to a floor rate, with quarterly payments of interest only. At September 30, 2016, the available line was $10 million, the rate was one-month LIBOR plus 2.25% with a 3.25% floor. The outstanding balance was zero at September 30, 2016 and December 31, 2015, and the line was not used during 2016 or 2015.

 

Note 9 – Junior Subordinated Debentures

 

The Company’s carrying value of junior subordinated debentures was $24.6 million at September 30, 2016 and $12.5 million at December 31, 2015. In July 2004 Nicolet Bankshares Statutory Trust I (the “Statutory Trust”), issued $6.0 million of guaranteed preferred beneficial interests (“trust preferred securities”) that qualify asTier 1 capital under Federal Reserve Board guidelines. All of the common securities of the Statutory Trust are owned by the Company. The proceeds from the issuance of the common securities and the trust preferred securities were used by the Statutory Trust to purchase $6.2 million of junior subordinated debentures of the Company, which pay an 8% fixed rate. Interest on these debentures is current. The debentures may be redeemed in part or in full, on or after July 15, 2009 at par plus any accrued but unpaid interest. The maturity date of the debenture, if not redeemed, is July 15, 2034.

 

As part of the 2013 acquisition of Mid-Wisconsin Financial Services, Inc., the Company assumed $10.3 million of junior subordinated debentures related to $10.0 million of issued trust preferred securities. The trust preferred securities and the debentures mature on December 15, 2035 and have a floating rate of the three-month LIBOR plus 1.43% adjusted quarterly. Interest on these debentures is current. The debentures may be called at par in part or in full, on or after December 15, 2010 or within 120 days of certain events. At acquisition in April 2013 the debentures were recorded at a fair value of $5.8 million, with the discount being accreted to interest expense over the remaining life of the debentures. At September 30, 2016, the carrying value of these junior debentures was $6.5 million, and the $6.2 million carrying value of related trust preferred securities qualifies as Tier 1 capital.

 

As part of the 2016 acquisition of Baylake, the Company assumed $16.6 million of junior subordinated debentures related to $16.1 million of issued trust preferred securities. The trust preferred securities and the debentures mature on September 30, 2036 and have a floating rate of three-month LIBOR plus 1.35% adjusted quarterly. Interest on these debentures is current. The debentures may be redeemed on any interest payment date at par in part or in full, on or after June 30, 2011. At acquisition in April 2016 the debentures were recorded at fair value of $11.8 million, with the discount being accreted to interest expense over the remaining life of the debentures. At September 30, 2016, the carrying value of these junior debentures was $11.9 million, and the $11.4 million carrying value of related trust preferred securities qualifies as Tier 1 capital.

 

26 

 

 

Note 10 – Subordinated Notes

 

In 2015 the Company placed an aggregate of $12 million in subordinated Notes in private placements with certain accredited investors. All Notes were issued with 10-year maturities, have a fixed annual interest rate of 5% payable quarterly, are callable on or after the fifth anniversary of their respective issuances dates, and qualify for Tier 2 capital for regulatory purposes.

 

The $0.2 million debt issuance costs associated with the $12 million Notes are being amortized on a straight line basis over the first five years, representing the no-call periods, as additional interest expense. As of September 30, 2016 and December 31, 2015, respectively, the $0.1 million and $0.2 million, of unamortized debt issuance costs remain and are reflected as a deduction to the carrying value of the outstanding Notes.

 

Note 11 – Fair Value Measurements

 

As provided for by accounting standards, the Company records and/or discloses financial instruments on a fair value basis. These financial assets and financial liabilities are measured at fair value in three levels, based on the markets in which the assets and liabilities are traded and the observability of the assumptions used to determine fair value. These levels are: Level 1 - quoted market prices in active markets for identical assets or liabilities that a company has the ability to access at the measurement date; Level 2 - inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly; Level 3 – significant unobservable inputs for the asset or liability, which are typically based on an entity’s own assumptions, as there is little, if any, related market activity. In instances where the fair value measurement is based on inputs from different levels, the level within which the entire fair value measurement will be categorized is based on the lowest level input that is significant to the fair value measurement in its entirety; this assessment of the significance of an input requires management judgment.

 

Disclosure of the fair value of financial instruments, whether recognized or not recognized in the balance sheet, is required for those instruments for which it is practicable to estimate that value, with the exception of certain financial instruments and all nonfinancial instruments as provided for by the accounting standards. For financial instruments recognized at fair value in the consolidated balance sheets, the fair value disclosure requirements also apply.

 

Fair value (i.e. the price that would be received in an orderly transaction that is not a forced liquidation or distressed sale at the measurement date), among other things, is based on exit price versus entry price, should include assumptions about risk such as nonperformance risk in liability fair values, and is a market-based measurement versus an entity-specific measurement.

 

27 

 

 

Note 11 – Fair Value Measurements, continued

 

The following table presents the balances of assets and liabilities measured at fair value on a recurring basis for the periods presented. One security classified as Level 3 was purchased for $0.6 million during the first quarter of 2016.

 

       Fair Value Measurements Using 
Measured at Fair Value on a Recurring Basis:  Total   Level 1   Level 2   Level 3 
(in thousands)                
U.S. government sponsored enterprises  $1,994   $-   $1,994   $- 
State, county and municipals   187,492    -    186,966    526 
Mortgage-backed securities   162,926    -    162,926    - 
Corporate debt securities   10,690    -    8,990    1,700 
Equity securities   3,214    3,214    -    - 
Securities AFS, September 30, 2016  $366,316   $3,214   $360,876   $2,226 
                     
(in thousands)                    
U.S. government sponsored enterprises  $294   $-   $294   $- 
State, county and municipals   105,021    -    104,495    526 
Mortgage-backed securities   61,464    -    61,464    - 
Corporate debt securities   1,140    -    -    1,140 
Equity securities   4,677    4,677    -    - 
Securities AFS, December 31, 2015  $172,596   $4,677   $166,253   $1,666 

 

The following is a description of the valuation methodologies used by the Company for the Securities AFS noted in the tables of this footnote. Where quoted market prices on securities exchanges are available, the investment is classified as Level 1. Level 1 investments primarily include exchange-traded equity securities available for sale. If quoted market prices are not available, fair value is generally determined using prices obtained from independent pricing vendors who use pricing models (with typical inputs including benchmark yields, reported trades for similar securities, issuer spreads or relationship to other benchmark quoted securities), or discounted cash flows, and are classified as Level 2. Examples of these investments include mortgage-related securities and obligations of state, county and municipals. Finally, in certain cases where there is limited activity or less transparency around inputs to the estimated fair value, investments are classified within Level 3 of the hierarchy. Examples of these include private municipal bonds and corporate debt securities, which include trust preferred security investments. At September 30, 2016 and December 31, 2015, it was determined that carrying value was the best approximation of fair value for these Level 3 securities, based primarily on the internal analysis on these securities.

 

The following table presents the Company’s impaired loans and other real estate owned (“OREO”) measured at fair value on a nonrecurring basis for the periods presented. The additions to the Level 3 category were predominantly due to the April 2016 Baylake merger.

 

Measured at Fair Value on a Nonrecurring Basis

 

       Fair Value Measurements Using 
(in thousands)  Total   Level 1   Level 2   Level 3 
September 30, 2016:                
Impaired loans  $20,484   $-   $-   $20,484 
OREO   2,189    -    -    2,189 
December 31, 2015:                    
Impaired loans  $3,566   $-   $-   $3,566 
OREO   367    -    -    367 

 

28 

 

 

Note 11 – Fair Value Measurements, continued

 

The following is a description of the valuation methodologies used by the Company for the items noted in the table above, including the general classification of such instruments in the fair value hierarchy. For individually evaluated impaired loans, the amount of impairment is based upon the present value of expected future cash flows discounted at the loan’s effective interest rate, the estimated fair value of the underlying collateral for collateral-dependent loans, or the estimated liquidity of the note. For OREO, the fair value is based upon the estimated fair value of the underlying collateral adjusted for the expected costs to sell.

 

The carrying amounts and estimated fair values of the Company’s financial instruments at September 30, 2016 and December 31, 2015 are shown below.

 

September 30, 2016
(in thousands)  Carrying
Amount
   Estimated
Fair Value
   Level 1   Level 2   Level 3 
Financial assets:                         
Cash and cash equivalents  $104,371   $104,371   $104,371   $-   $- 
Certificates of deposit in other banks   5,177    5,206    -    5,206    - 
Securities AFS   366,316    366,316    3,214    360,876    2,226 
Other investments   18,297    18,297    -    12,419    5,878 
Loans held for sale   8,312    8,433    -    8,433    - 
Loans, net   1,542,643    1,556,853    -    -    1,556,853 
BOLI   53,730    53,730    53,730    -    - 
MSR asset   1,465    1,760    -    -    1,760 
                          
Financial liabilities:                         
Deposits  $1,934,082   $1,935,281   $-   $-   $1,935,281 
Notes payable   1,000    1,006    -    1,006    - 
Junior subordinated debentures   24,623    22,389    -    -    22,389 
Subordinated debentures   11,876    11,450    -    -    11,450 

 

December 31, 2015
(in thousands)  Carrying
Amount
   Estimated
Fair Value
   Level 1   Level 2   Level 3 
Financial assets:                         
Cash and cash equivalents  $83,619   $83,619   $83,619   $-   $- 
Certificates of deposit in other banks   3,416    3,416    -    3,416    - 
Securities AFS   172,596    172,596    4,677    166,253    1,666 
Other investments   8,135    8,135    -    5,995    2,140 
Loans held for sale   4,680    4,755    -    4,755    - 
Loans, net   866,754    865,027    -    -    865,027 
BOLI   28,475    28,475    28,475    -    - 
MSR asset   193    249    -    -    249 
                          
Financial liabilities:                         
Deposits  $1,056,417   $1,057,614   $-   $-   $1,057,614 
Notes payable   15,412    18,354    -    18,354    - 
Junior subordinated debentures   12,527    11,900    -    -    11,900 
Subordinated notes   11,849    11,414    -    -    11,414 

 

Not all the financial instruments listed in the table above are subject to the disclosure provisions of Accounting Standards Codification (“ASC”) 820, as certain assets and liabilities result in their carrying value approximating fair value. These include cash and cash equivalents, other investments, bank owned life insurance, short-term borrowings, and nonmaturing deposits. For those financial instruments not previously disclosed the following is a description of the evaluation methodologies used.

 

Certificates of deposits in other banks: Fair values are estimated using discounted cash flow analysis based on current interest rates being offered by instruments with similar terms and represents a Level 2 measurement.

 

29 

 

 

Note 11 – Fair Value Measurements, continued

 

Other investments: The carrying amount of Federal Reserve Bank, Bankers Bank, Farmer Mac, and FHLB stock is a reasonably accepted fair value estimate given their restricted nature. Fair value is the redeemable (carrying) value based on the redemption provisions of the instruments which is considered a Level 2 measurement. The carrying amount of the remaining other investments (particularly common stocks of companies or other banks that are not publicly traded) approximates their fair value, determined primarily by analysis of company financial statements and recent capital issuances of the respective companies or banks, if any, and represents a Level 3 measurement.

 

Loans held for sale: The fair value estimation process for the loans held for sale portfolio is segregated by loan type. The estimated fair value was based on what secondary markets are currently offering for portfolios with similar characteristics and represents a Level 2 measurement.

 

Loans, net: For variable-rate loans that reprice frequently and with no significant change in credit risk or other optionality, fair values are based on carrying values. Fair values for all other loans are estimated by discounting contractual cash flows using estimated market discount rates, which reflect the credit and interest rate risk inherent in the loan. Collateral-dependent impaired loans are included in loans, net. The fair value of loans is considered to be a Level 3 measurement due to internally developed discounted cash flow measurements.

 

Mortgage servicing rights asset: To estimate the fair value of the MSR asset, the underlying serviced loan pools are stratified by interest rate tranche and term of the loan, and a valuation model is used to calculate the present value of expected future cash flows for each stratum. When the carrying value of the MSR asset related to a stratum exceeds its fair value, the stratum is recorded at fair value. The valuation model incorporates assumptions that market participants would use in estimating future net servicing income, such as costs to service, a discount rate, ancillary income, default rates and losses, and prepayment speeds. Although some of these assumptions are based on observable market data, other assumptions are based on unobservable estimates of what market participants would use to measure fair value. As a result, the fair value measurement of mortgage servicing rights is considered a Level 3 measurement and represents an income approach to fair value.

 

Deposits: The fair value of deposits with no stated maturity (such as demand deposits, savings, interest and non-interest checking, and money market accounts) is, by definition, equal to the amount payable on demand at the reporting date. Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered in the market place on certificates of similar remaining maturities. Use of internal discounted cash flows provides a Level 3 fair value measurement.

 

Notes payable: The fair value of the Federal Home Loan Bank advances is obtained from the Federal Home Loan Bank which uses a discounted cash flow analysis based on current market rates of similar maturity debt securities and represents a Level 2 measurement. The fair values of remaining notes payable are estimated using discounted cash flow analysis based on current interest rates being offered by instruments with similar terms and credit quality which represents a Level 3 measurement.

 

Junior subordinated debentures and subordinated notes: The fair values of these debt instruments utilize a discounted cash flow analysis based on an estimate of current interest rates being offered by instruments with similar terms and credit quality. Since the market for these instruments is limited, the internal evaluation represents a Level 3 measurement.

 

Off-balance-sheet instruments: The estimated fair value of letters of credit at September 30, 2016 and December 31, 2015 was insignificant. Loan commitments on which the committed interest rate is less than the current market rate are also insignificant at September 30, 2016 and December 31, 2015.

