UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.
For the fiscal year ended December 31, 2016
¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from…………to………….
Commission file number 001-37700
NICOLET BANKSHARES, INC.
(Exact name of registrant as specified in its charter)
|(State or other jurisdiction of incorporation or organization)||(I.R.S. Employer Identification No.)|
111 North Washington Street
Green Bay, Wisconsin 54301
(Address, including zip code, and telephone number, including area code, of Registrant’s principal executive offices)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
|Title of each class||Name of each exchange on which registered|
|Common Stock, par value $0.01 per share||The NASDAQ Stock Market LLC|
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d). Yes ¨ No x
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 Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer ¨ Accelerated filer x Non-accelerated filer ¨ Smaller reporting company ¨
(Do not check if a smaller reporting company)
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
As of June 30, 2016, (the last business day of the registrant’s most recently completed second fiscal quarter) the aggregate market value of the common stock held by nonaffiliates of the registrant was approximately $284.9 million based on the closing sale price of $38.08 per share as reported on Nasdaq on June 30, 2016. The registrant’s common stock commenced trading on the Nasdaq Capital Market on February 24, 2016.
As of February 28, 2017, 8,588,634 shares of common stock were outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Part III of Form 10-K – Portions of the Proxy Statement for the 2017 Annual Meeting of Shareholders.
Nicolet Bankshares, Inc.
TABLE OF CONTENTS
|Item 1A.||Risk Factors||10-15|
|Item 1B.||Unresolved Staff Comments||16|
|Item 3.||Legal Proceedings||16|
|Item 4.||Mine Safety Disclosures||16|
|Item 5.||Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities||17-18|
|Item 6.||Selected Financial Data||18-19|
|Item 7.||Management’s Discussion and Analysis of Financial Condition and Results of Operation||20-47|
|Item 7A.||Quantitative and Qualitative Disclosures about Market Risk||47|
|Item 8.||Financial Statements and Supplementary Data||48-98|
|Item 9.||Changes in and Disagreements with Accountants on Accounting and Financial Disclosure||99|
|Item 9A.||Controls and Procedures||99|
|Item 9B.||Other Information||99|
|Item 10.||Directors, Executive Officers and Corporate Governance||100|
|Item 11.||Executive Compensation||100|
|Item 12.||Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters||100|
|Item 13.||Certain Relationships and Related Transactions, and Director Independence||100|
|Item 14.||Principal Accountant Fees and Services||100|
|Item 15.||Exhibits and Financial Statement Schedules||101-102|
This Annual Report on Form 10-K contains forward-looking statements within the meaning of the federal securities law. Statements in this report that are not strictly historical are forward-looking and based upon current expectations that may differ materially from actual results. These forward-looking statements, identified by words such as “will”, “expect”, “believe” and “prospects”, involve risks and uncertainties that could cause actual results to differ materially from those anticipated by the statement made herein. These risks and uncertainties include, but are not limited to, general economic trends and changes in interest rates, increased competition, regulatory or legislative developments affecting the financial industry generally or Nicolet Bankshares, Inc. specifically, changes in consumer demand for financial services, the possibility of unforeseen events affecting the industry generally or Nicolet Bankshares, Inc. specifically, the uncertainties associated with newly developed or acquired operations and market disruptions. Nicolet Bankshares, Inc. undertakes no obligation to release revisions to these forward-looking statements publicly to reflect events or circumstances after the date hereof or to reflect the occurrence of unforeseen events, except as required to be reported under the rules and regulations of the Securities and Exchange Commission (“SEC”).
Nicolet Bankshares, Inc. (individually referred to herein as the “Parent Company” and together with all its subsidiaries collectively referred to herein as “Nicolet,” the “Company,” “we,” “us” or “our”) is a registered bank holding company under the Bank Holding Company Act of 1956, as amended, and under the bank holding company laws of the State of Wisconsin. At December 31, 2016, Nicolet had total assets of $2.3 billion, loans of $1.6 billion, deposits of $2.0 billion and total stockholders’ equity of $276 million. For the year ended December 31, 2016, Nicolet earned net income of $18.5 million, and after $0.6 million of preferred stock dividends, net income available to common shareholders was $17.9 million or $2.37 per diluted common share. For 2016, Nicolet’s return on average assets was 0.95%.
Nicolet is a Wisconsin corporation, originally incorporated on April 5, 2000 as Green Bay Financial Corporation, a Wisconsin corporation, to serve as the holding company for and the sole shareholder of Nicolet National Bank. It amended and restated its articles of incorporation and changed its name to Nicolet Bankshares, Inc. on March 14, 2002. It subsequently became the holding company for the Bank upon the completion of the Bank’s reorganization into a holding company structure on June 6, 2002. Nicolet elected to become a financial holding company in 2008.
Nicolet conducts operations through its wholly owned subsidiary, Nicolet National Bank, a commercial bank which was organized in 2000 as a national bank under the laws of the United States and opened for business, in Green Bay, Brown County, Wisconsin, on November 1, 2000 (referred to herein as the “Bank”). Structurally, Nicolet also wholly owns a registered investment advisory firm, Brookfield Investment Partners, LLC. (“Brookfield”), that principally provides investment strategy and transactional services to select community banks, wholly owns a registered investment advisory firm, Nicolet Advisory Services, LLC (“Nicolet Advisory”), that conducts brokerage and financial advisory services primarily to individual consumers, and entered into a joint venture that provides for 50% ownership of the building in which Nicolet is headquartered. Structurally, the Bank wholly owns an investment subsidiary based in Nevada, wholly owns a subsidiary in Green Bay that provides a web-based investment management platform for financial advisor trades and related activity, and the Bank owns 99.2% of United Financial Services, Inc (“UFS Inc.”) which in turn owns 50.2% of UFS, LLC, a data processing services company located in Grafton, Wisconsin (collectively referred to herein as “UFS”). These subsidiaries are closely related to or incidental to the business of banking and none are individually or collectively significant to Nicolet’s financial position or results as of December 31, 2016.
The Bank is a full-service community bank, offering traditional banking products and services, and trust and brokerage products and services, to businesses and individuals in the markets it serves, delivered through a branch network serving northeast and central Wisconsin communities and Menominee, Michigan, as well as through on-line and mobile banking capabilities.
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, and mortgage income from sales of residential mortgages into the secondary market), 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.
Since its opening in late 2000, Nicolet has supplemented its organic growth with the December 2003 purchase of a branch and deposits in Menominee, Michigan, the July 2010 purchase of 4 branches and deposits in Brown County, the April 2013 merger transaction with Mid-Wisconsin Financial Services, Inc. (“Mid-Wisconsin”), the August 2013 acquisition of selected assets and liabilities of Bank of Wausau through a transaction with the Federal Deposit Insurance Corporation (“FDIC”) (the latter two collectively referred to as the “2013 acquisitions”), and two transactions completed in the first half of 2016 (collectively the “2016 acquisitions”) consisting of a private transaction to hire a select group of financial advisors and to purchase their respective books of business and operating platform completed on April 1, 2016 and the merger transaction with Baylake Corp. (“Baylake”) consummated on April 29, 2016.
On November 4, 2016, Nicolet announced the signing of an Agreement and Plan of Merger with First Menasha Bancshares, Inc. (“First Menasha” (OTCQX: FMBJ)) pursuant to which First Menasha will merge with and into Nicolet. As of December 31, 2016, First Menasha had total assets of $465 million, loans of $365 million, deposits of $383 million and total stockholders’ equity of $47 million. The merger with First Menasha is expected to close in April of 2017.
Products and Services Overview
Nicolet’s principal business is banking, consisting of lending and deposit gathering, as well as ancillary banking-related products and services, to businesses and individuals of the communities it serves, and the operational support to deliver, fund and manage such banking products and services. Additionally, through the Bank and Nicolet Advisory, trust, brokerage and other investment management services for individuals and retirement plan services for business customers are offered. Nicolet delivers its products and services principally through 36 bank branch locations, on-line banking, mobile banking and an interactive website. Nicolet’s call center also services customers.
Nicolet offers a variety of loans, deposits and related services to business customers (especially small and medium-sized businesses and professional concerns), including but not limited to: business checking and other business deposit products and cash management services, international banking services, business loans, lines of credit, commercial real estate financing, construction loans, agricultural real estate or production loans, and letters of credit, as well as retirement plan services. Similarly, Nicolet offers a variety of banking products and services to consumers, including but not limited to: residential mortgage loans and mortgage refinancing, home equity loans and lines of credit, residential construction loans, personal loans, checking, savings and money market accounts, various certificates of deposit and individual retirement accounts, safe deposit boxes, and personal brokerage, trust and fiduciary services. Nicolet also provides on-line services including commercial, retail and trust on-line banking, automated bill payment, mobile banking deposits and account access, remote deposit capture, and telephone banking, and other services such as wire transfers, debit cards, credit cards, pre-paid gift cards, direct deposit, official bank checks and U.S. savings bonds.
Lending is critical to Nicolet’s balance sheet and earnings potential. Nicolet seeks creditworthy borrowers principally within the geographic area of its branch locations. As a community bank with experienced commercial lenders and residential mortgage lenders, the primary lending function is to make commercial loans (consisting of commercial, industrial, and business loans and lines of credit, owner-occupied commercial real estate (“owner-occupied CRE”), and agricultural (“AG”) production loans]; commercial real estate (“CRE”) loans [consisting of investment real estate loans (“CRE investment”), AG real estate, and construction and land development loans); residential real estate loans (consisting of residential first lien mortgages, junior lien mortgages, home equity loans and lines of credit, and to a lesser degree residential construction loans); and other loans, mainly consumer in nature. As of December 31, 2016, Nicolet’s loan portfolio mix was as follows:
|Loan category||% of Total Loans|
|Commercial & industrial||27||%|
|Total commercial loans||53||%|
|AG real estate||3||%|
|Construction & land development||4||%|
|Total CRE loans||20||%|
|Residential first mortgages||19||%|
|Residential junior mortgages||6||%|
|Total residential real estate loans||26||%|
Lending involves credit risk. Nicolet has and follows extensive loan policies and procedures to standardize processes, meet compliance requirements and prudently manage underwriting, credit and other risks. Credit risk is further controlled and monitored through active asset quality management including the use of lending standards, thorough review of current and potential borrowers through Nicolet’s underwriting process, close relationships with and regular check-ins with borrowers, and active asset quality administration. For further discussion of credit risk management, see “Management’s Discussion and Analysis of Financial Condition and Results of Operation,” under Part II, Item 7.
At December 31, 2016, Nicolet had approximately 480 full-time equivalent employees. None of our employees are represented by unions.
Market Area and Competition
The Bank is a full-service community bank, providing a full range of traditional commercial and retail banking services throughout northeastern and central Wisconsin and the upper peninsula of Michigan. Nicolet markets its services to owner-managed companies, the individual owners of these businesses, and other residents of its market area, which at December 31, 2016 is through 36 branches located within 11 Wisconsin counties (Brown, Door, Outagamie, Kewaunee, Marinette, Taylor, Clark, Marathon, Oneida, Price and Vilas) and in Menominee, Michigan. Based on deposit market share data published by the FDIC as of June 30, 2016, the Bank ranks in the top three of market share for Brown, Door, Kewaunee, Taylor and Clark counties and in the top five for Menominee, Marinette and Price counties.
The financial services industry is highly competitive. Nicolet competes for loans, deposits and wealth management or financial services in all its principal markets. Nicolet competes directly with other bank and nonbank institutions located within our markets (some that may have an established customer base or name recognition), internet-based banks, out-of-market banks that advertise or otherwise serve its markets, money market and other mutual funds, brokerage houses, mortgage companies, insurance companies or other commercial entities that offer financial services products. Competition involves efforts to retain current or procure new customers, obtain new loans and deposits, increase the scope and type of products or services offered, and offer competitive interest rates paid on deposits or earned on loans, as well as to deliver other aspects of banking competitively. Many of Nicolet’s competitors may enjoy competitive advantages, including greater financial resources, broader geographic presence, more accessible branches or more advanced technologic delivery of products or services, more favorable pricing alternatives and lower origination or operating costs.
We believe our competitive pricing, personalized service and community engagement enable us to effectively compete in our markets. Nicolet employs seasoned banking and wealth management professionals with experience in its market areas and who are active in their communities. Nicolet’s emphasis on meeting customer needs in a relationship-focused manner, combined with local decision making on extensions of credit, distinguishes Nicolet from its competitors, particularly in the case of large financial institutions. Nicolet believes it further distinguishes itself by providing a range of products and services characteristic of a large financial institution while providing the personalized service, real conversation, and convenience characteristic of a local, community bank.
Supervision and Regulation
Set forth below is an explanation of the major pieces of legislation and regulation affecting the banking industry and how that legislation and regulation affects Nicolet’s business. The following summary is qualified by reference to the statutory and regulatory provisions discussed. Changes in applicable laws or regulations may have a material effect on the business and prospects of Nicolet or the Bank, and legislative changes and the policies of various regulatory authorities may significantly affect their operations. We cannot predict the effect that fiscal or monetary policies, or new federal or state legislation may have on the future business and earnings of Nicolet or the Bank.
The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), enacted in 2010, contains a comprehensive set of provisions designed to govern the practices and oversight of financial institutions and other participants in the financial markets. The Dodd-Frank Act made extensive changes in the regulation of financial institutions and their holding companies.
Uncertainty remains as to the ultimate impact of the Dodd-Frank Act, which could have a material adverse impact on the financial services industry as a whole or on Nicolet’s and the Bank’s business, results of operations, and financial condition. Many aspects of the Dodd-Frank Act are in the process of being implemented while other aspects remain subject to further rulemaking. These regulations are scheduled to take effect over several years, making it difficult to anticipate the overall financial impact on Nicolet, its customers or the financial industry more generally. However, full implementation of the Dodd-Frank Act would likely increase the regulatory burden, compliance costs and interest expense for Nicolet and the Bank. Some of the rules that have been adopted to comply with the Dodd-Frank Act’s mandates are discussed below.
Regulation of Nicolet
Because Nicolet owns all of the capital stock of the Bank, it is a bank holding company under the federal Bank Holding Company Act of 1956, as amended (the “Bank Holding Company Act”). As a result, Nicolet is primarily subject to the supervision, examination, and reporting requirements of the Bank Holding Company Act and the regulations of the Board of Governors of the Federal Reserve System (the “Federal Reserve”). As a bank holding company located in Wisconsin, the Wisconsin Department of Financial Institutions (the “WDFI”) also regulates and monitors all significant aspects of its operations.
Acquisitions of Banks. The Bank Holding Company Act requires every bank holding company to obtain the prior approval of the Federal Reserve before:
|·||acquiring direct or indirect ownership or control of any voting shares of any bank if, after the acquisition, the bank holding company will directly or indirectly own or control more than 5% of the bank’s voting shares;|
|·||acquiring all or substantially all of the assets of any bank; or|
|·||merging or consolidating with any other bank holding company.|
Additionally, the Bank Holding Company Act provides that the Federal Reserve may not approve any of these transactions if it would result in or tend to create a monopoly, substantially lessen competition, or otherwise function as a restraint of trade, unless the anti-competitive effects of the proposed transaction are clearly outweighed by the public interest in meeting the convenience and needs of the community to be served. The Federal Reserve is also required to consider the financial and managerial resources and future prospects of the bank holding companies and banks involved in the transaction and the convenience and needs of the community to be served. The Federal Reserve’s consideration of financial resources generally focuses on capital adequacy, which is discussed below.
Under the Bank Holding Company Act, if adequately capitalized and adequately managed, Nicolet or any other bank holding company located in Wisconsin may purchase a bank located outside of Wisconsin. Conversely, an adequately capitalized and adequately managed bank holding company located outside of Wisconsin may purchase a bank located inside Wisconsin. In each case, however, restrictions may be placed on the acquisition of a bank that has only been in existence for a limited amount of time or will result in specified concentrations of deposits.
Change in Bank Control. Subject to various exceptions, the Bank Holding Company Act and the Change in Bank Control Act, together with related regulations, require Federal Reserve approval prior to any person or company acquiring “control” of a bank holding company. Control is conclusively presumed to exist if an individual or company acquires 25% or more of any class of voting securities of the bank holding company. Control is rebuttably presumed to exist if a person or company acquires 10% or more, but less than 25%, of any class of voting securities of the bank holding company. The regulations provide a procedure for challenging rebuttable presumptions of control.
Permitted Activities. The Bank Holding Company Act has generally prohibited a bank holding company from engaging in activities other than banking or managing or controlling banks or other permissible subsidiaries and from acquiring or retaining direct or indirect control of any company engaged in any activities other than those determined by the Federal Reserve to be closely related to banking or managing or controlling banks as to be a proper incident thereto. Provisions of the Gramm-Leach-Bliley Act have expanded the permissible activities of a bank holding company that qualifies as a financial holding company to engage in activities that are financial in nature or incidental or complementary to financial activities. Those activities include, among other activities, certain insurance, advisory and security activities.
Nicolet meets the qualification standards applicable to financial holding companies, and elected to become a financial holding company in 2008. In order to remain a financial holding company, Nicolet must continue to be considered well managed and well capitalized by the Federal Reserve, and the Bank must continue to be considered well managed and well capitalized by the Office of the Comptroller of the Currency (the “OCC”) and have at least a “satisfactory” rating under the Community Reinvestment Act.
Support of Subsidiary Institutions. Under Federal Reserve policy and the Dodd-Frank Act, Nicolet is expected to act as a source of financial strength for the Bank and to commit resources to support the Bank. This support may be required at times when, without this Federal Reserve policy or the related rules, Nicolet might not be inclined to provide it.
In addition, any capital loans made by Nicolet to the Bank will be repaid only after the Bank’s deposits and various other obligations are repaid in full.
Capital Adequacy. Nicolet is subject to capital requirements applied on a consolidated basis, which are substantially similar to those required of the Bank, which are summarized below.
