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EX-32.2 - EXHIBIT 32.2 - NICOLET BANKSHARES INCtv478030_ex32-2.htm
EX-32.1 - EXHIBIT 32.1 - NICOLET BANKSHARES INCtv478030_ex32-1.htm
EX-31.2 - EXHIBIT 31.2 - NICOLET BANKSHARES INCtv478030_ex31-2.htm
EX-31.1 - EXHIBIT 31.1 - NICOLET BANKSHARES INCtv478030_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, 2017

 

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

(State or other jurisdiction of incorporation or organization)

47-0871001

(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, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

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

 

Emerging Growth Company x

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨

 

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 27, 2017 there were 9,801,613 shares of $0.01 par value common stock outstanding.

 

 

 

 
 

 

Nicolet Bankshares, Inc.

 

TABLE OF CONTENTS

 

    PAGE
PART I FINANCIAL INFORMATION
     
  Item 1. Financial Statements:  
       
    Consolidated Balance Sheets
September 30, 2017 (unaudited) and December 31, 2016
3
       
    Consolidated Statements of Income
Three Months and Nine Months ended September 30, 2017 and 2016 (unaudited)
4
       
    Consolidated Statements of Comprehensive Income
Three Months and Nine Months ended September 30, 2017 and 2016 (unaudited)
5
       
    Consolidated Statement of Changes in Stockholders’ Equity
Nine Months Ended September 30, 2017 (unaudited)
6
       
    Consolidated Statements of Cash Flows
Nine Months Ended September 30, 2017 and 2016 (unaudited)
7
       
    Notes to Unaudited Consolidated Financial Statements 8-31
       
  Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 32-55
       
  Item 3. Quantitative and Qualitative Disclosures About Market Risk 55
       
  Item 4. Controls and Procedures 55-56
       
PART II OTHER INFORMATION  
     
  Item 1. Legal Proceedings 56
       
  Item 1A. Risk Factors 56
       
  Item 2. Unregistered Sales of Equity Securities and Use of  Proceeds 56
       
  Item 3. Defaults Upon Senior Securities 56
       
  Item 4. Mine Safety Disclosures 56
       
  Item 5. Other Information 56
       
  Item 6. Exhibits 57
       
    Signatures 57

 

 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, 2017
(Unaudited)
   December 31, 2016
(Audited)
 
Assets          
Cash and due from banks  $64,075   $68,056 
Interest-earning deposits   31,297    60,320 
Federal funds sold   731    727 
Cash and cash equivalents   96,103    129,103 
Certificates of deposit in other banks   2,494    3,984 
Securities available for sale (“AFS”)   408,217    365,287 
Other investments   14,931    17,499 
Loans held for sale   6,963    6,913 
Loans   2,051,122    1,568,907 
Allowance for loan losses   (12,610)   (11,820)
Loans, net   2,038,512    1,557,087 
Premises and equipment, net   47,432    45,862 
Bank owned life insurance (“BOLI”)   63,989    54,134 
Goodwill and other intangibles   129,588    87,938 
Accrued interest receivable and other assets   37,501    33,072 
Total assets  $2,845,730   $2,300,879 
           
Liabilities and Stockholders’ Equity          
Liabilities:          
Demand  $638,447   $482,300 
Money market and NOW accounts   1,107,360    964,509 
Savings   274,828    221,282 
Time   346,316    301,895 
Total deposits   2,366,951    1,969,986 
Short-term borrowings   12,900    - 
Notes payable   41,571    1,000 
Junior subordinated debentures   29,497    24,732 
Subordinated notes   11,912    11,885 
Accrued interest payable and other liabilities   21,827    16,911 
Total liabilities   2,484,658    2,024,514 
           
Stockholders’ Equity:          
Common stock   98    86 
Additional paid-in capital   267,396    209,700 
Retained earnings   92,935    68,888 
Accumulated other comprehensive loss (“AOCI”)   (3)   (2,727)
Total Nicolet Bankshares, Inc. stockholders’ equity   360,426    275,947 
Noncontrolling interest   646    418 
Total stockholders’ equity and noncontrolling interest   361,072    276,365 
Total liabilities, noncontrolling interest and stockholders’ equity  $2,845,730   $2,300,879 
Preferred shares authorized (no par value)   10,000,000    10,000,000 
Preferred shares issued and outstanding   -    - 
Common shares authorized (par value $0.01 per share)   30,000,000    30,000,000 
Common shares outstanding   9,798,724    8,553,292 
Common shares issued   9,826,197    8,596,241 

 

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,
 
   2017   2016   2017   2016 
Interest income:                    
Loans, including loan fees  $27,329   $21,049   $73,098   $49,455 
Investment securities:                    
Taxable   1,114    902    3,422    2,068 
Non-taxable   604    493    1,761    1,146 
Other interest income   407    351    1,136    906 
Total interest income   29,454    22,795    79,417    53,575 
Interest expense:                    
Money market and NOW accounts   1,380    631    2,755    1,726 
Savings and time deposits   984    719    2,461    2,102 
Short-term borrowings   -    -    72    5 
Notes payable   81    6    133    230 
Junior subordinated debentures   459    376    1,284    926 
Subordinated notes   159    159    477    477 
Total interest expense   3,063    1,891    7,182    5,466 
Net interest income   26,391    20,904    72,235    48,109 
Provision for loan losses   975    450    1,875    1,350 
Net interest income after provision for loan losses   25,416    20,454    70,360    46,759 
Noninterest income:                    
Service charges on deposit accounts   1,238    1,051    3,367    2,514 
Mortgage income, net   1,774    2,010    4,022    3,713 
Trust services fee income   1,479    1,373    4,431    4,000 
Brokerage fee income   1,500    992    4,192    2,090 
Bank owned life insurance   459    318    1,314    880 
Rent income   285    285    852    820 
Investment advisory fees   92    146    357    341 
Gain on sale or writedown of assets, net   1,305    453    2,071    548 
Other income   2,032    1,904    5,412    3,874 
Total noninterest income   10,164    8,532    26,018    18,780 
Noninterest expense:                    
Personnel   11,488    10,516    32,404    24,748 
Occupancy, equipment and office   3,559    3,018    9,613    7,324 
Business development and marketing   1,113    985    3,359    2,353 
Data processing   2,238    1,831    6,428    4,408 
FDIC assessments   205    247    582    629 
Intangibles amortization   1,173    1,172    3,514    2,295 
Other expense   1,086    1,250    3,598    4,799 
Total noninterest expense   20,862    19,019    59,498    46,556 
                     
Income before income tax expense   14,718    9,967    36,880    18,983 
Income tax expense   5,132    3,438    12,605    6,432 
Net income   9,586    6,529    24,275    12,551 
Less: net income attributable to noncontrolling interest   74    65    228    176 
Net income attributable to Nicolet Bankshares, Inc.   9,512    6,464    24,047    12,375 
Less:  preferred stock dividends   -    247    -    633 
Net income available to common shareholders  $9,512   $6,217   $24,047   $11,742 
                     
Basic earnings per common share  $0.97   $0.72   $2.58   $1.76 
Diluted earnings per common share  $0.91   $0.69   $2.45   $1.67 
Weighted average common shares outstanding:                    
Basic   9,836,646    8,607,719    9,316,814    6,689,367 
Diluted   10,408,683    8,969,735    9,820,724    7,024,169 

 

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,
 
   2017   2016   2017   2016 
Net income  $9,586   $6,529   $24,275   $12,551 
Other comprehensive income, net of tax:                    
Unrealized gains on securities AFS:                    
Net unrealized holding gains (losses) arising during the period   834    (984)   5,685    2,257 
Reclassification adjustment for net gains included in net income   (1,221)   (37)   (1,220)   (77)
Income tax benefit (expense)   125    397    (1,741)   (851)
Total other comprehensive income (loss)   (262)   (624)   2,724    1,329 
Comprehensive income  $9,324   $5,905   $26,999   $13,880 

 

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         
   Common
Stock
   Additional
Paid-In
Capital
   Retained
Earnings
   Accumulated
Other
Comprehensive
Income (loss)
   Noncontrolling
Interest
   Total 
Balance December 31, 2016  $86   $209,700   $68,888   $(2,727)  $418   $276,365 
Comprehensive income:                              
Net income   -    -    24,047    -    228    24,275 
Other comprehensive income   -    -    -    2,724    -    2,724 
Stock compensation expense   -    1,871    -    -    -    1,871 
Exercise of stock options, net   1    1,285    -    -    -    1,286 
Issuance of common stock   -    175    -    -    -    175 
Issuance of  common stock in acquisitions, net of capitalized issuance costs of $186   13    62,047    -    -    -    62,060 
Purchase and retirement of common stock   (2)   (7,682)   -    -    -    (7,684)
Balance, September 30, 2017  $98   $267,396   $92,935   $(3)  $646   $361,072 

 

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, 
   2017   2016 
Cash Flows From Operating Activities, net of effects of business combinations:          
Net income  $24,275   $12,551 
Adjustments to reconcile net income to net cash provided by operating activities:          
Depreciation, amortization, and accretion   7,038    4,227 
Provision for loan losses   1,875    1,350 
Increase in cash surrender value of life insurance   (1,314)   (880)
Stock compensation expense   1,871    1,123 
Gain on sale or writedown of assets, net   (2,071)   (548)
Gain on sale of loans held for sale, net   (3,614)   (3,713)
Proceeds from sale of loans held for sale   164,726    179,967 
Origination of loans held for sale   (164,806)   (179,581)
Net change in:          
Accrued interest receivable and other assets   239    1,182 
Accrued interest payable and other liabilities   1,733    (3,888)
Net cash provided by operating activities   29,952    11,790 
Cash Flows From Investing Activities, net of effects of business combinations:          
Net decrease in certificates of deposit in other banks   1,490    239 
Net decrease (increase) in loans   (126,499)   15,582 
Purchases of securities AFS   (49,119)   (57,510)
Proceeds from sales of securities AFS   10,798    30,319 
Proceeds from calls and maturities of securities AFS   34,426    22,962 
Purchase of other investments   (3,256)   (3,745)
Proceeds from sales of other investments   6,519    - 
Net increase in premises and equipment   (2,958)   (3,802)
Proceeds from sales of other real estate and other assets   3,410    1,661 
Purchase of BOLI   (70)   (20,000)
Proceeds from redemption of BOLI   -    21,549 
Intangible from acquired customer relationships   (870)   - 
Net cash received in business combination   9,119    66,517 
Net cash provided (used) by investing activities   (117,010)   73,772 
Cash Flows From Financing Activities, net of effects of business combinations:          
Net increase in deposits   22,054    55,332 
Net increase (decrease) in short-term borrowings   12,900    (49,087)
Proceeds from notes payable   30,000    - 
Repayments of notes payable   (4,487)   (56,519)
Redemption of preferred stock   -    (12,200)
Purchase and retirement of common stock   (7,462)   (3,046)
Capitalized issuance costs, net   (186)   (260)
Proceeds from issuance of common stock   175    101 
Proceeds from exercise of common stock options, net   1,064    1,502 
Cash dividends paid on preferred stock   -    (633)
Net cash provided (used) by financing activities   54,058    (64,810)
Net increase (decrease) in cash and cash equivalents   (33,000)   20,752 
Cash and cash equivalents:          
Beginning  $129,103   $83,619 
Ending  $96,103   $104,371 
Supplemental Disclosures of Cash Flow Information:          
Cash paid for interest  $7,117   $5,787 
Cash paid for taxes   8,805    7,150 
Transfer of loans and bank premises to other real estate owned   828    33 
Capitalized mortgage servicing rights   679    492 
Transfer of loans from held for sale to held for investment   3,236    - 
Acquisitions          
Fair value of assets acquired   439,000    1,035,000 
Fair value of liabilities assumed   398,000    937,000 
Net assets acquired   41,000    98,000 

 

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, 2016.

 

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, 2016.

 

Recent Accounting Developments Adopted

 

In December 2016, the Financial Accounting Standards Board (“FASB”) issued updated guidance to Accounting Standards Update (“ASU”) 2016-19, Technical Corrections and Improvements intended to make changes to clarify the Accounting Standards Codification or correct unintended application of guidance that is not expected to have a significant effect on current accounting practice. The ASU is effective for annual periods, including interim periods within those annual periods, beginning after December 15, 2016. The impact of the new guidance did not have a material impact on the Company’s consolidated financial statements.

 

In March 2016, the FASB issued updated guidance to ASU 2016-09, 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. The consolidated financial statements include the impact of the new guidance. The Company adopted the pronouncement as required on January 1, 2017, prospectively, which included a reduction to income tax expense of $14,000 and $176,000 for the three months and nine months ended September 30, 2017, respectively, for deductions attributable to exercised stock options and vesting of restricted stock.

 

 8 

 

 

Note 1 – Basis of Presentation, continued

 

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 2016 consolidated financial statements have been reclassified to conform to the 2017 presentation.

 

Note 2 – Acquisitions

 

First Menasha Bancshares, Inc. (“First Menasha”):

On April 28, 2017, the Company consummated its merger with First Menasha pursuant to the Agreement and Plan of Merger by and between the Company and First Menasha dated November 3, 2016, (the “Merger Agreement”), whereby First Menasha was merged with and into the Company, and The First National Bank-Fox Valley, the wholly owned commercial bank subsidiary of First Menasha serving the Fox Valley area of Wisconsin, was merged with and into Nicolet National Bank (the “Bank”). The system integration was completed, and five branches of First Menasha opened on May 1, 2017, as Nicolet National Bank branches, expanding its presence into Calumet and Winnebago Counties, Wisconsin. Concurrently, Nicolet closed one of its Calumet County locations, bringing the Bank’s footprint to 38 branches as of September 30, 2017.

 

The purpose of the merger was to continue Nicolet’s interest in strategic growth, consistent with its plan to improve profitability through efficiency, leverage the strengths of each bank across the combined customer base, and add shareholder value. With the merger, Nicolet became the leading community bank to serve the Fox Valley area of Wisconsin.

 

Pursuant to the Merger Agreement, the final purchase price consisted of issuing 1,309,885 shares of the Company’s common stock (given the final stock-for-stock exchange ratio of 3.126 except for First Menasha shares owned by the Company immediately prior to the time of the merger), for common stock consideration of $62.2 million (based on $47.52 per share, the volume weighted average closing price of the Company’s common stock over the preceding 20 trading day period) plus cash consideration of $19.3 million. Approximately $0.2 million in direct stock issuance costs for the merger were incurred and charged against additional paid in capital.

