UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.
For the quarterly period ended September 30, 2016
¨TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from…………to………………
Commission file number 001-37700
NICOLET BANKSHARES, INC.
(Exact name of registrant as specified in its charter)
111 North Washington Street
Green Bay, Wisconsin 54301
(920) 430-1400
(Address, including zip code, and telephone number, including area code, ofRegistrant’s principal executive offices)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Date File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer ¨ Accelerated filer xNon-accelerated filer ¨ (Do not check if a smaller reporting company) Smaller reporting company ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
As of October 31, 2016 there were 8,547,004 shares of $0.01 par value common stock outstanding.
Nicolet Bankshares, Inc.
TABLE OF CONTENTS
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PART I – FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS:
NICOLET BANKSHARES, INC. AND SUBSIDIARIES
Consolidated Balance Sheets(In thousands, except share and per share data)
September 30, 2016
(Unaudited)
See accompanying notes to unaudited consolidated financial statements.
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ITEM 1. Financial Statements Continued:
Consolidated Statements of Income
(In thousands, except share and per share data) (Unaudited)
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Consolidated Statements of Comprehensive Income
(In thousands) (Unaudited)
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Consolidated Statement of Stockholders’ Equity
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Consolidated Statements of Cash Flows
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Notes to Unaudited Consolidated Financial Statements
Note 1 – Basis of Presentation
General
In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments necessary to present fairly Nicolet Bankshares, Inc. (the “Company”) and its subsidiaries, consolidated balance sheets, statements of income, comprehensive income, changes in stockholders’ equity and cash flows for the periods presented, and all such adjustments are of a normal recurring nature. All material intercompany transactions and balances are eliminated. The results of operations for the interim periods are not necessarily indicative of the results to be expected for the entire year.
These interim consolidated financial statements have been prepared according to the rules and regulations of the Securities and Exchange Commission and, therefore, certain information and footnote disclosures normally presented in accordance with generally accepted accounting principles in the United States of America (“U.S. GAAP”) have been omitted or abbreviated. These consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements and footnotes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015.
Critical Accounting Policies and Estimates
Preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying disclosures. These estimates are based on management’s best knowledge of current events and actions the Company may undertake in the future. Estimates are used in accounting for, among other items, the allowance for loan losses, useful lives for depreciation and amortization, fair value of financial instruments, deferred tax assets, uncertain income tax positions and contingencies. Estimates that are particularly susceptible to significant change for the Company include the determination of the allowance for loan losses, the assessment of deferred tax assets and liabilities, and the valuation of loans acquired in acquisitions; therefore, these are critical accounting policies. Factors that may cause sensitivity to the aforementioned estimates include but are not limited to: external market factors such as market interest rates and employment rates, changes to operating policies and procedures, changes in applicable banking regulations, and changes to deferred tax estimates. Actual results may ultimately differ from estimates, although management does not generally believe such differences would materially affect the consolidated financial statements in any individual reporting period presented.
There have been no material changes or developments with respect to the assumptions or methodologies that the Company uses when applying what management believes are critical accounting policies and developing critical accounting estimates as disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015.
Recent Accounting Developments Adopted
The Company has implemented all new accounting pronouncements that are in effect and that may impact its consolidated financial statements or results of operations.
Operating Segment
While the chief decision makers monitor the revenue streams of the various products and services, and evaluate costs, balance sheet positions and quality, all such products, services and activities are directly or indirectly related to the business of community banking, with no regular, formal or material segment delineations. Operations are managed and financial performance is evaluated on a company-wide basis, and accordingly, all the financial service operations are considered by management to be aggregated in one reportable operating segment.
Reclassifications
Certain amounts in the 2015 consolidated financial statements have been reclassified to conform to the 2016 presentation.
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Note 2 – Acquisitions
On April 29, 2016, the Company consummated its merger with Baylake Corp. (“Baylake”), pursuant to the Agreement and Plan of Merger by and between the Company and Baylake dated September 8, 2015, (the “Merger Agreement”), whereby Baylake was merged with and into the Company, and Baylake Bank, Baylake’s wholly owned commercial bank subsidiary serving northeastern Wisconsin, was merged with and into Nicolet National Bank. The system integration was completed, and 21 branches of Baylake opened, on May 2, 2016, as Nicolet National Bank branches, expanding its presence into Door, Kewaunee, and Manitowoc Counties, Wisconsin. Concurrently, Nicolet closed one of its Brown County locations, bringing the Bank’s footprint to 42 branches as of September 30, 2016.
The purpose of the merger was for strategic reasons beneficial to the Company. The acquisition is consistent with its plan to drive growth and efficiency through increased scale, leverage the strengths of each bank across the combined customer base, enhance profitability, and add liquidity and shareholder value.