 

Limitations: Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of a particular financial instrument. Fair value estimates may not be realizable in an immediate settlement of the instrument. In some instances, there are no quoted market prices for the Company’s various financial instruments, in which case fair values may be based on estimates using present value or other valuation techniques, or based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of the financial instruments, or other factors. Those techniques are significantly affected by the assumptions used, including the discount rate and estimate of future cash flows. Subsequent changes in assumptions could significantly affect the estimates.

 

Note 12 – Pending Merger Transaction
 
On November 4, 2016 Nicolet announced the signing of a definitive merger agreement (“Merger Agreement”) with First Menasha Bancshares, Inc., (“First Menasha”) (OTCQX:FMBJ) under which First Menasha will merge with and into Nicolet.  Based upon the financial results as of September 30, 2016, the combined company would have total assets of approximately $2.7 billion, deposits of $2.3 billion and loans of $1.9 billion. The merger transaction is expected to close in the second quarter of 2017. 

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

 

Nicolet Bankshares, Inc. is a bank holding company headquartered in Green Bay, Wisconsin, providing a diversified range of traditional banking and wealth management services to individuals and businesses in its market area through the 42 branch offices of its banking subsidiary, Nicolet National Bank, in northeastern and central Wisconsin and Menominee, Michigan.

 

Overview

 

At September 30, 2016, Nicolet Bankshares, Inc. and its subsidiaries (“Nicolet” or the “Company”) had total assets of $2.3 billion, loans of $1.6 billion, deposits of $1.9 billion and total stockholders’ equity of $277 million, representing increases over December 31, 2015 of 87%, 77%, 83% and 152% in assets, loans, deposits and total equity, respectively. This growth was predominantly attributable to two transactions completed in the first half of 2016 (the “2016 acquisitions”), which are detailed in Note 2, “Acquisitions” of the notes to unaudited consolidated financial statements. On April 29, 2016, Nicolet completed its transformative stock-for-stock merger with Baylake Corp. (“Baylake”), which added 21 branches and a dominant position in Door County, Wisconsin, based on deposit market share. At the time of the Baylake merger and based on estimated fair values, assets of $1.0 billion, loans of $0.7 billion, deposits of $0.8 billion, core deposit intangible of $17 million and goodwill of $66 million were added to the consolidated balance sheet, for a total purchase price of approximately $164 million, including the issuance of 4.3 million shares of Nicolet common stock and assumption of outstanding Baylake equity awards. On a smaller scale, Nicolet completed on April 1, 2016 its private transaction to hire a select group of financial advisors and to purchase their respective books of business and operating platform, to enhance the leadership and future growth of Nicolet’s wealth management business. In this transaction, Nicolet paid total initial consideration of $4.9 million (including $2.6 million in common stock), accrued an earn-out liability of $1.5 million, recorded $0.4 million of goodwill, $0.2 million of fixed assets and $4.3 million of customer relationship intangibles.

 

For the nine months ended September 30, 2016, net income was $12.4 million, and after $0.6 million of preferred stock dividends, net income available to common shareholders was $11.7 million or $1.67 per diluted common share. Evaluation of financial performance between 2016 and 2015 periods was impacted in general from the timing of the two 2016 acquisitions, and inclusion of non-recurring merger-based expenses and integration costs, as described under the section “Management’s Discussion and Analysis.”

 

Nicolet’s profitability is significantly dependent upon net interest income (interest income earned on loans and other interest-earning assets such as investments, net of interest expense on deposits and other borrowed funds), and noninterest income sources (including but not limited to service charges on deposits, trust and brokerage fees, mortgage income from sales of residential mortgages into the secondary market, and other fees or revenue from financial services provided to customers or ancillary to loans and deposits), offset by the level of the provision for loan losses, noninterest expenses (largely employee compensation and overhead expenses tied to processing and operating the Bank’s business), and income taxes. Business volumes and pricing drive revenue potential and tend to be influenced by overall economic factors, including market interest rates, business spending, consumer confidence, economic growth and competitive conditions within the marketplace.

 

Forward-Looking Statements

 

Statements made in this document and in any documents that are incorporated by reference which are not purely historical are forward-looking statements, as defined in the Private Securities Litigation Reform Act of 1995, including any statements regarding descriptions of management’s plans, objectives, or goals for future operations, products or services, and forecasts of its revenues, earnings, or other measures of performance. Forward-looking statements are based on current management expectations and, by their nature, are subject to risks and uncertainties. These statements generally may be identified by the use of words such as “believe,” “expect,” “anticipate,” “plan,” “estimate,” “should,” “will,” “intend,” or similar expressions. Shareholders should note that many factors, some of which are discussed elsewhere in this document, could affect the future financial results of Nicolet and could cause those results to differ materially from those expressed in forward-looking statements contained in this document. These factors, many of which are beyond Nicolet’s control, include, but are not necessarily limited to the following:

 

·operating, legal and regulatory risks, including the effects of the Dodd-Frank Wall Street Reform and Consumer Protection Act and regulations promulgated thereunder, as well as the rules by the Federal bank regulatory agencies to implement the Basel III capital accord;
·economic, political and competitive forces affecting Nicolet’s banking and wealth management businesses;
·changes in interest rates, monetary policy and general economic conditions, which may impact Nicolet’s net interest income;
·potential difficulties in integrating the operations of Nicolet with those of acquired entities, if any;

 

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·compliance or operational risks related to new products, services, ventures, or lines of business, if any, that Nicolet may pursue or implement; and
·the risk that Nicolet’s analyses of these risks and forces could be incorrect and/or that the strategies developed to address them could be unsuccessful.

 

These factors should be considered in evaluating the forward-looking statements, and you should not place undue reliance on such statements. Nicolet specifically disclaims any obligation to update factors or to publicly announce the results of revisions to any of the forward-looking statements or comments included herein to reflect future events or developments.

 

Branch Closures

 

In September 2016, Nicolet announced that it will close six branches that are in close proximity to other Nicolet branches by the end of 2016. The first of these branches was closed on October 28, 2016. The primary reason for the closures is to eliminate the costs associated with the branches in overlapping geographies that resulted from its recent acquisitions. Following the closings Nicolet will operate 36 branches in Northeast and Central Wisconsin and the upper peninsula of Michigan.

 

Critical Accounting Policies

 

The consolidated financial statements of Nicolet are prepared in conformity with U.S. GAAP and follow general practices within the industry in which it operates. This preparation requires management to make estimates, assumptions and judgments that affect the amounts reported in the consolidated financial statements and accompanying notes. These estimates, assumptions and judgments are based on information available as of the date of the consolidated financial statements; accordingly, as this information changes, actual results could differ from the estimates, assumptions and judgments reflected in the consolidated financial statements. Certain policies inherently have a greater reliance on the use of estimates, assumptions and judgments and, as such, have a greater possibility of producing results that could be materially different than originally reported. Estimates that are particularly susceptible to significant change include the valuation of loans acquired in business combinations, as well as the determination of the allowance for loan losses and income taxes and, therefore, are critical accounting policies.

 

Valuation of Loans Acquired in Business Combinations

 

Acquisitions accounted for under Financial Accounting Standards Board (“FASB”) ASC Topic 805, Business Combinations, require the use of the acquisition method of accounting. Assets acquired and liabilities assumed in a business combination are recorded at estimated fair value on their purchase date. In particular, the valuation of acquired loans involves significant estimates, assumptions and judgment based on information available as of the acquisition date. Substantially all loans acquired in the transaction are evaluated either individually or in pools of loans with similar characteristics; and since the estimated fair value of acquired loans includes a credit consideration, no carryover of any previously recorded allowance for loan losses is recorded at acquisition. A number of factors are considered in determining the estimated fair value of purchased loans including, among other things, the remaining life of the acquired loans, estimated prepayments, estimated loss ratios, estimated value of the underlying collateral, estimated holding periods, contractual interest rates compared to market interest rates, and net present value of cash flows expected to be received.

 

In determining the Day 1 Fair Values of acquired loans, management calculates a non-accretable difference (the credit mark component of the acquired loans) and an accretable difference (the market rate or yield component of the acquired loans). The non-accretable difference is the difference between the undiscounted contractually required payments and the undiscounted cash flows expected to be collected in accordance with management’s determination of the Day 1 Fair Values. Subsequent decreases to the expected cash flows will generally result in a provision for loan losses. Subsequent increases in cash flows will result in a reversal of the provision for loan losses to the extent of prior charges and then an adjustment to the accretable and non-accretable differences, which would have a positive impact on interest income.

 

The accretable yield on acquired loans is the difference between the expected cash flows and the initial investment in the acquired loans. The accretable yield is recognized into earnings through interest income using the effective yield method over the term of the loans. Management separately monitors the acquired loan portfolio and periodically reviews loans contained within this portfolio against the factors and assumptions used in determining the Day 1 Fair Values.

 

Allowance for Loan Losses (“ALLL”)

 

The ALLL is a reserve for estimated credit losses on individually evaluated loans determined to be impaired as well as estimated credit losses inherent in the loan portfolio. Actual credit losses, net of recoveries, are deducted from the ALLL. Loans are charged off when management believes that the collectability of the principal is unlikely. Subsequent recoveries, if any, are credited to the ALLL. A provision for loan losses, which is a charge against earnings, is recorded to bring the ALLL to a level that, in management’s judgment, is adequate to absorb probable losses in the loan portfolio. Management’s evaluation process used to determine the appropriateness of the ALLL is subject to the use of estimates, assumptions, and judgment. The evaluation process involves gathering and interpreting many qualitative and quantitative factors which could affect probable credit losses. Because interpretation and analysis involves judgment, current economic or business conditions can change, and future events are inherently difficult to predict, the anticipated amount of estimated loan losses and therefore the appropriateness of the ALLL could change significantly.

 

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The allocation methodology applied by Nicolet is designed to assess the appropriateness of the ALLL and includes allocations for specifically identified impaired loans and loss factor allocations for all remaining loans, with a component primarily based on historical loss rates and a component primarily based on other qualitative factors. The methodology includes evaluation and consideration of several factors, such as, but not limited to, management’s ongoing review and grading of loans, facts and issues related to specific loans, historical loan loss and delinquency experience, trends in past due and nonaccrual loans, existing risk characteristics of specific loans or loan pools, the fair value of underlying collateral, current economic conditions and other qualitative and quantitative factors which could affect potential credit losses. While management uses the best information available to make its evaluation, future adjustments to the allowance may be necessary if there are significant changes in economic conditions or circumstances underlying the collectability of loans. Because each of the criteria used is subject to change, the allocation of the ALLL is made for analytical purposes and is not necessarily indicative of the trend of future loan losses in any particular loan category. The total allowance is available to absorb losses from any segment of the loan portfolio. Management believes the ALLL is appropriate at September 30, 2016. The allowance analysis is reviewed by the board of directors on a quarterly basis in compliance with regulatory requirements. In addition, various regulatory agencies periodically review the ALLL. These agencies may require Nicolet to make additions to the ALLL based on their judgments of collectability based on information available to them at the time of their examination. Acquired loans were purchased at fair value without any ALLL, and subsequent to acquisition such acquired loans will be evaluated and ALLL will be recorded on them to the extent necessary.

 

Income taxes

 

The assessment of income tax assets and liabilities involves the use of estimates, assumptions, interpretation, and judgment 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 operations and reported earnings.

 

Nicolet files a consolidated federal income tax return and a combined state income tax return (both of which include Nicolet and its wholly owned subsidiaries). Accordingly, amounts equal to tax benefits of those companies having taxable federal losses or credits are reimbursed by the companies that incur federal tax liabilities. Amounts provided for income tax expense are based on income reported for financial statement purposes and do not necessarily represent amounts currently payable under tax laws. Deferred income tax assets and liabilities are computed annually for differences between the financial statement and tax bases of assets and liabilities that will result in taxable or deductible amounts in the future based on enacted tax law rates applicable to the periods in which the differences are expected to affect taxable income. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through provision for income tax expense. Valuation allowances are established when it is more likely than not that a portion of the full amount of the deferred tax asset will not be realized. In assessing the ability to realize deferred tax assets, management considers the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies. Nicolet may also recognize a liability for unrecognized tax benefits from uncertain tax positions. Unrecognized tax benefits represent the differences between a tax position taken or expected to be taken in a tax return and the benefit recognized and measured in the financial statements. Penalties related to unrecognized tax benefits are classified as income tax expense.

 

Management’s Discussion and Analysis

 

The following discussion is Nicolet management’s analysis of the consolidated financial condition as of September 30, 2016 and December 31, 2015 and results of operations for the three and nine-month periods ended September 30, 2016 and 2015. It should be read in conjunction with Nicolet’s audited consolidated financial statements as of December 31, 2015 and 2014, and for the three years ended December 31, 2015, included in Nicolet’s Annual Report on Form 10-K for the year ended December 31, 2015.

 

Evaluation of financial performance between 2016 and 2015 periods was impacted in general from the timing of Nicolet’s two 2016 acquisitions. Since the balances and results of operations of the acquired entities prior to consummation are appropriately not included in the accompanying consolidated financial statements, income statement results and average balances for 2016 included partial period contributions from the 2016 acquisitions versus no contribution in 2015 periods. The inclusion of the Baylake balance sheet and operational results for approximately five months in 2016 analytically explains roughly 45% of the increase in certain average balances and income statement line items between the nine month periods ended September 30, 2016 and 2015, while the financial advisory business acquisition primarily impacts the brokerage fee income, personnel expense and certain other expense line items. In addition, the 2016 acquisitions impacted pre-tax net income by inclusion of non-recurring direct merger expenses of approximately $0.1 million, $0.7 million, $0.4 million and $0.4 million in third quarter 2015, fourth quarter 2015, first quarter 2016 and second quarter 2016, respectively, along with a $1.7 million pre-tax lease termination charge in the second quarter of 2016 related to the closure of a Nicolet branch concurrent with the Baylake merger.