 

Upon consummation, the Company added $480 million in assets, $351 million in loans, $375 million in deposits, $4 million in core deposit intangible, and $41 million of goodwill. The Company accounted for the transaction under the acquisition method of accounting, and thus, the financial position and results of operations of First Menasha 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 estimated fair values at the date of acquisition. The estimated fair values may 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. During the third quarter of 2017, adjustments were made based on additional information. Goodwill was increased by $1.0 million to account for the gain in the Company’s pre-acquisition equity interest holding in First Menasha, resulting in a $1.2 million gain in pre-tax earnings.

 

Financial advisor business acquired:

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. 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). During the third quarter of 2017, the previously variable earn-out liability was agreed to be modified to a fixed amount. Therefore, the earn-out liability was adjusted to $2.4 million, with a corresponding $0.9 million increase in the customer relationship intangible, being amortized over the original term. The transaction impacts the income statement primarily within brokerage income, personnel expense, and intangibles amortization.

 

 9 

 

 

Note 2 – Acquisitions, continued

 

Baylake Corp. (“Baylake”):

On April 29, 2016, the Company consummated its merger with Baylake. The system integration was completed, and 21 branches of Baylake opened, on May 2, 2016, as branches of the Bank, expanding its presence into Door, Kewaunee, and Manitowoc Counties, Wisconsin. The Company closed one of its Brown County locations concurrently with the Baylake merger, and closed an additional six branches in the fourth quarter of 2016.

 

The purpose of the Baylake merger was for strategic reasons beneficial to the Company. The acquisition was 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.

 

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.

 

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 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 

 

The following unaudited pro forma information presents the results of operations for the three and nine months ended September 30, 2016, as if the Baylake acquisition had occurred January 1 of that year. 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.

 

(in thousands, except per share data)  Three Months Ended
September 30, 2016
   Nine Months Ended
September 30, 2016
 
Total revenues, net of interest expense  $29,436   $82,870 
Net income   6,827    17,042 
Diluted earnings per share   0.74    1.85 

 

 10 

 

 

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,
 
   2017   2016   2017   2016 
(In thousands except per share data)                    
Net income, net of noncontrolling interest  $9,512   $6,464   $24,047   $12,375 
Less: preferred stock dividends   -    247    -    633 
Net income available to common shareholders  $9,512   $6,217   $24,047   $11,742 
Weighted average common shares outstanding   9,837    8,608    9,317    6,689 
Effect of dilutive stock instruments   572    362    504    335 
Diluted weighted average common shares outstanding   10,409    8,970    9,821    7,024 
Basic earnings per common share*  $0.97   $0.72   $2.58   $1.76 
Diluted earnings per common share*  $0.91   $0.69   $2.45   $1.67 

 

*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.

 

There were no options outstanding at September 30, 2017 or September 30, 2016 that were excluded from the calculation of diluted earnings per common share as anti-dilutive.

 

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, 2017
   Year Ended
December 31, 2016
 
Dividend yield   0%   0%
Expected volatility   25%   25%
Risk-free interest rate   2.13%   1.52%
Expected average life   7 years    7 years 
Weighted average per share fair value of options  $15.44   $11.04 

 

 11 

 

 

Note 4 – Stock-based Compensation, continued

 

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

 

   Option Shares
Stock Options
Outstanding
   Weighted-
Average
Exercise Price
   Exercisable
Shares
   Weighted-
Average
Exercise
Price
 
Balance – December 31, 2015   746,004   $21.56    325,979   $19.09 
Granted (1)   170,500    36.86           
Options assumed in acquisition   91,701    21.03           
Exercise of stock options*   (84,723)   20.98           
Forfeited   (1,456)   21.71           
Balance – December 31, 2016   922,026    24.39    439,639   $19.97 
Granted (2)   814,500    48.86           
Exercise of stock options*   (65,833)   19.52           
Forfeited   (400)   16.50           
Balance – September 30, 2017   1,670,293   $36.51    471,043   $21.49 

 

*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, and accordingly 4,443 shares were surrendered during the nine months ended September 30, 2017 and 10,244 shares were surrendered during the year ended December 31, 2016. These stock options were considered exercised and then surrendered and are included in the Exercise of stock option line.

(1) The weighted average per share fair value of options granted was $11.04 for the period.

(2) The weighted average per share fair value of options granted was $15.44 for the period.

 

The following options were outstanding at September 30, 2017:

 

   Number of Shares   Weighted-Average Exercise
Price
   Weighted-Average
Remaining Life (Years)
 
   Outstanding   Exercisable   Outstanding   Exercisable   Outstanding   Exercisable 
$9.19 – $20.00   257,750    238,000   $16.30   $16.28    3.78    3.71 
$20.01 – $25.00   241,455    110,055    23.68    23.54    6.54    5.89 
$25.01 – $30.00   153,724    71,524    26.00    26.11    6.91    6.44 
$30.01 – $40.00   202,864    51,464    35.88    34.76    8.64    8.27 
$40.01 – $49.30   814,500    -    48.86    -    9.63    - 
    1,670,293    471,043   $36.51   $21.49    7.91    5.14 

 

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 2017, and full year of 2016 was approximately $1.8 million and $1.3 million, respectively.

 

Restricted Stock  Weighted-
Average Grant
Date Fair Value
   Restricted
Shares
Outstanding
 
Balance – December 31, 2015  $18.70    36,690 
Granted   33.68    31,466 
Vested*   23.58    (25,207)
Forfeited   -    - 
Balance – December 31, 2016   26.80    42,949 
Granted   -    - 
Vested *   22.47    (15,346)
Forfeited   16.50    (130)
Balance – September 30, 2017  $29.27    27,473 

 

*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 4,553 shares were surrendered during the nine months ended September 30, 2017 and 7,851 shares were surrendered during the twelve months ended December 31, 2016.

 

 12 

 

 

Note 4 – Stock-based Compensation, continued

 

The Company recognized approximately $1.9 million and $1.1 million of stock-based employee compensation expense during the nine months ended September 30, 2017 and 2016, respectively, associated with its stock equity awards. As of September 30, 2017, there was approximately $15.2 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 four years.

 

Note 5 – Securities Available for Sale

 

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

 

   September 30, 2017 
(in thousands)  Amortized Cost   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
   Fair Value 
U.S. government sponsored enterprises  $26,394   $-   $122   $26,272 
State, county and municipals   189,226    521    1,031    188,716 
Mortgage-backed securities   159,113    261    1,438    157,936 
Corporate debt securities   32,203    541    -    32,744 
Equity securities   1,288    1,261    -    2,549 
   $408,224   $2,584   $2,591   $408,217 
                     
   December 31, 2016 
(in thousands)  Amortized Cost   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
   Fair Value 
U.S. government sponsored enterprises  $1,981   $-   $18   $1,963 
State, county and municipals   191,721    160    4,638    187,243 
Mortgage-backed securities   161,309    242    2,422    159,129 
Corporate debt securities   12,117    52    -    12,169 
Equity securities   2,631    2,152    -    4,783 
   $369,759   $2,606   $7,078   $365,287 

 

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, 2017 and December 31, 2016.

 

   September 30, 2017 
   Less than 12 months   12 months or more   Total 
(in thousands)  Fair
Value
   Unrealized
Losses
   Fair
Value
   Unrealized
Losses
   Fair
Value
   Unrealized
Losses
 
U.S. government sponsored enterprises  $26,272   $122   $-   $-   $26,272   $122 
State, county and municipals   63,924    352    46,677    679    110,601    1,031 
Mortgage-backed securities   94,850    747    35,475    691    130,325    1,438 
   $185,046   $1,221   $82,152   $1,370   $267,198   $2,591 
                               
   December 31, 2016 
   Less than 12 months   12 months or more   Total 
(in thousands)  Fair
Value
   Unrealized
Losses
   Fair
Value
   Unrealized
Losses
   Fair
Value
   Unrealized
Losses
 
U.S. government sponsored enterprises  $1,963   $18   $-   $-   $1,963   $18 
State, county and municipals   167,457    4,629    1,300    9    168,757    4,638 
Mortgage-backed securities   134,770    2,311    3,653    111    138,423    2,422 
   $304,190   $6,958   $4,953   $120   $309,143   $7,078 

 

 13 

 

 

Note 5 – Securities Available for Sale, continued

 

At September 30, 2017 the Company had $2.6 million of gross unrealized losses related to 507 securities. As of September 30, 2017, 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 and current market conditions subsequent to purchase, not credit deterioration. 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, 2017 or September 30, 2016.

 

The amortized cost and fair values of securities available for sale at September 30, 2017 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, 2017 
(in thousands)  Amortized Cost   Fair Value 
Due in less than one year  $13,262   $13,261 
Due in one year through five years   96,098    96,410 
Due after five years through ten years   130,477    129,769 
Due after ten years   7,986    8,292 
    247,823    247,732 
Mortgage-backed securities   159,113    157,936 
Equity securities   1,288    2,549 
Securities available for sale  $408,224   $408,217 

 

Proceeds from sales of securities available for sale during the first nine months of 2017 and 2016 were approximately $10.8 million and $30.3 million, respectively. During the first nine months of 2017, gross gains and losses realized were $1.2 million and $7,000, respectively, while gross gains and gross losses were $90,000 and $13,000, respectively, for the comparable nine months of 2016.

 

 14 

 

 

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

 

The loan composition as of September 30, 2017 and December 31, 2016 is summarized as follows.

 

   Total 
   September 30, 2017   December 31, 2016 
(in thousands)  Amount  

% of

Total

   Amount   % of
Total
 
Commercial & industrial  $625,729    30.5%  $428,270    27.3%
Owner-occupied commercial real estate (“CRE”)   428,054    20.9    360,227    23.0 
Agricultural (“AG”) production   36,352    1.8    34,767    2.2 
AG real estate   48,443    2.4    45,234    2.9 
CRE investment   303,448    14.8    195,879    12.5 
Construction & land development   87,649    4.3    74,988    4.8 
Residential construction   33,163    1.6    23,392    1.5 
Residential first mortgage   363,116    17.7    300,304    19.1 
Residential junior mortgage   102,654    5.0    91,331    5.8 
Retail & other   22,514    1.0    14,515    0.9 
Loans   2,051,122    100.0%   1,568,907    100.0%
Less allowance for loan losses   12,610         11,820      
Loans, net  $2,038,512        $1,557,087      
Allowance for loan losses to loans   0.61%        0.75%     
                     
   Originated 
   September 30, 2017   December 31, 2016 
(in thousands)  Amount  

% of

Total

   Amount   % of
Total
 
Commercial & industrial  $470,700    40.4%  $330,073    36.6%
Owner-occupied CRE   221,556    19.0    182,776    20.3 
AG production   11,605    1.0    9,192    1.0 
AG real estate   23,876    2.0    18,858    2.1 
CRE investment   98,328    8.4    72,930    8.1 
Construction & land development   55,387    4.7    44,147    4.9 
Residential construction   27,129    2.3    20,768    2.3 
Residential first mortgage   180,509    15.5    164,949    18.3 
Residential junior mortgage   60,207    5.2    48,199    5.3 
Retail & other   17,092    1.5    10,095    1.1 
Loans   1,166,389    100.0%   901,987    100.0%
Less allowance for loan losses   10,406         9,449      
Loans, net  $1,155,983        $892,538      
Allowance for loan losses to loans   0.89%        1.05%     
                     
   Acquired 
   September 30, 2017   December 31, 2016 
(in thousands)  Amount  

% of

Total

   Amount   % of
Total
 
Commercial & industrial  $155,029    17.5%  $98,197    14.7%
Owner-occupied CRE   206,498    23.3    177,451    26.6 
AG production   24,747    2.8    25,575    3.8 
AG real estate   24,567    2.8    26,376    4.0 
CRE investment   205,120    23.2    122,949    18.4 
Construction & land development   32,262    3.7    30,841    4.6 
Residential construction   6,034    0.7    2,624    0.4 
Residential first mortgage   182,607    20.6    135,355    20.3 
Residential junior mortgage   42,447    4.8    43,132    6.5 
Retail & other   5,422    0.6    4,420    0.7 
Loans   884,733    100.0%   666,920    100.0%
Less allowance for loan losses   2,204         2,371      
Loans, net  $882,529        $664,549      
Allowance for loan losses to loans   0.25%        0.36%     

 

 15 

 

 

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, 2017:

 

   TOTAL – Nine Months Ended September 30, 2017 
(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  $3,919   $2,867   $150   $285   $1,124   $774   $304   $1,784   $461   $152   $11,820 
Provision   2,183    (253)   16    (17)   132    (19)   (137)   (124)   4    90    1,875 
Charge-offs   (1,097)   -    -    -    -    (13)   -    (8)   -    (38)   (1,156)
Recoveries   20    29    -    -    1    -    -    6    2    13    71 
Net charge-offs   (1,077)   29    -    -    1    (13)   -    (2)   2    (25)   (1,085)
Ending balance  $5,025   $2,643   $166   $268   $1,257   $742   $167   $1,658   $467   $217   $12,610 
As percent of ALLL   39.9%   21.0%   1.3%   2.1%   10.0%   5.9%   1.3%   13.1%   3.7%   1.7%   100.0%
                                                        
ALLL:                                                       
Individually evaluated  $226   $-   $-   $-   $-   $-   $-   $-   $-   $-   $226 
Collectively evaluated   4,799    2,643    166    268    1,257    742    167    1,658    467    217    12,384 
Ending balance  $5,025   $2,643   $166   $268   $1,257   $742   $167   $1,658   $467   $217   $12,610 
                                                        
Loans:                                                       
Individually evaluated  $5,071   $1,116   $-   $218   $4,845   $723   $80   $1,619   $60   $-   $13,732 
Collectively evaluated   620,658    426,938    36,352    48,225    298,603    86,926    33,083    361,497    102,594    22,514    2,037,390 
Total loans  $625,729   $428,054   $36,352   $48,443   $303,448   $87,649   $33,163   $363,116   $102,654   $22,514   $2,051,122 
                                                        
Less ALLL  $5,025   $2,643   $166   $268   $1,257   $742   $167   $1,658   $467   $217   $12,610 
Net loans  $620,704   $425,411   $36,186   $48,175   $302,191   $86,907   $32,996   $361,458   $102,187   $22,297   $2,038,512 