Dividend Restrictions. Under Federal Reserve policies, bank holding companies may pay cash dividends on common stock only out of income available over the past year if prospective earnings retention is consistent with the organization's expected future needs and financial condition and if the organization is not in danger of not meeting its minimum regulatory capital requirements. Federal Reserve policy also provides that bank holding companies should not maintain a level of cash dividends that undermines the bank holding company's ability to serve as a source of strength to its banking subsidiaries.
Regulation of the Bank
Because the Bank is chartered as a national bank, it is primarily subject to the supervision, examination, and reporting requirements of the National Bank Act and the regulations of the OCC. The OCC regularly examines the Bank’s operations and has the authority to approve or disapprove mergers, the establishment of branches and similar corporate actions. The OCC also has the power to prevent the continuance or development of unsafe or unsound banking practices or other violations of law. Because the Bank’s deposits are insured by the FDIC to the maximum extent provided by law, it is also subject to certain FDIC regulations and the FDIC also has examination authority and back-up enforcement power over the Bank. The Bank is also subject to numerous state and federal statutes and regulations that affect Nicolet, its business, activities, and operations.
Branching. National banks are required by the National Bank Act to adhere to branching laws applicable to state banks in the states in which they are located. Under Wisconsin law and the Dodd-Frank Act, and with the prior approval of the OCC, the Bank may open branch offices within or outside of Wisconsin, provided that a state bank chartered by the state in which the branch is to be located would also be permitted to establish a branch. In addition, with prior regulatory approval, the Bank may acquire branches of existing banks located in Wisconsin or other states.
Capital Adequacy. Banks and bank holding companies, as regulated institutions, are required to maintain minimum levels of capital. The Federal Reserve and the OCC have adopted minimum risk-based capital requirements (Tier 1 capital, common equity Tier 1 capital (“CET1”) and total capital) and leverage capital requirements, as well as guidelines that define components of the calculation of capital and the level of risk associated with various types of assets. Financial institutions are expected to maintain a level of capital commensurate with the risk profile assigned to their assets in accordance with the guidelines.
In addition to the minimum risk-based capital and leverage ratios, banking organizations must maintain a “capital conservation buffer” consisting of CET1 in an amount equal to 2.5% of risk-weighted assets in order to avoid restrictions on their ability to make capital distributions and to pay certain discretionary bonus payments to executive officers. In order to avoid those restrictions, the capital conservation buffer effectively increases the minimum CET1 capital, Tier 1 capital, and total capital ratios for U.S. banking organizations to 7.0%, 8.5%, and 10.5%, respectively. Banking organizations with capital levels that fall within the buffer will be required to limit dividends, share repurchases or redemptions (unless replaced within the same calendar quarter by capital instruments of equal or higher quality), and discretionary bonus payments. The capital conservation buffer is phased in over a 5-year period beginning January 1, 2016.
The following table presents the risk-based and leverage capital requirements applicable to the Bank:
with Buffer, fully
phased in 2019
Although capital instruments such as trust preferred securities and cumulative preferred shares were required by the Dodd-Frank Act to be phased-out of Tier 1 capital by January 1, 2016, for certain larger banking organizations, Nicolet’s trust preferred securities are permanently grandfathered as Tier 1 capital (provided they do not exceed 25% of Tier 1 capital) as a result of Nicolet qualifying as a smaller entity.
The capital rules require that goodwill and other intangible assets (other than mortgage servicing assets), net of associated deferred tax liabilities (“DTLs”), be deducted from CET1 capital. Additionally, deferred tax assets (“DTAs”) that arise from net operating loss and tax credit carryforwards, net of associated DTLs and valuation allowances, are fully deducted from CET1 capital. However, DTAs arising from temporary differences that could not be realized through net operating loss carrybacks, along with mortgage servicing assets and “significant” (defined as greater than 10% of the issued and outstanding common stock of the unconsolidated financial institution) investments in the common stock of unconsolidated “financial institutions” are partially includible in CET1 capital, subject to deductions defined in the rules.
The OCC also considers interest rate risk (arising when the interest rate sensitivity of the Bank’s assets does not match the sensitivity of its liabilities or its off-balance-sheet position) in the evaluation of the bank’s capital adequacy. Banks with excessive interest rate risk exposure are required to hold additional amounts of capital against their exposure to losses resulting from that risk. Through the risk-weighting of assets, the regulators also require banks to incorporate market risk components into their risk-based capital. Under these market risk requirements, capital is allocated to support the amount of market risk related to a bank’s lending and trading activities.
The Bank’s capital categories are determined solely for the purpose of applying the “prompt corrective action” rules described below and they are not necessarily an accurate representation of its overall financial condition or prospects for other purposes. Failure to meet capital guidelines could subject a bank or bank holding company to a variety of enforcement remedies, including issuance of a capital directive, the termination of deposit insurance by the FDIC, a prohibition on accepting brokered deposits, and certain other restrictions on its business. See “Prompt Corrective Action” below.
Prompt Corrective Action. The Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”) establishes a system of prompt corrective action to resolve the problems of undercapitalized financial institutions. Under this system, the federal banking regulators have established five capital categories: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized, in which all institutions are placed. The federal banking agencies have also specified by regulation the relevant capital levels for each category.
A “well-capitalized” bank is one that is not required to meet and maintain a specific capital level for any capital measure, pursuant to any written agreement, order, capital directive, or prompt corrective action directive, and has a total risk-based capital ratio of at least 10%, a Tier 1 risk-based capital ratio of at least 8%, a common equity Tier 1 capital ratio of at least 6.5%, and a Tier 1 leverage ratio of at least 5%. Generally, a classification as well capitalized will place a bank outside of the regulatory zone for purposes of prompt corrective action. However, a well-capitalized bank may be reclassified as “adequately capitalized” based on criteria other than capital, if the federal regulator determines that a bank is in an unsafe or unsound condition, or is engaged in unsafe or unsound practices, which requires certain remedial action.
As of December 31, 2016, the Bank satisfied the requirements of “well-capitalized” under the regulatory framework for prompt corrective action. See Note 19, “Regulatory Capital Requirements and Restrictions of Dividends,” in the Notes to Consolidated Financial Statements, under Part II, Item 8, for Nicolet and the Bank regulatory capital ratios.
As a bank’s capital position deteriorates, federal banking regulators are required to take various mandatory supervisory actions and are authorized to take other discretionary actions with respect to institutions in the three undercapitalized categories: undercapitalized, significantly undercapitalized, and critically undercapitalized. The severity of the action depends upon the capital category in which the institution is placed. Generally, subject to a narrow exception, the banking regulator must appoint a receiver or conservator for an institution that is critically undercapitalized.
FDIC Insurance Assessments. The Bank’s deposits are insured by the Deposit Insurance Fund of the FDIC up to the maximum amount permitted by law, which was permanently increased to $250,000 by the Dodd-Frank Act. The FDIC uses the Deposit Insurance Fund to protect against the loss of insured deposits if an FDIC-insured bank or savings association fails. The Bank is thus subject to FDIC deposit premium assessments. The cost of premium assessments are impacted by, among other things, a bank’s capital category under the prompt corrective action system.
Commercial Real Estate Lending. The federal banking regulators have issued the following guidance to help identify institutions that are potentially exposed to significant commercial real estate lending risk and may warrant greater supervisory scrutiny:
|·||total reported loans for construction, land development and other land represent 100% or more of the institution’s total capital, or|
|·||total commercial real estate loans represent 300% or more of the institution’s total capital, and the outstanding balance of the institution’s commercial real estate loan portfolio has increased by 50% or more.|
At December 31, 2016 the Bank’s commercial real estate lending levels are below the guidance levels noted above.
Enforcement Powers. The Financial Institution Reform Recovery and Enforcement Act (“FIRREA”) expanded and increased civil and criminal penalties available for use by the federal regulatory agencies against depository institutions and certain “institution-affiliated parties.” Institution-affiliated parties primarily include management, employees, and agents of a financial institution, as well as independent contractors and consultants such as attorneys and accountants and others who participate in the conduct of the financial institution’s affairs. These practices can include the failure of an institution to timely file required reports or the filing of false or misleading information or the submission of inaccurate reports. Civil penalties may be as high as $1,893,610 per day for such violations. Criminal penalties for some financial institution crimes have been increased to 20 years.
Community Reinvestment Act. The Community Reinvestment Act requires that, in connection with examinations of financial institutions within their respective jurisdictions, the federal banking agencies evaluate the record of each financial institution in meeting the credit needs of its local community, including low- and moderate-income neighborhoods. These facts are also considered in evaluating mergers, acquisitions, and applications to open a branch or facility. Failure to adequately meet these criteria could impose additional requirements and limitations on the Bank. Additionally, the Bank must publicly disclose the terms of various Community Reinvestment Act-related agreements.
Payment of Dividends. Statutory and regulatory limitations apply to the Bank’s payment of dividends to Nicolet. If, in the opinion of the OCC, the Bank were engaged in or about to engage in an unsafe or unsound practice, the OCC could require that the Bank stop or refrain from engaging in the practice. The federal banking agencies have indicated that paying dividends that deplete a depository institution’s capital base to an inadequate level would be an unsafe and unsound banking practice.
The Bank is required by federal law to obtain prior approval of the OCC for payments of dividends if the total of all dividends declared by the Bank in any year will exceed (1) the total of the Bank’s net profits for that year, plus (2) the Bank’s retained net profits of the preceding two years, less any required transfers to surplus. The payment of dividends may also be affected by other factors, such as the requirement to maintain adequate capital above regulatory guidelines or any conditions or restrictions that may be imposed by regulatory authorities.
Transactions with Affiliates and Insiders. The Bank is subject to the provisions of Regulation W promulgated by the Federal Reserve, which encompasses Sections 23A and 23B of the Federal Reserve Act. Regulation W places limits and conditions on the amount of loans or extensions of credit to, investments in, or certain other transactions with, affiliates and on the amount of advances to third parties collateralized by the securities or obligations of affiliates. Regulation W also prohibits, among other things, an institution from engaging in certain transactions with certain affiliates unless the transactions are on terms substantially the same, or at least as favorable to such institution or its subsidiaries, as those prevailing at the time for comparable transactions with nonaffiliated companies. Federal law also places restrictions on the Bank’s ability to extend credit to its executive officers, directors, principal shareholders and their related interests. These extensions of credit must be made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unrelated third parties; and must not involve more than the normal risk of repayment or present other unfavorable features.
USA PATRIOT Act. The Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the "USA PATRIOT Act") requires each financial institution to: (i) establish an anti-money laundering program; and (ii) establish due diligence policies, procedures and controls with respect to its private and correspondent banking accounts involving foreign individuals and certain foreign banks. In addition, the USA PATRIOT Act encourages cooperation among financial institutions, regulatory authorities and law enforcement authorities with respect to individuals, entities and organizations engaged in, or reasonably suspected of engaging in, terrorist acts or money laundering activities.
Customer Protection. The Bank is also subject to consumer laws and regulations intended to protect consumers in transactions with depository institutions, as well as other laws or regulations affecting customers of financial institutions generally. While the list set forth herein is not exhaustive, these laws and regulations include the Truth in Lending Act, the Truth in Savings Act, the Electronic Funds Transfer Act, the Expedited Funds Availability Act, the Equal Credit Opportunity Act, the Fair Housing Act, the Real Estate Settlement and Procedures Act, the Fair Credit Reporting Act and the Federal Trade Commission Act, among others. These laws and regulations mandate certain disclosure requirements and regulate the manner in which financial institutions must deal with customers when taking deposits or making loans to such customers.
Consumer Financial Protection Bureau. The Dodd-Frank Act centralized responsibility for consumer financial protection including implementing, examining and enforcing compliance with federal consumer financial laws with the Consumer Financial Protection Bureau (the “CFPB”). Depository institutions with less than $10 billion in assets, such as the Bank, will be subject to rules promulgated by the CFPB but will continue to be examined and supervised by federal banking regulators for consumer compliance purposes.
UDAP and UDAAP. Bank regulatory agencies have increasingly used a general consumer protection statute to address "unethical" or otherwise "bad" business practices that may not necessarily fall directly under the purview of a specific banking or consumer finance law. The law of choice for enforcement against such business practices has been Section 5 of the Federal Trade Commission Act—the primary federal law that prohibits unfair or deceptive acts or practices and unfair methods of competition in or affecting commerce ("UDAP" or "FTC Act"). "Unjustified consumer injury" is the principal focus of the FTC Act. Prior to the Dodd-Frank Act, there was little formal guidance to provide insight to the parameters for compliance with the UDAP law. However, the UDAP provisions have been expanded under the Dodd-Frank Act to apply to "unfair, deceptive or abusive acts or practices" ("UDAAP"), which has been delegated to the CFPB for supervision. The CFPB has brought a variety of enforcement actions for violations of UDAAP provisions and CFPB guidance continues to evolve.
Mortgage Reform. The CFPB has adopted final rules implementing minimum standards for the origination of residential mortgages, including standards regarding a customer's ability to repay, restricting variable-rate lending by requiring that the ability to repay variable-rate loans be determined by using the maximum rate that will apply during the first five years of a variable-rate loan term, and making more loans subject to provisions for higher cost loans, new disclosures, and certain other revisions. In addition, the Dodd-Frank Act allows borrowers to raise certain defenses to foreclosure if they receive any loan other than a “qualified mortgage” as defined by the CFPB.
Nicolet became a public reporting company under Section 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) on March 26, 2013, when Nicolet’s registration statement related to its acquisition of Mid-Wisconsin Financial Services, Inc. (Registration Statement on Form S-4, Regis. No. 333-186401) became effective. Nicolet registered its common stock under Section 12(b) of the Exchange Act on February 24, 2016 in connection with listing on the Nasdaq Capital Market. Nicolet files annual, quarterly, and current reports, and other information with the SEC. These filings are available to the public on the Internet at the SEC’s website at www.sec.gov. Shareholders may also read and copy any document that we file at the SEC’s public reference rooms located at 100 F Street, NE, Washington, DC 20549. Shareholders may call the SEC at 1-800-SEC-0330 for further information on the public reference room.
Nicolet’s internet address is www.nicoletbank.com. We make available free of charge on or through our website our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC.
|ITEM 1A.||RISK FACTORS|
An investment in our common stock involves risks. If any of the following risks, or other risks which have not been identified or which we may believe are immaterial or unlikely, actually occurs, our business, financial condition and results of operations could be harmed. In such a case, the trading price of our common stock could decline, and you could lose all or part of your investment. The risks discussed below also include forward-looking statements, and our actual results may differ substantially from those discussed in these forward-looking statements.
Risks Relating to Nicolet’s Business
Nicolet may not be able to sustain its historical rate of growth, or may encounter issues associated with its growth, either of which could adversely affect our financial condition, results of operations, and share price.
We have grown over the past several years and intend to continue to pursue a significant growth strategy for our business. Our prospects must be considered in light of the risks, expenses and difficulties frequently encountered by companies in significant growth stages of development. We may not be able to further expand our market presence in existing markets or to enter new markets successfully, nor can we guarantee that any such expansion would not adversely affect our results of operations. Failure to manage growth effectively could have a material adverse effect on the business, future prospects, financial condition or results of our operations, and could adversely affect our ability to successfully implement business strategies. Also, if such growth occurs more slowly than anticipated or declines, our operating results could be materially adversely affected.
Our ability to grow successfully will depend on a variety of factors including the continued availability of desirable business opportunities, the competitive responses from other financial institutions in our market areas and the ability to manage our growth. While we believe we have the management resources and internal systems in place to manage future growth successfully, there can be no assurance that growth opportunities will be available or that any growth will be managed successfully. In addition, our recent growth may distort some of our historical financial ratios and statistics.
As part of our growth strategy, we regularly evaluate merger and acquisition opportunities and conduct due diligence activities related to possible transactions with other financial institutions and financial services companies. As a result, negotiations may take place and future mergers or acquisitions involving cash, debt, or equity securities may occur at any time. We seek merger or acquisition partners that are culturally similar, have experienced management, and possess either significant market presence or have potential for improved profitability through financial management, economies of scale, or expanded services.
As noted above in Item 1, Business, Nicolet completed its acquisition of Baylake on April 29, 2016, and completed the hiring of a select group of financial advisors and purchase of their respective books of business and operating platform on April 1, 2016. In addition, on November 4, 2016, we announced the signing of a definitive merger agreement pursuant to which Nicolet will acquire First Menasha. As evidenced by our pending acquisition of First Menasha, we intend to continue pursuing a growth strategy for our business through attractive acquisition opportunities.
Acquiring other banks, businesses, or branches involves potential adverse impact to our financial results and various other risks commonly associated with acquisitions, including, among other things, difficulty in estimating the value of the target company, payment of a premium over book and market values that may dilute our tangible book value and earnings per share in the short and long term, potential exposure to unknown or contingent liabilities of the target company, exposure to potential asset quality issues of the target company, potential volatility in reported income as goodwill impairment losses could occur irregularly and in varying amounts, difficulty and expense of integrating the operations and personnel of the target company, inability to realize the expected revenue increases, cost savings, increases in geographic or product presence, and / or other projected benefits, potential disruption to our business, potential diversion of our management’s time and attention, and the possible loss of key employees and customers of the target company.
As a community bank, Nicolet’s success depends upon local and regional economic conditions and has different lending risks than larger banks.
We provide services to our local communities. Our ability to diversify economic risks is limited by our own local markets and economies. We lend primarily to individuals and small- to medium-sized businesses, which may expose us to greater lending risks than those of banks lending to larger, better-capitalized businesses with longer operating histories.
We manage our credit exposure through careful monitoring of loan applicants and loan concentrations in particular industries, and through loan approval and review procedures. We have established an evaluation process designed to determine the adequacy of our allowance for loan losses. While this evaluation process uses historical and other objective information, the classification of loans and the establishment of loan losses is an estimate based on experience, judgment and expectations regarding borrowers and economic conditions, as well as regulator judgments. We can make no assurance that our loan loss reserves will be sufficient to absorb future loan losses or prevent a material adverse effect on its business, profitability or financial condition.
The core industries in our market area are manufacturing, wholesaling, paper, packaging, food production and processing, agriculture, forest products, retail, service, and businesses supporting the general building industry. The area has a broad range of diversified equipment manufacturing services related to these core industries and others. The residential and commercial real estate markets throughout these areas depend primarily on the strength of these core industries. A material decline in any of these sectors will affect the communities we serve and could negatively impact our financial results and have a negative impact on profitability.