Pursuant to the terms of the Merger Agreement, Baylake shareholders received 0.4517 shares of the Company’s common stock for each outstanding share of Baylake common stock (except for Baylake shares pre-owned by the Company at the time of the merger), and cash in lieu of any fractional share. Pre-existing Baylake equity awards (restricted stock units and stock options) immediately vested upon consummation of the merger. The Company issued 0.4517 shares of its common stock for each vesting Baylake restricted stock unit, and Nicolet assumed, after appropriate adjustment by the 0.4517 exchange ratio, all pre-existing Baylake stock options. As a result, the Company issued 4,344,243 shares of the Company’s common stock, for common stock consideration of $163.3 million (based on $37.58 per share, the volume weighted average closing price of the Company’s common stock over the preceding 20 trading day period, and recorded an additional $1.2 million consideration for the assumed stock options. Approximately $0.3 million in direct stock issuance costs for the merger were incurred and charged against additional paid in capital, bringing the total purchase price to $164.2 million.
The Company accounted for the transaction under the acquisition method of accounting, and thus, the financial position and results of operations of Baylake prior to the consummation date were not included in the accompanying consolidated financial statements. The accounting required assets purchased and liabilities assumed to be recorded at their respective fair values at the date of acquisition. The Company determined the fair value of core deposit intangibles, securities, premises and equipment, loans, OREO, BOLI and other assets, deposits, debt and deferred taxes with the assistance of third party valuations, appraisals, and third party advisors. The estimated fair values will be subject to refinement as additional information relative to the closing date fair values becomes available through the measurement period of approximately one year from consummation.
The fair value of the assets acquired and liabilities assumed on April 29, 2016 was as follows:
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Note 2 – Acquisitions, continued
The following unaudited pro forma information presents the results of operations for three months and nine months ended September 30, 2016 and 2015, as if the acquisition had occurred January 1 of each period. The Company expects to achieve further operating cost savings and other business synergies as a result of the acquisition which are not reflected in the pro forma amounts. These unaudited pro forma results are presented for illustrative purposes and are not intended to represent or be indicative of the actual results of operations of the combined company that would have been achieved had the acquisition occurred at the beginning of each period presented, nor are they intended to represent or be indicative of future results of operations.
During the first quarter of 2016, Nicolet agreed in a private transaction to hire a select group of financial advisors and purchase their respective books of business, as well as their operating platform, to enhance the leadership and future growth of the Company’s wealth management business. The transaction was effected in phases and completed April 1, 2016. The Company paid $4.9 million total initial consideration, including $0.8 million cash, $2.6 million of Nicolet common stock, and recorded a $1.5 million earn-out liability payable to one principal in the future (which may require adjustment based on change in initial business purchased over a period, but not contingent upon the principal’s employment). The Company initially recorded $0.4 million of goodwill, $0.2 million of fixed assets, and $4.3 million of customer relationship intangibles (a portion amortizing straight-line over 10 years and a portion over 15 years). The transaction will impact the income statement primarily within brokerage income, personnel expense, and intangibles amortization.
Note 3 – Earnings per Common Share
Basic earnings per common share are calculated by dividing net income available to common shareholders by the weighted average number of common shares outstanding during the period. Diluted earnings per share is calculated by dividing net income available to common shareholders by the weighted average number of shares adjusted for the dilutive effect of common stock awards (outstanding stock options and unvested restricted stock), if any. Presented below are the calculations for basic and diluted earnings per common share.
*Cumulative quarterly per share performance may not equal annual per share totals due to the effects of the amount and timing of capital increases. When computing earnings per share for an interim period, the denominator is based on the weighted-average shares outstanding during the interim period, and not on an annualized weighted-average basis. Accordingly, the sum of the quarters' earnings per share data will not necessarily equal the year to date earnings per share data.
No shares were outstanding at September 30, 2016 which were excluded from the calculation of diluted earnings per common share as anti-dilutive. Options to purchase approximately 0.2 million shares were outstanding at September 30, 2015, but were excluded from the calculation of diluted earnings per common share as the effect would have been anti-dilutive.
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Note 4 – Stock-based Compensation
A Black-Scholes model is utilized to estimate the fair value of stock options and the market price of the Company’s stock at the date of grant is used to estimate the value of restricted stock awards. The weighted average assumptions used in the model for valuing option grants were as follows:
Activity in the Company’s Stock Incentive Plans is summarized in the following tables:
*The terms of the stock option agreements permit having a number of shares of stock withheld, the fair market value of which as of the date of exercise is sufficient to satisfy the exercise price and/or tax withholding requirements.