 

 16 

 

 

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

 

   Originated – Nine Months Ended September 30, 2017 
(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  $3,150   $2,263   $122   $222   $893   $656   $266   $1,372   $373   $132   $9,449 
Provision   2,128    (167)   19    (11)   140    (20)   (135)   (44)   13    82    2,005 
Charge-offs   (1,043)   -    -    -    -    -    -    (8)   -    (38)   (1,089)
Recoveries   1    24    -    -    -    -    -    1    2    13    41 
Net charge-offs   (1,042)   24    -    -    -    -    -    (7)   2    (25)   (1,048)
Ending balance  $4,236   $2,120   $141   $211   $1,033   $636   $131   $1,321   $388   $189   $10,406 
As percent of ALLL   40.7%   20.4.%   1.4%   2.0%   9.9%   6.1%   1.3%   12.7%   3.7%   1.8%   100.0%
                                                        
ALLL:                                                       
Individually evaluated  $226   $-   $-   $-   $-   $-   $-   $-   $-   $-   $226 
Collectively evaluated   4,010    2,120    141    211    1,033    636    131    1,321    388    189    10,180 
Ending balance  $4,236   $2,120   $141   $211   $1,033   $636   $131   $1,321   $388   $189   $10,406 
                                                        
Loans:                                                       
Individually evaluated  $615   $-   $-   $-   $-   $-   $-   $-   $-   $-   $615 
Collectively evaluated   470,085    221,556    11,605    23,876    98,328    55,387    27,129    180,509    60,207    17,092    1,165,774 
Total loans  $470,700   $221,556   $11,605   $23,876   $98,328   $55,387   $27,129   $180,509   $60,207   $17,092   $1,166,389 
                                                        
Less ALLL  $4,236   $2,120   $141   $211   $1,033   $636   $131   $1,321   $388   $189   $10,406 
Net loans  $466,464   $219,436   $11,464   $23,665   $97,295   $54,751   $26,998   $179,188   $59,819   $16,903   $1,155,983 
                                                        
   Acquired – Nine Months Ended September 30, 2017 
(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  $769   $604   $28   $63   $231   $118   $38   $412   $88   $20   $2,371 
Provision   55    (86)   (3)   (6)   (8)   1    (2)   (80)   (9)   8    (130)
Charge-offs   (54)   -    -    -    -    (13)   -    -    -    -    (67)
Recoveries   19    5    -    -    1    -    -    5    -    -    30 
Net charge-offs   (35)   5    -    -    1    (13)   -    5    -    -    (37)
Ending balance  $789   $523   $25   $57   $224   $106   $36   $337   $79   $28   $2,204 
As percent of ALLL   35.8%   23.7%   1.1%   2.6%   10.2%   4.8%   1.6%   15.3%   3.6%   1.3%   100.0%
                                                        
Loans:                                                       
Individually evaluated  $4,456   $1,116   $-   $218   $4,845   $723   $80   $1,619   $60   $-   $13,117 
Collectively evaluated   150,573    205,382    24,747    24,349    200,275    31,539    5,954    180,988    42,387    5,422    871,616 
Total loans  $155,029   $206,498   $24,747   $24,567   $205,120   $32,262   $6,034   $182,607   $42,447   $5,422   $884,733 
                                                        
Less ALLL  $789   $523   $25   $57   $224   $106   $36   $337   $79   $28   $2,204 
Net loans  $154,240   $205,975   $24,722   $24,510   $204,896   $32,156   $5,998   $182,270   $42,368   $5,394   $882,529 

 

 17 

 

 

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, 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 
                                                        
   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 

 

 18 

 

 

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

 

   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 

 

 19 

 

 

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, 2017 and December 31, 2016.

 

   Total Nonaccrual Loans 
(in thousands)  September 30,
2017
   % to Total   December 31,
2016
   % to Total 
Commercial & industrial  $5,078    35.2%  $358    1.8%
Owner-occupied CRE   1,276    8.8    2,894    14.3 
AG production   2    -    9    0.1 
AG real estate   186    1.3    208    1.0 
CRE investment   4,537    31.4    12,317    60.6 
Construction & land development   723    5.0    1,193    5.9 
Residential construction   80    0.6    260    1.3 
Residential first mortgage   2,301    16.0    2,990    14.7 
Residential junior mortgage   239    1.7    56    0.3 
Retail & other   -    -    -    - 
Nonaccrual loans - Total  $14,422    100.0%  $20,285    100.0%
                     
   Originated 
(in thousands)  September 30,
2017
   % to Total   December 31,
2016
   % to Total 
Commercial & industrial  $615    62.3%  $4    1.6%
Owner-occupied CRE   38    3.8    42    16.3 
AG production   2    0.2    7    2.7 
AG real estate   -    -    -    - 
CRE investment   -    -    -    - 
Construction & land development   -    -    -    - 
Residential construction   -    -    -    - 
Residential first mortgage   333    33.7    204    79.4 
Residential junior mortgage   -    -    -    - 
Retail & other   -    -    -    - 
Nonaccrual loans - Originated  $988    100.0%  $257    100.0%
                     
   Acquired 
(in thousands)  September 30,
2017
   % to Total   December 31,
2016
   % to Total 
Commercial & industrial  $4,463    33.2%  $354    1.8%
Owner-occupied CRE   1,238    9.2    2,852    14.2 
AG production   -    -    2    0.1 
AG real estate   186    1.4    208    1.0 
CRE investment   4,537    33.8    12,317    61.4 
Construction & land development   723    5.4    1,193    6.0 
Residential construction   80    0.6    260    1.3 
Residential first mortgage   1,968    14.6    2,786    13.9 
Residential junior mortgage   239    1.8    56    0.3 
Retail & other   -    -    -    - 
Nonaccrual loans – Acquired  $13,434    100.0%  $20,028    100.0%

 

 20 

 

 

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, 2017 and December 31, 2016:

   September 30, 2017 
(in thousands)  30-89 Days
Past Due
(accruing)
   90 Days &
Over or
nonaccrual
   Current   Total 
Commercial & industrial  $303   $5,078   $620,348   $625,729 
Owner-occupied CRE   229    1,276    426,549    428,054 
AG production   -    2    36,350    36,352 
AG real estate   -    186    48,257    48,443 
CRE investment   -    4,537    298,911    303,448 
Construction & land development   38    723    86,888    87,649 
Residential construction   1,085    80    31,998    33,163 
Residential first mortgage   537    2,301    360,278    363,116 
Residential junior mortgage   23    239    102,392    102,654 
Retail & other   4    -    22,510    22,514 
Total loans  $2,219   $14,422   $2,034,481   $2,051,122 
As a percent of total loans   0.1%   0.7%   99.2%   100.0%
                     
   December 31, 2016 
(in thousands)  30-89 Days
Past Due
(accruing)
   90 Days &
Over or
nonaccrual
   Current   Total 
Commercial & industrial  $22   $358   $427,890   $428,270 
Owner-occupied CRE   268    2,894    357,065    360,227 
AG production   -    9    34,758    34,767 
AG real estate   -    208    45,026    45,234 
CRE investment   -    12,317    183,562    195,879 
Construction & land development   -    1,193    73,795    74,988 
Residential construction   -    260    23,132    23,392 
Residential first mortgage   486    2,990    296,828    300,304 
Residential junior mortgage   200    56    91,075    91,331 
Retail & other   15    -    14,500    14,515 
Total loans  $991   $20,285   $1,547,631   $1,568,907 
As a percent of total loans   0.1%   1.3%   98.6%   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.

 

 21 

 

 

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, 2017 and December 31, 2016:

 

   September 30, 2017 
(in thousands)  Grades 1- 4   Grade 5   Grade 6   Grade 7   Grade 8   Grade 9   Total 
Commercial & industrial  $594,129   $15,356   $4,585   $11,659   $-   $-   $625,729 
Owner-occupied CRE   402,021    22,058    1,348    2,627    -    -    428,054 
AG production   31,245    4,067    -    1,040    -    -    36,352 
AG real estate   40,982    4,845    -    2,616    -    -    48,443 
CRE investment   288,346    9,191    -    5,911    -    -    303,448 
Construction & land development   85,932    627    17    1,073    -    -    87,649 
Residential construction   33,083    -    -    80    -    -    33,163 
Residential first mortgage   356,985    2,207    779    3,145    -    -    363,116 
Residential junior mortgage   102,281    17    -    356    -    -    102,654 
Retail & other   22,514    -    -    -    -    -    22,514 
Total loans  $1,957,518   $58,368   $6,729   $28,507   $-   $-   $2,051,122 
Percent of total   95.4%   2.9%   0.3%   1.4%   -    -    100.0%
                                    
   December 31, 2016 
(in thousands)  Grades 1- 4   Grade 5   Grade 6   Grade 7   Grade 8   Grade 9   Total 
Commercial & industrial  $401,954   $16,633   $2,133   $7,550   $-   $-   $428,270 
Owner-occupied CRE   340,846    14,758    193    4,430    -    -    360,227 
AG production   31,026    3,191    70    480    -    -    34,767 
AG real estate   41,747    2,727    -    760    -    -    45,234 
CRE investment   173,652    8,137    -    14,090    -    -    195,879 
Construction & land development   69,097    4,318    -    1,573    -    -    74,988 
Residential construction   22,030    1,102    -    260    -    -    23,392 
Residential first mortgage   295,109    1,348    192    3,655    -    -    300,304 
Residential junior mortgage   91,123    -    114    94    -    -    91,331 
Retail & other   14,515    -    -    -    -    -    14,515 
Total loans  $1,481,099   $52,214   $2,702   $32,892   $-   $-   $1,568,907 
Percent of total   94.4%   3.3%   0.2%   2.1%   -    -    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, all loans determined to be troubled debt restructurings, 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.

 

 22 

 

 

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

 

The following tables present impaired loans and then as a further breakdown by originated or acquired as of September 30, 2017 and December 31, 2016.

 

   Total Impaired Loans – September 30, 2017 
(in thousands)  Recorded
Investment
   Unpaid
Principal
Balance
   Related
Allowance
   Average
Recorded
Investment
   Interest
Income
Recognized
 
Commercial & industrial  $5,071   $12,275   $226   $5,057   $469 
Owner-occupied CRE   1,116    2,793    -    1,185    96 
AG production   -    15    -    -    - 
AG real estate   218    308    -    229    25 
CRE investment   4,845    8,863    -    5,099    353 
Construction & land development   723    1,189    -    743    44 
Residential construction   80    983    -    94    27 
Residential first mortgage   1,619    2,971    -    1,699    121 
Residential junior mortgage   60    500    -    64    6 
Retail & Other   -    14    -    -    - 
Total  $13,732   $29,911   $226   $14,170   $1,141 
                          
   Originated Impaired Loans – September 30, 2017 
(in thousands)  Recorded
Investment
   Unpaid
Principal
Balance
   Related
Allowance
   Average
Recorded
Investment
   Interest
Income
Recognized
 
Commercial & industrial  $615   $615   $226   $615   $91 
Owner-occupied CRE   -    -    -    -    - 
AG production   -    -    -    -    - 
AG real estate   -    -    -    -    - 
CRE investment   -    -    -    -    - 
Construction & land development   -    -    -    -    - 
Residential construction   -    -    -    -    - 
Residential first mortgage   -    -    -    -    - 
Residential junior mortgage   -    -    -    -    - 
Retail & Other   -    -    -    -    - 
Total  $615   $615   $226   $615   $91 
                          
   Acquired Impaired Loans – September 30, 2017 
(in thousands)  Recorded
Investment
   Unpaid
Principal
Balance
   Related
Allowance
   Average
Recorded
Investment
   Interest
Income
Recognized
 
Commercial & industrial  $4,456   $11,660   $-   $4,442   $378 
Owner-occupied CRE   1,116    2,793    -    1,185    96 
AG production   -    15    -    -    - 
AG real estate   218    308    -    229    25 
CRE investment   4,845    8,863    -    5,099    353 
Construction & land development   723    1,189    -    743    44 
Residential construction   80    983    -    94    27 
Residential first mortgage   1,619    2,971    -    1,699    121 
Residential junior mortgage   60    500    -    64    6 
Retail & Other   -    14    -    -    - 
Total  $13,117   $29,296   $-   $13,555   $1,050 

 

 23 

 

 

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

 

   Total Impaired Loans – December 31, 2016 
(in thousands)  Recorded
Investment
   Unpaid
Principal
Balance
   Related
Allowance
   Average
Recorded
Investment
   Interest
Income
Recognized
 
Commercial & industrial  $338   $720   $-   $348   $34 
Owner-occupied CRE   2,588    4,661    -    2,700    271 
AG production   41    163    -    48    6 
AG real estate   240    332    -    245    26 
CRE investment   12,552    19,695    -    12,982    1,051 
Construction & land development   694    2,122    -    752    112 
Residential construction   261    1,348    -    287    82 
Residential first mortgage   2,204    3,706    -    2,312    190 
Residential junior mortgage   299    639    -    209    17 
Retail & Other   -    36    -    -    - 
Total  $19,217   $33,422   $-   $19,883   $1,789 

 

There were no originated impaired loans as of December 31, 2016. All loans in the table above were acquired loans.

 

In April 2017, the First Menasha merger added purchased credit impaired loans at a fair value of $5.4 million, net of an initial $5.9 million non-accretable mark. Also, during the third quarter a loan of $3.1 million was acquired, net of an initial $2.4 million non-accretable mark. Including these credit impaired loans acquired in the First Menasha merger and third quarter acquisition, total purchased credit impaired loans acquired in aggregate were initially recorded at a fair value of $43.6 million on their respective acquisition dates, net of an initial $34.4 million non-accretable mark and a zero accretable mark. At September 30, 2017, $12.3 million of the $43.6 million remain in impaired loans and $0.8 million of acquired loans have subsequently become impaired, bringing acquired impaired loans to $13.1 million.