If the communities in which we operate do not grow or if the prevailing economic conditions locally or nationally are less favorable than we have assumed, our ability to maintain our low volume of non-performing loans and other real estate owned and implement our business strategies may be adversely affected and our actual financial performance may be materially different from our projections.
Nicolet may experience increased delinquencies and credit losses, which could have a material adverse effect on our capital, financial condition, results of operations, and share price.
Our success depends to a significant extent upon the quality of our assets, particularly loans. In originating loans, there is a substantial likelihood that we will experience credit losses. The risk of loss will vary with, among other things, general economic conditions, the type of loan, the creditworthiness of the borrower over the term of the loan, and, in the case of a collateralized loan, the quality of the collateral for the loan.
Our loan customers may not repay their loans according to the terms of these loans, and the collateral securing the payment of these loans may be insufficient to assure repayment. As a result, we may experience significant loan losses, which could have a material adverse effect on our operating results. Management makes various assumptions and judgments about the collectability of our loan portfolio, including the creditworthiness of our borrowers and the value of the real estate and other assets serving as collateral for the repayment of many of our loans. We maintain an allowance for loan losses in an attempt to cover any loan losses that may occur. In determining the size of the allowance, we rely on an analysis of our loan portfolio based on historical loss experience, volume and types of loans, trends in classification, volume and trends in delinquencies and non-accruals, national and local economic conditions, and other pertinent information.
If management’s assumptions are wrong, our current allowance may not be sufficient to cover future loan losses, and we may need to make adjustments to allow for different economic conditions or adverse developments in our loan portfolio. Material additions to our allowance would materially decrease net income. We expect our allowance to continue to fluctuate; however, given current and future market conditions, we can make no assurance that our allowance will be adequate to cover future loan losses.
In addition, the market value of the real estate securing our loans as collateral could be adversely affected by the economy and unfavorable changes in economic conditions in our market areas. As of December 31, 2016, approximately 40% of our loans were secured by commercial-based real estate, 3% of loans were secured by agriculture-based real estate, and 26% of our loans were secured by residential real estate. Any sustained period of increased payment delinquencies, foreclosures, or losses caused by adverse market and economic conditions, including another downturn in the real estate market, in our markets could adversely affect the value of our assets, revenues, results of operations, and financial condition.
Nicolet is subject to extensive regulation that could limit or restrict our activities, which could have a material adverse effect on our results of operations or share price.
We operate in a highly regulated industry and are subject to examination, supervision, and comprehensive regulation by various regulatory agencies. Our compliance with these regulations, including compliance with regulatory commitments, is costly and restricts certain of our activities, including the declaration and payment of cash dividends to stockholders, mergers and acquisitions, investments, loans and interest rates charged, interest rates paid on deposits, and locations of offices. We are also subject to capitalization guidelines established by our regulators, which require us to maintain adequate capital to support our growth and operations.
The laws and regulations applicable to the banking industry have recently changed and may continue to change, and we cannot predict the effects of these changes on our business and profitability. Some or all of the changes, including the rulemaking authority granted to the CFPB, may result in greater reporting requirements, assessment fees, operational restrictions, capital requirements, and other regulatory burdens for us, and many of our competitors that are not banks or bank holding companies may remain free from such limitations. This could affect our ability to attract and retain depositors, to offer competitive products and services, and to expand our business. Because government regulation greatly affects the business and financial results of all commercial banks and bank holding companies, the cost of compliance could adversely affect our ability to operate profitably.
Congress may consider additional proposals to substantially change the financial institution regulatory system and to expand or contract the powers of banking institutions, bank holding companies and financial holding companies. Such legislation may change existing banking statutes and regulations, as well as the current operating environment significantly. If enacted, such legislation could increase or decrease the cost of doing business, limit or expand permissible activities, or affect the competitive balance among banks, savings associations, credit unions, and other financial institutions. We cannot predict whether new legislation will be enacted and, if enacted, the effect that it, or any regulations, would have on our business, financial condition, or results of operations.
Nicolet’s profitability is sensitive to changes in the interest rate environment.
As a financial institution, our earnings significantly depend on net interest income, which is the difference between the interest income that we earn on interest-earning assets, such as investment securities and loans, and the interest expense that we pay on interest-bearing liabilities, such as deposits and borrowings. Therefore, any change in general market interest rates, including changes in federal fiscal and monetary policies, affects us more than non-financial institutions and can have a significant effect on our net interest income and total income. Our assets and liabilities may react differently to changes in overall market rates or conditions because there may be mismatches between the repricing or maturity characteristics of the assets and liabilities. As a result, an increase or decrease in market interest rates could have material adverse effects on our net interest margin and results of operations.
In addition, we cannot predict whether interest rates will continue to remain at present levels, or the timing of any anticipated changes. Changes in interest rates may cause significant changes, up or down, in our net interest income. Depending on our portfolio of loans and investments, our results of operations may be adversely affected by changes in interest rates. If there is a substantial increase in interest rates, our investment portfolio is at risk of experiencing price declines that may negatively impact our total capital position through changes in other comprehensive income. In addition, any significant increase in prevailing interest rates could adversely affect our mortgage banking business because higher interest rates could cause customers to request fewer refinancing and purchase money mortgage originations.
We rely on other companies to provide key components of our business infrastructure.
Third party vendors provide key components of our business infrastructure such as internet connections, network access and core application processing. While we have selected these third party vendors carefully, we do not control their actions. Any problems caused by these third parties, including as a result of their not providing us their services for any reason or their performing their services poorly, could adversely affect our ability to deliver products and services to our customers and otherwise to conduct our business. Replacing these third party vendors could also entail significant delay and expense.
Negative publicity could damage our reputation.
Reputation risk, or the risk to our earnings and capital from negative public opinion, is inherent in our business. Negative public opinion could adversely affect our ability to keep and attract customers and expose us to adverse legal and regulatory consequences. Negative public opinion could result from our actual or alleged conduct in any number of activities, including lending or foreclosure practices, corporate governance, regulatory compliance, mergers and acquisitions, and disclosure, sharing or inadequate protection of customer information, and from actions taken by government regulators and community organizations in response to that conduct.
Competition in the banking industry is intense and Nicolet faces strong competition from larger, more established competitors.
The banking business is highly competitive, and we experience strong competition from many other financial institutions. We compete with commercial banks, credit unions, savings and loan associations, mortgage banking firms, consumer finance companies, securities brokerage firms, insurance companies, money market funds, and other financial institutions that operate in our primary market areas and elsewhere.
We compete with these institutions both in attracting deposits and in making loans. In addition, we have to attract our customer base from other existing financial institutions and from new residents. Many of our competitors are well-established, much larger financial institutions. While we believe we can and do successfully compete with these other financial institutions in its markets, we may face a competitive disadvantage as compared to large national or regional banks as a result of our smaller size and relative lack of geographic diversification.
Although we compete by concentrating our marketing efforts in our primary market area with local advertisements, personal contacts, and greater flexibility in working with local customers, we can give no assurance that this strategy will be successful.
Nicolet continually encounters technological change and we may have fewer resources than our competition to continue to invest in technological improvements, and Nicolet’s information systems may experience an interruption or breach in security.
The banking and financial services industry is undergoing rapid technological changes, with frequent introductions of new technology-driven products and services. In addition to better serving customers, the effective use of technology increases efficiency and enables financial institutions to reduce costs. Our future success will depend, in part, upon our ability to address the needs of our customers by using technology to provide products and services that enhance customer convenience, as well as create additional efficiencies in operations. Many of our competitors have greater resources to invest in technological improvements, and we may not be able to effectively implement new technology-driving products and services, which could reduce our ability to effectively compete.
In addition, we rely heavily on communications and information systems to conduct our business. Any failure, interruption or breach in security of these systems could result in failures or disruptions in customer relationship management, general ledger, deposit, loan functionality and the effective operation of other systems. While we have policies and procedures designed to prevent or limit the effect of a failure, interruption or security breach of our information systems, there can be no assurance that any such failures, interruptions or security breaches will not occur or, if they do occur, that they will be adequately addressed. The occurrence of any failures, interruptions or security breaches of our information systems could damage our reputation, result in a loss of customer business, subject us to additional regulatory scrutiny, or expose us to civil litigation and possible financial liability, any of which could have a material adverse effect on our financial condition and results of operations.
Risks Related to Ownership of Nicolet’s Common Stock
Our stock price can be volatile.
Stock price volatility may make it more difficult for you to sell your common stock when you want and at prices you find attractive. Our stock price can fluctuate widely in response to a variety of factors including, among other things:
|•||actual or anticipated variations in quarterly results of operations or financial condition;|
|•||operating results and stock price performance of other companies that investors deem comparable to us;|
|•||news reports relating to trends, concerns, and other issues in the financial services industry;|
|•||perceptions in the marketplace regarding us and / or our competitors;|
|•||new technology used or services offered by competitors;|
|•||significant acquisitions or business combinations, strategic partnerships, joint ventures, or capital commitments by or involving us or our competitors;|
|•||failure to integrate acquisitions or realize anticipated benefits from acquisitions;|
|•||changes in government regulations;|
|•||geopolitical conditions such as acts or threats of terrorism or military conflicts;|
|•||available supply and demand of investors interested in trading our common stock;|
|•||our own participation in the market through our buyback program; and|
|•||recommendations by securities analysts.|
General market fluctuations, industry factors, and general economic and political conditions and events, such as economic slowdowns or recessions, interest rate changes, or credit loss trends, could also cause our stock price to decrease regardless of our operating results.
Nicolet has not historically paid dividends to our common shareholders, and we cannot guarantee that it will pay dividends to such shareholders in the future.
The holders of our common stock receive dividends if and when declared by the Nicolet board of directors out of legally available funds. Nicolet’s board of directors has not declared a dividend on the common stock since our inception in 2000 and does not expect to do so in the foreseeable future. Any future determination relating to dividend policy will be made at the discretion of Nicolet’s board of directors and will depend on a number of factors, including the company’s future earnings, capital requirements, financial condition, future prospects, regulatory restrictions and other factors that the board of directors may deem relevant.
Our principal business operations are conducted through the Bank. Cash available to pay dividends to our shareholders is derived primarily, if not entirely, from dividends paid by the Bank. The ability of the Bank to pay dividends to us, as well as our ability to pay dividends to our shareholders, is subject to and limited by certain legal and regulatory restrictions, as well as contractual restrictions related to our junior subordinated debentures. Further, any lenders making loans to us may impose financial covenants that may be more restrictive than regulatory requirements with respect to the payment of dividends by us. There can be no assurance of whether or when we may pay dividends in the future.
Nicolet may need to raise additional capital in the future but that capital may not be available when it is needed or may be dilutive to our shareholders.
We are required by federal and state regulatory authorities to maintain adequate capital levels to support our operations. In order to support our operations and comply with regulatory standards, we may need to raise capital in the future. Our ability to raise additional capital will depend on conditions in the capital markets at that time, which are outside our control, and on our financial performance. Accordingly, we cannot assure you of our ability to raise additional capital, if needed, on favorable terms. The capital and credit markets have experienced significant volatility in recent years. In some cases, the markets have produced downward pressure on stock prices and credit availability for certain issuers without regard to those issuers’ underlying financial strength. If current levels of volatility worsen, our ability to raise additional capital may be disrupted. If we cannot raise additional capital when needed, our results of operations and financial condition may be adversely affected, and our banking regulators may subject us to regulatory enforcement action, including receivership. In addition, the issuance of additional shares of our equity securities will dilute the economic ownership interest of our common shareholders.
Nicolet’s directors and executive officers own a significant portion of our common stock and can influence shareholder decisions.
Our directors and executive officers, as a group, beneficially owned approximately 14% of our fully diluted issued and outstanding common stock as of December 31, 2016. As a result of their ownership, our directors and executive officers have the ability, if they voted their shares in concert, to influence the outcome of all matters submitted to our shareholders for approval, including the election of directors.
Holders of Nicolet’s subordinated debentures have rights that are senior to those of its common shareholders.
We have supported our continued growth by issuing trust preferred securities and accompanying junior subordinated debentures and by assuming the trust preferred securities and accompanying junior subordinated debentures issued by companies we have acquired. As of December 31, 2016, we had outstanding trust preferred securities and associated junior subordinated debentures with an aggregate par principal amount of approximately $32.6 million.
We have unconditionally guaranteed the payment of principal and interest on our trust preferred securities. Also, the junior debentures issued to the special purpose trusts that relate to those trust preferred securities are senior to our common stock. As a result, we must make payments on the junior subordinated debentures before we can pay any dividends on our common stock, and in the event of our bankruptcy, dissolution or liquidation, holders of our junior subordinated debentures must be satisfied before any distributions can be made on our common stock. We do have the right to defer distributions on our junior subordinated debentures (and related trust preferred securities) for up to five years, but during that time would not be able to pay dividends on our common stock.
Because Nicolet is a regulated bank holding company, your ability to obtain “control” or to act in concert with others to obtain control over Nicolet without the prior consent of the Federal Reserve or other applicable bank regulatory authorities is limited and may subject you to regulatory oversight.
Nicolet is a bank holding company and, as such, is subject to significant regulation of its business and operations. In addition, under the provisions of the Bank Holding Company Act and the Change in Bank Control Act, certain regulatory provisions may become applicable to individuals or groups who are deemed by the regulatory authorities to “control” Nicolet or our subsidiary bank. The Federal Reserve and other bank regulatory authorities have very broad interpretive discretion in this regard and it is possible that the Federal Reserve or some other bank regulatory authority may, whether through a merger or through subsequent acquisition of Nicolet’s shares, deem one or more of Nicolet’s shareholders to control or to be acting in concert for purposes of gaining or exerting control over Nicolet. Such a determination may require a shareholder or group of shareholders, among other things, to make voluminous regulatory filings under the Change in Bank Control Act, including disclosure to the regulatory authorities of significant amounts of confidential personal or corporate financial information. In addition, certain groups or entities may also be required to either register as a bank holding company under the Bank Holding Company Act, becoming themselves subject to regulation by the Federal Reserve under that Act and the rules and regulations promulgated thereunder, which may include requirements to materially limit other operations or divest other business concerns, or to divest immediately their investments in Nicolet.
In addition, these limitations on the acquisition of our stock may generally serve to reduce the potential acquirers of our stock or to reduce the volume of our stock that any potential acquirer may be able to acquire. These restrictions may serve to generally limit the liquidity of our stock and, consequently, may adversely affect its value.
We are an emerging growth company and we cannot be certain if the reduced disclosure requirements applicable to emerging growth companies will make our common stock less attractive.
We are an “emerging growth company,” as defined in the Jumpstart Our Business Startups Act of 2012 (the “JOBS Act”), and we have taken advantage of certain exemptions from various reporting requirements that are applicable to other public companies that are not emerging growth companies, including, but not limited to, reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements, and exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and shareholder approval of any golden parachute payments not previously approved. In addition, even if we comply with the greater obligations of public companies that are not emerging growth companies, we may avail ourselves of the reduced requirements applicable to emerging growth companies from time to time in the future, so long as we are an emerging growth company. We will remain an emerging growth company for up to five years following the first sale of our common stock pursuant to an effective registration statement filed under the Securities Act, though we may cease to be an emerging growth company earlier under certain circumstances, including if, before the end of such five years, we are deemed to be a large accelerated filer under the rules of the SEC (which depends on, among other things, having a market value of common stock held by non-affiliates in excess of $700 million) or if our total annual gross revenues equal or exceed $1 billion in a fiscal year. We cannot predict if investors will find our common stock less attractive because we will rely on these exemptions. If some investors find our common stock less attractive as a result, there may be a less active trading market for our common stock and our stock price may be more volatile.
Nicolet’s securities are not FDIC insured.
Our securities are not savings or deposit accounts or other obligations of the Bank, and are not insured by the Deposit Insurance Fund, or any other agency or private entity and are subject to investment risk, including the possible loss of some or all of the value of your investment.
ITEM 1B. UNRESOLVED STAFF COMMENTS
The corporate headquarters of both Nicolet and the Bank is located at 111 North Washington Street, Green Bay, Wisconsin. At year-end 2016, including the main office, the Bank operated 36 bank branch locations, 28 of which are owned and eight that are leased. In addition, we have one leased location solely related to Nicolet Advisory. Most of the offices are free-standing, newer buildings that provide adequate access, customer parking, and drive-through and/or ATM services. The properties are in good condition and considered adequate for present and near term requirements. In addition, Nicolet owns or leases other real property that, when considered in aggregate, is not significant to its financial position. None of the owned properties are subject to a mortgage or similar encumbrance.
Four of the leased locations involve directors, executive officers, or direct relatives of a director or executive officer, each with lease terms that management considers arms-length. For additional disclosure, see Note 17, “Related Party Transactions,” of the Notes to Consolidated Financial Statements under Part II, Item 8.
During the fourth quarter of 2016, six bank branch locations were closed and are not included in the numbers above. An additional two branch locations are expected to be closed in March 2017.
|ITEM 3.||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 4.||MINE SAFETY DISCLOSURES|
|ITEM 5.||MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES|
Nicolet registered its common stock under Section 12(b) of the Exchange Act on February 24, 2016, in connection with listing on the Nasdaq Capital Market, and trades under the symbol “NCBS”. Prior to February 24, 2016, Nicolet’s common stock was traded on the Over-The-Counter Markets (“OTCBB”), also under the symbol “NCBS”. The trading volume of Nicolet’s common stock is less than that of banks with larger market capitalizations, even though Nicolet has improved accessibility to its common stock first through the OTCBB and more recently through its listing on Nasdaq. As of February 28, 2017, Nicolet had approximately 2,400 shareholders of record.
The following table sets forth the high and low sales prices (beginning February 24, 2016) or the high and low bid prices (prior to February 24, 2016) and quarter end closing prices of Nicolet’s common stock as reported by Nasdaq and the OTCBB for the periods presented.