 

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Performance Summary

 

Nicolet reported net income of $12.4 million for the nine months ended September 30, 2016, compared to $8.6 million for the first nine months of 2015. After $0.6 million of preferred stock dividends, net income available to common shareholders was $11.8 million, or $1.67 per diluted common share for the first nine months of 2016. Comparatively, after $0.2 million of preferred stock dividends, net income available to common shareholders was $8.4 million, or $1.93 per diluted common share for the first nine months of 2015. Beginning March 1, 2016, the annual dividend rate on preferred stock moved from 1% to 9% in accordance with the contractual terms. In advance of such increase, Nicolet redeemed half of its then outstanding preferred stock in September 2015. The remaining half was redeemed in the third quarter of 2016. As a result, Nicolet will not pay preferred dividends going forward. The changes in rate and preferred stock outstanding affected the preferred stock dividends between the comparable nine-month periods.

 

Net income for the first nine months of 2016 includes combined operating results following the consummation dates of the 2016 acquisitions, and compares favorably to net income for the first nine months of 2015, considering that pre-tax net income for 2016 also includes non-recurring direct merger expenses of $0.8 million and a lease termination charge of $1.7 million as compared to non-recurring direct merger expenses of $0.1 million in pre-tax net income for 2015.

 

·Net interest income was $48.1 million for the first nine months of 2016, an increase of $17.4 million or 57% over the first nine months of 2015. The improvement was primarily the result of favorable volume variances, driven by the addition of the Baylake net interest-earning assets, and net favorable rate variances. On a tax-equivalent basis, the net interest margin for the first nine months of 2016 was 3.99%, up 14 basis points (“bps”) from 3.85% for the comparable 2015 period. Between the comparable nine-month periods, the earning asset yield decreased 7 bps to 4.44%, while the cost of interest bearing liabilities decreased by 26 bps to 0.58%, resulting in a 19 bps increase in the interest rate spread between the comparable nine-month periods.

 

·Loans were $1.6 billion at September 30, 2016, up $677 million or 77% over $877 million at December 31, 2015, and up $670 million or 76% over $884 million at September 30, 2015, largely attributable to the $691 million loans added from Baylake at acquisition. Between the comparative nine-month periods, average loans grew $391 million or 44%, to $1.3 billion for 2016 yielding 5.13%, compared to $884 million for 2015 yielding 5.09%, in part due to inclusion of Baylake loans carrying a lower portfolio yield but more than offset by higher discount accretion income on acquired loans.

 

·Total deposits were $1.9 billion at September 30, 2016, up $878 million or 83% over $1.1 billion at December 31, 2015, and up $922 million or 91% over $1.0 billion a year ago, largely attributable to the $822 million deposits added from Baylake at acquisition. Between the comparative nine-month periods, average total deposits grew $529 million or 52%, to $1.5 billion for 2016, compared to $1.0 billion for 2015. For the nine-month periods, interest-bearing deposits cost 0.43% for 2016, down 22 bps from 0.65% for 2015, benefiting from deposit product rate changes implemented in December 2015 and inclusion of Baylake deposits carrying a lower overall cost.

 

·Asset quality measures were elevated at September 30, 2016, impacted by the Baylake merger. Nonperforming assets were $23.7 million at September 30, 2016, compared to pre-merger levels of $3.9 million and $5.0 million at December 31, 2015 and September 30, 2015, respectively. Nonperforming assets represented 1.04%, 0.32% and 0.43% of total assets at September 30, 2016, December 31, 2015, and September 30, 2015, respectively. The allowance for loan losses was $11.5 million, declining to 0.74% of loans at September 30, 2016 (as a result of recording the Baylake loan portfolio at fair value with no carryover of its allowance at the time of the merger), compared to $10.3 million or 1.18%, respectively at year end 2015, and $10.0 million or 1.13%, respectively at September 30, 2015. The provision for loan losses was $1.4 million, exceeding net charge offs of $0.2 million for the first nine months of 2016, versus provision of $1.4 million with $0.6 million of net charge offs for the comparable 2015 period.

 

·Noninterest income was $18.8 million for the first nine months of 2016 (including $0.5 million net gain on sales or write-downs of assets) compared to $13.1 million for the first nine months of 2015 (which included $1.0 million net gain on sales or write-downs of assets). Removing these net gains, noninterest income was up $6.1 million or 51% between the nine-month periods, aided by the 2016 acquisitions. The most notable increase over prior year was brokerage fee income which more than quadrupled between the nine-month periods, up $1.6 million to $2.1 million, directly related to the 2016 financial advisor business acquisition. Mortgage income was up $1.0 million or 39% to $3.7 million primarily due to higher production over a broader geographic footprint. Also favorably affected by the Baylake merger timing are revenue lines tied to deposit and ancillary fees, with services charges up $0.8 million or 44%, to $2.5 million, and other income up $2.3 million or 142% to $3.9 million (including $1.2 million increase in interchange income given higher volumes, $0.2 million higher wire fees, and the addition of $0.6 million from a processing business interest acquired in the Baylake merger).

 

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·Noninterest expense was $46.6 million for the first nine months of 2016, up $17.2 million or 59% over the first nine months of 2015, largely attributable to the larger operating base from the 2016 acquisitions and non-recurring merger-related charges in the 2016 period. Direct merger expenses for the first nine months of 2016 consisted of approximately $0.8 million ($0.1 million in personnel, $0.3 million in processing and $0.4 million in other expense), with a $1.7 million lease termination charge in other expense, compared to $0.1 million direct merger expense in the comparable 2015 period. Salaries and benefits were up $7.8 million or 46%, largely a result of the 2016 acquisitions with an increase in average full-time equivalent employees of 39% between the nine-month periods as well as merit increases, higher overtime and increased equity and incentive expense between the years. Increases in other expense categories were primarily attributed to the inclusion of the 2016 acquisitions.

 

Net Interest Income

 

Nicolet’s earnings are substantially dependent on net interest income. Net interest income is the primary source of Nicolet’s revenue and is the difference between interest income earned on interest earning assets, such as loans and investments, and interest expense on interest-bearing liabilities, such as deposits and other borrowings. Net interest income is directly impacted by the sensitivity of the balance sheet to changes in interest rates and by the amount and composition of earning assets and interest-bearing liabilities, including characteristics such as the fixed or variable nature of the financial instruments, contractual maturities, and repricing frequencies.

 

Net interest income in the consolidated statements of income (which excludes any taxable equivalent adjustment) was $48.1 million in the first nine months of 2016, $17.4 million or 57% higher than $30.7 million in the first nine months of 2015, largely impacted by the five months of additional net interest income resulting from the merger. Taxable equivalent adjustments (adjustments to bring tax-exempt interest to a level that would yield the same after-tax income had that been subject to a 34% tax rate) were $1.3 million and $0.9 million for the first nine months of 2016 and 2015, respectively, resulting in taxable equivalent net interest income of $49.4 million and $31.6 million, respectively.

 

Taxable equivalent net interest income is a non-GAAP measure, but is a preferred industry measurement of net interest income (and its use in calculating a net interest margin) as it enhances the comparability of net interest income arising from taxable and tax-exempt sources.

 

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Table 1: Year-To-Date Net Interest Income Analysis

 

   For the Nine Months Ended September 30, 
   2016   2015 
(in thousands)  Average
Balance
   Interest   Average
Rate
   Average
Balance
   Interest   Average
Rate
 
ASSETS                              
Earning assets                              
Loans, including loan fees (1)(2)  $1,274,405   $49,634    5.13%  $883,616   $34,006    5.09%
Investment securities                              
Taxable   147,720    2,068    1.87%   75,324    1,098    1.94%
Tax-exempt (2)   122,850    2,265    2.46%   87,243    1,553    2.37%
Other interest-earning assets   87,840    906    1.38%   37,289    327    1.17%
Total interest-earning assets   1,632,815   $54,873    4.44%   1,083,472   $36,984    4.51%
Cash and due from banks   43,001              30,015           
Other assets   147,070              69,319           
Total assets  $1,822,886             $1,182,806           
LIABILITIES AND STOCKHOLDERS’ EQUITY                              
Interest-bearing liabilities                              
Savings  $184,156   $166    0.12%  $125,268   $231    0.25%
Interest-bearing demand   310,801    1,310    0.56%   203,359    1,266    0.83%
MMA   421,920    415    0.13%   250,164    427    0.23%
Core CDs and IRAs   249,788    1,657    0.89%   202,771    1,682    1.11%
Brokered deposits   28,897    280    1.29%   29,954    312    1.39%
Total interest-bearing deposits   1,195,562    3,828    0.43%   811,516    3,918    0.65%
Other interest-bearing liabilities   52,470    1,638    4.11%   43,100    1,483    4.55%
Total interest-bearing liabilities   1,248,032    5,466    0.58%   854,616    5,401    0.84%
Noninterest-bearing demand   348,765              204,106           
Other liabilities   16,779              10,201           
Total equity   209,310              113,883           
Total liabilities and stockholders’ equity  $1,822,886             $1,182,806           
Net interest income and rate spread       $49,407    3.86%       $31,583    3.67%
Net interest margin             3.99%             3.85%

 

(1)Nonaccrual loans are included in the daily average loan balances outstanding.
(2)The yield on tax-exempt loans and tax-exempt investment securities is computed on a tax-equivalent basis using a federal tax rate of 34% and adjusted for the disallowance of interest expense.

 

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Table 2: Year-To-Date Volume/Rate Variance

 

Comparison of the nine months ended September 30, 2016 versus the nine months ended September 30, 2015 follows:

 

   Increase (decrease)
Due to Changes in
 
(in thousands)  Volume   Rate   Net 
Earning assets               
                
Loans  $15,316   $312   $15,628 
Investment securities               
Taxable   1,015    (45)   970 
Tax-exempt   656    56    712 
Other interest-earning assets   420    159    579 
                
Total interest-earning assets  $17,407   $482   $17,889 
                
Interest-bearing liabilities               
Savings deposits  $82   $(147)  $(65)
Interest-bearing demand   536    (492)   44 
MMA   216    (228)   (12)
Core CDs and IRAs   350    (375)   (25)
Brokered deposits   (10)   (22)   (32)
                
Total interest-bearing deposits   1,174    (1,264)   (90)
Other interest-bearing liabilities   274    (119)   155 
                
Total interest-bearing liabilities   1,448    (1,383)   65 
Net interest income  $15,959   $1,865   $17,824 

 

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Table 3: Quarterly Net Interest Income Analysis

 

   For the Three Months Ended September 30, 
   2016   2015 
(in thousands)  Average
Balance
   Interest   Average
Rate
   Average
Balance
   Interest   Average
Rate
 
ASSETS                        
Earning assets                              
Loans, including loan fees (1)(2)  $1,562,151   $21,138    5.32%  $883,266   $11,185    4.98%
Investment securities                              
Taxable   199,843    902    1.80%   71,744    339    1.89%
Tax-exempt (2)   152,959    969    2.53%   88,842    504    2.27%
Other interest-earning assets   84,782    351    1.66%   28,346    108    1.50%
Total interest-earning assets   1,999,735   $23,360    4.57%   1,072,198   $12,136    4.46%
Cash and due from banks   59,573              29,849           
Other assets   206,774              67,886           
Total assets  $2,266,082             $1,169,933           
LIABILITIES AND STOCKHOLDERS’ EQUITY                              
Interest-bearing liabilities                              
Savings  $216,055   $60    0.11%  $127,592   $81    0.25%
Interest-bearing demand   367,854    451    0.49%   201,362    438    0.86%
MMA   539,160    180    0.13%   232,886    131    0.22%
Core CDs and IRAs   300,827    583    0.77%   193,893    547    1.12%
Brokered deposits   29,639    76    1.02%   28,728    104    1.43%
Total interest-bearing deposits   1,453,535    1,350    0.37%   784,461    1,301    0.66%
Other interest-bearing liabilities   39,898    541    5.35%   46,537    541    4.58%
Total interest-bearing liabilities   1,493,433    1,891    0.50%   830,998    1,842    0.88%
Noninterest-bearing demand   464,131              211,414           
Other liabilities   22,616              12,599           
Total equity   285,902              114,922           
Total liabilities and stockholders’ equity  $2,266,082             $1,169,933           
Net interest income and rate spread       $21,469    4.07%       $10,294    3.58%
Net interest margin             4.19%             3.78%

 

(1)Nonaccrual loans are included in the daily average loan balances outstanding.
(2)The yield on tax-exempt loans and tax-exempt investment securities is computed on a tax-equivalent basis using a federal tax rate of 34% and adjusted for the disallowance of interest expense.