 

Non-accretable discount on purchase credit impaired (“PCI”) loans:  Nine Months Ended   Year ended 
(in thousands)  September 30, 2017   December 31, 2016 
Balance at beginning of period  $14,327   $4,229 
Acquired balance, net   8,352    13,923 
Accretion to loan interest income   (5,925)   (3,458)
Disposals of loans   (1,121)   (367)
Balance at end of period  $15,633   $14,327 

 

Troubled Debt Restructurings

 

During the quarter ended September 30, 2017, there were two additional loans that were restructured. One loan was an existing PCI loan which was restructured as part of a new agreement with a loan amount of $3.5 million. The other loan was an acquired loan for $0.7 million in which terms were extended subsequent to acquisition. At September 30, 2017, there were seven loans classified as troubled debt restructurings totaling $5.2 million. These seven loans had a combined premodification balance of $5.2 million. There were no other loans which were modified and classified as troubled debt restructurings at September 30, 2017. There were no loans classified as troubled debt restructurings during the previous twelve months that subsequently defaulted as of September 30, 2017. Loans which were considered troubled debt restructurings by First Menasha and Baylake prior to acquisition are not required to be classified as troubled debt restructurings in the Company’s consolidated financial statements unless and until such loans 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, Intangible Assets and Mortgage Servicing Rights

 

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 other intangibles was required for 2016 or the first nine months of 2017.

 

 24 

 

 

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

 

Goodwill: Goodwill was $107.4 million at September 30, 2017 and $66.7 million at December 31, 2016. There was an addition to the carrying amount of goodwill in the second quarter of 2017 of $39.7 million related to the First Menasha merger. In accordance with business combination accounting standards, an additional increase to goodwill of $1.0 million occurred in the third quarter of 2017 due to the Company recording its previously held equity interest in First Menasha at its then acquisition date fair value, resulting in a $1.2 million gain in pre-tax earnings. See Note 2 for additional information on the acquisitions.

 

Other intangible assets: Other intangible assets, consisting of core deposit intangibles (related to branch or bank acquisitions) and customer list intangibles (related to the customer relationships acquired in the 2016 financial advisor business acquisition), are amortized over their estimated finite lives. There was an addition of $3.7 million to the core deposit intangibles related to the First Menasha merger in the second quarter of 2017. The customer relationship intangible was increased $0.9 million in the third quarter of 2017 due to a modification to the contingent earn-out payment, fixing the previously variable earn-out payment on a portion of the purchase price. See Note 2 for additional information on the acquisitions.

 

(in thousands)  September 30, 2017   December 31, 2016 
Core deposit intangibles:          
Gross carrying amount  $29,015   $25,345 
Accumulated amortization   (11,469)   (8,244)
Net book value  $17,546   $17,101 
Additions during the period  $3,670   $17,259 
Amortization during the period  $3,225   $3,189 
           
Customer list intangibles:          
Gross carrying amount  $5,233   $4,363 
Accumulated amortization   (558)   (269)
Net book value  $4,675   $4,094 
Additions during the period  $870   $4,363 
Amortization during the period  $289   $269 

 

Mortgage servicing rights: A summary of the mortgage servicing rights (“MSR”) asset, which is included in other assets in the consolidated balance sheets, for the nine months ended September 30, 2017 and year ended December 31, 2016 was as follows:

 

(in thousands)  September 30, 2017   December 31, 2016 
Mortgage servicing rights (MSR) asset:          
MSR asset at beginning of year  $1,922   $193 
Capitalized MSR   679    1,023 
MSR asset acquired   874    885 
Amortization during the period   (339)   (179)
Valuation allowance at end of period   -    - 
Net book value at end of period  $3,136   $1,922 
           
Fair value of MSR asset at end of period  $4,116   $2,013 
Residential mortgage loans serviced for others   509,897   $295,353 
Net book value of MSR asset to loans serviced for others   0.62%   0.65%

 

The Company periodically evaluates its mortgage servicing rights asset for impairment. At each reporting date, impairment is assessed based on an 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). No valuation or impairment charge was recorded for 2016 or year to date 2017.

 

 25 

 

 

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

 

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, 2017. 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
   Customer list
intangibles
   MSR asset 
Year ending December 31,               
2017 (remaining three months)  $1,070   $112   $136 
2018   3,915    449    544 
2019   3,337    449    544 
2020   2,657    449    677 
2021   2,167    449    301 
Thereafter   4,400    2,767    934 
Total  $17,546   $4,675   $3,136 

 

Note 8 – Notes Payable

 

The Company had the following long-term notes payable (notes with original maturities of greater than one year):

 

(in thousands)  September 30, 2017   December 31, 2016 
Federal Home Loan Bank (“FHLB”) advances  $41,571   $1,000 
Notes payable  $41,571   $1,000 

 

The Company’s FHLB advances bear fixed rates, require interest-only monthly payments, and have maturities ranging from December 2017 to November 2022. The weighted average rates of FHLB advances were 1.65% at September 30, 2017 and 1.17% at December 31, 2016. FHLB advances are collateralized by a blanket lien on qualifying first mortgages, home equity loans, multi-family loans and certain farmland loans which totaled $330.7 million and $283.8 million at September 30, 2017 and December 31, 2016, respectively.

 

The following table shows the maturity schedule of the notes payable as of September 30, 2017:

 

Maturing in  (in thousands) 
2017 (remaining three months)  $5,018 
2018   1,000 
2019   - 
2020    10,000 
2021   - 
2022   25,553 
   $41,571 

 

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, 2017, 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, 2017 and December 31, 2016, and the line was not used during 2017 or 2016.

 

Note 9 – Junior Subordinated Debentures

 

At September 30, 2017 and December 31, 2016, the Company’s carrying value of junior subordinated debentures was $29.5 million and $24.7 million, respectively. At September 30, 2017 and December 31, 2016, $28.3 million and $23.6 million, respectively, of guaranteed preferred beneficial interests (“trust preferred securities”) qualify as Tier 1 capital under the Federal Reserve Bank guidelines.

 

The following table shows the breakdown of junior subordinated debentures as of September 30, 2017 and December 31, 2016. Interest on all debentures is current. Any applicable discounts (initially recorded to carry an acquired debenture at its then estimated fair market value) are being accreted to interest expense over the remaining life of the debentures. All the debentures below are currently callable and may be redeemed in part or in full plus any accrued but unpaid interest.

 

 26 

 

 

Note 9 – Junior Subordinated Debentures, continued

 

      Junior Subordinated Debentures 
(in thousands)  Maturity
Date
  Par   9/30/2017
Unamortized
Discount
   9/30/2017
Carrying
Value
   12/31/2016
Carrying
Value
 
2004 Nicolet Bankshares Statutory Trust(1)  7/15/2034  $6,186   $-   $6,186   $6,186 
2005 Mid-Wisconsin Financial Services, Inc.(2)  12/15/2035   10,310    (3,620)   6,690    6,540 
2006 Baylake Corp.(3)  9/30/2036   16,598    (4,415)   12,183    12,006 
2004 First Menasha Bancshares, Inc.(4)  3/17/2034   5,155    (717)   4,438    - 
Total     $38,249   $(8,752)  $29,497   $24,732 

 

(1)The interest rate is 8.00% fixed.
(2)The debentures, assumed in April 2013 as the result of acquisition, have a floating rate of the three-month LIBOR plus 1.43%, adjusted quarterly. The interest rates were 2.75% and 2.39% as of September 30, 2017 and December 31, 2016, respectively.
(3)The debentures, assumed in April 2016 as a result of acquisition, have a floating rate of the three-month LIBOR plus 1.35%, adjusted quarterly. The interest rates were 2.69% and 2.35% as of September 30, 2017 and December 31, 2016, respectively.
(4)The debentures, assumed in April 2017 as the result of acquisition, have a floating rate of the three-month LIBOR plus 2.79%, adjusted quarterly. The interest rate was 4.11% as of September 30, 2017.

 

Underlying respective statutory trusts (the “statutory trusts”) issued trust preferred securities and common securities. The proceeds from the issuance of the common and the trust preferred securities were used by each trust to purchase junior subordinated debentures of the Company. The debentures represent the sole asset of the statutory trusts. All of the common securities of the statutory trusts are owned by the Company. The statutory trusts are not included in the consolidated financial statements. The net effect of all the documents entered into with respect to the trust preferred securities is that the Company, through payments on its debentures, is liable for the distributions and other payments required on the trust preferred securities.

 

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. At September 30, 2017, the carrying value of these subordinated notes was $11.9 million.

 

The $180,000 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, 2017 and December 31, 2016, respectively, $88,000 and $115,000, of unamortized debt issuance costs remain and are reflected as a reduction to the carrying value of the outstanding debt.

 

 27 

 

 

Note 11 – Fair Value Measurements

 

Fair value represents the estimated price at which an orderly transaction to sell an asset or transfer a liability would take place between market participants at the measurement date under current market conditions (i.e. an exit price concept), and is a market-based measurement versus an entity-specific measurement.

 

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.

 

Recurring basis fair value measurements:

The following table presents the balances of assets and liabilities measured at fair value on a recurring basis for the periods presented. During the second quarter of 2017, three securities classified as Level 3 were acquired with the First Menasha acquisition with a fair value of $0.2 million. The remaining changes in Level 3 were due to pay downs.

 

       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  $26,272   $-   $26,272   $- 
State, county and municipals   188,716    -    188,057    659 
Mortgage-backed securities   157,936    -    157,929    7 
Corporate debt securities   32,744    -    24,254    8,490 
Equity securities   2,549    2,549    -    - 
Securities AFS, September 30, 2017  $408,217   $2,549   $396,512   $9,156 
                     
(in thousands)                    
U.S. government sponsored enterprises  $1,963   $-   $1,963   $- 
State, county and municipals   187,243    -    186,717    526 
Mortgage-backed securities   159,129    -    159,076    53 
Corporate debt securities   12,169    -    3,640    8,529 
Equity securities   4,783    4,783    -    - 
Securities AFS, December 31, 2016  $365,287   $4,783   $351,396   $9,108 

 

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, 2017 and December 31, 2016, it was determined that carrying value was the best approximation of fair value for all of the Level 3 securities, based primarily on the internal analysis on these securities.

 

 28 

 

 

Note 11 – Fair Value Measurements, continued

 

Nonrecurring basis fair value measurements:

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.

 

Measured at Fair Value on a Nonrecurring Basis

       Fair Value Measurements Using 
(in thousands)  Total   Level 1   Level 2   Level 3 
September 30, 2017:                    
Impaired loans  $13,506   $-   $-   $13,506 
OREO   1,314    -    -    1,314 
December 31, 2016:                    
Impaired loans  $19,217   $-   $-   $19,217 
OREO   2,059    -    -    2,059 

 

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.

 

 29 

 

 

Note 11 – Fair Value Measurements, continued

 

Financial instruments:

The carrying amounts and estimated fair values of the Company’s financial instruments at September 30, 2017 and December 31, 2016 are shown below.

 

September 30, 2017
(in thousands)  Carrying
Amount
   Estimated
Fair Value
   Level 1   Level 2   Level 3 
Financial assets:                         
Cash and cash equivalents  $96,103   $96,103   $96,103   $-   $- 
Certificates of deposit in other banks   2,494    2,495    -    2,495    - 
Securities AFS   408,217    408,217    2,549    396,512    9,156 
Other investments   14,931    14,931    -    13,236    1,695 
Loans held for sale   6,963    7,089    -    7,089    - 
Loans, net   2,038,512    2,030,248    -    -    2,030,248 
BOLI   63,989    63,989    63,989    -    - 
MSR asset   3,136    4,116    -    -    4,116 
                          
Financial liabilities:                         
Deposits  $2,366,951   $2,366,199   $-   $-   $2,366,199 
Short-term borrowings   12,900    12,900    12,900    -    - 
Notes payable   41,571    41,708    -    41,708    - 
Junior subordinated debentures   29,497    28,907    -    -    28,907 
Subordinated notes   11,912    11,417    -    -    11,417 
                          
December 31, 2016
(in thousands)  Carrying
Amount
   Estimated
Fair Value
   Level 1   Level 2   Level 3 
Financial assets:                         
Cash and cash equivalents  $129,103   $129,103   $129,103   $-   $- 
Certificates of deposit in other banks   3,984    3,992    -    3,992    - 
Securities AFS   365,287    365,287    4,783    351,396    9,108 
Other investments   17,499    17,499    -    15,779    1,720 
Loans held for sale   6,913    6,968    -    6,968    - 
Loans, net   1,557,087    1,568,676    -    -    1,568,676 
BOLI   54,134    54,134    54,134    -    - 
MSR asset   1,922    2,013    -    -    2,013 
                          
Financial liabilities:                         
Deposits  $1,969,986   $1,969,973   $-   $-   $1,969,973 
Notes payable   1,000    1,002    -    1,002    - 
Junior subordinated debentures   24,732    24,095    -    -    24,095 
Subordinated notes   11,885    11,459    -    -    11,459 

 

Not all the financial instruments listed in the table above are subject to the disclosure provisions of Accounting Standards Codification (“ASC”) 820, Fair Value Measurements and Disclosures, as certain assets and liabilities result in their carrying value approximating fair value. These include cash and cash equivalents, BOLI, 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.

 

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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 any 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: At September 30, 2017 and December 31, 2016, the estimated fair value of letters of credit, loan commitments on which the committed interest rate is less than the current market rate, and of outstanding mandatory commitments to sell mortgages into the secondary market were not significant.

 

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.

 

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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 and through the 38 branch offices of its banking subsidiary, Nicolet National Bank, in northeastern and central Wisconsin and Menominee, Michigan.

 

Overview

 

At September 30, 2017, Nicolet Bankshares, Inc. and its subsidiaries (“Nicolet” or the “Company”) had total assets of $2.8 billion, loans of $2.0 billion, deposits of $2.4 billion and total stockholders’ equity of $360 million, representing increases over December 31, 2016 of 24%, 31%, 20% and 31% in assets, loans, deposits and total equity, respectively. This balance sheet growth was predominately attributable to the April 28, 2017 acquisition of First Menasha Bancshares, Inc. (“First Menasha”), which added assets of $480 million (about 20% of Nicolet’s pre-merger asset size), loans of $351 million, deposits of $375 million, core deposit intangible of $4 million and goodwill of $41 million (as of the consummation date and based on estimated fair values), for a total purchase price that included the issuance of $62 million of common equity (or 1.3 million shares) and $19 million of cash, and which is further described in Note 2, “Acquisitions” of the notes to unaudited consolidated financial statements. In particular, organic loan growth has been strong since year end 2016, with loans, excluding $351 million of loans at acquisition of First Menasha, up $131 million or 8%.