For The Quarter Ended
|December 31, 2016||$||48.00||$||37.21||$||47.69|
|September 30, 2016||39.91||35.63||38.35|
|June 30, 2016||47.00||33.72||38.08|
|March 31, 2016||38.91||30.51||38.85|
|December 31, 2015||$||32.49||$||30.60||$||31.79|
|September 30, 2015||34.75||30.80||32.00|
|June 30, 2015||31.50||27.00||30.80|
|March 31, 2015||27.50||25.00||27.50|
Nicolet has not paid dividends on its common stock since its inception in 2000, nor does it currently have any plans to pay dividends on Nicolet common stock in the foreseeable future. Any cash dividends paid by Nicolet on its common stock must comply with applicable Federal Reserve policies described further in “Business—Regulation of Nicolet—Dividend Restrictions.” The Bank is also subject to regulatory restrictions on the amount of dividends it is permitted to pay to Nicolet as further described in “Business—Regulation of the Bank – Payment of Dividends” and in Note 19, “Regulatory Capital Requirements and Restrictions of Dividends,” in the Notes to Consolidated Financial Statements under Part II, Item 8.
Following are Nicolet’s monthly common stock purchases during the fourth quarter of 2016.
Paid per Share
Shares Purchased as
Part of Publicly
Shares that May Yet
Be Purchased Under
|October 1 – October 31, 2016||52,485||$||38.82||48,687||281,000|
|November 1– November 30, 2016||3,070||$||42.73||—||281,000|
|December 1 – December 31, 2016||—||—||—||281,000|
(a) During the fourth quarter of 2016, the Company repurchased 4,198 and 2,340 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 through January 2017, the use of up to $30 million to repurchase up to 1,050,000 shares of outstanding common stock. The common stock repurchase program has no expiration date. During 2016 and 2015, Nicolet spent $4.4 million and $4.2 million to repurchase and cancel 114,914 and 146,404 shares, respectively, at a weighted average price per share of $37.98 and $28.35, respectively, including commissions. Since the commencement of the common stock repurchase program through December 31, 2016, Nicolet has used $14.2 million to repurchase and cancel 518,609 shares at a weighted average price per share of $27.31 including commissions. Given the pending merger with First Menasha, Nicolet has suspended its repurchase program.
The following graph shows the cumulative stockholder return on our common stock for the period of May 17, 2013 to December 31, 2016, compared with the KBW NASDAQ Bank Index and the S&P 500 Index. The graph assumes a $100 investment on May 17, 2013, the date Nicolet began trading on the OTCBB.
|Nicolet Bankshares, Inc.||100.00||103.38||156.25||198.69||298.06|
|S&P 500 Index||100.00||112.30||127.67||129.43||144.91|
|KBW Nasdaq Bank Index||100.00||114.66||125.40||126.02||161.95|
|ITEM 6.||SELECTED FINANCIAL DATA|
The selected consolidated financial data presented as of December 31, 2016 and 2015 and for each of the years in the three-year period ended December 31, 2016 is derived from the audited consolidated financial statements and related notes included in this report and should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” The selected consolidated financial data for all other periods shown is derived from audited consolidated financial statements that are not required to be included in this report.
EARNINGS SUMMARY AND SELECTED FINANCIAL DATA
|(In thousands, except per share data)||At and for the year ended December 31,|
|Results of operations:|
|Net interest income||68,133||41,384||41,882||36,904||22,265|
|Provision for loan losses||1,800||1,800||2,700||6,200||4,325|
|Net interest income after provision for loan losses||66,333||39,584||39,182||30,704||17,940|
|Income before income taxes||28,065||17,644||14,658||20,009||4,622|
|Income tax expense||9,371||6,089||4,607||3,837||1,529|
|Net income attributable to noncontrolling interest||232||127||102||31||57|
|Net income attributable to Nicolet Bankshares, Inc.||18,462||11,428||9,949||16,141||3,036|
|Preferred stock dividends and discount accretion||633||212||244||976||1,220|
|Net income available to common shareholders||$||17,829||$||11,216||$||9,705||$||15,165||$||1,816|
|Earnings per common share:|
|Weighted average common shares outstanding:|
|Allowance for loan losses||11,820||10,307||9,288||9,232||7,120|
|Investment securities available for sale, at fair value||365,287||172,596||168,475||127,515||55,901|
|Junior subordinated debentures||24,732||12,527||12,328||12,128||6,186|
|Book value per common share||32.26||23.42||21.34||18.97||15.45|
|Return on average assets||0.95||%||0.96||%||0.84||%||1.62||%||0.45||%|
|Return on average equity||8.16||%||10.20||%||9.18||%||16.97||%||3.97||%|
|Return on average common equity||8.20||%||12.35||%||11.55||%||21.44||%||3.48||%|
|Average equity to average assets||11.69||%||9.45||%||9.10||%||9.54||%||11.35||%|
|Net interest margin||4.01||%||3.88||%||3.89||%||4.06||%||3.67||%|
|Stockholders’ equity to assets||11.99||%||9.02||%||9.13||%||8.75||%||10.38||%|
|Net loan charge-offs to average loans||0.02||%||0.09||%||0.31||%||0.54||%||0.60||%|
|Nonperforming loans to total loans||1.29||%||0.40||%||0.61||%||1.21||%||1.27||%|
|Nonperforming assets to total assets||0.97||%||0.32||%||0.61||%||1.02||%||0.97||%|
|ITEM 7.||MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION|
The following discussion is management’s analysis to assist in the understanding and evaluation of the consolidated financial condition and results of operations of Nicolet. It should be read in conjunction with the consolidated financial statements and footnotes and the selected financial data presented elsewhere in this report.
The detailed financial discussion that follows focuses on 2016 results compared to 2015. See “2015 Compared to 2014” for the summary comparing 2015 and 2014 results. Some tabular information is shown for trends of three years or for five years as required under SEC regulations.
Nicolet is a bank holding company headquartered in Green Bay, Wisconsin, providing a diversified range of traditional commercial and retail banking services, as well as wealth management services, to individuals, business owners, and businesses in its market area primarily through, as of year-end 2016, the 36 bank branch offices of its banking subsidiary, the Bank, located within 11 Wisconsin counties (Brown, Door, Outagamie, Kewaunee, Marinette, Taylor, Clark, Marathon, Oneida, Price and Vilas) and in Menominee, Michigan.
Nicolet’s primary revenue sources are net interest income, representing interest income from loans and other interest-earning assets such as investments, less interest expense on deposits and other borrowings, and noninterest income, including, among others, trust and brokerage fees, service charges on deposit accounts, secondary mortgage income and other fees or revenue from financial services provided to customers or ancillary to loans and deposits. 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.
As previously noted in Item 1, Business, Nicolet has used acquisitions as part of its growth strategy. Nicolet’s 2016 acquisitions (described in detail in Note 2, “Acquisitions,” of the Notes to Consolidated Financial Statements under Part II, Item 8) included the transformative stock-for-stock merger with Baylake (announced in September 2015 and consummated on April 29, 2016) which nearly doubled the size of the Bank, provided opportunity for economies of scale, and added Door County and Kewaunee County to the footprint. On April 1, 2016, Nicolet completed a smaller but strategically important transaction to hire a select group of financial advisors and to purchase their respective books of business and operating platform, enhancing the leadership and growth of the wealth management business. In November 2016 Nicolet signed a definitive merger agreement with First Menasha; this acquisition, subject to First Menasha shareholder approval, regulatory approvals and other customary closing conditions, is expected to close in April of 2017 and would position Nicolet as the lead-local community bank in the Fox Valley area of Wisconsin.
2016 was a year for execution on growth, capital management and performance. At December 31, 2016, Nicolet had assets of $2.3 billion, loans of $1.6 billion, deposits of $2.0 billion and total stockholders’ equity of $276 million, representing increases over December 31, 2015 of 89%, 79%, 86% and 152%, in assets, loans, deposits and total equity, respectively. This balance sheet growth was predominantly attributable to the merger with Baylake, which added assets of $1.0 billion, loans of $0.7 billion, deposits of $0.8 billion, core deposit intangible of $17 million and goodwill of $66 million (as of the consummation date and based on estimated fair values), for a total purchase price of $164 million, including the issuance of 4.3 million shares of Nicolet common stock and assumption of outstanding Baylake equity awards. Asset quality remained strong, despite some elevation in nonperforming assets resulting from assets acquired in the Baylake merger, with net charge offs to average loans of 0.02% for 2016 and nonperforming assets to assets of 0.97% at December 31, 2016, reflecting diligent integration of acquired loans and continuing sound credit practices. Common equity increased in 2016 predominantly from new equity issued in the 2016 acquisitions. Nicolet redeemed $12.2 million (half) of its outstanding preferred stock in September 2015 and the remaining half in September 2016, as part of its capital plan and partially motivated by the adjustment of the preferred stock dividend rate from 1% to 9% effective March 1, 2016. Nicolet also repurchased $4.4 million of common stock in 2016 under its common stock repurchase program. As further capital management, 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.
Net income attributable to Nicolet was $18.5 million for 2016, 62% higher than 2015, and after preferred stock dividends, diluted earnings per common share was $2.37, compared to $2.57 for 2015. The 8% decline in diluted earnings per share was largely attributable to the 72% increase in diluted weighted average shares and higher preferred stock dividends ($0.6 million for 2016 versus $0.2 million for 2015). Return on average assets of 0.95% and return on average common equity of 8.20% for 2016, reflect favorable performance in light of absorbing merger and integration costs and new shares from the 2016 acquisitions.
Evaluation of financial performance and average balances between 2016 and 2015 was impacted in general from the timing of the two 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 2016 included partial period contributions from the 2016 acquisitions versus no contribution in 2015. The inclusion of the Baylake balance sheet (at about 83% of Nicolet’s pre-merger asset size) and operational results for approximately eight months in 2016 analytically explains most of the increase in certain average balances and income statement line items between 2016 and 2015, while the financial advisory business acquisition primarily impacts the brokerage fee income, personnel expense and certain other expense line items. In addition, the 2016 acquisitions and the pending First Menasha transaction impacted pre-tax net income by inclusion of non-recurring direct merger expenses of approximately $0.8 million in 2015 ($0.1 million in third quarter and $0.7 million in fourth quarter), and $1.3 million in 2016 ($0.4 million, $0.4 million, $0.1 million and $0.4 million in first through fourth 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.
For 2017, Nicolet’s focus will remain on the consummation and integration of its pending First Menasha acquisition, efficiencies from increased scale, and organic growth in our expanded markets and in brokerage services. The First Menasha transaction is a cash and stock transaction, subject to proration procedures and other terms and limitations as outlined in the definitive merger agreement. It is on target for an April 2017 consummation subject to customary closing conditions, including approvals by regulators and by First Menasha shareholders. Based upon the financial results as of December 31, 2016, the combined company would have approximately $2.8 billion in assets, $1.9 billion in loans and $2.4 billion in deposits, prior to any purchase accounting fair value marks. Appropriately, the transaction will not be included in Nicolet’s financial position or financial results until its consummation date in 2017. At year-end 2016 Nicolet had plans to close three of its branches in 2017, two in March (one outlier branch and one in close proximity to another Nicolet branch) and one concurrent upon consummation of the pending First Menasha transaction (which will bring in five new branch locations).
Net income attributable to Nicolet was $18.5 million for 2016, and after $0.6 million of preferred stock dividends, net income available to common shareholders was $17.9 million, or $2.37 per diluted common share. Comparatively, 2015 net income attributable to Nicolet was $11.4 million, and after $0.2 million of preferred stock dividends, net income available to common shareholders was $11.2 million or $2.57 per diluted common share. Between the years, net income increased 62%, predominantly due to inclusion of results from the 2016 acquisitions, and diluted earnings per common share decreased 8%, largely attributable to a 72% increase in diluted weighted average shares and higher preferred stock dividends. Return on average assets was 0.95% and 0.96% for 2016 and 2015, respectively, while return on average common equity was 8.20% for 2016 and 12.35% for 2015, with the 2016 ratios absorbing higher merger and integration costs and new shares from the 2016 acquisitions. Book value per common share was $32.26 at December 31, 2016, up 38% over $23.42 at December 31, 2015. Affecting total capital and the amount of preferred stock dividends between the years were the rate on and amount of preferred stock outstanding. Beginning March 1, 2016, the annual dividend rate on preferred stock moved from 1% to 9% in accordance with contractual terms. In advance of such increase, Nicolet redeemed $12.2 million (half) of its then outstanding preferred stock in September 2015 and redeemed the remaining half in September 2016, eliminating preferred stock and preferred dividends going forward.
As previously noted under the Overview section, the timing of the 2016 Baylake merger analytically explains most of the increase in certain average balances and income statement line items, while the timing of the financial advisors acquisition mostly impacts brokerage fee income, personnel expense and certain other expense between 2016 and 2015.
|•||Net interest income was $68.1 million for 2016, an increase of $26.7 million or 65% compared to 2015. The improvement was primarily the result of favorable volume variances, driven by the addition of Baylake net interest-earning assets, and net favorable rate variances, predominantly from lower cost of funds. The earning asset yield was 4.44% for 2016 and 4.54% for 2015, influenced mainly by the earning asset mix, with more balances in lower-yielding assets. Loans, investments and other interest-earning assets (mostly low-earning cash) represented 78%, 17% and 5% of average earning assets, respectively for 2016, compared to 82%, 15% and 3%, respectively, for 2015. The cost of funds was 0.56% for 2016, 28 bps lower than 2015, driven by a lower cost of deposits between the years. As a result, the interest rate spread was 3.88% for 2016, 18 bps higher than 2015. The net interest margin was 4.01% for 2016 compared to 3.88% for 2015, with a lower contribution from net free funds partly offsetting the increase in interest rate spread.|
|•||Loans were $1.6 billion at December 31, 2016, up $0.7 billion or 78% over December 31, 2015; however, excluding the impact of the $0.7 billion loans added at acquisition, loans were essentially unchanged (up 0.1%) with underlying organic growth replacing acquired loan run off. Average loans were $1.3 billion in 2016 yielding 5.11%, compared to $884 million in 2015 yielding 5.12%, a 52% increase in average balances. The minimal change in loan yield was due to downward pressure on rates of new and renewing loans in the 2016 competitive rate environment offset by $3.9 million higher aggregate discount accretion on acquired loans between 2016 and 2015.|
|•||Total deposits were $2.0 billion at December 31, 2016, up $0.9 billion or 86% over December 31, 2015. Excluding the impact of the $0.8 billion deposits added at acquisition, deposits grew 8.7%. Between 2016 and 2015, average deposits were up $0.6 billion or 61%, with noninterest-bearing deposits representing 23% and 21% of total deposits for 2016 and 2015, respectively. Interest-bearing deposits cost 0.41% for 2016 and 0.64% for 2015 benefiting from deposit product rate changes in December 2015 and inclusion of Baylake deposits carrying a lower overall cost.|
|•||Asset quality measures remained strong, despite some elevation in nonperforming assets due to assets acquired in the Baylake merger. Nonperforming assets were $22.3 million (or 0.97% of total assets) at December 31, 2016, compared to the pre-merger level of $3.9 million (or 0.32% of assets) at December 31, 2015. For 2016, the provision for loan losses was $1.8 million, exceeding net charge offs of $0.3 million, versus provision of $1.8 million and net charge offs of $0.8 million for 2015. The allowance for loan losses (“ALLL”) was $11.8 million at December 31, 2016 (representing 0.75% of loans), compared to $10.3 million (representing 1.18% of loans) at December 31, 2015. The decline in the ratio of the ALLL to loans resulted from recording the Baylake loan portfolio at fair value with no carryover of its allowance at the time of the merger.|
|•||Noninterest income was $26.7 million (including $0.1 million of net gain on sale or write-down of assets), compared to $17.7 million for 2015 (including $1.7 million of net gain on sale or write-down of assets). Removing these net gains, noninterest income was up $10.6 million or 66.6%, with increases in all line items, except rental income, aided largely by the 2016 acquisitions. The most notable increase over prior year was brokerage fee income (up $3.0 million or 440.9%), directly related to the 2016 financial advisor business acquisition. Net mortgage income was up $2.2 million or 68.6% on increased production over a broader geographic footprint and higher servicing fees. Other income was up $3.3 million or 144.0%, mostly attributable to higher card interchange income (up $1.6 million given stronger volumes) and income from equity in UFS, a data processing company interest acquired in the Baylake merger (up $1.0 million).|
|•||Noninterest expense was $64.9 million (which included $1.3 million direct merger-related expenses and a non-recurring $1.7 million lease termination charge), compared to $39.6 million for 2015 (which included $0.8 million merger-related expenses). Removing these noted merger-related and lease charge expenses from both years, noninterest expense was up approximately $23.1 million or 59%, commensurate with the larger operating base and timing of the 2016 acquisitions. Additionally, the $2.4 million increase in intangibles amortization was exclusively attributable to the 2016 acquisitions, and $0.2 million in other expenses was related to the in-process implementation of a customer relationship management system.|
Net Interest Income
Net interest income in the consolidated statements of income (which excludes any taxable equivalent adjustments) was $68.1 million in 2016, up 64.6% compared to $41.4 million in 2015. Taxable equivalent adjustments (adjustments to bring tax-exempt interest to a level that would yield the same after-tax income had that been subject to a 34% tax rate) were $1.9 million for 2016 and $1.1 million for 2015, resulting in taxable equivalent net interest income of $70.0 million for 2016 and $42.5 million for 2015.
Taxable equivalent net interest income is a non-GAAP measure, but is a preferred industry measurement of net interest income (and its use in calculating a net interest margin) as it enhances the comparability of net interest income arising from taxable and tax-exempt sources.
Net interest income is the primary source of Nicolet’s revenue, and is the difference between interest income on earning assets, such as loans and investment securities, and interest expense on interest-bearing liabilities, such as deposits and other borrowings. Net interest income is directly impacted by the sensitivity of the balance sheet to changes in interest rates and by the amount, mix and composition of interest-earning assets and interest-bearing liabilities, including characteristics such as the fixed or variable nature of the financial instruments, contractual maturities, and repricing frequencies.