 

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Table 4: Quarterly Volume/Rate Variance

 

Comparison of the three months ended September 30, 2016 versus the three months ended September 30, 2015 follows:

 

   Increase (decrease)
Due to Changes in
 
(in thousands)  Volume   Rate   Net 
Earning assets               
                
Loans  $9,077   $876   $9,953 
Investment securities               
Taxable   577    (14)   563 
Tax-exempt   400    65    465 
Other interest-earning assets   256    (13)   243 
                
Total interest-earning assets  $10,310   $914   $11,224 
                
Interest-bearing liabilities               
Savings deposits  $38   $(59)  $(21)
Interest-bearing demand   257    (244)   13 
MMA   118    (69)   49 
Core CDs and IRAs   240    (204)   36 
Brokered deposits   3    (31)   (28)
                
Total interest-bearing deposits   656    (607)   49 
Other interest-bearing liabilities   104    (104)   - 
                
Total interest-bearing liabilities   760    (711)   49 
Net interest income  $9,550   $1,625   $11,175 

 

Table 5: Interest Rate Spread, Margin and Average Balance Mix — Taxable Equivalent Basis

 

   Nine Months Ended September 30, 
   2016   2015 
(in thousands)  Average
Balance
   % of
Earning
Assets
   Yield/Rate   Average
Balance
   % of
Earning
Assets
   Yield/Rate 
Total loans  $1,274,405    78.0%   5.13%  $883,616    81.6%   5.09%
Securities and other earning assets   358,410    22.0%   1.95%   199,856    18.4%   1.99%
Total interest-earning assets  $1,632,815    100.0%   4.44%  $1,083,472    100.0%   4.51%
                               
Interest-bearing liabilities  $1,248,032    76.4%   0.58%  $854,616    78.9%   0.84%
Noninterest-bearing funds, net   384,783    23.6%        228,856    21.1%     
Total funds sources  $1,632,815    100.0%   0.43%  $1,083,472    100.0%   0.64%
Interest rate spread             3.86%             3.67%
Contribution from net free funds             0.13%             0.18%
Net interest margin             3.99%             3.85%

 

Taxable equivalent net interest income was $49.4 million for the first nine months of 2016, an increase of $17.8 million or 56% over the same period in 2015, largely impacted by the five months of net interest income added from the Baylake merger. Taxable equivalent interest income increased $17.9 million (or 48%) between the nine-month periods, including $17.4 million more interest income from favorable earning asset volumes (driven by inclusion of the Baylake earning assets) and $0.5 million net favorable rate variances. Interest expense remained consistent between the nine-month periods at $5.5 million for 2016 compared to $5.4 million for 2015. While higher funding volumes added $1.5 million interest expense, a lower cost of funds (mostly attributable to the lower overall cost of funds on acquired balances from Baylake and deposit product rate changes implemented in December 2015) reduced interest expense by $1.4 million.

 

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The taxable equivalent net interest margin was 3.99% for the first nine months of 2016, up 14 bps versus the first nine months of 2015. With a decrease in earning asset yield to 4.44% (down 7 bps) and a 26 bps decline in the cost of funds (to 0.58%), the interest rate spread improved by 19 bps between the first nine-month periods. There has been and will continue to be underlying downward margin pressure as assets mature in this prolonged low-rate environment, with current reinvestment rates substantially lower than previous rates and less opportunity to offset such with similar changes in the already low cost of funds. However, this negative impact for 2016 was partially offset by the merger which added a lower cost of funds and additional favorable income from discount accretion.

 

The 7 bps decline in earning asset yield was influenced mainly by an increase in loan yield (up 4 bps to 5.13%), though more than offset by a lower proportion of loans in average earning assets (78% versus 82% for the nine-months in 2016 and 2015, respectively). The 4 bps increase in loan yield between the nine-month periods was largely due to higher aggregate discount accretion on loans (including $1.6 million of from three favorably resolved discounted loans in third quarter 2016), partially offset by the addition of Baylake loans carrying a lower overall yield and underlying rate pressure on loan yields from competition and the low rate environment. The earning asset yield decline was also impacted by non-loan earning assets yielding 1.95% for the nine-months of 2016 (down 4 bps from the comparable 2015 period, mostly due to a higher proportion of low-earning cash than the prior year) and representing 22% of average earning assets (versus 18% for the comparable nine-month period in 2015).

 

Nicolet’s cost of funds decreased 26 bps to 0.58% for the first nine months of 2016 compared to a year ago, driven primarily by deposit funding. The average cost of interest-bearing deposits (which represent approximately 95% of average interest-bearing liabilities for both periods), was 0.43% for the first nine months of 2016, down 22 bps from the first nine months of 2015. The cost of interest-bearing deposits decreased as a result of rate decreases initiated in December 2015, from the lower cost of funds on acquired balances, and a favorable fair value interest mark on acquired CDs. Average other interest-bearing liabilities (comprised of short- and long-term borrowings) increased $9 million but cost 44 bps less between the nine-month periods, as higher cost advances matured and were not renewed, certain acquired advances were paid off in the quarter acquired, and lower-cost variable-rate trust preferred securities were added to the funding mix with the Baylake acquisition in the first nine months of 2016.

 

Average interest-earning assets were $1.6 billion and $1.1 billion for the first nine months of 2016 and 2015, respectively, for an increase of 51%, predominantly attributable to five months of acquired balances. While the balance of average interest-earning assets increased, the mix of loans declined from 82% to 78% and the securities and other earning assets increased from 18% to 22%. Average total loans increased by $391 million (to $1.3 billion, up 44%) and average non-loan earning assets increased by $159 million (comprised of a $41 million increase in interest-bearing cash and a $118 million increase in investments) to $358 million.

 

Average interest-bearing liabilities were $1.2 billion, up $393 million or 46% versus the first nine months of 2015, predominantly attributable to five months of acquired balances. Interest-bearing deposits represented 96% and 95% of average interest-bearing liabilities for the first nine months of 2016 and 2015, respectively, while the mix of average interest-bearing deposits moved more to lower-costing MMA deposits and less in higher costing core CDs improving the overall deposit cost between nine-month periods.

 

Provision for Loan Losses

 

The provision for loan losses for the nine months ended September 30, 2016 and 2015 was $1.4 million for each period, respectively, exceeding net charge offs of $0.2 million and $0.6 million, respectively. Asset quality measures were elevated at September 30, 2016, impacted by the Baylake merger, but remained strong with continued resolutions of problem loans. The ALLL was $11.5 million (0.74% of loans) at September 30, 2016, compared to $10.3 million (1.18% of loans) at December 31, 2015 and $10.0 million (1.13% of loans) at September 30, 2015. The decline in the ratio was a result of recording the Baylake loan portfolio at fair value with no carryover of its allowance at the time of the merger.

 

The provision for loan losses is predominantly a function of Nicolet’s methodology and judgment as to qualitative and quantitative factors used to determine the adequacy of the ALLL. The adequacy of the ALLL is affected by changes in the size and character of the loan portfolio, changes in levels of impaired and other nonperforming loans, historical losses and delinquencies in each portfolio segment, the risk inherent in specific loans, concentrations of loans to specific borrowers or industries, existing and future economic conditions, the fair value of underlying collateral, and other factors which could affect potential credit losses. For additional information regarding asset quality and the ALLL, see “Balance Sheet Analysis — Loans,” “— Allowance for Loan and Lease Losses,” and “— Impaired Loans and Nonperforming Assets.”

 

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Noninterest Income

 

Table 6: Noninterest Income

 

   For the three months ended September 30,   For the nine months ended September 30, 
   2016   2015   $ Change   % Change   2016   2015   $ Change   % Change 
(in thousands)                                        
Service charges on deposit accounts  $1,051   $631   $420    66.6%  $2,514   $1,752   $762    43.5%
Trust services fee income   1,373    1,196    177    14.8    4,000    3,636    364    10.0 
Mortgage income, net   2,010    811    1,199    147.8    3,713    2,670    1,043    39.1 
Brokerage fee income   992    170    822    483.5    2,090    509    1,581    310.6 
Bank owned life insurance (“BOLI”)   318    252    66    26.2    880    749    131    17.5 
Rent income   285    324    (39)   (12.0)   820    890    (70)   (7.9)
Investment advisory fees   146    98    48    49.0    341    301    40    13.3 
Gain on sale or write-down of assets, net   453    91    362    397.8    548    1,042    (494)   (47.4)
Other income   1,904    612    1,292    211.1    3,874    1,600    2,274    142.1 
Total noninterest income  $8,532   $4,185   $4,347    103.9%  $18,780   $13,149   $5,631    42.8%
Noninterest income without net gains  $8,079   $4,094   $3,985    97.3%  $18,232   $12,107   $6,125    50.6%

 

Comparison of the nine months ending September 30, 2016 versus 2015

 

Noninterest income was $18.8 million for the first nine months of 2016 (including $0.5 million net gain on sales or write-downs of assets) compared to $13.1 million for the first nine months of 2015 (which included $1.0 million net gain on sales or write-downs of assets). Removing these net gains, noninterest income was up $6.1 million or 51% between the nine-month periods, aided by the 2016 acquisitions. The most notable increase over prior year was brokerage fee income which more than quadrupled between the nine-month periods and was directly related to the 2016 financial advisor business acquisition. Since the year-to-date 2016 results reflect only five months of combined noninterest income activity, comparisons to prior period operating results are expected to widen in the future.

 

Net gain on sale or write-down of assets was $0.5 million and $1.0 million for the nine months of 2016 and 2015, respectively. The 2016 activity consisted of $0.1 million net gains on sales of investments and $0.4 million net gains on sales of OREO and other assets while the 2015 activity consisted of $0.6 million net gains on the sale of investments and $0.4 million net gains on sales of OREO.

 

Service charges on deposit accounts were $2.5 million for the first nine months of 2016, up $0.8 million (or 44%) over the comparable period of 2015, given the increase in deposit balances and accounts mainly from the Baylake merger, and higher non-sufficient funds (“NSF”) volumes.

 

Trust service fees increased to $4.0 million for the first nine months of 2016, up $0.4 million (or 10%) over the comparable 2015 period, on market improvements and net new business with only a modest increase attributable to the Baylake merger. Brokerage fees were $2.1 million, up 311% over the first nine months of 2015, directly attributable to the 2016 financial advisor business acquisition and hiring of selected advisors. Both the financial advisor acquisition as well as the expanded footprint from the Baylake merger will provide growth potential for wealth management in future periods.

 

Mortgage income, net includes predominantly net gains received from the sale of residential real estate loans service-released into the secondary market, as well as net revenue related to mortgages sold servicing retained, including net gains on mortgages sold, capitalized mortgage servicing gains and servicing fees, net of MSR asset amortization. Mortgage income, net was $3.7 million for first nine months of 2016 compared to $2.7 million for first nine months of 2015, up $1.0 million or 39% between the nine-month periods. The increase between the nine-month periods is attributable to higher sales volume producing higher cash and capitalized gains and a larger mortgage portfolio serviced for others (including the Baylake servicing portfolio acquired) increasing servicing fees , offset partly by higher MSR amortization. The first nine months of 2016 had 27% higher secondary mortgage production with nine-month originations of $181 million for 2016 versus $143 million for 2015.

 

BOLI income was $0.9 million for the first nine months of 2016, up 18% over the comparable period in 2015 while average BOLI balances increased 26%. A BOLI investment of $25.4 million was added at acquisition in the Baylake merger (impacting the nine-month average balance comparison), at a lower overall earning rate. During June 2016, $21.5 million of the acquired BOLI was surrendered. In September 2016, additional BOLI of $20.0 million was purchased.

 

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Rent income and investment advisory fees were unaffected by the 2016 acquisitions and showed slight changes between the nine-month periods. Other noninterest income increased $2.3 million (or 142%) between the nine-month periods, mostly attributable to ancillary fees tied to deposit-related products, such as a $1.2 million increase in interchange income (mostly higher volumes from debit cards, but also from credit cards usage given the decision in late 2015 to issue credit cards directly to customers rather than through a third party) and $0.2 million higher wire fee income on the expanded customer base, as well as the addition of $0.6 million from a processing business interest in UFS, Inc. (accounted for under the equity method of accounting) acquired in the Baylake merger.

 

Noninterest Expense

 

Table 7: Noninterest Expense

 

   For the three months ended September 30,   For the nine months ended September 30, 
   2016   2015   $ Change   % Change   2016   2015   $ Change   % Change 
(in thousands)                                        
Salaries and employee benefits  $10,516   $5,637   $4,879    86.6%  $24,748   $16,996   $7,752    45.6%
Occupancy, equipment and office   3,018    1,745    1,273    73.0    7,324    5,263    2,061    39.2 
Business development and marketing   985    549    436    79.4    2,353    1,584    769    48.5 
Data processing   1,831    864    967    111.9    4,408    2,585    1,823    70.5 
FDIC assessments   247    142    105    73.9    629    469    160    34.1 
Intangibles amortization   1,172    248    924    372.6    2,295    783    1,512    193.1 
Other expense   1,250    664    586    88.3    4,799    1,695    3,104    183.1 
Total noninterest expense  $19,019   $9,849   $9,170    93.1%  $46,556   $29,375   $17,181    58.5%

 

Comparison of the nine months ending September 30, 2016 versus 2015

 

Noninterest expense was $46.6 million for the first nine months of 2016, up $17.2 million or 59% over the first nine months of 2015, predominantly attributable to the larger operating base from the 2016 acquisitions and non-recurring merger-related charges in the 2016 period. Direct merger expenses in the first nine months of 2016 consisted of approximately $0.8 million ($0.1 million in personnel, $0.3 million in processing and $0.4 million in other expense), and a $1.7 million lease termination charge in other expense, compared to $0.1 million direct merger expense in the comparable 2015 period. Since the year-to-date 2016 results reflect only five months of combined noninterest expense activity, comparisons to prior period operating results are expected to widen in the future.