 

For the nine months ended September 30, 2017, net income was $24.0 million (94% above the comparable period of 2016), and net income available to common shareholders was $24.0 million or $2.45 per diluted common share. Evaluation of financial performance between 2017 and 2016 periods was impacted in general from the timing of the 2017 acquisition and the 2016 acquisitions, and inclusion of non-recurring merger-based expenses and integration costs, as described more fully 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 related servicing fees, 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;
·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.

 

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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 April 2017, Nicolet closed one branch in conjunction with the 2017 acquisition due to overlapping geography. In March 2017, Nicolet closed two branches, one in close proximity to another Nicolet branch and one that was an outlier branch. Nicolet closed seven branches in 2016 that were in close proximity to other Nicolet branches, one concurrent with the Baylake merger, one in October and five in December 2016. As a result, Nicolet operates 38 branches as of September 30, 2017. Nicolet started its effort to eliminate costs associated with branches in overlapping or outlier geographies in 2015 from its acquisition activity, and will continue to evaluate opportunities for efficiencies.

 

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 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.

 

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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.

 

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, 2017. 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.

 

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Management’s Discussion and Analysis

 

The following discussion is Nicolet management’s analysis of the consolidated financial condition as of September 30, 2017 and December 31, 2016 and results of operations for the three and nine-month periods ended September 30, 2017 and 2016. It should be read in conjunction with Nicolet’s audited consolidated financial statements as of December 31, 2016 and 2015, and for the three years ended December 31, 2016, included in Nicolet’s Annual Report on Form 10-K for the year ended December 31, 2016.

 

Evaluation of financial performance and average balances between 2017 and 2016 was impacted in general from the timing and sizes of the 2017 and 2016 acquisitions. Since the balances and results of operations of the acquired entities are appropriately not included in the accompanying consolidated financial statements until their consummation dates, income statement results and average balances for 2017 included full contributions from the 2016 acquisitions and no or partial contributions from the 2017 acquisition. Similarly for 2016 income statement and average balance results, the 2016 acquisitions provided no to partial contributions and the 2017 acquisition provided no contribution.

 

The inclusion of the Baylake balance sheet (at about 83% of Nicolet’s then pre-merger asset size) and operational results for approximately eight months in 2016 (and approximately five months in the nine month period ended September 30, 2016) analytically explains most of the increase in certain average balances and income statement line items between 2017 and 2016 periods. To a lesser extent, the inclusion of the First Menasha balance sheet (at about 20% of Nicolet’s then pre-merger asset size) and operational results for approximately five of nine months in 2017 analytically explains a portion of the increase in certain average balances and income statement line items between 2017 and 2016 periods. The 2016 financial advisory business acquisition primarily impacts the brokerage fee income, personnel expense and certain other expense line items. Last, the 2016 and 2017 acquisitions impacted pre-tax net income by inclusion of non-recurring direct merger expenses of approximately $1.3 million in 2016 ($0.4 million, $0.4 million, $0.1 million and $0.4 million in first through fourth quarters, respectively) and $0.5 million in 2017 ($0.2 million and $0.3 million in the first and second quarters, respectively), along with a $1.7 million lease termination charge in second quarter 2016 related to a Nicolet branch closed concurrent with the Baylake merger.

 

Nicolet remains focused on gaining efficiencies from its increased scale from the acquisitions, as well as on organic growth in our expanded markets and in brokerage services.

 

Performance Summary

 

Nicolet reported net income of $24.0 million for the nine months ended September 30, 2017, a 94% increase over $12.4 million for the first nine months of 2016. Net income available to common shareholders was $24.0 million, or $2.45 per diluted common share for the first nine months of 2017. Comparatively, after $633,000 of preferred stock dividends, net income available to common shareholders was $11.7 million, or $1.67 per diluted common share for the first nine months of 2016. Beginning March 1, 2016, the annual dividend rate on preferred stock moved from 1% to 9% in accordance with the contractual terms. Nicolet redeemed its outstanding preferred stock in full in September 2016, explaining the difference in preferred stock dividends between the nine-month periods.

 

The results for the first nine months of 2017 include full contributions from the 2016 acquisitions and five months from First Menasha, while the comparative 2016 period includes approximately five months from the 2016 acquisitions and nothing from First Menasha.

 

·Net interest income was $72.2 million for the first nine months of 2017, an increase of $24.1 million or 50% over the comparable period of 2016, including $4.5 million higher aggregate discount accretion income between the periods. The improvement was primarily the result of favorable volume and mix variances (driven by the addition of acquired net interest-earning assets albeit at lower yields, as well as organic growth), and net favorable rate variances, largely from higher earning asset yields partially offset by a higher cost of funds. On a tax-equivalent basis, the earning asset yield was 4.69% for the first nine months of 2017, 25 basis points (“bps”) higher than the comparable period in 2016, influenced by more earning assets in loans and investments than in low-earning cash and higher aggregate discount accretion income. The cost of funds was 0.56% for the first nine months of 2017, 2 bps lower than 2016, driven by a lower cost of deposits (largely due to the addition of Baylake deposits at lower rates) between the comparable periods. As a result, the interest rate spread was 4.13% for the first nine months of 2017, 27 bps higher than the comparable period in 2016. The net interest margin was 4.27%, 28 bps over the comparable period of 2016.

 

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·Noninterest income was $26.0 million for the first nine months of 2017, an increase of $7.2 million or 39% over the first nine months of 2016, aided largely by the 2016 acquisitions and, to a lesser extent, the 2017 acquisition. Excluding net gains on sale or write-down of assets from both periods, noninterest income increased $5.7 million or 31%. Brokerage fee income led the increase, growing $2.1 million or 101%, attributable to the 2016 financial advisor business acquisition and subsequent new growth. Between the nine-month periods, increases due primarily to higher volumes and activity were also experienced in service charges on deposits (up $0.9 million or 34%), net mortgage income (up $0.3 million or 8%), trust fee income (up $0.4 million or 11%), card interchange fees were up $1.2 million or 54% on higher volume and activity, and other income (up $0.4 million or 21%).

 

·Noninterest expense for the first nine months of 2017 was $59.5 million (including $0.5 million attributable to non-recurring merger-based expenses) compared to $46.6 million for the comparable period in 2016 (including $2.6 million merger-related expenses). Excluding the noted merger-based expenses from both periods, noninterest expense increased approximately $15 million or 34%. The increase between the nine-month periods was primarily due to a larger operating base, attributable to the acquisitions. Personnel expense accounted for the majority of the increase in total expense, up $7.7 million or 31% over the first nine months of 2016, commensurate with the 32% increase in average full time equivalent employees for the comparable periods.

 

·Loans were $2.05 billion at September 30, 2017, up $482 million or 31% from $1.57 billion at December 31, 2016, and up $497 million or 32% over September 30, 2016, largely driven by $351 million of loans acquired with First Menasha at acquisition. Excluding the impact of First Menasha, loans increased $131 million or 8% organically since year end 2016. Between the comparative nine-month periods, average loans were $1.84 billion yielding 5.26% in 2017, compared to $1.27 billion yielding 5.13% in 2016, a 45% increase in average balances. The 13 bps increase in loan yield was largely due to $4.5 million of higher aggregate discount accretion income on acquired loans between the nine-month periods (inclusive of $3.2 million higher discount income related to favorably resolved purchased credit impaired loans), partially offset by pressure on rates of new and renewing loans in the competitive rate environment.

 

·Total deposits were $2.37 billion at September 30, 2017, up $397 million or 20% from $1.97 billion at December 31, 2016, and up $433 million or 22% over September 30, 2016, primarily due to $375 million of deposits acquired with First Menasha at acquisition). Excluding the impact of First Menasha, deposits increased $22 million or 1% since year end 2016. Between the comparative nine-month periods, average total deposits were up $631 million or 41%, attributable to the acquisitions, with noninterest-bearing demand deposits representing 24% and 23% of total deposits for the nine-month periods ended September 30, 2017 and 2016, respectively. Interest-bearing deposits cost 0.42% for the first nine months of 2017, down 1 bp from 0.43% for the same period in 2016, benefiting mostly from the lower-costing Baylake deposits acquired, offset partly by the higher-costing First Menasha deposits acquired, an increase in selected deposit rates that began in July 2017, and general rate pressures influenced by a 75 bps increase in the federal funds rate since January 1, 2016.

 

·Asset quality measures remained strong with continued improvement. Nonperforming assets declined to $15.7 million at September 30, 2017, from $22.3 million at year end 2016 and $23.7 million a year ago. As a percentage of total assets, nonperforming assets were 0.55% at September 30, 2017, 0.97% at December 31, 2016, and 1.04% at September 30, 2016. The allowance for loan losses was $12.6 million at September 30, 2017 (representing 0.61% of loans), compared to $11.8 million at December 31, 2016 (representing 0.75% of loans), and $11.5 million at September 30, 2016 (representing 0.74% of loans). The decline in the ratio of the ALLL to loans primarily resulted from recording the acquired loan portfolios at fair value with no carryover of allowance at the time of each merger. The provision for loan losses was $1.9 million with net charge-offs of $1.1 million for the first nine months of 2017, versus provision of $1.4 million and $0.2 million of net charge-offs for the comparable 2016 period.

 

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.

 

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Net interest income in the consolidated statements of income (which excludes any taxable equivalent adjustment) was $72.2 million in the first nine months of 2017, $24.1 million or 50% higher than $48.1 million in the first nine months of 2016, including $4.5 million higher aggregate discount accretion between the periods and impacted by the timing of the acquisitions (with 2017 including five months of First Menasha and full contribution from Baylake, while the 2016 period included only five months from Baylake). 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 35% tax rate) were $1.8 million and $1.3 million for the first nine months of 2017 and 2016, respectively, resulting in taxable equivalent net interest income of $74.0 million and $49.4 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.

 

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

 

   For the Nine Months Ended September 30, 
   2017   2016 
(in thousands)  Average
Balance
   Interest   Average
Rate
   Average
Balance
   Interest   Average
Rate
 
ASSETS                              
Earning assets                              
Loans, including loan fees (1)(2)  $1,842,695   $73,377    5.26%  $1,274,405   $49,634    5.13%
Investment securities                              
Taxable   236,275    3,422    1.93%   147,720    2,068    1.87%
Tax-exempt (2)   160,815    3,267    2.71%   122,850    2,265    2.46%
Other interest-earning assets   51,803    1,136    2.92%   87,840    906    1.38%
Total interest-earning assets   2,291,588   $81,202    4.69%   1,632,815   $54,873    4.44%
Cash and due from banks   76,992              43,001           
Other assets   211,546              147,070           
Total assets  $2,580,126             $1,822,886           
LIABILITIES AND STOCKHOLDERS’ EQUITY                              
Interest-bearing liabilities                              
Savings  $249,099   $271    0.15%  $184,156   $166    0.12%
Interest-bearing demand   419,266    1,590    0.51%   310,801    1,310    0.56%
MMA   581,277    1,165    0.27%   421,920    415    0.13%
Core CDs and IRAs   288,524    1,568    0.73%   249,788    1,657    0.89%
Brokered deposits   120,782    622    0.69%   28,897    280    1.29%
Total interest-bearing deposits   1,658,948    5,216    0.42%   1,195,562    3,828    0.43%
Other interest-bearing liabilities   62,414    1,966    4.17%   52,470    1,638    4.11%
Total interest-bearing liabilities   1,721,362    7,182    0.56%   1,248,032    5,466    0.58%
Noninterest-bearing demand   516,412              348,765           
Other liabilities   19,079              16,779           
Total equity   323,273              209,310           
Total liabilities and stockholders’ equity  $2,580,126             $1,822,886           
                               
Net interest income and rate spread       $74,020    4.13%       $49,407    3.86%
Net interest margin             4.27%             3.99%

 

(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 35% 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, 2017 versus the nine months ended September 30, 2016 follows:

 

   Increase (decrease)
Due to Changes in
 
(in thousands)  Volume   Rate   Net 
Earning assets               
                
Loans (1)(2)  $22,613   $1,130   $23,743 
Investment securities               
Taxable   1,382    (28)   1,354 
Tax-exempt (2)   752    250    1,002 
Other interest-earning assets   (234)   464    230 
                
Total interest-earning assets  $24,513   $1,816   $26,329 
                
Interest-bearing liabilities               
Savings deposits  $66   $39   $105 
Interest-bearing demand   421    (141)   280 
MMA   200    550    750 
Core CDs and IRAs   234    (323)   (89)
Brokered deposits   525    (183)   342 
                
Total interest-bearing deposits   1,446    (58)   1,388 
Other interest-bearing liabilities   412    (84)   328 
                
Total interest-bearing liabilities   1,858    (142)   1,716 
Net interest income  $22,655   $1,958   $24,613 

 

(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 35% and adjusted for the disallowance of interest expense.

 

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Table 3: Quarterly Net Interest Income Analysis

 

   For the Three Months Ended September 30, 
   2017   2016 
(in thousands)  Average
Balance
   Interest   Average
Rate
   Average
Balance
   Interest   Average
Rate
 
ASSETS                              
Earning assets                              
Loans, including loan fees (1)(2)  $2,035,277   $27,420    5.29%  $1,562,151   $21,138    5.32%
Investment securities                              
Taxable   248,579    1,114    1.79%   199,843    902    1.80%
Tax-exempt (2)   160,965    1,107    2.75%   152,959    969    2.53%
Other interest-earning assets   60,252    407    2.69%   84,782    351    1.66%
Total interest-earning assets   2,505,073   $30,048    4.72%   1,999,735   $23,360    4.57%
Cash and due from banks   54,925              59,573           
Other assets   265,544              206,774           
Total assets  $2,825,542             $2,266,082           
LIABILITIES AND STOCKHOLDERS’ EQUITY                              
Interest-bearing liabilities                              
Savings  $268,552   $129    0.19%  $216,055   $60    0.11%
Interest-bearing demand   441,409    758    0.68%   367,854    451    0.49%
MMA   606,737    622    0.41%   539,160    180    0.13%
Core CDs and IRAs   297,318    595    0.79%   300,827    583    0.77%
Brokered deposits   172,200    260    0.60%   29,639    76    1.02%
Total interest-bearing deposits   1,786,216    2,364    0.53%   1,453.535    1,350    0.37%
Other interest-bearing liabilities   68,123    699    4.04%   39,898    541    5.35%
Total interest-bearing liabilities   1,854,339    3,063    0.65%   1,493,433    1,891    0.50%
Noninterest-bearing demand   591,013              464,131           
Other liabilities   21,962              22,616           
Total equity   358,228              285,902           
Total liabilities and stockholders’ equity  $2,825,542             $2,266,082           
Net interest income and rate spread       $26,985    4.07%       $21,469    4.07%
Net interest margin             4.24%             4.19%

 

(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 35% 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, 2017 versus the three months ended September 30, 2016 follows:

 

   Increase (decrease)
Due to Changes in
 
(in thousands)  Volume   Rate   Net 
Earning assets               
                
Loans (1) (2)  $6,462   $(180)  $6,282 
Investment securities               
Taxable   182    30    212 
Tax-exempt(2)   52    86    138 
Other interest-earning assets   (144)   200    56 
                
Total interest-earning assets  $6,552   $136   $6,688 
                
Interest-bearing liabilities               
Savings deposits  $17   $52   $69 
Interest-bearing demand   103    204    307 
MMA   25    417    442 
Core CDs and IRAs   (7)   19    12 
Brokered deposits   228    (44)   184 
                
Total interest-bearing deposits   366    648    1,014 
Other interest-bearing liabilities   143    15    158 
                
Total interest-bearing liabilities   509    663    1,172 
Net interest income  $6,043   $(527)  $5,516 

 

(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 35% and adjusted for the disallowance of interest expense.