Tables 1, 2, and 3 present information to facilitate the review and discussion of selected average balance sheet items, taxable equivalent net interest income, interest rate spread and net interest margin.
Table 1: Average Balance Sheet and Net Interest Income Analysis — Taxable-Equivalent Basis
(dollars in thousands)
|Years Ended December 31,|
|Other interest-earning assets||86,625||1,327||1.53||%||37,385||443||1.18||%||85,782||469||0.55||%|
|Total interest-earning assets||1,723,600||$||77,335||4.44||%||1,083,967||$||49,731||4.54||%||1,084,408||$||49,744||4.54||%|
|Cash and due from banks||40,474||25,172||39,954|
|LIABILITIES AND STOCKHOLDERS’ EQUITY|
|Core time deposits||259,730||2,220||0.85||%||197,862||2,211||1.12||%||226,112||2,348||1.04||%|
|Total interest-bearing deposits||1,258,748||5,144||0.41||%||809,531||5,190||0.64||%||848,214||5,342||0.63||%|
|Other interest-bearing liabilities||48,723||2,190||4.44||%||42,426||2,023||4.72||%||44,658||1,725||3.81||%|
|Total interest-bearing liabilities||1,307,471||7,334||0.56||%||851,957||7,213||0.84||%||892,872||7,067||0.79||%|
|Total liabilities and stockholders’ equity||$||1,934,770||$||1,185,921||$||1,191,348|
|Net interest income and rate spread||$||70,001||3.88||%||$||42,518||3.70||%||$||42,677||3.75||%|
|Net interest margin||4.01||%||3.88||%||3.89||%|
|(1)||Nonaccrual loans are included in the daily average loan balances outstanding.|
|(2)||The yield on tax-exempt loans and tax-exempt investment securities is computed on a tax-equivalent basis using a federal tax rate of 34% and adjusted for the disallowance of interest expense.|
|(3)||Interest income includes loan fees of $1.6 million in 2016, $0.7 million in 2015 and $0.7 million in 2014.|
2: Volume/Rate Variance — Taxable-Equivalent Basis
(dollars in thousands)
|2016 Compared to 2015|
Due to Changes in
|2015 Compared to 2014|
Due to Changes in
|Other interest-earning assets||665||219||884||(50||)||24||(26||)|
|Total interest-earning assets||$||27,403||$||201||$||27,604||$||1,871||$||(1,884||)||$||(13||)|
|Core time deposits||599||(590||)||9||(308||)||171||(137||)|
|Total interest-bearing deposits||1,815||(1,861||)||(46||)||(445||)||293||(152||)|
|Other interest-bearing liabilities||344||(177||)||167||403||(105||)||298|
|Total interest-bearing liabilities||2,159||(2,038||)||121||(42||)||188||146|
|Net interest income||$||25,244||$||2,239||$||27,483||$||1,913||$||(2,072||)||$||(159||)|
|*||Nonaccrual loans are included in the daily average loan balances outstanding.|
|(1)||The change in interest due to both rate and volume has been allocated in proportion to the relationship of dollar amounts of change in each.|
|(2)||The yield on tax-exempt loans and tax-exempt investment securities is computed on a tax-equivalent basis using a federal tax rate of 34% adjusted for the disallowance of interest expense.|
Table 3: Interest Rate Spread, Margin and Average Balance
Mix — Taxable-Equivalent Basis
(dollars in thousands)
|Years Ended December 31,|
|2016 Average||2015 Average||2014 Average|
|Securities and other earning assets||377,296||21.9||%||2.03||%||200,063||18.5||%||1.99||%||225,152||20.8||%||1.57||%|
|Total interest-earning assets||$||1,723,600||100.0||%||4.44||%||$||1,083,967||100.0||%||4.54||%||$||1,084,408||100.0||%||4.54||%|
|Noninterest-bearing funds, net||416,129||24.1||%||232,010||21.4||%||191,536||17.7||%|
|Total funds sources||$||1,723,600||100.0||%||0.41||%||$||1,083,967||100.0||%||0.64||%||$||1,084,408||100.0||%||0.65||%|
|Interest rate spread||3.88||%||3.70||%||3.75||%|
|Contribution from net free funds||0.13||%||0.18||%||0.14||%|
|Net interest margin||4.01||%||3.88||%||3.89||%|
Comparison of 2016 versus 2015
Taxable-equivalent net interest income was $70.0 million for 2016, up $27.5 million or 64.6%, compared to 2015. Between 2016 and 2015, volume variances were favorable, driven by the addition of Baylake net interest-earning assets, and rate variances were favorable, predominantly from lower cost of funds between the years. Net favorable volume variances added $25.2 million to net interest income (with $24.0 million due to higher average loan balances and $3.4 million due to higher average investment securities and other interest-earning assets balances combined, offset by $2.2 million less net interest income from higher average interest-bearing liability balances), while net rate variances were favorable increasing net interest income by $2.2 million (with $2.0 million from lower funding costs, predominantly deposits, and $0.2 million from improved net earning asset rates, predominantly other interest earning assets).
The taxable-equivalent net interest margin was 4.01% for 2016, up 13 bps from 2015, aided by an 18 bps increase in the interest spread offset partly by a lower contribution from net free funds. The earning asset yield was 4.44% for 2016, down from 4.54% for 2015, influenced mainly by the interest-earning asset mix, with more balances in lower-yielding assets. Loans, investments and other interest-earning assets (mostly low-earning cash) represented 78%, 17% and 5% of average earning assets, respectively for 2016, compared to 82%, 15% and 3%, respectively, for 2015. The cost of funds was 0.56% for 2016, 28 bps lower than 2015, driven by a lower cost of deposits between the years. As a result, the interest rate spread was 3.88%, 18 bps higher than 2015.
The earning asset yield was down 10 bps between 2016 and 2015, mainly due to the earning asset mix, including the acquired Baylake mix having a lower proportion of loans. Loans represented 78% of average earning assets and yielded 5.11% for 2016, compared to 82% and 5.12%, respectively, for 2015. The 1 bp decline in loan yield between the years was primarily due to the addition of lower-yielding Baylake loans in 2016 and downward pressure on rates of new and renewing loans in the 2016 competitive rate environment, partially offset by $3.9 million higher aggregate discount accretion on acquired loans between 2016 and 2015. All other interest-earning assets combined represented 22% of average earning assets and yielded 2.03% versus 18% and 1.99%, respectively, for 2015. This 4 bps increase in the non-loan yield was driven by higher yields on investments partially offset by lower returns on higher levels of earning cash between the years.
Nicolet’s cost of funds was 0.56% for 2016, 28 bps lower than 0.84% for 2015, driven primarily by lower rates on deposit funding. Average interest-bearing deposits (which represented 96% of average interest-bearing liabilities for 2016 and 95% for 2015) cost 0.41% for 2016, 23 bps lower than 2015. The cost of interest-bearing deposits decreased as a result of a higher proportion of balances carried in lower-rate transaction accounts (77.1% for 2016 compared to 71.9% for 2015), as well as rate decreases initiated on certain deposit products in December 2015, lower cost of funds on acquired balances and a favorable fair value interest mark on acquired CDs. Deposit rate changes included decreases in savings, interest bearing demand, and money market accounts of 13 bps, 28 bps, and 9 bps, respectively, as well as decreases in rates on core time deposits and brokered deposits of 27 bps and 29 bps, respectively. Other interest-bearing liabilities balances (comprised of short- and long-term borrowings) increased $6.3 million while their cost decreased to 4.44% (down 28 bps from 4.72% in 2015) as higher cost advances matured and were not renewed, certain acquired advances were paid off in the quarter acquired, and lower-cost repurchase agreements and variable-rate junior subordinated debentures were added to the funding mix with the 2016 Baylake acquisition.
Average interest-earning assets were $1.7 billion for 2016, $639.6 million, or 59% higher than 2015, consisting of a $462.4 million increase in average loans (up 52.3% to $1.3 billion and representing 78% of interest-earning assets), a $128.0 million increase in investment securities (up 78.7% to $290.7 million and representing 17% of interest-earning assets), and a $49.2 million increase, or 131.7% higher in other interest-earning assets, predominantly low-earning cash.
Average interest-bearing liabilities were $1.3 billion, up $455.5 million or 53.5% from 2015, led by interest-bearing deposits, while the mix of interest-bearing deposits and other interest-bearing liabilities remained relatively unchanged at 96% and 4% for 2016 compared to 95% and 5% for 2015. Between 2016 and 2015, average total deposits were up $620.7 million or 60.8%, with interest-bearing deposits up $449.2 million and noninterest-bearing deposits up $171.5 million. Average other interest-bearing liabilities were up $6.3 million (to $48.7 million), led by an $8.2 million increase in junior subordinated debt, a $6.1 million net increase in low-costing repurchase agreements (both acquired with the 2016 Baylake merger), and a $2.6 million increase in subordinated notes which were procured in the first half of 2015, offset by decreases in average balances of all other borrowings.
Provision for Loan Losses
The provision for loan losses in 2016 was $1.8 million, exceeding $0.3 million of net charge offs. Comparatively, 2015 provision and net charge offs were $1.8 million and $0.8 million, respectively. The consistent provision in 2016 was reflective of the continued loan portfolio quality. At December 31, 2016, the ALLL was $11.8 million or 0.75% of loans compared to $10.3 million or 1.18% of loans at December 31, 2015. The decline in this ratio was due to recording the Baylake loan portfolio at fair value with no carryover of its allowance at the time of merger.
Nonperforming loans were $20.3 million (or 1.29% of total loans) at December 31, 2016, up from $3.5 million (or 0.40% of total loans) at December 31, 2015. The increase in nonperforming loans was the result of the acquisition of the Baylake loan portfolio with higher nonperforming loans. Of the $37.5 million purchase credit impaired (“PCI”) loans initially acquired in the 2016 acquisitions ($20.8 million) and 2013 acquisitions ($16.7 million), $20.0 million remain included in the $20.3 million of nonaccruals at December 31, 2016, compared to $2.9 million included in the $3.5 million of nonaccruals at December 31, 2015.
The provision for loan losses is predominantly a function of Nicolet’s methodology and judgment as to qualitative and quantitative factors used to determine the adequacy of the ALLL. The adequacy of the ALLL is affected by changes in the size and character of the loan portfolio, changes in levels of impaired and other nonperforming loans, historical losses and delinquencies in each portfolio segment, the risk inherent in specific loans, concentrations of loans to specific borrowers or industries, existing and future economic conditions, the fair value of underlying collateral, and other factors which could affect potential credit losses. For additional information regarding asset quality and the ALLL, see “Balance Sheet Analysis — Loans,” and “— Allowance for Loan and Lease Losses” and “—Nonperforming Assets.”
Table 4: Noninterest Income
(dollars in thousands)
|Years ended December 31,||Change From Prior Year|
|Service charges on deposit accounts||$||3,571||$||2,348||$||2,128||$||1,223||52.1||%||$||220||10.3||%|
|Mortgage income, net||5,494||3,258||1,926||2,236||68.6||1,332||69.2|
|Trust services fee income||5,435||4,822||4,569||613||12.7||253||5.5|
|Brokerage fee income||3,624||670||631||2,954||440.9||39||6.2|
|Bank owned life insurance (“BOLI”)||1,284||996||933||288||28.9||63||6.8|
|Investment advisory fees||452||408||440||44||10.8||(32||)||(7.3||)|
|Gain on sale or write-down of assets, net||54||1,726||539||(1,672||)||(96.9||)||1,187||220.2|
|Total noninterest income||$||26,674||$||17,708||$||14,185||$||8,966||50.6||%||$||3,523||24.8||%|
|Noninterest income without net gains||$||26,620||$||15,982||$||13,646||$||10,638||66.6||%||$||2,336||17.1||%|
|Included in Other income:|
|Debit and credit card interchange income||3,167||1,566||1,220||1,601||102.2||346||28.4|
Comparison of 2016 versus 2015
Noninterest income for 2016 was $26.7 million (including $0.1 million of net gain on sale or write-down of assets), up $9.0 million or 50.6%, compared to $17.7 million for 2015 (including $1.7 million of net gain on sale or write-down of assets). Removing these net gains from both periods, noninterest income was up $10.6 million or 66.6%, with increases in all line items, except rental income, aided largely by the 2016 acquisitions and higher volumes over a broader geographic footprint.
Service charges on deposit accounts for 2016 were $3.6 million, up $1.2 million or 52.1% over 2015, resulting predominantly from higher overdraft activity and the higher number of transaction accounts from the Baylake merger correspondingly increasing service charges.
Mortgage income represents net gains received from the sale of residential real estate loans service-released and service-retained into the secondary market, capitalized gains on MSRs, servicing fees, offsetting MSR amortization, valuation changes if any, and to a smaller degree some related income. Residential refinancing activity and new purchase activity vary with movements in mortgage rates, changes in mortgage regulation, and the impact of economic conditions on consumers. The mortgage market continued strong in 2016, with secondary mortgage production of $254 million, up 47% from 2015’s production of $173 million. Net mortgage income was $5.5 million for 2016, up $2.2 million or 68.6%, compared to $3.3 million for 2015, largely due to gains on increased volumes and servicing fees particularly related to the acquired servicing portfolio.
Trust service fees were $5.4 million for 2016, up $0.6 million or 12.7% over 2015, benefitting from new net business on steadily increasing assets under management, while minimally impacted by the Baylake merger. Brokerage fees were $3.6 million for 2016, up $3.0 million or 440.9% over 2015. The increase in brokerage business was directly related to the 2016 financial advisor business acquisition in the beginning of the year, with more dedicated resources to that area and revenue on books of business acquired.
BOLI income was $1.3 million, up $0.3 million or 28.9% over 2015 while average BOLI balances increased 48% to $41 million for 2016. BOLI investments of $25.4 million were added at acquisition in the Baylake merger at a lower overall earning rate, followed by the surrender of $21.5 million of acquired BOLI in June 2016 and the reinvestment of $20.0 million in September 2016.
Net gain on sale or write-down of assets in 2016 was $0.1 million, down $1.6 million or 96.9% compared to $1.7 million in 2015. The 2016 activity consisted mainly of a $0.5 million other-than-temporary impairment loss on an other investment security and $0.6 million in net gains from the sale of OREO. The 2015 activity consisted of $0.6 million net gains on sales of equity securities and $1.1 million net gains on OREO sales and other assets.
Other income was $5.7 million, up $3.3 million or 144.0% over 2015, with the majority of the increase due to debit and credit card interchange fees, up $1.6 million or 102.2% on higher volume and activity, and income from equity in UFS, a data processing company acquired in the Baylake merger, up $1.0 million.
Table 5: Noninterest Expense
(dollars in thousands)
|Years ended December 31,||Change From Prior Year|
|Occupancy, equipment and office||10,276||6,928||7,086||3,348||48.3||(158||)||(2.2||)|
|Business development and marketing||3,488||2,244||2,267||1,244||55.4||(23||)||1.0|
|Total noninterest expense||$||64,942||$||39,648||$||38,709||$||25,294||63.8||%||$||939||2.4||%|
Comparison of 2016 versus 2015
Total noninterest expense was $64.9 million for 2016 (which included $1.3 million direct merger-related expense and a non-recurring $1.7 million lease termination charge), compared to $39.6 million for 2015 (which included $0.8 million merger-related expenses). Removing these noted merger-related expenses and lease charge from both years, noninterest expense was up approximately $23.1 million or 59%, commensurate with the larger operating base and timing of the 2016 acquisitions. Additionally, the $2.4 million increase in intangibles amortization was exclusively attributable to the 2016 acquisitions and $0.2 million in other expenses was related to the in-process implementation of a customer relationship management system. Cost saves anticipated with the Baylake merger began to be realized by year end 2016, due to more efficient processes and elimination of duplicative efforts in overhead areas.
Personnel expense (including salaries, brokerage variable pay, overtime, cash and equity incentives, and employee benefit and payroll-related expenses) was $34.0 million for 2016, up $11.5 million or 51.1% over 2015. In addition to merit increases, higher overtime and higher incentives and equity award costs between the years, salaries and benefits increased largely due to the 48% increase in average full-time equivalent employees from the 2016 acquisitions (415 for 2016). The six branch closures that occurred in fourth quarter 2016 should produce some cost savings in 2017.
Occupancy, equipment and office expense was $10.3 million for 2016, up $3.3 million or 48.3% from 2015, in line with the 2016 acquisitions adding a net 21 branches, an expanded operations facility and a financial advisors location, as well as some infrastructure and set-up costs needed to integrate the new office locations, customer communications, signage and phone and data systems to consistent platforms. The six branch closures that occurred in fourth quarter 2016 should produce some cost savings in 2017.
Business development and marketing expense was $3.5 million for 2016, up $1.2 million or 55.4%, with higher spending on promotional materials, media advertising, and donations as emphasis was focused on expanded and new markets.
Data processing expenses, which are primarily volume-based, were $6.4 million for 2016, up $2.8 million or 78.7% over 2015, in line with a higher number of accounts and volumes processed due to the 2016 acquisitions, an increase in the core processing rate charged and higher integration costs ($0.4 million in 2016 versus $0.1 million in 2015).
FDIC assessments were higher between the years mostly due to an increased assessment base in 2016. The intangibles amortization increased to $3.5 million, up $2.4 million or 236.7%, fully attributable to new core deposit intangible and customer list intangible balances added from the 2016 acquisitions.
Other expense was $6.4 million for 2016, up $3.7 million or 133.4%, with 2016 including $0.7 million of direct merger-related expense (mostly legal, consultant and professional in nature) and a $1.7 million lease termination charge and 2015 including $0.6 million of direct merger-related expense. In addition to the larger operating base increasing other expense levels, other expense increased $0.2 million related to the in-process implementation of a customer relationship management system and $0.2 million related to higher foreclosure and OREO costs.
Income tax expense was $9.4 million for 2016 and $6.1 million for 2015. The effective tax rates were 33.4% for 2016 and 34.5% for 2015. Impacting tax expense and the effective tax rate for both 2016 and 2015 was the non-deductibility of certain merger-related costs. The net deferred tax asset was $10.9 million at December 31, 2016 compared to $5.2 million at the end of 2015. The basic principles for accounting for income taxes require 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. At December 31, 2016 and 2015, no valuation allowance was determined to be necessary.