 

Salaries and employee benefits expense was $24.7 million for the first nine months of 2016, up $7.8 million or 46% compared to the first nine months of 2015. In addition to merit increases, higher overtime and higher equity award and incentive costs between the years, salaries and benefits were up largely as a result of an increase in average full time equivalent employees from the 2016 acquisitions, at 393 for the first nine months of 2016, up 39% over 282 for the comparable 2015 period.

 

Occupancy, equipment and office expense increased $2.1 million to $7.3 million for the first nine months of 2016 compared to 2015. This 39% increase was in line with the 2016 net addition of 21 branches which doubled the branch facilities, an expanded operations facility and a financial advisors location. Utilities, rent, and other occupancy expenses increased proportionately in conjunction with the 2016 acquisitions.

 

Business development and marketing expense increased $0.8 million (or 49%) between the comparable nine-month periods, with higher spending on promotional materials, media advertising and donations as emphasis was focused on expanded and new markets.

 

Data processing expenses, which are primarily volume-based, rose $1.8 million or 71% between the nine-month periods, including approximately $0.3 million of direct merger expenses, continued integration costs, increased services, and five of nine months of combined operations in 2016 increasing the number of accounts and volumes processed.

 

FDIC assessments were higher between the nine-month periods mostly due to a higher assessment base. Intangibles amortization increased due to the addition of $17.3 million of core deposit intangible from the Baylake merger being amortized on an accelerated basis over a 10-year period, and $4.3 million of customer relationship intangibles amortizing straight line over a 12-year average period. Other expense increased $3.1 million (or 183%), primarily due to inclusion of a $1.7 million lease termination charge and $0.4 million of direct merger expenses, in addition to the larger operating base.

 

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Income Taxes

 

For the nine-month periods ending September 30, 2016 and 2015, income tax expense was $6.4 million and $4.5 million, respectively. The effective tax rates were 33.9% and 33.8%, respectively (with 2016 tax rate partly impacted by the merger). GAAP requires that deferred income taxes be analyzed to determine if a valuation allowance is required. A valuation allowance is required if it is more likely than not that some portion of the deferred tax asset will not be realized. No valuation allowance was determined to be necessary as of September 30, 2016 or December 31, 2015.

 

Comparison of the three months ending September 30, 2016 versus 2015

 

Nicolet reported net income of $6.5 million for the three months ended September 30, 2016, up $3.9 million or 149% over $2.6 million for the comparable period of 2015. Net income available to common shareholders for the third quarter of 2016 was $6.2 million, or $0.69 per diluted common share, compared to net income available to common shareholders of $2.5 million, or $0.58 per diluted common share, for the third quarter of 2015.

 

Net interest income in the consolidated statements of income (which excludes any taxable equivalent adjustment) was $20.9 million in the third quarter of 2016 versus $10.0 million in the third quarter of 2015. Taxable equivalent adjustments (adjustments to bring tax-exempt interest to a level that would yield the same after-tax income had that been subject to a 34% tax rate) were $0.6 million and $0.3 million for the three months ended September 30, 2016 and 2015, respectively, resulting in taxable equivalent net interest income of $21.5 million and $10.3 million, respectively. Taxable equivalent net interest income for third quarter 2016 was up $11.2 million or 109% versus third quarter 2015, with $9.6 million of the increase due to net favorable volume variances (predominately due to the Baylake merger included for the three months in 2016 versus zero in 2015), and $1.6 million increase from net favorable rate variances (especially in higher loan yields and lower cost of funds).

 

The earning asset yield was 4.57% for third quarter 2016, 11 bps higher than third quarter 2015, mainly due to an increase in the yield on loans (up 34 bps to 5.32% for third quarter 2016), though partially offset by a lower proportion of loans in average earning assets (78% versus 82% for third quarter 2016 and 2015, respectively). The 34 bps increase in loan yield between the three-month periods was largely due to higher aggregate discount accretion on loans (including $1.6 million from three favorably resolved discounted loans) partially offset by the addition of Baylake loans carrying a lower overall yield and underlying rate pressure on loan yields from competition and the low rate environment. Non-loan earning assets which earn less than loan assets represented 22% of average earning assets for third quarter 2016 (including higher low-earning cash) and earned 1.89%, versus 18% of earning assets yielding 2.01% for third quarter 2015.

 

The cost of funds was 0.50% for third quarter 2016, 38 bps lower than third quarter 2015, driven by a decline in the cost of deposits (down 29 bps to 0.37% for third quarter 2016) and a higher proportion of deposits in average interest-bearing liabilities (97% versus 94% for third quarter 2016 and 2015, respectively). The decrease in the cost of deposits resulted from product rate decreases initiated in the fourth quarter of 2015, lower overall rates on Baylake deposits acquired, and a favorable fair value interest mark on acquired CDs. The cost of other interest-bearing liabilities increased 77 bps to 5.35% between the third quarter periods, mostly due to a lower proportion of low-cost funding in the mix (such as fed funds purchased and other notes payable).

 

Noninterest income was $8.5 million for third quarter 2016, up $4.3 million from $4.2 million for the third quarter 2015. Noninterest income without net gains was up $4.0 million or 97%, largely due to mortgage income (up $1.2 million given higher production over a broader geographic footprint), service charges on deposits (up $0.4 million given the larger deposit base), and trust and brokerage fees (up $1.0 million combined, mostly attributable to the 2016 financial advisor business acquisition and market improvements). Net gain on sale or write-down of assets for third quarter 2016 consisted of a $0.5 million net gain on OREO resolutions, while third quarter 2015 included a $0.1 million net gain on OREO resolutions and gains on sales of assets. The $1.3 million increase in other noninterest income between the third quarter periods included interchange income up $0.6 million and wire fee income up $0.1 million on higher volumes, and UFS, Inc. income up $0.4 million due to the acquisition of this processing business as part of the Baylake merger in April 2016.

 

Noninterest expense was $19.0 million for the third quarter of 2016, up $9.2 million or 93% from third quarter 2015Non-recurring Baylake merger-based expenses were $0.1 million in third quarter 2015 and zero in the third quarter of 2016. Salaries and employee benefits for the third quarter of 2016 were $10.5 million or 87% higher than the third quarter of 2015. In addition to merit increases, higher overtime and higher equity award and incentive costs between the comparable third quarter periods, salaries and benefits were up largely from a 75% increase in average full time equivalent employees attributable to the 2016 acquisitions. Occupancy expense was $1.3 million higher due to the increased office locations. Data processing was $1.0 million higher than third quarter 2015 from increased accounts, rate increases and higher plastics processing costs. Amortization of intangibles was $0.9 million higher due to the added intangibles from the 2016 acquisitions.

 

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The provision for loan losses was $0.5 million for third quarter 2016 and 2015. Net charge offs for the quarter ending September 30, 2015 were $0.2 million compared to a net recovery of $0.1 million for the third quarter of 2016. At September 30, 2016, the ALLL was $11.5 million (or 0.74% of total loans) compared to $10.0 million (or 1.13% of total loans) at September 30, 2015. The decline in the ratio was a result of recording the Baylake loan portfolio at fair value with no carryover of its allowance at the time of the merger.

 

Income tax expense was $3.4 million and $1.3 million for the third quarters of 2016 and 2015, respectively. The effective tax rates were 34.5% for third quarter 2016 (partly impacted by the merger) and 32.8% for third quarter 2015.

 

BALANCE SHEET ANALYSIS

 

Loans

 

Nicolet services a diverse customer base throughout Northeast and Central Wisconsin and in Menominee, Michigan including the following industries: manufacturing, agriculture, wholesaling, retail, service, and businesses supporting the general building industry. It continues to concentrate its efforts in originating loans in its local markets and assisting its current loan customers. It actively utilizes government loan programs such as those provided by the U.S. Small Business Administration to help customers weather current economic conditions and position their businesses for the future.

 

Nicolet’s primary lending function is to make 1) commercial loans, consisting of commercial and industrial business loans, agricultural (“AG”) production, and owner-occupied commercial real estate (“CRE”) loans; 2) CRE loans, consisting of commercial investment real estate loans, AG real estate, and construction and land development loans; 3) residential real estate loans, including residential first mortgages, residential junior mortgages (such as home equity loans and lines), and residential construction loans; and 4) retail and other loans. Using these four broad groups the mix of loans at September 30, 2016 was 53% commercial, 20% CRE loans, 26% residential real estate, and 1% retail and other loans; and grouped further the loan mix was 73% commercial-based and 27% retail-based.

 

Total loans were $1.6 billion at September 30, 2016 compared to $877 million at December 31, 2015. Compared to September 30, 2015, loans grew $670 million or 76%, primarily as a result of the $691 million loans added fromBaylake at acquisition in April 2016. On average, loans were $1.3 billion and $884 million for the first nine months of 2016 and 2015, respectively, up 44%, largely attributable to the inclusion of acquired loans for five of nine months in 2016. At the time of the merger, the acquired Baylake loan portfolio was somewhat similar to Nicolet’s pre-merger loan mix, with the most notable differences being a higher mix in owner-occupied CRE and CRE investment and a lower mix in commercial and industrial loans.

 

Table 8: Period End Loan Composition

 

   September 30, 2016   December 31, 2015   September 30, 2015 
   Amount   % of
Total
   Amount   % of
Total
   Amount   % of
Total
 
Commercial & industrial  $423,790    27.3%  $294,419    33.6%  $304,858    34.5%
Owner-occupied CRE   362,554    23.3    185,285    21.1    179,569    20.3 
AG production   34,077    2.2    15,018    1.7    15,709    1.8 
AG real estate   45,671    2.9    43,272    4.9    39,715    4.5 
CRE investment   197,884    12.7    78,711    9.0    83,278    9.4 
Construction & land development   68,161    4.4    36,775    4.2    39,487    4.5 
Residential construction   27,331    1.8    10,443    1.2    8,106    0.9 
Residential first mortgage   284,653    18.3    154,658    17.6    153,562    17.3 
Residential junior mortgage   95,901    6.2    51,967    5.9    54,170    6.1 
Retail & other   14,102    0.9    6,513    0.8    5,994    0.7 
Total loans  $1,554,124    100.0%  $877,061    100.0%  $884,448    100.0%

 

Broadly, loans were 73% commercial-based and 27% retail-based at September 30, 2016 compared to 74% commercial-based and 26% retail-based at December 31, 2015. Commercial-based loans are considered to have more inherent risk of default than retail-based loans, in part because of the broader list of factors that could impact a commercial borrower negatively as well as the commercial balance per borrower is typically larger than that for retail-based loans, implying higher potential losses on an individual customer basis.

 

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Commercial and industrial loans consist primarily of commercial loans to small businesses and, to a lesser degree, to municipalities within a diverse range of industries. The credit risk related to commercial and industrial loans is largely influenced by general economic conditions and the resulting impact on a borrower’s operations, or on the value of underlying collateral, if any. Commercial and industrial loans increased $129 million to $424 million since year end 2015. Commercial and industrial loans continue to be the largest segment of Nicolet’s portfolio but decreased to 27.3% of the total portfolio at September 30, 2016, down from 33.6% at December 31, 2015, largely attributable to the acquired Baylake loan mix.

 

Owner-occupied CRE loans increased to 23.3% of loans at September 30, 2016 from 21.1% at December 31, 2015, largely attributable to the acquired Baylake loan mix. Owner-occupied CRE loans primarily consist of loans within a diverse range of industries secured by business real estate that is occupied by borrowers (i.e. who operate their businesses out of the underlying collateral) and who may also have commercial and industrial loans. The credit risk related to owner-occupied CRE loans is largely influenced by general economic conditions and the resulting impact on a borrower’s operations, or on the value of underlying collateral.

 

AG production and AG real estate loans combined consist of loans secured by farmland and related farming operations. The credit risk related to agricultural loans is largely influenced by the prices farmers can get for their production and/or the underlying value of the farmland. In total, agricultural loans increased $21 million since year end 2015, representing 5.1% of total loans at September 30, 2016, versus 6.6% at December 31, 2015.

 

The CRE investment loan classification primarily includes commercial-based mortgage loans that are secured by non-owner occupied, nonfarm/nonresidential real estate properties, and multi-family residential properties. Lending in this segment has been focused on loans that are secured by commercial income-producing properties as opposed to speculative real estate development. The balance of these loans increased $119 million since year end 2015, representing 12.7% of total loans at September 30, 2016 compared to 9.0% of total loans at December 31, 2015, largely attributable to the acquired Baylake loan mix.

 

Loans in the construction and land development portfolio provide financing for the development of commercial income properties, multi-family residential development, and land designated for future development. Nicolet controls the credit risk on these types of loans by making loans in familiar markets, reviewing the merits of individual projects, controlling loan structure, and monitoring the progress of projects through the analysis of construction advances. Credit risk is managed by employing sound underwriting guidelines, lending primarily to borrowers in local markets, periodically evaluating the underlying collateral, and formally reviewing the borrower’s financial soundness and relationships on an ongoing basis. Lending on originated loans in this category has remained relatively steady as a percent of loans. Since December 31, 2015, balances have increased $31 million, and this category represented 4.4% and 4.2% of total loans at September 30, 2016 and year-end 2015, respectively.