 

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

   Nine Months Ended September 30, 
   2017   2016 
(in thousands)  Average
Balance
   % of
Earning
Assets
   Yield/Rate   Average
Balance
   % of
Earning
Assets
   Yield/Rate 
Total loans  $1,842,695    80.4%   5.26%  $1,274,405    78.0%   5.13%
Securities and other earning assets   448,893    19.6%   2.32%   358,410    22.0%   1.95%
Total interest-earning assets  $2,291,588    100.0%   4.69%  $1,632,815    100.0%   4.44%
                               
Interest-bearing liabilities  $1,721,362    75.1%   0.56%  $1,248,032    76.4%   0.58%
Noninterest-bearing funds, net   570,226    24.9%        384,783    23.6%     
Total funds sources  $2,291,588    100.0%   0.56%  $1,632,815    100.0%   0.43%
Interest rate spread             4.13%             3.86%
Contribution from net free funds             0.14%             0.13%
Net interest margin             4.27%             3.99%

 

Taxable-equivalent net interest income was $74.0 million and $49.4 million for the nine months of 2017 and 2016, respectively, up $24.6 million or 50%, with $22.7 million from net favorable volume and mix variances (due to the addition of acquired net interest-earning assets, as well as organic growth), and $1.9 million from net favorable rate variances (from both a lower cost of funds and higher earning asset yield) between the periods. Taxable equivalent interest income on earning assets increased $26.3 million or 48% between the nine-month periods, with $23.7 million more interest from loans ($22.6 million from greater volume and $1.1 million from rates (with $4.5 million in higher aggregate discount accretion income, including $3.2 million higher discount income related to favorably resolved purchased credit impaired loans, more than offsetting lower underlying loan yields mainly from the acquired portfolios)), $2.4 million more interest from total investments (mostly volume-based), and $0.2 million more interest from other earning assets. Interest expense increased $1.7 million, led by $1.9 million higher interest on interest-bearing liabilities due to volume and mix variances (mostly acquired deposits and a higher proportion of brokered deposits), partially offset by $0.2 million of net favorable rate variances due to lower cost funding (largely from lower-costing Baylake deposits acquired, offset partly by higher-costing First Menasha deposits acquired, an increase in select deposit rates that began in July 2017, and general rate pressures influenced by a 75 bps increase in the federal funds rate since January 1, 2016).

 

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The taxable-equivalent net interest margin was 4.27% for the first nine months of 2017, up 28 bps versus the first nine months of 2016. The interest rate spread increased 27 bps between the periods, with a favorable increase in the earning asset yield (up 25 bps to 4.69% for first nine months of 2017), and an improvement in the cost of funds (down 2 bps to 0.56% for the first nine months of 2017). The contribution from net free funds increased by 1 bp, mostly due to lower costs on the funding side of the balance sheet. Since January 1, 2016, the Federal Reserve raised short-term interest rates by 75 bps to 125 bps as of September 30, 2017 (up 25 bps in each of December 2016, March 2017 and June 2017). These increases have impacted the rate earned on cash and the cost of shorter-term deposits and borrowings, but have not significantly influenced rates further out on the yield curve; and thus, have only minimally impacted new investment yields or new loan pricing. Additionally, while both 2017 and 2016 periods are experiencing favorable income from discount accretion on acquired loans, particularly where such loans pay or resolve at better than their carrying values, such favorable interest flow can be sporadic and will diminish over time.

 

The earning asset yield was influenced largely by the mix of underlying earning assets, particularly carrying a higher proportion of loans and investments (each at higher yields in the 2017 period than the 2016 period) and a lower proportion of low-earning cash. Loans, investments and other interest earning assets (mostly low-earning cash) represented 80%, 18% and 2% of average earning assets, respectively, for the first nine months of 2017, and 78%, 17%, and 5%, respectively, for the comparable 2016 period. Loans yielded 5.26% and 5.13%, respectively, for the first nine months of 2017 and 2016, while non-loan earning assets combined yielded 2.32% and 1.95%, respectively, for the periods. The 13 bps increase in loan yield between the nine-month periods was largely due to the higher aggregate discount accretion on acquired loans between periods, more than offsetting lower underlying loan yields mainly from the acquired loan portfolios and competitive pricing.

 

Average interest-earning assets were $2.29 billion for the first nine months of 2017, $659 million, or 40% higher than the first nine months of 2016, largely attributable to acquired balances as well as strong organic loan growth. The change consisted of a $568 million increase in average loans (up 45% to $1.8 billion), a $127 million increase in investment securities (up 47% to $397 million) and a $36 million decrease in other interest-earning assets, predominantly low earning cash.

 

Nicolet’s cost of funds decreased 2 bps to 0.56% for the first nine months of 2017 compared to a year ago. The average cost of interest-bearing deposits (which represented 96% of average interest-bearing liabilities for the nine months ended September 30, 2017 and 2016), was 0.42% for the first nine months of 2017, down 1 bp from the first nine months of 2016, largely benefiting from the lower-costing Baylake deposits acquired, offset partly by the higher-costing First Menasha deposits acquired, an increase in select deposit rates that began in July 2017, and general rate pressures influenced by a 75 bps increase in the federal funds rate since January 1, 2016.

 

Average interest-bearing liabilities were $1.72 billion for the first nine months of 2017, up $473 million or 38% from the comparable period in 2016, predominantly attributable to acquired balances. Interest-bearing deposits represented 96% of average interest-bearing liabilities for the first nine months of 2017 and 2016, while the mix of average interest-bearing deposits moved from higher costing core CDs to lower costing transaction accounts, improving the overall deposit cost slightly between the nine-month periods. Average brokered deposits were $121 million for the first nine months of 2017, up $92 million or 318% from the comparable period in 2016, with average yields declining from 1.29% to 0.69%. The increase in brokered deposits was partly due to brokered deposits assumed in the 2017 acquisition. The Company has reduced yields on these brokered deposits by repricing to market rates.

 

Provision for Loan Losses

 

The provision for loan losses for the nine months ended September 30, 2017 and 2016 was $1.9 million and $1.4 million, respectively, exceeding net charge offs of $1.1 million and $0.2 million, respectively. Asset quality measures have been strong and improving with continued resolutions of problem loans. The ALLL was $12.6 million (0.61% of loans) at September 30, 2017, compared to $11.8 million (0.75% of loans) at December 31, 2016 and $11.5 million (0.74% of loans) at September 30, 2016. The decline in the ratio was a result of recording the acquired loan portfolios at fair value with no carryover of allowance at the time of each 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, 
   2017   2016   $ Change   % Change   2017   2016   $ Change   % Change 
(in thousands)                                
Service charges on deposit accounts  $1,238   $1,051   $187    17.8%  $3,367   $2,514   $853    33.9%
Mortgage income, net   1,774    2,010    (236)   (11.7)   4,022    3,713    309    8.3 
Trust services fee income   1,479    1,373    106    7.7    4,431    4,000    431    10.8 
Brokerage fee income   1,500    992    508    51.2    4,192    2,090    2,102    100.6 
BOLI income   459    318    141    44.3    1,314    880    434    49.3 
Rent income   285    285    -    -    852    820    32    3.9 
Investment advisory fees   92    146    (54)   (37.0)   357    341    16    4.7 
Gain on sale or write-down of assets, net   1,305    453    852    188.1    2,071    548    1,523    277.9 
Card interchange income   1,224    922    302    32.8    3,378    2,199    1,179    53.6 
Other income   808    982    (174)   (17.7)   2,034    1,675    359    21.4 
Total noninterest income  $10,164   $8,532   $1,632    19.1%  $26,018   $18,780   $7,238    38.5%
Noninterest income without net gains  $8,859   $8,079   $780    9.7%  $23,947   $18,232   $5,715    31.3%
Components of the gain on sale or write-down of assets, net:                                        
Gain on sale of AFS securities, net  $1,221   $37   $1,184    3200.0%  $1,220   $77   $1,143    1,484.4%
Gain on sale of OREO, net   84    439    (355)   (80.9)   253    582    (329)   (56.5)
Write-down of OREO   -    -    -    -    (126)   -    (126)   N/M 
Gain/(loss) on sale or disposition of assets, net   -    (23)   23    N/M    724    (111)   835    752.3 
Gain on sale or write-down of assets, net  $1,305   $453   $852    188.1%  $2,071   $548   $1,523    277.9%

 

N/M means not meaningful

 

Comparison of the nine months ending September 30, 2017 versus 2016

 

Noninterest income was $26.0 million for the first nine months of 2017, compared to $18.8 million for the first nine months of 2016, aided largely by the 2016 acquisitions and, to a lesser extent, the 2017 acquisition. Excluding net gains on sale or write-down of assets from both nine-month periods, noninterest income increased $5.7 million or 31.3%.

 

The 2017 activity in net gain on sale or write-down of assets consisted of a $1.2 million gain to record the fair value of Nicolet’s pre-acquisition interest in First Menasha, a $0.3 million net gain on the sale of OREO, a $0.1 million write-down of OREO properties, and a $0.7 million gain on the sale or disposition of assets (consisting of $0.9 million of gain from the sale two vacated bank branches, a $0.4 million loss from the transfer of bank branches to OREO, and a $0.2 million gain from the sale of an other investment). The 2016 activity included gains of $0.6 million from the sale of OREO properties.

 

Service charges on deposit accounts were $3.4 million for the first nine months of 2017, up $0.9 million or 33.9% over the first nine months of 2016, resulting from an increased number of accounts mostly attributable to the bank acquisitions and an increase to the fee charged on overdrafts implemented in May 2017.

 

Mortgage income represents net gains received from the sale of residential real estate loans service-released and service-retained into the secondary market, capitalized mortgage servicing rights (“MSRs”), servicing fees, offsetting MSR amortization, valuation changes, if any, and to a smaller degree some related income. Net mortgage income increased $0.3 million or 8.3% between the comparable nine-month periods due to greater secondary mortgage production and sales aided by a broader geographic footprint and increased net servicing fees on the growing portfolio of mortgage loans serviced for others.

 

Trust service fees were up $0.4 million or 10.8% between the nine-month periods due to higher assets under management. Between the nine-month periods, brokerage fees were up significantly, up $2.1 million or 100.6%, attributable to the 2016 financial advisor business acquisition as well as subsequent new growth and pricing.

 

BOLI income was up $0.4 million or 49.3% between the nine-month periods, commensurate with the growth in average BOLI investments, including additional insurance purchases in 2016. Card interchange fees were up $1.2 million or 53.6% on higher volume and activity. Other noninterest income was $2.0 million, up $0.4 million or 21.4% over the comparable period of 2016 with income from equity in UFS, a data processing company acquired in the Baylake merger, up $0.3 million.

 

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Noninterest Expense

 

Table 7: Noninterest Expense

 

   For the three months ended September 30,   For the nine months ended September 30, 
   2017   2016   $ Change   % Change   2017   2016   $ Change   % Change 
(in thousands)                                
Personnel  $11,488   $10,516   $972    9.2%  $32,404   $24,748   $7,656    30.9%
Occupancy, equipment and office   3,559    3,018    541    17.9    9,613    7,324    2,289    31.3 
Business development and marketing   1,113    985    128    13.0    3,359    2,353    1,006    42.8 
Data processing   2,238    1,831    407    22.2    6,428    4,408    2,020    45.8 
FDIC assessments   205    247    (42)   (17.0)   582    629    (47)   (7.5)
Intangibles amortization   1,173    1,172    1    0.1    3,514    2,295    1,219    53.1 
Other expense   1,086    1,250    (164)   (13.1)   3,598    4,799    (1,201)   (25.0)
Total noninterest expense  $20,862   $19,019   $1,843    9.7%  $59,498   $46,556   $12,942    27.8%
Non-personnel expenses  $9,374   $8,503   $871    10.2%  $27,094   $21,808   $5,286    24.2%

 

Comparison of the nine months ending September 30, 2017 versus 2016

 

Total noninterest expense was $59.5 million for the first nine months of 2017 (including $0.5 million attributable to non-recurring, merger-based expenses such as legal and conversion processing costs), compared to $46.6 million for the comparable period in 2016 (including $2.6 million merger-related expenses, of which $1.7 million was a lease termination charge). Excluding the noted merger-based expenses from both periods, noninterest expense increased approximately $15.0 million or 34.2%, primarily attributable to the larger operating base as a result of the 2016 and 2017 acquisitions.

 

Personnel expense was $32.4 million for the first nine months of 2017, up $7.7 million or 30.9% compared to the first nine months of 2016, largely due to the expanded workforce, with average full time equivalent employees up 32% (from 393 to 519 for the first nine months of 2016 and 2017, respectively). Also contributing to the increase were merit increases between the periods, incentives timing, equity grants in the second quarter of 2017, and higher health and other benefits costs.

 

Occupancy, equipment and office expense was $9.6 million for the first nine months of 2017, up $2.3 million or 31.3% compared to 2016, primarily the result of the larger operating base and software needs, offset partly by branch closure savings.

 

Business development and marketing expense increased $1.0 million, or 42.8%, between the comparable nine-month periods, largely due to the expanded operating base and branding efforts influencing additional marketing, promotions and media.