BALANCE SHEET ANALYSIS
Nicolet services a diverse customer base throughout northeastern and central Wisconsin and in Menominee, Michigan including the following industries: manufacturing, wholesaling, paper, packaging, food production and processing, agriculture, forest products, retail, service, and businesses supporting the general building industry. It continues to concentrate its efforts in originating loans in its local markets and assisting its current loan customers. It actively utilizes government loan programs such as those provided by the U.S. Small Business Administration to help customers weather current economic conditions and position their businesses for the future.
Nicolet’s primary lending function is to make 1) commercial loans, consisting of commercial, industrial and business loans and lines of credit, owner-occupied CRE loans and AG production loans; 2) CRE loans, consisting of CRE investment 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 to a lesser degree residential construction loans; and 4) retail and other loans. Using these four broad categories the mix of loans at December 31, 2016 was 53% commercial, 20% CRE loans, 26% residential real estate loans, and 1% retail and other loans; and grouped further the loan mix is 73% commercial-based and 27% retail-based. Comparatively, at December 31, 2015, loans were 56% commercial, 18% CRE, 25% residential real estate, and 1% retail and other, and more broadly remained 74% commercial-based and 26% retail-based.
Total loans were $1.6 billion at December 31, 2016, an increase of $691.8 million, or 78.9%, compared to total loans of $877 million at December 31, 2015; however, excluding the $691 million loans added at acquisition in 2016, loans were essentially unchanged (up 0.1%) with underlying organic growth replacing acquired loan runoff. Combined, loans acquired in the 2013 and 2016 acquisitions at their respective acquisition dates totaled $974 million, and had a combined outstanding balance of $667 million and $137 million at December 31, 2016 and 2015, respectively, given amortization, refinances, and payoffs.
Table 6: Loan Composition
As of December 31,
(dollars in thousands)
|Commercial & industrial||$||428,270||27.3||%||$||294,419||33.6||%||$||289,379||32.7||%||$||253,674||29.9||%||$||197,301||35.7||%|
|AG real estate||45,234||2.9||43,272||4.9||42,754||4.8||37,057||4.4||11,354||2.1|
|Construction & land development||74,988||4.8||36,775||4.2||44,114||5.0||42,881||5.1||21,791||3.9|
|Residential first mortgage||300,304||19.1||154,658||17.6||158,683||18.0||154,403||18.2||85,588||15.5|
|Residential junior mortgage||91,331||5.8||51,967||5.9||52,104||5.9||49,363||5.8||39,352||7.1|
|Retail & other||14,515||0.9||6,513||0.8||5,910||0.7||5,418||0.6||5,537||1.0|
As noted above, year-end 2016 loans were broadly 73% commercial-based and 27% retail-based compared to 74% commercial-based and 26% retail-based at year-end 2015. Commercial-based loans are considered to have more inherent risk of default than retail-based loans, in part because the commercial balance per borrower is typically larger than that for retail-based loans, implying higher potential losses on an individual customer basis. All loan types were impacted by the loans acquired in the 2016 Baylake merger, which carried a higher mix in CRE-related loan types.
Commercial and industrial loans consist primarily of commercial loans to small businesses and, to a lesser degree, to municipalities within a diverse range of industries. The credit risk related to commercial and industrial loans is largely influenced by general economic conditions and the resulting impact on a borrower’s operations, or on the value of underlying collateral, if any. Commercial and industrial loans continue to be the largest segment of Nicolet’s portfolio but decreased to 27.3% of the portfolio at year end 2016, due to the 2016 acquired loan mix, compared to 33.6% of the total portfolio at year end 2015. This continues to be a strong growth area for Nicolet.
Owner-occupied CRE loans increased to 23.0% of loans at year end 2016 compared to 21.1% of loans at year end 2015. This category primarily consists of loans within a diverse range of industries secured by business real estate that is occupied by borrowers 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.
Agricultural production and agricultural real estate loans 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. These loans decreased to 5.1% of loans at year end compared to 6.6% of loans at year end 2015.
The CRE investment loan classification primarily includes commercial-based mortgage loans that are secured by non-owner occupied, nonfarm/nonresidential real estate properties, and multi-family residential properties. Lending in this segment has been focused on loans that are secured by commercial income-producing properties as opposed to speculative real estate development. From December 31, 2015 to December 31, 2016, these loans increased $117.2 million, and grew to represent 12.5% of loans, due to the 2016 acquired loan mix, compared to 9.0% a year ago.
Loans in the construction and land development portfolio represented 4.8% of total loans at year end 2016 compared to 4.2% at year-end 2015. Construction and land development loans 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.
On a combined basis, Nicolet’s residential real estate loans represented 26.4% of total loans at year end 2016 compared to 24.7% of total loans at year end 2015. Residential first mortgage loans include conventional first-lien home mortgages. Residential junior mortgage real estate loans consist of home equity lines and term loans secured by junior mortgage liens. Across the industry, home equities involve loans that are often in second or junior lien positions, but Nicolet has secured many of these types of 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 declines in market values in the residential real estate markets worsen, particularly in Nicolet’s market area, the value of collateral securing its real estate loans could decline, which 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 with or without retaining the servicing rights. Nicolet’s mortgage loans have historically had low net charge off rates and typically are of high quality.
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.
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 December 31, 2016, no significant industry concentrations existed in Nicolet’s portfolio in excess of 25% of total loans. Nicolet has also developed guidelines to manage its exposure to various types of concentration risks.
Table 7: Loan Maturity Distribution
The following table presents the maturity distribution of the loan portfolio at December 31, 2016:
(dollars in thousands)
|One Year |
|Over One |
to Five Years
|Commercial & industrial||$||204,858||$||195,715||$||27,697||$||428,270|
|AG real estate||11,909||31,520||1,805||45,234|
|Construction & land development||29,259||38,298||7,431||74,988|
|Residential first mortgage||12,020||49,654||238,630||300,304|
|Residential junior mortgage||27,486||19,649||44,196||91,331|
|Retail & other||6,728||6,900||887||14,515|
|Percent by maturity distribution||29||%||45||%||26||%||100||%|
Allowance for Loan Losses
In addition to the discussion that follows, accounting policies behind loans and the allowance for loan losses are described in Note 1, “Nature of Business and Significant Accounting Policies,” and additional disclosures are included in Note 4, “Loans and Allowance for Loan Losses,” in the Notes to Consolidated Financial Statements, under Part II, Item 8.
Credit risks within the loan portfolio are inherently different for each loan type as described under “Balance Sheet Analysis-Loans.” Credit risk is controlled and monitored through the use of lending standards, a thorough review of potential borrowers, and on-going review of loan payment performance. Active asset quality administration, including early problem loan identification and timely resolution of problems, aids in the management of credit risk and minimization of loan losses.
The ALLL is established through a provision for loan losses charged to expense to appropriately provide for potential credit losses in the existing loan portfolio. Loans are charged 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, 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. Lastly, management allocates ALLL to the remaining loan portfolio using the qualitative factors mentioned above. Consideration is given to those current qualitative or environmental factors that are likely to cause estimated credit losses as of the evaluation date to differ from the historical loss experience of each loan segment.
Management performs ongoing intensive analyses of its loan portfolio to allow for early identification of customers experiencing financial difficulties, maintains prudent underwriting standards, understands the economy in its markets, and considers the trend of deterioration in loan quality in establishing the level of the ALLL.
Consolidated net income and stockholders’ equity could be affected if management’s estimate of the ALLL necessary to cover expected losses is subsequently materially different, requiring a change in the level of provision for loan losses to be recorded. While management uses currently available information to recognize losses on loans, future adjustments to the ALLL may be necessary based on newly received appraisals, updated commercial customer financial statements, rapidly deteriorating customer cash flow, and changes in economic conditions that affect Nicolet’s customers. As an integral part of their examination process, federal regulatory agencies also review the ALLL. Such agencies may require additions to the ALLL or may require that certain loan balances be charged-off or downgraded into criticized loan categories when their credit evaluations differ from those of management based on their judgments about information available to them at the time of their examination.
At December 31, 2016, the ALLL was $11.8 million compared to $10.3 million at December 31, 2015. The increase was a result of the 2016 provision of $1.8 million exceeding 2016 net charge offs of $0.3 million. Comparatively, the 2015 provision for loan losses was $1.8 million and 2015 net charge offs were $0.8 million. Net charge offs as a percent of average loans were 0.02% in 2016 compared to 0.09% in 2015. 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 0.75% and 1.18% at December 31, 2016 and 2015, respectively. The ALLL to loans ratio is impacted by the accounting treatment of the 2016 and 2013 acquisitions, which combined at their acquisition dates added no ALLL to the numerator and $974 million of loans into the denominator at their then estimated fair values ($691 million in 2016 and $283 million in 2013), net of applicable discounts for credit quality. Such acquired loans combined have declined since their acquisition dates to $667 million and $137 million outstanding at December 31, 2016 given amortization, refinances and payoffs. However, since their acquisition, the performance trends of acquired loans have been evolving and evaluated. As events have occurred in the acquired loan portfolio, beginning in mid-2015, an ALLL was provided directly for this portfolio (especially the 2013 acquired loans), reflecting an increase in risk as acquired credits age and several larger and other loans migrate to a watch or worse loan grades. Therefore, the provision for loan losses and net charge offs for 2016 were $1.0 million and $0.2 million, respectively, for acquired loans, and $0.8 million and $0.1 million, respectively, for originated loans. Comparatively, the provision for loan losses and net charge offs for 2015, were $1.7 million and $0.1 million, respectively, for acquired loans, and $0.1 million and $0.7 million, respectively, for originated loans. At December 31, 2016, the ALLL was $11.8 million (or 0.75% of total loans), with $2.4 million for acquired loans (0.36% of acquired loans) and $9.4 million for originated loans (1.05% of originated loans). In particular, see additional disclosures in Note 4, “Loans and Allowance for Loan Losses,” in the Notes to Consolidated Financial Statements, under Part II, Item 8.
Table 8: Loan Loss Experience
For the Years Ended December 31,
(dollars in thousands)
|Allowance for loan losses (ALLL):|
|Loans charged off:|
|Commercial & industrial||279||374||1,923||574||295|
|AG real estate||—||—||—||—||—|
|Construction & land development||—||—||12||319||713|
|Residential first mortgage||80||84||218||156||265|
|Residential junior mortgage||57||111||81||190||166|
|Retail & other||60||35||39||71||39|
|Total loans charged off||584||883||2,743||4,238||3,507|
|Recoveries of loans previously charged off:|
|Commercial & industrial||26||36||55||40||36|
|AG real estate||—||—||—||—||—|
|Construction & land development||—||—||—||15||22|
|Residential first mortgage||31||20||2||8||11|
|Residential junior mortgage||8||12||1||1||6|
|Retail & other||6||13||10||1||1|
|Total net charge offs||287||781||2,644||4,088||3,104|
|Provision for loan losses||1,800||1,800||2,700||6,200||4,325|
|Ending balance of ALLL||$||11,820||$||10,307||$||9,288||$||9,232||$||7,120|
|ALLL to total loans at December 31||0.75||%||1.18||%||1.05||%||1.09||%||1.29||%|
|ALLL to net charge offs for the year ended December 31||4,118.5||%||1,319.7||%||351.3||%||225.8||%||229.4||%|
|Net charge offs to average loans for the year ended December 31||0.02||%||0.09||%||0.31||%||0.54||%||0.60||%|
The allocation of the ALLL for each of the past five years is based on Nicolet’s estimate of loss exposure by category of loans and is shown in Table 9.
As a commercial bank, Nicolet continues to carry the largest allocation of ALLL against commercial & industrial loans (the largest loan type at roughly 27% of loans at year-end 2016 and 34% of loans at year-end 2015) of $3.9 million (or 33.2% of ALLL) and $3.7 million (or 36.2% of ALLL) at December 31, 2016 and 2015, respectively. While the balances of construction & land development loans have been relatively steady (at 4% to 5% of loans at year-end 2016 and 2015), the category carries higher historical loss rates, which are improving with better current loan performance and granularity; hence, the allocation was $0.8 million to represent 6.5% of ALLL at December 31, 2016, compared to 14.0% at year-end 2015. With less allocated to construction & land development, allocations increased to other loan types that would be more affected by management’s growing concerns that the recent period of economic recovery is slowing in light of current economic data and events that pressure collateral values or businesses’ and consumers’ ability to perform on loans. Management allocated additional amounts in 2016 to owner-occupied CRE (up $1.0 million to $2.9 million, or 24.3% of ALLL), residential first and junior mortgages (up $0.5 million combined, and representing 19.0% of ALLL combined), and CRE investment (up $0.3 million, representing 9.5% of ALLL). The remaining allocated ALLL balances were consistent with changes in outstanding loan balances at December 31, 2016.
Table 9: Allocation of the Allowance for Loan Losses
As of December 31,
(dollars in thousands)
|2014||% of |
|2013||% of |
|2012||% of |
|Commercial & industrial||$||3,919||27.3||%||$||3,721||33.6||%||$||3,191||32.7||%||$||1,798||29.9||%||$||1,969||35.7||%|
|AG real estate||285||2.9||380||4.9||226||4.8||59||4.4||—||2.1|
|Construction & land development||774||4.8||1,446||4.2||2,685||5.0||4,970||5.1||2,580||3.9|
|Residential first mortgage||1,784||19.1||1,240||17.6||866||18.0||544||18.2||685||15.5|
|Residential junior mortgage||461||5.8||496||5.9||337||5.9||321||5.8||312||7.1|
|Retail & other||152||0.9||74||0.8||49||0.7||22||0.6||31||1.0|
|ALLL category as a percent of total ALLL:|
|Commercial & industrial||33.2||%||36.2||%||34.4||%||19.5||%||27.7||%|
|AG real estate||2.4||3.7||2.4||0.6||—|
|Construction & land development||6.5||14.0||28.9||53.8||36.2|
|Residential first mortgage||15.1||12.0||9.3||5.9||9.6|
|Residential junior mortgage||3.9||4.8||3.6||3.5||4.4|
|Retail & other||1.2||0.7||0.6||0.2||0.5|
As part of its overall credit risk management process, 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 $20.3 million (consisting of $0.3 million originated loans and $20.0 million acquired loans) at December 31, 2016, up $16.8 million, compared to $3.5 million (consisting of $0.6 million originated loans and $2.9 million acquired loans) at December 31, 2015. OREO was $2.1 million at December 31, 2016, up $1.7 million, compared to $0.4 million at December 31, 2015. Consequently, nonperforming assets (i.e. nonperforming loans plus OREO) were $22.3 million at December 31, 2016, up $18.4 million, compared to $3.9 million at December 31, 2015, with the increase attributable to the 2016 acquisitions adding nonaccrual loans and OREO properties, plus the transfer into OREO of bank properties that are no longer in use. Nonperforming assets as a percent of total assets increased to 0.97% at December 31, 2016 compared to 0.32% at December 31, 2015.
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 totaled $12.6 million and $9.2 million, and represented 0.8% and 1.0% of total outstanding loans at December 31, 2016 and 2015, respectively. Potential problem loans require a heightened management review of the pace at which a credit may deteriorate, the duration of asset quality stress, and uncertainty around the magnitude and scope of economic stress that may be felt by Nicolet’s customers and on underlying real estate values.
Table 10: Nonperforming Assets
As of December 31,
(dollars in thousands)
|Commercial & industrial||$||358||$||204||$||171||$||68||$||784|
|AG real estate||208||230||392||448||—|
|Construction & land development||1,193||280||934||1,265||2,560|
|Residential first mortgage||2,990||674||1,155||2,365||1,580|
|Residential junior mortgage||56||141||141||262||—|
|Retail & other||—||—||—||129||142|
|Total nonaccrual loans considered impaired||20,285||3,533||5,392||10,266||7,026|
|Accruing loans past due 90 days or more||—||—||—||—||—|
|Total nonperforming loans||20,285||3,533||5,392||10,266||7,026|
|Commercial & industrial||64||—||—||—||—|
|Commercial real estate owned||304||52||697||935||71|
|Construction & land development real estate owned||623||—||139||854||17|
|Residential real estate owned||29||—||630||198||105|
|Bank property real estate owned||1,039||315||500||—||—|
|Total nonperforming assets||$||22,344||$||3,900||$||7,358||$||12,253||$||7,219|
|Performing troubled debt restructurings||—||—||3,777||3,970||—|
|Nonperforming loans to total loans||1.29||%||0.40||%||0.61||%||1.21||%||1.27||%|
|Nonperforming assets to total loans plus OREO||1.42||%||0.44||%||0.83||%||1.44||%||1.31||%|
|Nonperforming assets to total assets||0.97||%||0.32||%||0.61||%||1.02||%||0.97||%|
|ALLL to nonperforming loans||58.3||%||291.7||%||172.3||%||89.9||%||101.3||%|
|ALLL to total loans||0.75||%||1.18||%||1.05||%||1.09||%||1.29||%|
Table 11 shows the approximate gross interest that would have been recorded if the loans accounted for on a nonaccrual basis at the end of each year shown had performed in accordance with their original terms, in contrast to the amount of interest income that was included in interest income on such loans for the period. The interest income recognized generally includes cash interest received and potentially includes prior nonaccrual interest on acquired loans which existed at acquisition and was subsequently collected.
Table 11: Foregone Loan Interest
For the Years Ended December 31,
(dollars in thousands)
|Interest income in accordance with original terms||$||1,979||$||429||$||709|
|Interest income recognized||(1,789||)||(416||)||(667||)|
|Reduction in interest income||$||190||$||13||$||42|
Investment Securities Portfolio
The investment securities portfolio is intended to provide Nicolet with adequate liquidity, flexible asset/liability management and a source of stable income. The portfolio is structured with minimal credit exposure to Nicolet. All securities are classified as available for sale (“AFS”) and are carried at fair value.