 

On a combined basis, Nicolet’s residential real estate loans represent 26.3% of total loans at September 30, 2016, up from 24.7% at December 31, 2015. Residential first mortgage loans include conventional first-lien home mortgages. Residential junior mortgage real estate loans consist mainly of home equity lines and term loans secured by junior mortgage liens. Across the industry, home equities generally involve loans that are in second or junior lien positions, but Nicolet has secured many such loans in a first lien position, further mitigating the portfolio risks. Nicolet has not experienced significant losses in its residential real estate loans; however, if market values in the residential real estate markets decline, particularly in Nicolet’s market area, rising loan-to-value ratios could cause an increase in the provision for loan losses. As part of its management of originating residential mortgage loans, the vast majority of Nicolet’s long-term, fixed-rate residential real estate mortgage loans are sold in the secondary market without retaining the servicing rights. Mortgage loans retained in the portfolio are typically of high quality and have historically had low net charge off rates.

 

Loans in the retail and other classification represent less than 1% of the total loan portfolio, and include predominantly short-term and other personal installment loans not secured by real estate. Credit risk is primarily controlled by reviewing the creditworthiness of the borrowers, monitoring payment histories, and taking appropriate collateral and/or guaranty positions. The loan balances in this portfolio increased $8 million from December 31, 2015 to September 30, 2016.

 

Factors that are important to managing overall credit quality are sound loan underwriting and administration, systematic monitoring of existing loans and commitments, effective loan review on an ongoing basis, early problem loan identification and remedial action to minimize losses, an adequate ALLL, and sound nonaccrual and charge-off policies. An active credit risk management process is used for commercial loans to further ensure that sound and consistent credit decisions are made. The credit management process is regularly reviewed and the process has been modified over the past several years to further strengthen the controls.

 

The loan portfolio is widely diversified by types of borrowers, industry groups, and market areas. Significant loan concentrations are considered to exist for a financial institution when there are amounts loaned to multiple numbers of borrowers engaged in similar activities that would cause them to be similarly impacted by economic or other conditions. At September 30, 2016, no significant industry concentrations existed in Nicolet’s portfolio in excess of 25% of total loans. Nicolet has also developed guidelines to manage its exposure to various types of concentration risks.

 

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Allowance for Loan and Lease Losses

 

In addition to the discussion that follows, see also Note 1, “Basis of Presentation,” and Note 6, “Loans, Allowance for Loan Losses and Credit Quality,” in the notes to the unaudited consolidated financial statements and the “Critical Accounting Policies” within management’s discussion and analysis.

 

Credit risks within the loan portfolio are inherently different for each loan type as described under “Balance Sheet Analysis-Loans.” Credit risk is controlled and monitored through the use of lending standards, a thorough review of potential borrowers, and on-going review of loan payment performance. Active asset quality administration, including early problem loan identification and timely resolution of problems, aids in the management of credit risk and minimization of loan losses.

 

The ALLL is established through a provision for loan losses charged to expense to appropriately provide for potential credit losses in the existing loan portfolio. Loans are charged off against the ALLL when management believes that the collection of principal is unlikely. The level of the ALLL represents management’s estimate of an amount of reserves that provides for estimated probable credit losses in the loan portfolio at the balance sheet date. To assess the ALLL, an allocation methodology is applied by Nicolet which focuses on evaluation of qualitative and environmental factors, including but not limited to: (i) evaluation of facts and issues related to specific loans; (ii) management’s ongoing review and grading of the loan portfolio; (iii) consideration of historical loan loss and delinquency experience on each portfolio segment; (iv) trends in past due and nonperforming loans; (v) the risk characteristics of the various loan segments; (vi) changes in the size and character of the loan portfolio; (vii) concentrations of loans to specific borrowers or industries; (viii) existing and forecasted economic conditions; (ix) the fair value of underlying collateral; and (x) other qualitative and quantitative factors which could affect potential credit losses. Nicolet’s methodology reflects guidance by regulatory agencies to all financial institutions.

 

Management allocates the ALLL by pools of risk within each loan portfolio segment. The allocation methodology consists of the following components. First, a specific reserve for the estimated shortfall is established for all loans determined to be impaired. The specific reserve in the ALLL is equal to the aggregate collateral or discounted cash flow shortfall calculated from the impairment analyses. Loans measured for impairment include nonaccrual loans, non-performing troubled debt-restructurings (“restructured loans”), or other loans determined to be impaired by management. Second, Nicolet’s management allocates ALLL with historical loss rates by loan segment. The loss factors applied in the methodology are periodically re-evaluated and adjusted to reflect changes in historical loss levels on an annual basis. Beginning in the first quarter of 2015, management extended the look-back period on which the average historical loss rates are determined, from a prior three-year period to a rolling 20-quarter (five-year) average, as a means of capturing more of a full credit cycle now that recent period loss levels are stabilizing. Contrarily, the six-year average (used by the Company’s methodology during 2009-2013) was considered more appropriate for the severe and prolonged economic downturn particularly evidenced by higher net charge off levels in 2008 through 2011. Lastly, management allocates ALLL to the remaining loan portfolio using the qualitative factors mentioned above. Consideration is given to those current qualitative or environmental factors that are likely to cause estimated credit losses as of the evaluation date to differ from the historical loss experience of each loan segment.

 

Management performs ongoing intensive analyses of its loan portfolio to allow for early identification of customers experiencing financial difficulties, maintains prudent underwriting standards, understands the economy in its markets, and considers the trend of deterioration in loan quality in establishing the level of the ALLL.

 

Consolidated net income and stockholders’ equity could be affected if management’s estimate of the ALLL necessary to cover expected losses is subsequently materially different, requiring a change in the level of provision for loan losses to be recorded. While management uses currently available information to recognize losses on loans, future adjustments to the ALLL may be necessary based on newly received appraisals, updated commercial customer financial statements, rapidly deteriorating customer cash flow, and changes in economic conditions that affect Nicolet’s customers. As an integral part of their examination process, federal regulatory agencies also review the ALLL. Such agencies may require additions to the ALLL or may require that certain loan balances be charged-off or downgraded into criticized loan categories when their credit evaluations differ from those of management based on their judgments about information available to them at the time of their examination.

 

At September 30, 2016, the ALLL was $11.5 million compared to $10.3 million at December 31, 2015. The nine-month increase was a result of a 2016 provision of $1.4 million exceeding 2016 net charge offs of $0.2 million. Comparatively, the provision for loan losses in the first nine months of 2015 was $1.4 million and net charge offs were $0.6 million. Annualized net charge offs as a percent of average loans were 0.02% in the first nine months of 2016 compared to 0.10% for the first nine months of 2015 and 0.09% for the entire 2015 year. Loans charged off are subject to continuous review, and specific efforts are taken to achieve maximum recovery of principal, accrued interest, and related expenses. The level of the provision for loan losses is directly correlated to the assessment of the adequacy of the allowance, including, but not limited to, consideration of the amount of net charge-offs, loan growth, levels of nonperforming loans, and trends in the risk profile of the loan portfolio.

 

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The ratio of the ALLL as a percentage of period-end loans was 0.74% at September 30, 2016 (with a 1.05% ratio on originated loans and a 0.36% ratio on acquired loans) compared to 1.18% at December 31, 2015 (with a 1.18% ratio on originated loans and a 1.16% ratio on acquired loans). The ALLL to loans ratio is impacted by the accounting treatment of Nicolet’s 2013 and 2016 bank acquisitions, which combined at their acquisition dates added no ALLL to the numerator and $974 million of loans into the denominator. Acquired loans were $702 million and $137 million at September 30, 2016 and December 31, 2015, respectively. The change in the ALLL to loans ratio was driven by the increase in the denominator from acquired loans in 2016.

 

The largest portions of the ALLL were allocated to commercial & industrial (“C&I”) loans and owner-occupied CRE loans combined, representing 59.1% and 55.0% of the ALLL at September 30, 2016 and December 31, 2015, respectively. Most notably since December 31, 2015, the increased allocations to C&I (from 36.2% to 36.6%), Owner-occupied CRE (from 18.8% to 22.5%) and CRE investment (from 7.6% to 9.0%) and the decreased allocation in construction and land development (from 14.0% to 7.5%) was largely the result of changes to allowance allocations in conjunction with changes in past due and loss histories and balance mix changes.

 

Table 9: Loan Loss Experience

 

   For the nine months ended   Year ended 
(in thousands) 

September 30,

2016

  

September 30,

2015

   December 31,
2015
 
Allowance for loan losses (ALLL):               
Balance at beginning of period  $10,307   $9,288   $9,288 
Provision for loan losses   1,350    1,350    1,800 
Charge-offs   432    717    883 
Recoveries   (256)   (84)   (102)
Net charge-offs   176    633    781 
Balance at end of period  $11,481   $10,005   $10,307 
                
Net loan charge-offs (recoveries):               
Commercial & industrial  $262   $268   $338 
Owner-occupied CRE   58    216    225 
Agricultural production   -    -    - 
Agricultural real estate   -    -    - 
CRE investment   (221)   (13)   33 
Construction & land development   -    -    - 
Residential construction   -    -    - 
Residential first mortgage   (5)   42    64 
Residential junior mortgage   46    103    99 
Retail & other   36    17    22 
Total net loans charged-off  $176   $633   $781 
                
ALLL to total loans   0.74%   1.13%   1.18%
ALLL to net charge-offs   6,523.3%   1,580.6%   1,319.7%
Net charge-offs to average loans, annualized   0.02%   0.10%   0.09%

 

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The allocation of the ALLL is based on Nicolet’s estimate of loss exposure by category of loans and is shown in Table 10 for September 30, 2016 and December 31, 2015.

 

Table 10: Allocation of the Allowance for Loan Losses

 

(in thousands)  September 30,
2016
   % of Loan
Type to
Total
Loans
   December 31,
2015
   % of Loan
Type to
Total
Loans
 
ALLL allocation                    
Commercial & industrial  $4,204    27.3%  $3,721    33.6%
Owner-occupied CRE   2,585    23.3    1,933    21.1 
Agricultural production   125    2.2    85    1.7 
Agricultural real estate   303    2.9    380    4.9 
CRE investment   1,029    12.7    785    9.0 
Construction & land development   860    4.4    1,446    4.2 
Residential construction   323    1.8    147    1.2 
Residential first mortgage   1,433    18.3    1,240    17.6 
Residential junior mortgage   492    6.2    496    5.9 
Retail & other   127    0.9    74    0.8 
Total ALLL  $11,481    100.0%  $10,307    100.0%
                     
ALLL category as a percent of total ALLL:                    
Commercial & industrial   36.6%        36.2%     
Owner-occupied CRE   22.5         18.8      
Agricultural production   1.1         0.8      
Agricultural real estate   2.6         3.7      
CRE investment   9.0         7.6      
Construction & land development   7.5         14.0      
Residential construction   2.8         1.4      
Residential first mortgage   12.5         12.0      
Residential junior mortgage   4.3         4.8      
Retail & other   1.1         0.7      
Total ALLL   100.0%        100.0%     

 

Impaired Loans and Nonperforming Assets

 

As part of its overall credit risk management process, Nicolet’s management has been committed to an aggressive problem loan identification philosophy. This philosophy has been implemented through the ongoing monitoring and review of all pools of risk in the loan portfolio to ensure that problem loans are identified early and the risk of loss is minimized.

 

Nonperforming loans are considered one indicator of potential future loan losses. Nonperforming loans are defined as nonaccrual loans, including those defined as impaired under current accounting standards, and loans 90 days or more past due but still accruing interest. Loans are generally placed on nonaccrual status when contractually past due 90 days or more as to interest or principal payments. Additionally, whenever management becomes aware of facts or circumstances that may adversely impact the collectability of principal or interest on loans, it is management’s practice to place such loans on nonaccrual status immediately. Nonaccrual loans were $21.5 million (consisting of $0.7 million originated loans and $20.8 million acquired loans) at September 30, 2016 compared to $3.5 million at December 31, 2015 (consisting of $0.6 million originated loans and $2.9 million acquired loans). Of the $37.5 million nonaccrual loans initially acquired in the 2016 and 2013 acquisitions, $20.8 million remain and are included in the $21.5 million of nonaccrual loans at September 30, 2016. Nonperforming assets (which include nonperforming loans and OREO) were $23.7 million at September 30, 2016 compared to $3.9 million at December 31, 2015. OREO increased from $0.4 million at year end 2015 to $2.2 million at September 30, 2016 as a result of OREO properties acquired in the Baylake merger. Nonperforming assets as a percent of total assets were 1.04% at September 30, 2016 compared to 0.32% at December 31, 2015.

 

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The level of potential problem loans is another predominant factor in determining the relative level of risk in the loan portfolio and in determining the adequacy of the ALLL. Potential problem loans are generally defined by management to include loans rated as Substandard by management but that are in performing status; however, there are circumstances present which might adversely affect the ability of the borrower to comply with present repayment terms. The decision of management to include performing loans in potential problem loans does not necessarily mean that Nicolet expects losses to occur, but that management recognizes a higher degree of risk associated with these loans. The loans that have been reported as potential problem loans are predominantly commercial-based loans covering a diverse range of businesses and real estate property types. Potential problem loans were $9.2 million (0.6% of loans) and $9.2 million (1.0% of loans) at September 30, 2016 and December 31, 2015, respectively. Potential problem loans require a heightened management review of the pace at which a credit may deteriorate, the duration of asset quality stress, and uncertainty around the magnitude and scope of economic stress that may be felt by Nicolet’s customers and on underlying real estate values.