 

Data processing expenses, which are primarily volume-based, rose $2.0 million or 45.8% between the nine-month periods predominantly attributable to the acquisitions, higher card processing, and expanded functionalities. Intangible amortization increased $1.2 million, due exclusively to timing of and the addition of intangibles recorded as part of the acquisitions.

 

Other noninterest expense decreased $1.2 million or 25.0% between the nine-month periods, due primarily to $2.1 million lower merger-related expenses, partially offset by a $0.9 million increase in all other costs, which were largely a function of higher other operating costs associated with size (such as OREO expenses, legal, audit and bank insurance costs) and a $0.4 million increase in 2017 associated with implementing the customer relationship system that began in the fourth quarter of 2016.

 

Income Taxes

 

For the nine-month periods ending September 30, 2017 and 2016, income tax expense was $12.6 million and $6.4 million, respectively. The increase was primarily attributable to higher pre-tax income between the two periods. Included in 2017 is a tax benefit of $0.2 million related to the exercise of stock options and restricted stock vesting in accordance with ASU 2016-09. U.S. 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, 2017 or December 31, 2016.

 

Comparison of the three months ending September 30, 2017 versus 2016

 

Nicolet reported net income of $9.5 million for the three months ended September 30, 2017, up $3.0 million or 47% over $6.5 million for the comparable period of 2016. Net income available to common shareholders for the third quarter of 2017 was $9.5 million, or $0.91 per diluted common share, compared to net income available to common shareholders of $6.2 million, or $0.69 per diluted common share, for the third quarter of 2016.

 

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Pre-tax earnings of the third quarter of 2016 was negatively impacted by $0.1 million merger-based expenses compared to no merger-based expense in the third quarter of 2017.

 

Net interest income in the consolidated statements of income (which excludes any taxable equivalent adjustment) was $26.4 million in the third quarter of 2017 versus $20.9 million in the third quarter of 2016, including $0.4 million higher aggregate discount income between the periods. 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 35% tax rate) were $0.6 million in each of the three months ended September 30, 2017 and 2016, resulting in taxable equivalent net interest income of $27.0 million and $21.5 million, respectively. Taxable equivalent net interest income for third quarter 2017 was up $5.5 million or 26% versus third quarter 2016, with $6.0 million of the increase due to net favorable volume variances (predominately due to the First Menasha assets included in 2017 but not in 2016), and $0.5 million lower net interest income from net unfavorable rate variances (especially from higher costing deposits).

 

The earning asset yield was 4.72% for third quarter 2017, 15 bps higher than third quarter 2016, mainly due to a higher mix of loans as a percent of earning assets. Loans earned 5.29% and represented 81% of average earning assets for third quarter 2017, compared to 5.32% and 78%, respectively, for third quarter 2016. The 3 bps decrease in loan yield between the three-month periods was negatively impacted by the underlying rate pressure on loan yields from competition and the flatter yield curve environment, partially offset by higher aggregate discount accretion on loans. Non-loan earning assets which earn less than loan assets represented 19% of average earning assets for third quarter 2017 (including higher low-earning cash) and earned 2.24%, versus 22% of earning assets yielding 2.03% for third quarter 2016.

 

The cost of funds was 0.65% for third quarter 2017, 15 bps higher than third quarter 2016, driven by an increase in the cost of deposits (up 16 bps to 0.53% for third quarter 2017), mostly from higher-costing First Menasha deposits acquired and an increase in select deposit rates that began in July 2017. The cost of other interest-bearing liabilities decreased 131 bps to 4.04% between the third quarter periods, mostly due to a higher proportion of lower-cost, shorter term funding in the mix.

 

Noninterest income was $10.2 million for third quarter 2017, up $1.6 million over the third quarter 2016. Noninterest income without net gains was up $0.8 million or 10%, with service charges on deposits up $0.2 million (given the larger deposit base), and trust and brokerage fees up $0.6 million combined (mostly attributable to the 2016 financial advisor business acquisition and market improvements). Card interchange income was up $0.3 million on greater activity. Other income decreased $0.2 million between the third quarter periods, although there was an increase in UFS, Inc. income of $0.1 million. Net gain on sale or write-down of assets increased by $0.9 million between the third quarter periods, mostly due to a $1.2 million gain to record the fair value of Nicolet’s pre-acquisition interest in First Menasha in the third quarter of 2017.

 

Noninterest expense was $20.9 million for the third quarter of 2017, up $1.8 million or 9.7% from third quarter 2016. There were no non-recurring merger-based expenses in the third quarter 2017 compared to $0.1 million in the third quarter of 2016. Excluding the noted merger-based expenses, noninterest expense increased approximately $1.9 million or 10.2%. Salaries and employee benefits for the third quarter of 2017 were $11.5 million, $1.0 million or 9.2% higher than the third quarter of 2016, due to merit increases, higher equity award costs, and an increase in average full time equivalent employees attributable to the 2017 acquisition. Occupancy, equipment and office expense was $0.6 million higher due to the larger operating base and software needs. Data processing was $0.4 million higher than third quarter 2016 from increased accounts, higher card processing costs and expanded functionalities.

 

The provision for loan losses was $1.0 million and $0.5 million for third quarter 2017 and 2016, respectively. Net charge-offs for the quarter ending September 30, 2017 were $1.1 million (due to the charge off of a large commercial loan) compared to a net recovery of $0.1 million for the third quarter of 2016. At September 30, 2017, the ALLL was $12.6 million (or 0.61% of total loans) compared to $11.5 million (or 0.74% of total loans) at September 30, 2016. The decline in the ratio was a result of recording the First Menasha loan portfolio at fair value with no carryover of their allowance at the time of the merger.

 

Income tax expense was $5.1 million and $3.4 million for the third quarters of 2017 and 2016, respectively. The effective tax rates were 34.9% for third quarter 2017 and 34.5% for third quarter 2016.

 

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, among others, the general building and paper industries. 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.

 

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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, 2017 was 53% commercial, 22% CRE loans, 24% residential real estate, and 1% retail and other loans; and grouped further the loan mix was 75% commercial-based and 25% retail-based.

 

Total loans were $2.1 billion at September 30, 2017 compared to $1.6 billion at December 31, 2016. Compared to September 30, 2016, loans grew $497 million or 32%, primarily as a result of the $351 million loans added from First Menasha at acquisition in April 2017 and also through strong organic growth. On average, loans were $1.8 billion and $1.3 billion for the first nine months of 2017 and 2016, respectively, up 45%, largely attributable to the timing of inclusion of acquired loans. At the time of the merger, the acquired First Menasha loan portfolio was somewhat similar to Nicolet’s pre-merger loan mix, with the most notable differences being a higher mix in CRE investment and a lower mix in commercial and industrial loans. The majority of organic growth experienced in the first nine months of 2017 has been in commercial and industrial loans.

 

Table 8: Period End Loan Composition

 

   September 30, 2017   December 31, 2016   September 30, 2016 
   Amount   % of
Total
   Amount   % of
Total
   Amount   % of
Total
 
Commercial & industrial  $625,729    30.5%  $428,270    27.3%  $423,790    27.3%
Owner-occupied CRE   428,054    20.9    360,227    23.0    362,554    23.3 
AG production   36,352    1.8    34,767    2.2    34,077    2.2 
AG real estate   48,443    2.4    45,234    2.9    45,671    2.9 
CRE investment   303,448    14.8    195,879    12.5    197,884    12.7 
Construction & land development   87,649    4.3    74,988    4.8    68,161    4.4 
Residential construction   33,163    1.6    23,392    1.5    27,331    1.8 
Residential first mortgage   363,116    17.7    300,304    19.1    284,653    18.3 
Residential junior mortgage   102,654    5.0    91,331    5.8    95,901    6.2 
Retail & other   22,514    1.0    14,515    0.9    14,102    0.9 
Total loans  $2,051,122    100.0   $1,568,907    100.0%  $1,554,124    100.0%

 

Broadly, loans were 75% commercial-based and 25% retail-based at September 30, 2017 compared to 73% commercial-based and 27% retail-based at December 31, 2016. 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.

 

Commercial and industrial loans consist primarily of commercial loans to small businesses within a diverse range of industries and, to a lesser degree, to municipalities. 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 $197 million to $626 million since year end 2016, largely attributable to acquired First Menasha loans and strong organic growth. Commercial and industrial loans continue to be the largest segment of Nicolet’s portfolio and increased to 30.5% of the total portfolio at September 30, 2017, up from 27.3% at December 31, 2016.

 

Owner-occupied CRE loans decreased to 20.9% of loans at September 30, 2017 from 23.0% at December 31, 2016. 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 $5 million since year end 2016, representing 4.2% of total loans at September 30, 2017, versus 5.1% at December 31, 2016.

 

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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 $108 million since year end 2016, largely attributable to the acquired First Menasha loan mix, representing 14.8% of total loans at September 30, 2017 compared to 12.5% of total loans at December 31, 2016.

 

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, 2016, balances have increased $13 million, and this category represented 4.3% and 4.8% of total loans at September 30, 2017 and year-end 2016, respectively.

 

On a combined basis, Nicolet’s residential real estate loans represent 24.3% of total loans at September 30, 2017, down from 26.4% at December 31, 2016. 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, 2016 to September 30, 2017.

 

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, 2017, 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.

 

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.

 

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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. The look-back period on which the average historical loss rates are determined is a rolling 20-quarter (5 year) average. 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 conducts its allocation methodology on both the originated loans and on the acquired loans separately to account for differences, such as different loss histories and qualitative factors, between the two segments.

 

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, 2017, the ALLL was $12.6 million compared to $11.8 million at December 31, 2016. The nine-month increase was a result of a 2017 provision of $1.9 million exceeding 2017 net charge offs of $1.1 million. Comparatively, the provision for loan losses in the first nine months of 2016 was $1.4 million and net charge offs were $0.2 million. Annualized net charge offs as a percent of average loans were 0.08% in the first nine months of 2017 compared to 0.02% for the first nine months of 2016 and 0.02% for the entire 2016 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.

 

The ratio of the ALLL as a percentage of period-end loans was 0.61% at September 30, 2017 (with a 0.89% ratio on originated loans and a 0.25% ratio on acquired loans) compared to 0.75% at December 31, 2016 (with a 1.05% ratio on originated loans and a 0.36% ratio on acquired loans). The ALLL to loans ratio is impacted by the accounting treatment of Nicolet’s 2013, 2016 and 2017 bank acquisitions, which combined at their acquisition dates added no ALLL to the numerator and $1.3 billion of loans into the denominator. Acquired loans were $885 million and $667 million at September 30, 2017 and December 31, 2016, respectively, representing 43% of total loans at both September 30, 2017 and December 31, 2016. The change in the ALLL to loans ratio was driven by the increase in the denominator from acquired loans in 2016 and 2017.

 

The largest portions of the ALLL were allocated to commercial & industrial (“C&I”) loans and owner-occupied CRE loans combined, representing 60.9% and 57.5% of the ALLL at September 30, 2017 and December 31, 2016, respectively. Most notably since December 31, 2016, the increased allocations to C&I (from 33.2% to 39.9%), and the decreased allocation in owner-occupied CRE investment (from 24.3% to 21.0%) was largely the result of changes to allowance allocations in conjunction with changes in past due and loss histories and balance mix changes. The large $1.0 million charge-off in the third quarter of 2017 was an originated C&I loan.

 

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Table 9: Loan Loss Experience

 

   For the nine months ended   Year ended 
(in thousands)  September 30,
2017
   September 30,
2016
   December 31,
2016
 
Allowance for loan losses (ALLL):               
Balance at beginning of period  $11,820   $10,307   $10,307 
Provision for loan losses   1,875    1,350    1,800 
Charge-offs   (1,156)   432    (584)
Recoveries   71    (256)   297 
Net charge-offs   (1,085)   176    (287)
Balance at end of period  $12,610   $11,481   $11,820 
                
Net loan charge-offs (recoveries):               
Commercial & industrial  $1,077   $262   $253 
Owner-occupied CRE   (29)   58    103 
Agricultural production   -    -    - 
Agricultural real estate   -    -    - 
CRE investment   (1)   (221)   (221)
Construction & land development   13    -    - 
Residential construction   -    -    - 
Residential first mortgage   2    (5)   49 
Residential junior mortgage   (2)   46    49 
Retail & other   25    36    54 
Total net loans charged-off  $1,085   $176   $287 
                
ALLL to total loans   0.61%   0.74%   0.75%
ALLL to net charge-offs   1,162.2%   6,523.3%   4,118.5%
Net charge-offs to average loans, annualized   0.08%   0.02%   0.02%

 

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, 2017 and December 31, 2016.

 

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Table 10: Allocation of the Allowance for Loan Losses

 

(in thousands)  September 30, 2017   % of Loan
Type to
Total
Loans
   December 31, 2016   % of Loan
Type to
Total
Loans
 
ALLL allocation                    
Commercial & industrial  $5,025    30.5%  $3,919    27.3%
Owner-occupied CRE   2,643    20.9    2,867    23.0 
Agricultural production   166    1.8    150    2.2 
Agricultural real estate   268    2.4    285    2.9 
CRE investment   1,257    14.8    1,124    12.5 
Construction & land development   742    4.3    774    4.8 
Residential construction   167    1.6    304    1.5 
Residential first mortgage   1,658    17.7    1,784    19.1 
Residential junior mortgage   467    5.0    461    5.8 
Retail & other   217    1.0    152    0.9 
Total ALLL  $12,610    100.0%  $11,820    100.0%
                     
ALLL category as a percent of total ALLL:                    
Commercial & industrial   39.9%        33.2%     
Owner-occupied CRE   21.0         24.3      
Agricultural production   1.3         1.3      
Agricultural real estate   2.1         2.4      
CRE investment   10.0         9.5      
Construction & land development   5.9         6.5      
Residential construction   1.3         2.6      
Residential first mortgage   13.1         15.1      
Residential junior mortgage   3.7         3.9      
Retail & other   1.7         1.2      
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 $14.4 million (consisting of $1.0 million originated loans and $13.4 million acquired loans) at September 30, 2017 compared to $20.3 million at December 31, 2016 (consisting of $0.3 million originated loans and $20.0 million acquired loans). Nonperforming assets (which include nonperforming loans and other real estate owned “OREO”) were $15.7 million at September 30, 2017 compared to $22.3 million at December 31, 2016. OREO was $1.3 million at September 30, 2017, down from $2.1 million at year end 2016, the majority of which is closed bank branch property. Nonperforming assets as a percent of total assets were 0.55% at September 30, 2017 compared to 0.97% at December 31, 2016.