Table 12: Investment Securities Portfolio
As of December 31,
(dollars in thousands)
|U.S. Government sponsored enterprises||$||1,981||$||1,963||1||%||$||287||$||294||-||%||$||1,025||$||1,039||1||%|
|State, county and municipals||191,721||187,243||51||%||104,768||105,021||61||%||102,472||102,776||61||%|
|Corporate debt securities||12,117||12,169||3||%||1,140||1,140||1||%||220||220||-||%|
|Total securities AFS||$||369,759||$||365,287||100||%||$||170,991||$||172,596||100||%||$||166,785||$||168,475||100||%|
At December 31, 2016, the total carrying value of investment securities was $365.3 million, up from $172.6 million at December 31, 2015, and represented 15.9% and 14.2% of total assets at December 31, 2016 and 2015, respectively. The $192.7 million increase since December 31, 2015 was largely attributable to securities acquired in the 2016 acquisitions which added a higher proportion of mortgage-backed securities and corporate debt securities. At December 31, 2016, the securities portfolio did not contain securities of any single issuer, including any securities issued by a state or political subdivision that were payable from and secured by the same source of revenue or taxing authority where the aggregate carrying value of such securities exceeded 10% of stockholders’ equity.
In addition to AFS securities, Nicolet had other investments of $17.5 million and $8.1 million at December 31, 2016 and 2015, respectively, consisting of capital stock in the Federal Reserve, Federal Agricultural Mortgage Corporation, and the FHLB (required as members of the Federal Reserve Bank System and the FHLB System), and to a lesser degree equity investments in other private 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 temporarily impaired (“OTTI”) charges, if any. These other investments are evaluated periodically for impairment, considering financial condition and other available relevant information. A $0.5 million OTTI charge was recorded in fourth quarter 2016 related to a private company equity investment based on circumstances arising at year end which management determined would likely impact the future earning capacity of the underlying operating company. There were no OTTI charges recorded in 2015 or 2014.
Table 13: Investment Securities Portfolio Maturity Distribution
As of December 31, 2016
(dollars in thousands)
|U.S. Government sponsored enterprises||$||—||—||%||$||1,981||2.9||%||$||—||—||%||$||—||—||%||$||—||—||%||$||1,981||2.9||%||$||1,963|
|State and county municipals||9,833||2.4||$||74,168||2.7||%||106,416||2.7||1,304||3.2||—||—||191,721||2.7||187,243|
|Corporate debt securities||—||—||5,139||6.5||—||—||6,978||5.4||—||—||12,117||5.9||12,169|
|Total amortized cost||$||9,833||2.4||%||$||81,288||2.9||%||$||106,416||2.7||%||$||8,282||5.1||%||$||163,940||3.1||%||$||369,759||3.0||%||$||365,287|
|Total fair value and carrying value||$||9,835||$||80,847||$||102,401||$||8,292||$||163,912||$||365,287|
|(1)||The yield on tax-exempt investment securities is computed on a tax-equivalent basis using a federal tax rate of 34% adjusted for the disallowance of interest expense.|
Deposits 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 competitive deposit product features, 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 $21 million, $27 million and $29 million at year end 2016, 2015 and 2014, respectively.
Table 14: Deposits
At December 31,
(dollars in thousands)
|Money market and NOW accounts||964,509||49.0||486,677||46.1||494,945||46.7|
Total deposits were $2.0 billion at December 31, 2016, an increase of $914 million or 86.5% over December 31, 2015; however, excluding the impact of $822 million deposits added at acquisition in 2016, deposits grew 8.7%. As brokered deposits are not significant, customer-based deposits continue to grow organically from stable customer relationships. Total average deposits for 2016 were $1.6 billion, an increase of $621 million or 60.8% over 2015. On average, the mix of deposits changed between 2016 and 2015, with 2016 carrying more demand (i.e. non-interest bearing) deposits, money market and NOW accounts, and less in savings and time deposits.
Table 15: Average Deposits
For the Years Ended December 31,
(dollars in thousands)
|2016 Average||2015 Average||2014 Average|
|Money market and NOW accounts||776,756||47.3||455,344||44.6||472,814||46.0|
Table 16: Maturity Distribution of Certificates of Deposit of $100,000 or More
At December 31,
(dollars in thousands)
|3 months or less||$||19,058||$||6,856||$||11,134|
|Over 3 months through 6 months||11,428||5,733||7,632|
|Over 6 months through 12 months||31,569||19,319||15,783|
|Over 12 months||59,208||58,934||41,855|
Other Funding Sources
Other funding sources include short-term borrowings (zero at December 31, 2016 and 2015) and long-term borrowings (totaling $37.6 million and $39.8 million at December 31, 2016 and 2015, respectively). Short-term borrowings consist mainly of customer repurchase agreements maturing in less than nine months or federal funds purchased. Long-term borrowings include notes payable (consisting of FHLB advances and a joint venture note, prior to its refinance in 2016 from an outside lender to the Bank subsequently requiring elimination in consolidation), 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). Notes payable declined $14.4 million to $1.0 million at December 31, 2016, given the elimination of the joint venture note and repayments of FHLB advances during 2016. Junior subordinated debentures increased $12.2 million to $24.7 million at year end 2016, attributable to acquired Baylake debentures at fair value. Subordinated debt increased $0.1 million to $11.9 million at December 31, 2016, given amortization of capitalized issuance costs. The interest on all long-term borrowings is current, and while the various junior subordinated debentures are callable at par plus any accrued but unpaid interest, there are no current plans to redeem these debentures early. See Note 9, “Notes Payable,” Note 10, “Junior Subordinated Debentures”, and Note 11, “Subordinated Notes” of the Notes to Consolidated Financial Statements under Part II, Item 8 for additional details.
Additional funding sources consist of a $10 million available and unused line of credit at the holding company, $143 million of available and unused Federal funds purchased lines, available total borrowing capacity at the FHLB of $181 million of which $9.0 million was used at December 31, 2016 (consisting of $1 million in outstanding advances and $8 million related to outstanding letters of credit), and borrowing capacity in the brokered deposit market.
Off-Balance Sheet Obligations
As of December 31, 2016, 2015 and 2014, Nicolet had the following lending-related commitments that did not appear on its balance sheet:
Table 17: Commitments
At December 31,
(dollars in thousands)
|Commitments to extend credit — fixed and variable rate||$||554,980||$||302,591||$||269,648|
|Financial letters of credit — fixed rate||12,444||2,610||2,996|
|Standby letters of credit — fixed rate||4,898||4,314||3,629|
These commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. The commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Further discussion of these commitments is included in Note 16, “Commitments and Contingencies” of the Notes to Consolidated Financial Statements, under Part II, Item 8.
Nicolet is party to various contractual obligations requiring the use of funds as part of its normal operations. The table below outlines principal amounts and timing of these obligations, excluding amounts due for interest, if applicable. Most of these obligations are routinely refinanced into similar replacement obligations. However, renewal of these obligations is dependent on the ability to procure competitive interest rates, liquidity needs, availability of collateral for pledging purposes supporting the long-term advances, or other borrowing alternatives.
Table 18: Contractual Obligations
As of December 31, 2016
(dollars in thousands)
|Maturity by Years|
|Total||1 or less||1-3||3-5||Over 5|
|Junior subordinated debentures||$||24,732||$||—||$||—||$||—||$||24,732|
|Total long-term contractual obligations||$||41,398||$||685||$||2,329||$||1,085||$||37,299|
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; amortization, repayment and maturity of loans; maturing investments and investments sales; and procurement of brokered deposits. All investment securities are classified as available for sale and are reported at fair value on the consolidated balance sheet. At December 31, 2016, approximately 8.3% of the $365.3 million investment securities carrying value was pledged to secure public deposits and short-term borrowings, as applicable, and for other purposes as required by law. Other funding sources available include the ability to procure short-term borrowings, federal funds purchased, and long-term borrowings (such as FHLB advances).
Dividends from the Bank represent a significant source of cash flow for the Parent Company. The Bank is required by federal law to obtain prior approval of the OCC for payments of dividends if the total of all dividends declared by the Bank in any year will exceed certain thresholds, as more fully described in “Business—Regulation of the Bank – Payment of Dividends” and in Note 19, “Regulatory Capital Requirements and Restrictions on Dividends,” in the Notes to the Consolidated Financial Statements under Part II, Item 8. Management does not believe that regulatory restrictions on dividends from the Bank will adversely affect its ability to meet its cash obligations.
Cash and cash equivalents at December 31, 2016 and 2015 were approximately $129.1 million and $83.6 million, respectively. The increased cash and cash equivalents for 2016 when compared to historical levels was predominantly due to strong customer deposit growth. The $45.5 million increase in cash and cash equivalents since year end 2015 included $24.7 million net cash provided by operating activities and $51.5 million from investing activities (mostly due to the net cash acquired with the 2016 acquisitions, offset partly by net investment purchase activity), exceeding the $30.7 million net cash used in financing activities (primarily from reductions in short-term and long-term borrowings, common stock repurchases and preferred stock redemption exceeding cash inflow from strong deposit growth). Nicolet’s liquidity resources were sufficient as of December 31, 2016 to fund loans, accommodate deposit trends and cycles, and to meet other cash needs as necessary.
Interest Rate Sensitivity Management
A reasonable balance between interest rate risk, credit risk, liquidity risk and maintenance of yield, is highly important to Nicolet’s business success and profitability. As an ongoing part of its financial strategy and risk management, Nicolet attempts to understand and manage the impact of fluctuations in market interest rates on its net interest income. The consolidated balance sheet consists mainly of interest-earning assets (loans, investments and cash) which are primarily funded by interest-bearing liabilities (deposits and other borrowings). Such financial instruments have varying levels of sensitivity to changes in market rates of interest. Market rates are highly sensitive to many factors beyond our control, including but not limited to general economic conditions and policies of governmental and regulatory authorities. Our operating income and net income depend, 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.
The following analysis assessed the impact on net interest income in the event of a gradual +/-100 bps and +/-200 bps change 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 financial data at December 31, 2016, the projected changes in net interest income over a one-year time horizon, versus the baseline, was -1.7%, -0.8%, -0.6% and -1.1% for the -200, -100, +100 and +200 bps scenarios, respectively; such results are within Nicolet’s guidelines of not greater than -15% for +/- 100 bps and not greater than -20% for +/- 200 bps.
Actual results may differ from these simulated results due to timing, magnitude and frequency of interest rate changes, as well as changes in market conditions and their impact on customer behavior and management strategies.
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.
Capital balances and changes in capital are presented in the Consolidated Statements of Changes in Stockholders’ Equity in Part II, Item 8 and are described in Note 14, “Stockholders’ Equity,” and a summary of regulatory capital amounts and ratios for Nicolet and the Bank are presented in Note 19, “Regulatory Capital Requirements and Restrictions of Dividends” of the Notes to Consolidated Financial Statements under Part II, Item 8.
The most notable capital-related actions in 2016 were: 1) on February 24, 2016, Nicolet’s common stock moved off the OTCBB and began trading on the Nasdaq Capital Market under the trading symbol “NCBS”, 2) the April 2016 issuance of common stock in connection with the Baylake merger and acquisition of a financial advisor business, 3) the September 2016 redemption of the final $12.2 million of its preferred stock, 4) common stock repurchases, and 5) the closure of 7 branches during 2016. The most notable capital-related actions in 2015 were: 1) the issuance of $12 million in 5% fixed rate, 10-year subordinated debt during the first half of 2015 (which qualifies as Tier 2 regulatory capital), 2) the September 2015 partial redemption of $12.2 million, or half, of its preferred stock at par, 3) common stock repurchases, and 3) the August 2015 sale of two outlying branches and accompanying loans and deposits.
On April 29, 2016, in connection with its acquisition of Baylake, Nicolet issued 4,344,243 shares of its common stock for consideration of $163.3 million, and recorded $1.2 million consideration for assumed stock options. Approximately $0.3 million of common stock issuance expenses related to the transaction were incurred and charged against additional paid in capital. In connection with the financial advisor business acquisition that completed April 1, 2016, Nicolet issued $2.6 million in common stock consideration.
Nicolet participated in the Small Business Lending Fund (“SBLF”) beginning in September 2011. The Company received $24.4 million for the issuance of 24,400 shares of Non-cumulative Perpetual Preferred Stock, Series C, with $1,000 per share liquidation value. The preferred stock qualified as Tier 1 capital for regulatory purposes and provided capital and liquidity for Nicolet’s small business lending, potential acquisition opportunities and defensive capital for the uncertain economic environment. Nicolet paid an annual dividend rate of 5% from initial funding through September 30, 2013, paid 1% thereafter through February 29, 2016, and paid 9% from March 1, 2016 through the date of redemption in September 2016. Nicolet redeemed $12.2 million (half) of its preferred stock in September 2015 and the remaining half in September 2016, as part of its capital plan and partially motivated by the adjustment of the preferred stock dividend rate to 9%.
As a result of the foregoing, Nicolet’s total capital was $275.9 million (100% common equity) at December 31, 2016, compared to $109.5 million at year-end 2015 (comprised of $12.2 million or 11% preferred equity and $97.3 million or 89% common equity). The $166.4 million increase in total equity since year end 2015 was dominated by the equity issued in relation to the 2016 acquisitions as noted above and $18.5 million of net income, exceeding the preferred stock redemption, common stock repurchases, a $3.7 million other comprehensive loss (related to market value declines in the investment portfolio given rate movements at year end 2016), $0.6 million of preferred stock dividends and other net activity in stock compensation and equity award activity in 2016.
Common equity to total assets at December 31, 2016 was 12.0%, up from 8.0% at December 31, 2015, and continues to reflect capacity to capitalize on opportunities. Book value per common share increased to $32.26 at year end 2016, up 37.7% over $23.42 at year end 2015. Common shares outstanding more than doubled from a year ago, to 8.55 million at December 31, 2016 from 4.15 million at December 31, 2015, predominantly attributable to the 2016 acquisitions.
Nicolet’s regulatory capital ratios remain strong and well above minimum regulatory ratios. At December 31, 2016, Nicolet’s Total, Tier 1, Common Equity Tier 1 (“CET1”) risk-based ratios and its leverage ratio were 13.9%, 12.6%, 11.3% and 10.3%, respectively, compared to the minimum regulatory requirements of 8.0%, 6.0%, 4.5% and 4.0%, respectively. Also, at December 31, 2016, the Bank’s Total, Tier 1, CETI and leverage ratios were 12.2%, 11.5%, 11.5% and 9.4%, respectively, and 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.
Nicolet has demonstrated the ability to raise capital efficiently directly related to acquisition transactions. Further, Nicolet’s investors have demonstrated a strong commitment to capital, providing common capital when needed, with the two examples being a December 2008 private placement raising $9.5 million in common capital as we entered the economic crisis and the April 2013 private placement raising $2.9 million in common capital alongside the predominately stock-for-stock Mid-Wisconsin merger which added $9.7 million in common capital. In managing capital for optimal return, we evaluate capital sources and uses, pricing and availability of our stock in the market, and alternative uses of capital (such as the level of organic growth or acquisition opportunities) in light of strategic plans. In early 2014, a common stock repurchase program was authorized and with subsequent modifications (the latest being January 17, 2017 for an additional $12 million to repurchase up to 250,000 more shares of common stock), the Board has authorized the use of up to $30 million to repurchase up to 1,050,000 shares of Nicolet common stock as an alternative use of capital. During 2016, $4.4 million was used to repurchase and cancel 114,914 shares at a weighted average price per share of $37.98 including commissions, bringing the life-to-date totals through December 31, 2016, to $14.2 million used to repurchase and cancel 518,609 shares at a weighted average price per share of $27.31 including commissions.
A source of income and funds for Nicolet as the parent company of the Bank are dividends from the Bank. Dividends declared by the Bank that exceed the retained net income for the most current year plus retained net income for the preceding two years must be approved by federal regulatory agencies. During the third quarter of 2016, the Bank requested approval from the regulatory agencies to a pay a $15 million special dividend out of Bank surplus and it was approved. The Bank paid dividends to the parent company of $35.5 million (which includes the special dividend) in 2016 and $11.0 million in 2015. At December 31, 2016, the Bank could pay dividends of approximately $1.1 million more without seeking regulatory approval.
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 Nicolet and the Bank on January 1, 2015, subject to a transition period for certain parts of the rules. See Part I, Item 1, “Business”, “- Supervision and Regulation”, for additional information. 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.
Effects of Inflation
The effect of inflation on a financial institution differs significantly from the effect on an industrial company. While a financial institution’s operating expenses, particularly salary and employee benefits, are affected by general inflation, the asset and liability structure of a financial institution consists largely of monetary items. Monetary items, such as cash, investments, loans, deposits and other borrowings, are those assets and liabilities which are or will be converted into a fixed number of dollars regardless of changes in prices. As a result, changes in interest rates have a more significant impact on a financial institution’s performance than does general inflation. For additional information regarding interest rates and changes in net interest income see “Interest Rate Sensitivity Management.” Inflation may have impacts on the Bank’s customers, on businesses and consumers and their ability or willingness to invest, save or spend, and perhaps on their ability to repay loans. As such, there would likely be impacts on the general appetite of banking products and the credit health of the Bank’s customer base.
Fourth Quarter 2016 Results
Nicolet recorded net income of $6.1 million for the fourth quarter of 2016, compared to net income of $2.8 million for the fourth quarter of 2015. Net income available to common equity for the fourth quarter of 2016 was $6.1 million, or $0.68 for diluted earnings per common share, compared to $2.8 million, or $0.64, respectively for the fourth quarter of 2015. Between the comparable quarters, net income available to common was up 118%, while diluted weighted average shares were up 105%, resulting in a 6% increase in diluted earnings per share. See Table 19 for selected quarterly information.
Taxable equivalent net interest income for the fourth quarter of 2016 was $20.6 million, compared to $11.0 million for the same quarter of 2015. Positive changes from balance sheet volume added $9.3 million to net interest income and were predominantly due to the Baylake merger, while favorable changes in rates added $0.3 million to net interest income (the net of $0.4 million less interest income from lower earning asset yields and $0.7 million less interest expense on lower cost of funds). The net interest margin between the comparable quarters was up 4 bps to 4.05% in the fourth quarter of 2016, comprised of a 10 bps higher interest rate spread (to 3.93%, as the yield on earning assets decreased by 25 bps and the rate on interest-bearing liabilities decreased by 35 bps) and a 2 bps higher contribution from net free funds (mainly from higher noninterest-bearing deposits).