 

Table 11: Nonperforming Assets

 

(in thousands)  September 30,
2016
   December 31,
2015
  

September 30,

2015

 
Nonaccrual loans:               
Commercial & industrial  $680   $204   $223 
Owner-occupied CRE   2,986    951    1,223 
AG production   23    13    15 
AG real estate   208    230    372 
CRE investment   13,216    1,040    771 
Construction & land development   1,220    280    686 
Residential construction   287         
Residential first mortgage   2,656    674    861 
Residential junior mortgage   212    141    148 
Retail & other   -         
Total nonaccrual loans   21,488    3,533    4,299 
Accruing loans past due 90 days or more            
Total nonperforming loans  $21,488   $3,533   $4,299 
OREO:               
Commercial & industrial  $64   $   $ 
CRE investment   -    52    32 
Owner-occupied CRE   278         
Construction & land development   651        126 
Residential real estate owned   109        56 
Bank property real estate owned   1,087    315    500 
Total OREO   2,189    367    714 
Total nonperforming assets  $23,677   $3,900   $5,013 
Total restructured loans accruing  $   $   $ 
Ratios               
Nonperforming loans to total loans   1.38%   0.40%   0.49%
Nonperforming assets to total loans plus OREO   1.52%   0.44%   0.57%
Nonperforming assets to total assets   1.04%   0.32%   0.43%
ALLL to nonperforming loans   53.4%   291.7%   232.7%
ALLL to total loans   0.74%   1.18%   1.13%

 

Table 12: Investment Securities Portfolio

 

   September 30, 2016   December 31, 2015 
(in thousands)  Amortized
Cost
   Fair
Value
   % of
Fair
Value
   Amortized
Cost
   Fair
Value
   % of
Fair
Value
 
U.S. Government sponsored enterprises  $1,985   $1,994    1%  $287   $294    -%
State, county and municipals   186,025    187,492    51    104,768    105,021    61 
Mortgage-backed securities   161,448    162,926    44    61,600    61,464    36 
Corporate debt securities   10,442    10,690    3    1,140    1,140    1 
Equity securities   2,631    3,214    1    3,196    4,677    2 
Total  $362,531   $366,316    100%  $170,991   $172,596    100%

 

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At September 30, 2016 the total carrying value of investment securities was $366 million, up from $173 million at December 31, 2015, and represented 16.1% and 14.2% of total assets at September 30, 2016 and December 31, 2015, respectively. The increase since year end 2016 was largely attributable to investment securities added from Baylake at acquisition in April 2016. At September 30, 2016, the securities portfolio did not contain securities of any single issuer that were payable from and secured by the same source of revenue or taxing authority where the aggregate carrying value of such securities exceeded 10% of stockholders’ equity.

 

In addition to securities available for sale, Nicolet had other investments of $18 million at September 30, 2016 and $8 million at December 31, 2015, consisting of capital stock in the Federal Reserve and the FHLB (required as members of the Federal Reserve Bank System and the Federal Home Loan Bank System), and the Federal Agricultural Mortgage Corporation, as well as equity investments in other privately-traded companies. The FHLB and Federal Reserve investments are “restricted” in that they can only be sold back to the respective institutions or another member institution at par, and are thus not liquid, have no ready market or quoted market value, and are carried at cost. The remaining investments have no quoted market prices, and are carried at cost less other than temporary impairment (“OTTI”) charges, if any. Nicolet’s management evaluates all these other investments periodically for impairment, considering financial condition and other available relevant information. There were no OTTI charges recorded in 2015 or year to date 2016.

 

Table 13: Investment Securities Portfolio Maturity Distribution

 

   As of September 30, 2016 
   Within
One Year
   After One
but Within
Five Years
   After Five
but Within
Ten Years
   After
Ten Years
   Mortgage-
related
and Equity
Securities
   Total
Amortized
Cost
   Total
Fair
Value
 
   Amount   Yield   Amount   Yield   Amount   Yield   Amount   Yield   Amount   Yield   Amount   Yield   Amount 
(in thousands)                                                                 
U.S. government sponsored enterprises  $    %  $1,985    2.9%  $-    -%  $    %  $    %  $1,985    2.9%  $1,994 
State and county municipals (1)   10,673    2.3    73,795    2.7    98,176    2.8    3,381    3.4            186,025    2.7    187,492 
Mortgage-backed securities                                   161,448    3.1    161,448    3.1    162,926 
Corporate debt securities           5,153    6.5            5,289    6.0            10,442    6.2    10,690 
Equity securities                                   2,631    6.2    2,631    6.2    3,214 
Total amortized cost  $10,673    2.3%  $80,933    2.9%  $98,176    2.8%  $8,670    5.0%  $164,079    3.1%  $362,531    3.0%  $366,316 
Total fair value and carrying value  $10,675        $81,499        $99,029        $8,973        $166,139                  $366,316 
As a percent of total fair value   3%        22%        27%        3%        45%                  100%

 

 

 

(1)The yield on tax-exempt investment securities is computed on a tax-equivalent basis using a federal tax rate of 34% adjusted for the disallowance of interest expense.

 

Deposits

 

Deposits represent Nicolet’s largest source of funds. Nicolet competes with other bank and nonbank institutions for deposits, as well as with a growing number of non-deposit investment alternatives available to depositors, such as mutual funds, money market funds, annuities, and other brokerage investment products. Challenges to deposit growth include price changes on deposit products given movements in the rate environment and other competitive pricing pressures, and customer preferences regarding higher-costing deposit products or non-deposit investment alternatives. Included in total deposits in Table 14 are brokered deposits of $29 million at September 30, 2016 and $31 million at December 31, 2015.

 

Table 14: Deposits

 

   September 30, 2016   December 31, 2015 
(in thousands)  Amount   % of
Total
   Amount   % of
Total
 
Demand  $485,421    25.1%  $226,554    21.5%
Money market and NOW accounts   902,427    46.7%   486,677    46.1%
Savings   222,887    11.5%   136,733    12.9%
Time   323,347    16.7%   206,453    19.5%
Total deposits  $1,934,082    100.0%  $1,056,417    100.0%

 

Total deposits were $1.9 billion at September 30, 2016, up $878 million or 83% since December 31, 2015, largely attributable to the $822 million deposits added from Baylake at acquisition in April 2016. On average for the first nine months of 2016, total deposits were $1.5 billion, up $529 million, or 52%, from the comparable 2015 period, largely attributable to the inclusion of acquired deposits for five of nine months in 2016. On average, the mix of deposits changed between the comparable nine-month periods, with 2016 carrying more in demand (i.e. noninterest bearing) deposits, money market and NOW accounts, and less in savings and time deposits.

 

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Table 15: Average Deposits

 

   For the nine months ended 
   September 30, 2016   September 30, 2015 
(in thousands)  Amount   % of
Total
   Amount   % of
Total
 
Demand  $348,765    22.6%  $204,106    20.1%
Money market and NOW accounts   732,721    47.4%   453,523    44.7%
Savings   184,156    11.9%   125,268    12.3%
Time   278,685    18.1%   232,725    22.9%
Total  $1,544,327    100.0%  $1,015,622    100.0%

 

Table 16: Maturity Distribution of Certificates of Deposit of $100,000 or More

 

(in thousands)  September 30,
2016
 
3 months or less  $23,289 
Over 3 months through 6 months   18,708 
Over 6 months through 12 months   26,099 
Over 12 months   67,957 
      
Total  $136,053 

 

Other Funding Sources

 

Other funding sources include short-term borrowings (zero at September 30, 2016 and December 31, 2015) and long-term borrowings (totaling $37 million at September 30, 2016 and $40 million at December 31, 2015). Short-term borrowings consist mainly of customer repurchase agreements maturing in less than nine months or federal funds purchased. Long-term borrowings include notes payable (consisting of FHLB advances and, prior to its repayment in 2016, a joint venture note), junior subordinated debentures (largely qualifying as Tier 1 capital for regulatory purposes, given their long maturity dates, even though they are redeemable in whole or in part at par), and subordinated debt (issued in 2015 with 10-year maturities, callable on or after the fifth anniversary date of their respective issuance dates, and qualifying as Tier 2 capital for regulatory purposes). During the third quarter of 2016, a $5 million FHLB advance matured and was paid off. Further information regarding these long-term borrowings is included in Note 8 – Notes Payable, Note 9 – Junior Subordinated Debentures, and Note 10 – Subordinated Notes in the notes to the unaudited consolidated financial statements. Given the high level of deposits to assets, other funding sources are currently utilized modestly, mainly for their capital equivalent characteristics and term funding.

 

Additional funding sources consist of a $10 million available and unused line of credit at the holding company, $143 million of available and unused federal funds purchased lines, and available total borrowing capacity at the FHLB of $298 million of which $9 million was used at September 30, 2016 (consisting of $1 million in outstanding advances and $8 million related to outstanding letters of credits).

 

Off-Balance Sheet Obligations

 

As of September 30, 2016 and December 31, 2015, Nicolet had the following commitments that did not appear on its balance sheet:

 

Table 17: Commitments

 

   September 30,   December 31, 
   2016   2015 
(in thousands)          
Commitments to extend credit — fixed and variable rate  $497,931   $302,591 
Financial letters of credit   12,685    2,610 
Standby letters of credit   4,223    4,314 

 

Liquidity Management

 

Liquidity management refers to the ability to ensure that cash is available in a timely and cost-effective manner to meet cash flow requirements of depositors and borrowers and to meet other commitments as they fall due, including the ability to pay dividends to shareholders, service debt, invest in subsidiaries, repurchase common stock, and satisfy other operating requirements.

 

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Funds are available from a number of basic banking activity sources including but not limited to the core deposit base, the repayment and maturity of loans, investment securities calls, maturities, and sales, and funds obtained through brokered deposits. All investment securities are classified as available for sale and are reported at fair value on the consolidated balance sheet. Approximately $29 million of the $366 million investment securities portfolio at September 30, 2016 was pledged to secure public deposits, short term borrowings, repurchase agreements, or for other purposes as required by law. Other funding sources available include short-term borrowings, federal funds purchased, and long-term borrowings.

 

Cash and cash equivalents at September 30, 2016 and December 31, 2015 were approximately $104 million and $84 million, respectively. These levels have increased through the first nine months of 2016 with $74 million net cash provided by investing activities (mostly due to net cash acquired with the 2016 acquisitions and a net decline in loans) and $12 million net cash provided by operating activities, exceeding the $65 million net cash used in financing activities (mostly due to reductions in short-term borrowings, notes payable and preferred stock exceeding the net increase in deposits). Nicolet’s liquidity resources were sufficient as of September 30, 2016 to fund loans, accommodate deposit trends and cycles, and to meet other cash needs as necessary.

 

Interest Rate Sensitivity Management

 

A reasonable balance between interest rate risk, credit risk, liquidity risk and maintenance of yield, is highly important to Nicolet’s business success and profitability. As an ongoing part of its financial strategy and risk management, Nicolet attempts to understand and manage the impact of fluctuations in market interest rates on its net interest income. The consolidated balance sheet consists mainly of interest-earning assets (loans, investments and cash) which are primarily funded by interest-bearing liabilities (deposits and other borrowings). Such financial instruments have varying levels of sensitivity to changes in market rates of interest. Market rates are highly sensitive to many factors beyond our control, including but not limited to general economic conditions and policies of governmental and regulatory authorities. Our operating income and net income depends, to a substantial extent, on “rate spread” (i.e., the difference between the income earned on loans, investments and other earning assets and the interest expense paid to obtain deposits and other funding liabilities).

 

Asset-liability management policies establish guidelines for acceptable limits on the sensitivity to changes in interest rates on earnings and market value of assets and liabilities. Such policies are set and monitored by management and the board of directors’ Asset and Liability Committee.

 

To understand and manage the impact of fluctuations in market interest rates on net interest income, Nicolet measures its overall interest rate sensitivity through a net interest income analysis, which calculates the change in net interest income in the event of hypothetical changes in interest rates under different scenarios versus a baseline scenario. Such scenarios can involve static balance sheets, balance sheets with projected growth, parallel (or non-parallel) yield curve slope changes, immediate or gradual changes in market interest rates, and one-year or longer time horizons. The simulation modeling uses assumptions involving market spreads, prepayments of rate-sensitive instruments, renewal rates on maturing or new loans, deposit retention rates, and other assumptions.

 

Nicolet assessed the impact on net interest income in the event of a gradual +/-100 bps and +/-200 bps decrease in market rates (parallel to the change in prime rate) over a one-year time horizon to a static (flat) balance sheet. The interest rate scenarios are used for analytical purposes only and do not necessarily represent management’s view of future market interest rate movements. Based on this analysis on financial data at September 30, 2016, the projected changes in net interest income over a one-year time horizon, versus the baseline, was -1.2%, -0.4%, -0.7% and -1.0% for the -200, -100, +100 and +200 bps scenarios, respectively; such results are within Nicolet’s guidelines of not greater than -15% for +/- 100 bps and not greater than -20% for +/- 200 bps.

 

Actual results may differ from these simulated results due to timing, magnitude and frequency of interest rate changes, as well as changes in market conditions and their impact on customer behavior and management strategies.

 

Capital

 

Management regularly reviews the adequacy of its capital to ensure that sufficient capital is available for current and future needs and is in compliance with regulatory guidelines and actively reviews capital strategies in light of perceived business risks associated with current and prospective earning levels, liquidity, asset quality, economic conditions in the markets served, and level of returns available to shareholders. Management intends to maintain an optimal capital and leverage mix for growth and for shareholder return.

 

At September 30, 2016, Nicolet’s capital structure consisted of $276.3 million of common stock equity. Comparatively, at December 31, 2015, Nicolet’s total stockholders’ equity was $109.5 million, consisting of $12.2 million preferred stock and $97.3 million of common stock equity. During the hird quarter of 2015, Nicolet redeemed $12.2 million of its outstanding Small Business Lending Fund (“SBLF”) Series C Preferred Stock. During the third quarter of 2016, the remaining $12.2 million of preferred stock was fully redeemed. These redemptions were part of an overall capital strategy partially motivated by the adjustment of the rate on the SBLF preferred stock from 1% to 9% effective March 1, 2016, according to the terms of the Securities Purchase Agreement.