 

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 $14.1 million (0.7% of loans) and $12.6 million (0.8% of loans) at September 30, 2017 and December 31, 2016, 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.

 

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Table 11: Nonperforming Assets

 

(in thousands)  September 30,
2017
   December 31,
2016
   September 30,
 2016
 
Nonaccrual loans:               
Commercial & industrial  $5,078   $358   $680 
Owner-occupied CRE   1,276    2,894    2,986 
AG production   2    9    23 
AG real estate   186    208    208 
CRE investment   4,537    12,317    13,216 
Construction & land development   723    1,193    1,220 
Residential construction   80    260    287 
Residential first mortgage   2,301    2,990    2,656 
Residential junior mortgage   239    56    212 
Retail & other            
Total nonaccrual loans   14,422    20,285    21,488 
Accruing loans past due 90 days or more            
Total nonperforming loans  $14,422   $20,285   $21,488 
OREO:               
Commercial & industrial  $   $64   $64 
Owner-occupied CRE   25    304    278 
CRE investment   160         
Construction & land development   90    623    651 
Residential real estate owned       29    109 
Bank property real estate owned   1,039    1,039    1,087 
Total OREO   1,314    2,059    2,189 
Total nonperforming assets  $15,736   $22,344   $23,677 
Total restructured loans accruing  $   $   $ 
Ratios               
Nonperforming loans to total loans   0.70%   1.29%   1.38%
Nonperforming assets to total loans plus OREO   0.77%   1.42%   1.52%
Nonperforming assets to total assets   0.55%   0.97%   1.04%
ALLL to nonperforming loans   87.4%   58.3%   53.4%
ALLL to total loans   0.61%   0.75%   0.74%

 

Table 12: Investment Securities Portfolio

 

   September 30, 2017   December 31, 2016 
(in thousands)  Amortized
Cost
   Fair
Value
   % of
Fair
Value
   Amortized
Cost
   Fair
Value
   % of
Fair
Value
 
U.S. government sponsored enterprises  $26,394   $26,272    6%  $1,981   $1,963    1%
State, county and municipals   189,226    188,716    46    191,721    187,243    51 
Mortgage-backed securities   159,113    157,936    39    161,309    159,129    44 
Corporate debt securities   32,203    32,744    8    12,117    12,169    3 
Equity securities   1,288    2,549    1    2,631    4,783    1 
Total  $408,224   $408,217    100%  $369,759   $365,287    100%

 

At September 30, 2017 the total carrying value of investment securities was $408.2 million, up from $365.3 million at December 31, 2016, and represented 14.3% and 15.9% of total assets at September 30, 2017 and December 31, 2016, respectively. The increase since year end 2016 was largely attributable to investment securities added from First Menasha at acquisition in April 2017 as well as purchase activity. At September 30, 2017, 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.

 

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In addition to securities available for sale, Nicolet has other investments, 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. Other investments totaled $14.9 million at September 30, 2017 and $17.5 million at December 31, 2016, with the decline primarily attributable to redeemed FHLB stock. One equity investment had an OTTI charge of $0.5 million recorded in the fourth quarter of 2016. There were no OTTI charges recorded in 2017.

 

Table 13: Investment Securities Portfolio Maturity Distribution

 

   As of September 30, 2017 
   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  $    %  $10,406    0.1%  $15,988    0.1%  $    %  $    %  $26,394    0.3%  $26,272 
State and county municipals (1)   13,262    2.5    74,612    2.8    100,339    2.5    1,013    2.9            189,226    2.6    188,716 
Mortgage-backed securities                                   159,113    2.9    159,113    3.0    157,936 
Corporate debt securities           11,080    4.2    14,150    2.9    6,973    5.8            32,203    3.9    32,744 
Equity securities                                   1,288    2.4    1,288    2.4    2,549 
                                                                  
Total amortized cost  $13,262    2.5%  $96,098    2.7%  $130,477    2.2%  $7,986    5.4%  $160,401    2.9%  $408,224    2.7%  $408,217 
Total fair value and carrying value  $13,261        $96,410        $129,769        $8,292        $160,485                  $408,217 
                                                                  
As a percent of total fair value   3%        24%        32%        2%        39%                  100%

 

 

 

(1)The yield on tax-exempt investment securities is computed on a tax-equivalent basis using a federal tax rate of 35% 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 $126 million at September 30, 2017 and $21 million at December 31, 2016.

 

Table 14: Deposits

 

   September 30, 2017   December 31, 2016 
(in thousands)  Amount   % of
Total
   Amount   % of
Total
 
Demand  $638,447    27.0%  $482,300    24.5%
Money market and NOW accounts   1,107,360    46.8    964,509    49.0 
Savings   274,828    11.6    221,282    11.2 
Time   346,316    14.6    301,895    15.3 
Total deposits  $2,366,951    100.0%  $1,969,986    100.0%

 

Total deposits were $2.4 billion at September 30, 2017, up $397 million or 20% since December 31, 2016, largely attributable to the $375 million deposits added from First Menasha at acquisition in April 2017. On average for the first nine months of 2017, total deposits were $2.2 billion, up $631 million, or 41%, from the comparable 2016 period, largely attributable to the inclusion of acquired Baylake deposits for all of 2017 versus five of nine months in 2016 and acquired First Menasha deposits for five months of 2017 versus no months in 2016. On average, the mix of deposits changed between the comparable nine-month periods, with 2017 carrying more in brokered deposits, demand (i.e. noninterest bearing) deposits and 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, 2017   September 30, 2016 
(in thousands)  Amount   % of
Total
   Amount   % of
Total
 
Demand  $516,412    23.7%  $348,765    22.6%
Money market and NOW accounts   1,064,585    48.9    732,721    47.4 
Savings   249,099    11.5    184,156    11.9 
Time   345,264    15.9    278,685    18.1 
Total  $2,175,360    100.0%  $1,544,327    100.0%

 

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

 

(in thousands)  September 30,
2017
 
3 months or less  $19,226 
Over 3 months through 6 months   25,973 
Over 6 months through 12 months   44,218 
Over 12 months   71,655 
Total  $161,072 

 

Other Funding Sources

 

Other funding sources included short-term borrowings ($12.9 million at September 30, 2017 and zero at December 31, 2016) and long-term borrowings (totaling $83.0 million at September 30, 2017 and $37.6 million at December 31, 2016). Short-term borrowings, when used, consist mainly of federal funds purchased, overnight borrowings with correspondent financial institutions, FHLB advances with original maturities of one year or less, and customer repurchase agreements maturing in less than six months. Long-term borrowings include notes payable (consisting of FHLB advances with original maturities greater than one year), 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). 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.

 

At September 30, 2017, additional funding sources consist of a $10 million available and unused line of credit at the holding company, $158 million of available and unused federal funds purchased lines, and remaining available total borrowing capacity at the FHLB of $115 million.

 

Off-Balance Sheet Obligations

 

As of September 30, 2017 and December 31, 2016, Nicolet had the following commitments that did not appear on its balance sheet:

 

Table 17: Commitments

 

   September 30,   December 31, 
   2017   2016 
(in thousands)        
Commitments to extend credit — fixed and variable rate  $660,578   $554,980 
Financial letters of credit   9,381    12,444 
Standby letters of credit   8,006    4,898 

 

Interest rate lock commitments to originate residential mortgage loans held for sale and forward commitments to sell residential mortgage loans held for sale are considered derivative instruments and represented $32.2 million and $5.9 million, respectively, at September 30, 2017. Fair value approximates the notional amounts.

 

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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.

 

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 $77 million of the $408 million investment securities portfolio at September 30, 2017 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, 2017 and December 31, 2016 were $96 million and $129 million, respectively. These levels have decreased through the first nine months of 2017 with $117 million net cash used by investing activities (mostly due to a net increase in loans and securities), partially offset by $30 million net cash provided by operating activities and $54 million net cash provided by financing activities (mostly due to a net increase in deposits). Nicolet’s liquidity resources were sufficient as of September 30, 2017 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, 2017, the projected changes in net interest income over a one-year time horizon, versus the baseline, was -0.5%, -0.2%, 0.3% and 0.6% for the -200, -100, +100 and +200 bps scenarios, respectively; such results are within Nicolet’s guidelines of not greater than -10% for +/- 100 bps and not greater than -15% 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.

 

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At September 30, 2017, Nicolet’s capital structure consisted of $360.4 million of common stock equity compared to $275.9 million of common equity at December 31, 2016. Nicolet’s common equity, representing 12.7% of total assets at September 30, 2017 and 12.0% at December 31, 2016, continues to reflect capacity to capitalize on opportunities. Nicolet’s common stock was accepted by shareholders as the primary consideration in the recent 2017 and 2016 acquisitions, as described in Note 2 – “Acquisitions,” in the notes to the unaudited consolidated financial statements.

 

On April 28, 2017 as part of the First Menasha merger, Nicolet issued 1.3 million shares of common stock for common stock consideration of $62.2 million. On April 29, 2016 as part of the Baylake merger, Nicolet issued 4.3 million 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. Book value per common share increased 14% to $36.78 at September 30, 2017 from $32.26 at year end 2016 aided mostly by the common equity issued in the 2017 acquisition and retained earnings exceeding stock purchases.

 

As shown in Table 18, Nicolet’s regulatory capital ratios remain well above minimum regulatory ratios. Also, at September 30, 2017, the Bank’s regulatory capital ratios qualify the Bank as well-capitalized under the prompt-corrective action framework with hurdles of 10.0%, 8.0%, 6.5% and 5.0%, respectively. This strong base of capital has allowed Nicolet to be opportunistic in the current environment and in strategic growth.

 

The primary source of income and funds for the parent company is 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 federal regulatory agencies. At September 30, 2017, the Bank could pay dividends of approximately $13.9 million without seeking regulatory approval. During 2016, the Bank paid $35.5 million of dividends (which included a special dividend of $15 million out of Bank surplus) to the parent company, and paid $10 million of dividends during the first nine months of 2017. On October 17, 2017, the Bank declared and paid a $12 million dividend to the Company.

 

A summary of Nicolet’s and Nicolet National Bank’s regulatory capital amounts and ratios as of September 30, 2017 and December 31, 2016 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, 2017:                              
Company                              
Total capital  $293,800    12.8%  $183,929    8.0%          
Tier 1 capital   269,277    11.7    137,947    6.0           
CET 1 capital   240,351    10.5    103,460    4.5           
Leverage   269,277    10.0    108,169    4.0           
                               
Bank                              
Total capital  $279,665    12.2%  $183,696    8.0%  $229,620    10.0%
Tier 1 capital   267,055    11.6    137,772    6.0    183,696    8.0 
CET 1 capital   267,055    11.6    103,329    4.5    149,253    6.5 
Leverage   267,055    9.9    108,053    4.0    135,067    5.0 
                               
As of December 31, 2016:                              
Company                              
Total capital  $249,723    13.9%  $144,195    8.0%          
Tier 1 capital   226,018    12.5    108,146    6.0           
CET 1 capital   202,313    11.2    81,110    4.5           
Leverage   226,018    10.3    87,566    4.0           
                               
Bank                              
Total capital  $217,682    12.1%  $144,322    8.0%  $180,403    10.0%
Tier 1 capital   205,862    11.4    108,242    6.0    144,322    8.0 
CET 1 capital   205,862    11.4    81,181    4.5    117,262    6.5 
Leverage   205,862    9.4    87,329    4.0    109,161    5.0 

 

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(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.

 

Future Accounting Pronouncements

 

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. Since a significant number of business transactions are not subject to the guidance, it is not expected to have a material impact on the Company’s financial statements when it goes into effect the first quarter of 2018.

 

In August 2017, the FASB issued updated guidance to ASU 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities. ASU 2017-12 expands the activities that qualify for hedge accounting and simplifies the rules for reporting hedging transactions. The updated guidance is effective for interim and annual reporting periods beginning after December 15, 2018, with early adoption permitted. The Company is currently assessing the impact of the new guidance on its consolidated financial statements, and it is not expected to have a significant impact on its consolidated financial statements because the Company does not have any significant derivatives and does not currently apply hedge accounting to derivatives.

 

In May 2017, the FASB issued updated guidance to ASU 2017-09, Compensation - Stock Compensation (Topic 718). ASU 2017-09 applies to entities that change the terms or conditions of a share-based payment award to provide clarity and reduce diversity in practice as well as cost and complexity when applying the guidance in Topic 718 to the modification to the terms and conditions of a share-based payment award. The updated guidance is effective for interim and annual reporting periods beginning after December 15, 2017, with early adoption 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.

 

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 President and Chief Executive Officer 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 President and Chief Executive Officer and the Chief Financial Officer concluded that our disclosure controls and procedures were effective.

 

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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.

 

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, 2016.

 

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

 

Following are Nicolet’s monthly common stock purchases during the third quarter of 2017.

 

   Total Number of
Shares Purchased (a)
   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, 2017   338   $54.82        458,000 
August 1– August 31, 2017   49,699   $53.45    49,699    408,000 
September 1 – September 30, 2017   17,316   $54.14    16,846    391,000 
Total   67,353   $53.63    66,545    391,000 

 

(a)During the third quarter of 2017, the Company repurchased 0 and 808 shares for minimum tax withholding settlements on restricted stock and net settlements of stock options, respectively. These purchases do not count against the maximum number of shares that may yet be purchased under the board of directors’ authorization.

 

(b)During early 2014, a common stock repurchase program was approved which authorized, with subsequent modifications the use of up to $30 million to repurchase up to 1,050,000 shares of outstanding common stock. At September 30, 2017, approximately $8.6 million remained available to repurchase up to 391,000 common shares. Using the closing stock price on September 30, 2017 of $57.53, a total of approximately 149,000 shares of common stock could be repurchased under this plan. Nicolet resumed repurchases of its shares under this program during the second quarter of 2017.

 

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
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.

 

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 3, 2017 /s/ Robert B. Atwell
  Robert B. Atwell
  Chairman, President and Chief Executive Officer
   
November 3, 2017 /s/ Ann K. Lawson
  Ann K. Lawson
  Chief Financial Officer

 

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