Average earning assets were $2.0 billion for the fourth quarter of 2016 compared to $1.1 billion for the fourth quarter of 2015, with average loans (up $676 million) and nonloan earning assets (up $250 million) representing 78% and 22% of average earning assets (including low-earning cash at 3% of earning assets), respectively, compared to fourth quarter 2015’s mix of 82% loans and 18% nonloan earning assets (with cash at 1%). On the funding side, average interest-bearing deposits were up $643 million, average demand deposits increased $252 million and average short and long-term funding balances decreased (down $3 million combined).
The provision for loan losses was $0.5 million for both fourth quarter periods, while net charge offs were $0.1 million for both periods.
Noninterest income for the fourth quarter of 2016 increased $3.3 million (73%) to $7.9 million versus the fourth quarter of 2015. Net loss on sale and write-down of assets was $0.5 million for fourth quarter 2016 due to an OTTI charge on a private company equity investment, compared to net gains of $0.7 million for fourth quarter 2015 attributable to OREO (with a large gain on sale of an OREO property partly offset by a write-down on a bank premise OREO), for a $1.2 million unfavorable variance between quarters. Other increases across line items were primarily commensurate with the larger volumes due to the 2016 acquisitions, but notably brokerage fee income increased $1.4 million, mortgage income, net increased $1.2 million, service charges on deposits increased $0.5 million, trust fees increased $0.2 million and other noninterest income increased $1.2 million (of which interchange income and UFS income account for $0.4 million and $0.5 million, respectively).
On a comparable quarter basis, noninterest expense increased $8.1 million (79%) to $18.4 million in the fourth quarter of 2016 (which included $0.4 million merger-based expenses) over the fourth quarter of 2015 (including $0.7 million merger based expenses). Personnel expense of $9.3 million, increased $3.8 million (68%) over the fourth quarter of 2015, primarily due to merit increases and the larger workforce after the 2016 acquisitions (with full-time equivalent employees up 71% between December 31, 2016 and 2015). All nonpersonnel expense categories combined were up $4.3 million, primarily commensurate with the larger operating base after the 2016 acquisitions, but most notably intangibles amortization up $1.0 million fully attributable to the acquisitions, data processing up $1.0 million on larger volumes and a rate increase, and occupancy, equipment and office costs combined up $1.3 million given the expanded footprint, additional integration and communication costs to customers and shareholders.
For the fourth quarter of 2016, Nicolet recognized income tax expense of $2.9 million, compared to income tax expense of $1.6 million for the fourth quarter of 2015. The change in income tax was primarily due to the level of pretax income between the comparable quarters. The effective tax rate was 32.4% for the fourth quarter of 2016 (including higher levels of non-taxable income from BOLI, investment securities, and other equity investment holdings), compared to an effective tax rate of 36.5% for the fourth quarter of 2015.
Selected Quarterly Financial Data
The following is selected financial data summarizing the results of operations for each quarter in the years ended December 31, 2016 and 2015.
Table 19: Selected Quarterly Financial Data
(dollars in thousands, except per share data)
|2016 Quarter Ended|
|December 31,||September 30,||June 30,||March 31,|
|Net interest income||20,024||20,904||16,466||10,739|
|Provision for loan losses||450||450||450||450|
|Net income attributable to Nicolet Bankshares, Inc.||6,087||6,464||3,257||2,654|
|Net income available to common shareholders||6,087||6,217||2,983||2,542|
|Basic earnings per common share*||0.71||0.72||0.41||0.61|
|Diluted earnings per common share*||0.68||0.69||0.39||0.57|
|2015 Quarter Ended|
|December 31,||September 30,||June 30,||March 31,|
|Net interest income||10,651||10,017||9,713||11,003|
|Provision for loan losses||450||450||450||450|
|Net income attributable to Nicolet Bankshares, Inc.||2,819||2,594||2,935||3,080|
|Net income available to common shareholders||2,789||2,534||2,874||3,019|
|Basic earnings per common share*||0.70||0.64||0.72||0.75|
|Diluted earnings per common share*||0.64||0.58||0.66||0.70|
*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.
2015 Compared to 2014
2015 was a year for balance sheet and capital management, with continued focus on financial performance and acquisitions. At December 31, 2015, Nicolet had assets of $1.2 billion, loans of $877 million and deposits of $1.1 billion. Net income attributed to Nicolet was $11.4 million for 2015, 15% higher than 2014, and after preferred stock dividends, diluted earnings per common share was $2.57, 14% higher than 2014. Earnings for 2015 were especially characterized by steady return over an improved mix of average interest-earning assets with slightly lower aggregate discount accretion on acquired loans between the years, strong secondary mortgage income, net gains on sales of investments and other real estate owned (“OREO”), and expense management, while also accommodating costs related to the pending Baylake merger. Strong asset quality metrics resulted in a lower 2015 loan loss provision than for 2014. As part of its active capital management, Nicolet sold two outlying branches in August 2015, issued $12 million of subordinated debt in the first half of 2015, redeemed $12.2 million of its preferred stock in September 2015 at par, and continued to repurchase its common stock until September 2015. As a result, total equity was $110 million at December 31, 2015, with preferred equity down $12 million and common equity up $11 million net (from retained earnings and issued common equity exceeding common stock repurchases for the year) compared to year end 2014. Return on average assets of 0.96% and return on average common equity of 12.35% indicates solid performance traction in 2015.
Net income attributable to Nicolet was $11.4 million for 2015, and after $0.2 million of preferred stock dividends, net income available to common shareholders was $11.2 million, or $2.57 per diluted common share. Comparatively, 2014 net income attributable to Nicolet was $9.9 million, and after $0.2 million of preferred stock dividends, net income available to common shareholders was $9.7 million or $2.25 per diluted common share. Between the years, net income increased 14.9% and diluted earnings per common share increased 14.2%. Return on average assets improved to 0.96% for 2015, compared to 0.84% for 2014. Return on average common equity was 12.35% for 2015, compared to 11.55% for 2014. Book value per common share was $23.42 at December 31, 2015, up 9.7% over $21.34 at December 31, 2014.
As part of its capital management, Nicolet sold two outlying branches in August 2015 (at that time reducing deposits by $34 million, loans by $13 million, fixed assets by $1 million and cash by $20 million), issued $12 million of 5% fixed-rate, 10-year subordinated debt in the first half of 2015 (increasing its regulatory Tier 2 capital), redeemed $12.2 million or half of its then outstanding SBLF Series C Preferred Stock in September 2015 at par (reducing total capital, regulatory Tier 1 capital, and the future cost of capital), and used $4.2 million to repurchase 146,404 common shares at a weighted average per share price of $28.35 including commissions.
Other key factors behind the results were:
|•||Net interest income was $41.4 million for 2015, a decrease of $0.5 million or 1% compared to 2014. The earning asset yield was unchanged at 4.54% for both 2015 and 2014, influenced mainly by the earning asset mix, with more balances in higher-yielding assets. Loans, investments and other interest-earning assets (mostly low-earning cash) represented 82%, 15% and 3% of average earning assets, respectively for 2015, compared to 79%, 13% and 8%, respectively, for 2014. The cost of funds was 0.84% for 2015, 5 bps higher than 2014, impacted by the new 5% subordinated debt and a 1 bp increase in the cost of interest-bearing deposits. As a result, the interest rate spread was 3.70% for 2015, 5 bps lower than 2014. The net interest margin was 3.88% for 2015 compared to 3.89% for 2014, with a higher contribution from net free funds partly offsetting the decline in interest rate spread.|
|•||Loans were $877 million at December 31, 2015, essentially unchanged (down only $6 million or 0.7%) from December 31, 2014; however, excluding the impact of the August 2015 branch sale noted earlier, loans grew 0.8%. Average loans were $884 million in 2015 yielding 5.12%, compared to $859 million in 2014 yielding 5.32%, a 3% increase in average balances. The 20 bps decline in loan yield was due to continued downward pressure on rates of new and renewing loans in the 2015 rate environment and $0.5 million lower aggregate discount accretion on acquired loans between 2015 and 2014.|
|•||Total deposits were $1.1 billion at December 31, 2015, essentially unchanged (down only $3 million or 0.3%) from December 31, 2014; however, excluding the impact of the August 2015 branch sale noted earlier, deposits grew 2.9%. Between 2015 and 2014, average deposits were down $7 million or 0.7%, with interest-bearing deposits down $39 million and noninterest-bearing deposits up $32 million, driving the improvement in net free funds. Interest-bearing deposits cost 0.64% for 2015 and 0.63% for 2014.|
|•||Asset quality measures remained strong. Nonperforming assets fell 47% to $3.9 million (or 0.32% of total assets) at December 31, 2015, compared to $7.4 million (or 0.61% of assets) at December 31, 2014. For 2015, the provision for loan losses was $1.8 million, exceeding net charge offs of $0.8 million, versus provision of $2.7 million and net charge offs of $2.6 million for 2014. The allowance for loan losses (“ALLL”) was $10.3 million (representing 1.18% of loans) at December 31, 2015, compared to $9.3 million (representing 1.05% of loans) at December 31, 2014.|
|•||Noninterest income was $17.7 million (including $1.7 million of net gain on sale or write-down of assets), compared to $14.2 million for 2014 (including $0.5 million of net gain on sale or write-down of assets). Removing these net gains, noninterest income was up $2.3 million or 17.1%, with increases in all line items, except rental income and investment advisory fees, but driven by the $1.3 million increase in net mortgage income largely due to increased volumes. Increases in service charges on deposit accounts (up 10%, trust revenues (up 6%) and brokerage income (up 6%) collectively accounted for another $0.5 million increase between 2015 and 2014.|
|•||Noninterest expense was $39.6 million, compared to $38.7 million for 2014. The increase between the years was modest (up $0.9 million or 2.4%, with approximately $0.8 million in 2015 attributable to non-recurring merger-based expenses such as the fairness opinion, legal and conversion costs related to the in-process merger with Baylake), exhibiting expense management. Most notably, salaries and employee benefits were up 4.9% over 2014 (including a base salary increase of 3%, and higher equity and cash incentive awards between the years) while average full-time equivalent employees were minimally changed. All other non-personnel expenses combined were down by less than 1%, and after excluding the 2015 merger-related expenses, were down 5% from 2014.|
Critical Accounting Policies
The consolidated financial statements of Nicolet are prepared in conformity with U.S. generally accepted accounting principles (“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 the 2013 and 2016 acquisitions, as well as the determination of the allowance for loan losses and income taxes and, therefore, are critical accounting policies. The critical accounting policies are discussed directly with Nicolet’s Audit Committee.
Business Combinations and Valuation of Loans Acquired in Business Combinations
We account for acquisitions under Financial Accounting Standards Board (“FASB”) ASC Topic 805, Business Combinations, which requires 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. As provided for under GAAP, management has up to 12 months following the date of the acquisition to finalize the fair values of acquired assets and assumed liabilities, where it was not possible to estimate the acquisition date fair value upon consummation. Management finalized the fair values of acquired assets and assumed liabilities within this 12-month period and management currently considers such values to be the Day 1 Fair Values for the 2016 acquisitions, but management may revise the Day 1 Fair Values for the 2016 acquisitions through April 2017. This was completed for the Mid-Wisconsin transaction during the second quarter of 2013 and was completed for the Bank of Wausau transaction in the third quarter of 2013.
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 nonaccretable difference (the credit mark component of the acquired loans) and an accretable difference (the market rate or yield component of the acquired loans). The nonaccretable 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 accretable yield, and nonaccretable difference 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 using the effective yield method over the term of the loans. Management separately monitors the acquired loan portfolio and periodically reviews loans contained within this portfolio against the factors and assumptions used in determining the Day 1 Fair Values.
Allowance for Loan Losses
The allowance for loan losses 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 December 31, 2016. The allowance analysis is reviewed by the board of directors on a quarterly basis in compliance with regulatory requirements. In addition, various regulatory agencies periodically review the ALLL. These agencies may require Nicolet to make additions to the ALLL based on their judgments of collectability based on information available to them at the time of their examination.
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.
Future Accounting Pronouncements
Recent accounting pronouncements adopted are included in Note 1, “Nature of Business and Significant Accounting Policies” of the Notes to Consolidated Financial Statements.
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 is not expected to have a material impact on the Company’s consolidated financial statements.
In March 2016, the FASB issued updated guidance to ASU 2015-09: Stock Compensation Improvements to Employee Share-Based Payment Activity intended to simplify and improve several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of such awards as either equity or liabilities and classification on the statement of cash flows. The updated guidance is effective for interim and annual reporting periods beginning after December 15, 2016, with early adoption permitted. The Company is currently assessing the impact of the new guidance on its consolidated financial statements.
In June 2016, the FASB issued ASU 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments intended to improve the financial reporting by requiring timelier recording of credit losses on loans and other financial instruments held by financial institutions and other organizations. The ASU requires the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Financial institutions and other organizations will now use forward-looking information to better inform their credit loss estimates. The ASU is effective for SEC filers for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. Entities should apply the amendment by means of a cumulative-effect adjustment to retained earnings as of the beginning of the fiscal year of adoption. Early application will be permitted for all organizations for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. The Company is currently assessing the impact of the new guidance on its consolidated financial statements.
In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts to address diversity in how certain cash receipts and cash payments are presented and classified in the statement of cash flows. The amendments provide guidance on specific cash flow issues, including: debt prepayment or debt extinguishment costs, contingent consideration payments made after a business combination, proceeds from the settlement of insurance claims, proceeds from the settlement of Corporate-Owned Life Insurance Policies, including Bank-Owned Life Insurance Policies, and distributions received from equity method investees. The amendments are effective for public business entities for fiscal years beginning after December 31, 2017, and interim periods within those fiscal years. Early adoption is permitted including adoption in an interim period. The Company is currently assessing the impact of the new guidance on its consolidated financial statements.
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606). The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods and services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods and services. In August 2015, the FASB issued an amendment to defer the effective date for all entities by one year. The updated guidance is effective for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period. The Company is currently assessing the impact of the new guidance on its consolidated financial statements. Since a significant number of business transactions are not subject to the guidance, it is not expected to have a significant impact on our financial statements.
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). The core principle of the guidance is a lessee should recognize the assets and liabilities that arise from leases. The recognition, measurement, and presentation of expenses and cash flows arising from a lease by a lessee primarily will depend on its classification as a finance or operating lease. However, unlike current GAAP which requires only capital leases to be recognized on the balance sheet, the new standard will require both types of leases to be recognized on the balances sheet. The updated guidance is effective for annual reporting periods beginning after December 15, 2018. Early application is permitted. The Company is currently assessing the impact of the new guidance on its consolidated financial statements.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
For additional disclosure, see section, “Interest Rate Sensitivity Management,” of the Management’s Discussion and Analysis of Financial Condition and Results of Operation under Part II, Item 7.
ITEM 8. FINANCIAL STATEMENTS
NICOLET BANKSHARES, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
|(In thousands, except share and per share data)||2016||2015|
|Cash and due from banks||$||68,056||$||11,947|
|Federal funds sold||727||917|
|Cash and cash equivalents||129,103||83,619|
|Certificates of deposit in other banks||3,984||3,416|
|Securities available for sale (“AFS”)||365,287||172,596|
|Loans held for sale||6,913||4,680|
|Allowance for loan losses||(11,820||)||(10,307||)|
|Premises and equipment, net||45,862||29,613|
|Bank owned life insurance (“BOLI”)||54,134||28,475|
|Goodwill and other intangibles||87,938||3,793|
|Accrued interest receivable and other assets||33,072||13,358|
|Liabilities and Stockholders’ Equity|
|Money market and NOW accounts||964,509||486,677|
|Junior subordinated debentures||24,732||12,527|
|Accrued interest payable and other liabilities||16,911||8,547|
|Additional paid-in capital||209,700||45,220|
|Accumulated other comprehensive income (loss)||(2,727||)||980|
|Total Nicolet Bankshares, Inc. stockholders’ equity||275,947||109,501|
|Total stockholders’ equity and noncontrolling interest||276,365||109,687|
|Total liabilities, noncontrolling interest and stockholders’ equity||$||2,300,879||$||1,214,439|
|Preferred shares authorized (no par value)||10,000,000||10,000,000|
|Preferred shares issued and outstanding||-||12,200|
|Common shares authorized (par value $0.01 per share)||30,000,000||30,000,000|
|Common shares outstanding||8,553,292||4,154,377|
|Common shares issued||8,596,241||4,191,067|
See Notes to Consolidated Financial Statements.
NICOLET BANKSHARES, INC. AND SUBSIDIARIES
Consolidated Statements of Income
|(In thousands, except share and per share data)||2016||2015||2014|
|Loans, including loan fees||$||69,425||$||45,638||$||46,081|
|Other interest income||1,327||443||469|
|Total interest income||75,467||48,597||48,949|
|Money market and NOW accounts||2,385||2,260||2,275|
|Savings and time deposits||2,759||2,930||3,067|
|Junior subordinated debentures||1,315||881||875|
|Total interest expense||7,334||7,213||7,067|
|Net interest income||68,133||41,384||41,882|
|Provision for loan losses||1,800||1,800||2,700|
|Net interest income after provision for loan losses||66,333||39,584||39,182|
|Service charges on deposit accounts||3,571||2,348||2,128|
|Mortgage income, net||5,494||3,258||1,926|
|Trust services fee income||5,435||4,822||4,569|
|Brokerage fee income||3,624||670||631|
|Bank owned life insurance||1,284||996||933|
|Investment advisory fees||452||408||440|
|Gain on sale or write-down of assets, net||54||1,726||539|
|Total noninterest income||26,674||17,708||14,185|
|Occupancy, equipment and office||10,276||6,928||7,086|
|Business development and marketing||3,488||2,244||2,267|