 

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Nicolet’s common equity, representing 12.2% of total assets at September 30, 2016 compared to 8.0% at December 31, 2015, continues to reflect capacity to capitalize on opportunities. Nicolet’s common stock was accepted by shareholders as the primary consideration in the recent predominantly stock-for-stock 2016 acquisitions, as described in Note 2 – “Acquisitions,” in the notes to the unaudited consolidated financial statements. On April 29, 2016 as part of the Baylake merger, Nicolet issued 4,344,243 shares of common stock for common stock consideration of $163.3 million, and recorded $1.2 million consideration for assumed stock options. In connection with the financial advisor business acquisition that completed on April 1, 2016, Nicolet issued $2.6 million in common stock consideration. Further, Nicolet’s investors have demonstrated a strong commitment to capital over time, providing common capital when needed, including a December 2008 private placement raising $9.5 million in common capital as we entered the economic crisis and the April 2013 private placement raising $2.9 million in common capital alongside a predominately stock-for-stock 2013 bank acquisition which added $9.7 million in common capital. Book value per common share increased 37% to $32.19 at September 30, 2016 from $23.42 at year end 2015 aided by the common equity issued in the 2016 acquisitions and retained earnings.

 

During early 2014, a common stock repurchase program was approved which authorized, with subsequent modifications in 2015, the use of up to $18 million to repurchase up to 800,000 shares of outstanding common stock. Nicolet suspended its repurchase program between announcement (September 8, 2015) and consummation (April 29, 2016) of the Baylake merger transaction. Nicolet resumed its repurchase program in the third quarter of 2016, using $2.5 million to repurchase and cancel 66,227 shares at a weighted average price per share of $37.36 including commissions. During the year ended December 31, 2015, $4.2 million was used to repurchase and cancel 146,404 shares at a weighted average price per share of $28.35 including commissions. Since beginning the repurchase program in February 2014, total shares repurchased through September 30, 2016 were 469,922 utilizing $12.3 million for an average cost of $26.11 per share.

 

As shown in Table 18, all of Nicolet’s regulatory capital ratios remain strong and are well above the minimum regulatory ratios. In comparing September 30, 2016 to December 31, 2015, certain regulatory capital ratios declined due to the increased asset size and recognition of new intangibles from the 2016 acquisitions; however, all required minimum capital levels were exceeded at September 30, 2016, and Nicolet maintains sufficient regulatory capital for current and future needs. The Bank’s regulatory ratios at September 30, 2016 and December 31, 2015 qualify the Bank as well-capitalized under the prompt-corrective action framework. This strong base of capital has allowed Nicolet to be opportunistic in the current environment.

 

A source of income and funds for Nicolet as the parent company of Nicolet National Bank are dividends from the Bank. Dividends declared by the Bank that exceed the retained net income for the most current year plus retained net income for the preceding two years must be approved by regulatory agencies. During the first nine months of 2016, the Bank paid dividends of $23 million to Nicolet, $8 million from Bank retained earnings and $15 million from the Bank’s surplus, the latter of which received the requisite pre-approval by regulatory agencies and was requested due to growth in surplus from the 2016 acquisitions. During 2015, the Bank paid $11 million of dividends to the parent company. At September 30, 2016, the Bank could pay dividends of approximately $7 million without seeking regulatory approval.

 

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A summary of Nicolet’s and Nicolet National Bank’s regulatory capital amounts and ratios as of September 30, 2016 and December 31, 2015 are presented in the following table.

 

Table 18: Capital

 

   Actual   For Capital
Adequacy Purposes
   To Be Well
Capitalized
Under Prompt
Corrective Action
Provisions (2)
 
(in thousands)  Amount   Ratio
(1)
   Amount   Ratio
(1)
   Amount   Ratio
(1)
 
As of September 30, 2016:                              
Company                              
Total capital  $240,359    13.6%  $141,856    8.0%          
Tier 1 capital   217,002    12.2    106,392    6.0           
CET 1 capital   193,409    10.9    79,794    4.5           
Leverage   217,002    10.0    87,221    4.0           
                               
Bank                              
Total capital  $219,568    12.4%  $141,584    8.0%  $176,980    10.0%
Tier 1 capital   208,086    11.8    106,188    6.0    141,584    8.0 
CET 1 capital   208,086    11.8    79,641    4.5    115,037    6.5 
Leverage   208,086    9.6    86,944    4.0    108,680    5.0 
                               
As of December 31, 2015:                              
Company                              
Total capital  $140,691    14.8%  $75,972    8.0%          
Tier 1 capital   118,535    12.5    56,979    6.0           
CET 1 capital   94,346    9.9    42,697    4.5           
Leverage   118,535    10.0    47,627    4.0           
                               
Bank                              
Total capital  $122,206    13.1%  $74,903    8.0%  $93,629    10.0%
Tier 1 capital   111,899    12.0    56,178    6.0    74,903    8.0 
CET 1 capital   111,899    12.0    42,133    4.5    60,859    6.5 
Leverage   111,899    9.5    47,036    4.0    58,794    5.0 
                               

 

 

 

(1)The total capital ratio is defined as Tier1 capital plus Tier 2 capital divided by total risk-weighted assets. The Tier 1 capital ratio is defined as Tier1 capital divided by total risk-weighted assets. CET 1 capital ratio is defined as Tier 1 capital, with deductions for goodwill and other intangible assets (other than mortgage servicing assets), net of associated deferred tax liabilities, and limitations on the inclusion of deferred tax assets, mortgage servicing assets and investments in other financial institutions, in each case as provided further in the rules, divided by total risk-weighted assets. The leverage ratio is defined as Tier 1 capital divided by the most recent quarter’s average total assets, adjusted in accordance with regulatory guidelines.

 

(2)Prompt corrective action provisions are not applicable at the bank holding company level.

 

In July 2013, the Federal Reserve Board and the OCC issued final rules implementing the Basel III regulatory capital framework and related Dodd-Frank Act changes. The final rules took effect for the Company and Bank on January 1, 2015, subject to a transition period for certain parts of the rules. The rules permitted certain banking organizations to retain, through a one-time election, the existing treatment for accumulated other comprehensive income. Nicolet and the Bank made the election in 2015 to retain the existing treatment for accumulated other comprehensive income.

 

The tables above calculate and present regulatory capital based upon the new regulatory capital ratio requirements under Basel III that became effective on January 1, 2015. Beginning in 2016, an additional capital conservation buffer was added to the minimum requirements for capital adequacy purposes, subject to a three year phase-in period. The capital conservation buffer will be fully phased-in on January 1, 2019 at 2.5 percent. A banking organization with a conservation buffer of less than 2.5 percent (or the required phase-in amount in years prior to 2019) will be subject to limitations on capital distributions, including dividend payments and certain discretionary bonus payments to executive officers. At the present time, the ratios for the Company and Bank are sufficient to meet the fully phased-in conservation buffer.

 

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Future Accounting Pronouncements

 

In March 2016, the Financial Accounting Standards Board (“FASB”) issued updated guidance to Accounting Standards Update (“ASU”) 2015-09 Stock Compensation Improvements to Employee Share-Based Payment Activity intended to simplify and improve several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of such awards as either equity or liabilities and classification on the statement of cash flows. The updated guidance is effective for interim and annual reporting periods beginning after December 15, 2016, with early adoption permitted. The Company is currently assessing the impact of the new guidance on its consolidated financial statements.

 

In June 2016, the FASB issued ASU 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments intended to improve the financial reporting by requiring timelier recording of credit losses on loans and other financial instruments held by financial institutions and other organizations. The ASU requires the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Financial institutions and other organizations will now use forward-looking information to better inform their credit loss estimates. The ASU is effective for SEC filers for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. Early application will be permitted for all organizations for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. The Company is currently assessing the impact of the new guidance on its consolidated financial statements.

 

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts to address diversity in how certain cash receipts and cash payments are presented and classified in the statement of cash flows. The amendments provide guidance on specific cash flow issues, including: debt prepayment or debt extinguishment costs, contingent consideration payments made after a business combination, proceeds from the settlement of insurance claims, proceeds from the settlement of Corporate-Owned Life Insurance Policies, including Bank-Owned Life Insurance Policies, and distributions received from equity method investees. The amendments are effective for public business entities for fiscal years beginning after December 31, 2017, and interim periods within those fiscal years. Early adoption is permitted including adoption in an interim period. The Company is currently assessing the impact of the new guidance on its consolidated financial statements.

 

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606). The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods and services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods and services. In August 2015, the FASB issued an amendment to defer the effective date for all entities by one year. The updated guidance is effective for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period. The Company is currently assessing the impact of the new guidance on its consolidated financial statements.

 

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). The core principle of the guidance is a lessee should recognize the assets and liabilities that arise from leases. The updated guidance is effective for annual reporting periods beginning after December 15, 2018. Early application is permitted. The Company is currently assessing the impact of the new guidance on its consolidated financial statements.

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

See section “Interest Rate Sensitivity Management,” of Management’s Discussion and Analysis under Part I, Item 2.

 

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ITEM 4. CONTROLS AND PROCEDURES

 

As of the end of the period covered by this report, management, under the supervision, and with the participation, of our Chief Executive Officer and President and Chief Financial Officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as such term in Rule 13a-15(e) and 15d-15(e) under the Exchange Act pursuant to Exchange Act Rule 13a-15. Based upon, and as of the date of such evaluation, the Chief Executive Officer and President and the Chief Financial Officer concluded that our disclosure controls and procedures were effective.

 

There have been no changes in the Company’s internal controls or, to the Company’s knowledge, in other factors during the quarter covered by this report that have materially affected, or are reasonably likely to materially affect, the Company’s internal controls over financial reporting. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

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PART II – OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

 

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

 

ITEM 1A. RISK FACTORS

 

There have been no material changes in the risk factors previously disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015.

 

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

 

Commencing on February 24, 2016, Nicolet’s common stock is traded on the Nasdaq Capital Market under the symbol NCBS. Following are Nicolet’s monthly common stock purchases during the third quarter of 2016.

 

   Total Number of
Shares Purchased
   Average Price
Paid per Share
   Total Number of
Shares Purchased as
Part of Publicly
Announced Plans
or Programs
   Maximum Number of
Shares that May Yet
Be Purchased Under
the Plans
or Programs(a)
 
   (#)   ($)   (#)   (#) 
Period                    
July 1 – July 31, 2016               214,000 
August 1– August 31, 2016   30,197   $37.09    30,197    185,000 
September 1 – September 30, 2016   36,030   $37.59    36,030    149,000 
Total   66,227   $37.36    66,227    149,000 

 

(a)During early 2014, a common stock repurchase program was approved which authorized, with subsequent modifications in 2015, the use of up to $18 million to repurchase up to 800,000 shares of outstanding common stock. At September 30, 2016, approximately $5.7 million remained available to repurchase common shares. Using the closing stock price on September 30, 2016 of $38.35, a total of approximately 149,000 shares of common stock could be repurchased under this plan.

 

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

 

None.

 

ITEM 4. MINE SAFETY DISCLOSURES

 

Not applicable.

 

ITEM 5. OTHER INFORMATION

 

None.

 

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ITEM 6. EXHIBITS

 

The following exhibits are filed herewith:

 

Exhibit    
Number   Description
  2.1  

Agreement and Plan of Merger by and between Nicolet Bankshares, Inc. and First Menasha Bancshares, Inc., dated November 3, 2016 (incorporated by reference to Exhibit 2.1 to the Registrant’s Current Report on Form 8-K filed on November 4, 2016).

10.5†  

Nicolet Bankshares, Inc. 2011 Long Term Incentive Plan, as amended and restated effective April 29, 2016 and approved by the shareholders of Nicolet Bankshares, Inc. on August 10, 2016 (Incorporated by reference to Appendix A of Nicolet’s Proxy Statement filed June 30, 2016).

31.1   Certification of CEO under Section 302 of Sarbanes-Oxley Act of 2002
31.2   Certification of CFO under Section 302 of Sarbanes-Oxley Act of 2002
32.1   Certification of CEO Pursuant to 18 U.S.C Section 1350 as Adopted Pursuant to Section 906 of Sarbanes-Oxley Act of 2002
32.2   Certification of CFO Pursuant to 18 U.S.C Section 1350 as Adopted Pursuant to Section 906 of Sarbanes-Oxley Act of 2002
101*   Interactive data files pursuant to Rule 405 of Regulation S-T: (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Income, (iii) Consolidated Statements of Comprehensive Income, (iv) Consolidated Statements of Stockholders’ Equity, (v) Consolidated Statement of Cash Flows, and (vi) Notes to Consolidated Financial Statements tagged as blocks of text.

 

*Indicates information that is furnished and not filed or a part of a registration statement or prospectus for purposes of sections 11 or 12 of the Securities Act of 1933, is deemed not filed for purposes of section 18 of the Securities Exchange Act of 1934, and otherwise is not subject to liability under these sections.

 

† Denotes a management compensatory agreement.

 

SIGNATURES

 

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

 

  NICOLET BANKSHARES, INC.

 

November 4, 2016 /s/ Robert B. Atwell
  Robert B. Atwell
  Chairman, President and Chief Executive Officer

 

November 4, 2016 /s/ Ann K. Lawson
  Ann K. Lawson
  Chief Financial Officer

 

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