Options outstanding at September 30, 2016 are exercisable at option prices ranging from $9.19 to $38.10. There are 304,393 options outstanding in the range from $9.19 - $20.00, 260,489 in the range from $20.01 - $25.00, 162,211 in the range from $25.01 - $30.00, and 206,873 options outstanding in the range from $30.01 - $38.10. At September 30, 2016, the exercisable options have a weighted average remaining contractual life of approximately 5 years and a weighted average exercise price of $19.60.
Intrinsic value represents the amount by which the fair market value of the underlying stock exceeds the exercise price of the stock options. The total intrinsic value of options exercised in the first nine months of 2016, and full year of 2015 was approximately $1.1 million and $5.2 million, respectively.
*The terms of the restricted stock agreements permit the surrender of shares to the Company upon vesting in order to satisfy applicable tax withholding requirements at the minimum statutory withholding rate, and accordingly 3,653 shares were surrendered during the nine months ended September 30, 2016 and 7,715 shares were surrendered during the twelve months ended December 31, 2015.
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Note 4 – Stock-based Compensation, continued
The Company recognized approximately $1.1 million and $0.9 million of stock-based employee compensation expense during the nine months ended September 30, 2016 and 2015, respectively, associated with its stock equity awards. As of September 30, 2016, there was approximately $4.7 million of unrecognized compensation cost related to equity award grants. The cost is expected to be recognized over the weighted average remaining vesting period of approximately three years.
Note 5 – Securities Available for Sale
Amortized costs and fair values of securities available for sale are summarized as follows:
Gross
Unrealized
Gains
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Note 5 – Securities Available for Sale, continued
The following table represents gross unrealized losses and the related fair value of investment securities available for sale, aggregated by investment category and length of time individual securities have been in a continuous unrealized loss position, at September 30, 2016 and December 31, 2015.
At September 30, 2016 the Company had $0.2 million of gross unrealized losses related to 152 securities. As of September 30, 2016, the Company does not consider securities with unrealized losses to be other-than-temporarily impaired as the unrealized losses in each category have occurred as a result of changes in interest rates, market spreads and market conditions subsequent to purchase. The Company has the ability and intent to hold its securities to maturity. There were no other-than-temporary impairments charged to earnings during the nine-month periods ending September 30, 2016 or September 30, 2015.
The amortized cost and fair values of securities available for sale at September 30, 2016 by contractual maturity are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Fair values of securities are estimated based on financial models or prices paid for the same or similar securities. It is possible interest rates could change considerably, resulting in a material change in estimated fair value.
Proceeds from sales of securities available for sale during the first nine months of 2016 and 2015 were approximately $30.3 million and $13.9 million, respectively. Gross gains of approximately $0.1 million and $0.6 million were realized during the first nine months of 2016 and 2015, respectively. Gross losses of approximately $13,000 were realized on sales of securities during the first nine months of 2016. No losses were realized on sales of securities during the first nine months of 2015.
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Note 6 – Loans, Allowance for Loan Losses, and Credit Quality
The loan composition as of September 30, 2016 and December 31, 2015 is summarized as follows.
% of
Total
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Note 6 – Loans, Allowance for Loan Losses, and Credit Quality, continued
Practically all of the Company’s loans, commitments, financial letters of credit and standby letters of credit have been granted to customers in the Company’s market area. Although the Company has a diversified loan portfolio, the credit risk in the loan portfolio is largely influenced by general economic conditions and trends of the counties and markets in which the debtors operate, and the resulting impact on the operations of borrowers or on the value of underlying collateral, if any.
The allowance for loan and lease losses (“ALLL”) represents management’s estimate of probable and inherent credit losses in the Company’s loan portfolio at the balance sheet date. In general, estimating the amount of the ALLL is a function of a number of factors, including but not limited to changes in the loan portfolio, net charge-offs, trends in past due and impaired loans, and the level of potential problem loans, all of which may be susceptible to significant change. To the extent actual outcomes differ from management estimates, additional provisions for loan losses could be required that could adversely affect our earnings or financial position in future periods. Allocations to the ALLL may be made for specific loans but the entire ALLL is available for any loan that, in management’s judgment, should be charged-off or for which an actual loss is realized.
The allocation methodology used by the Company includes specific allocations for impaired loans evaluated individually for impairment based on collateral values and for the remaining loan portfolio collectively evaluated for impairment primarily based on historical loss rates and other qualitative factors. Loan charge-offs and recoveries are based on actual amounts charged-off or recovered by loan category. Management allocates the ALLL by pools of risk within each loan portfolio.
The following tables present the balance and activity in the ALLL by portfolio segment and the recorded investment in loans by portfolio at or for the nine months ended September 30, 2016:
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The following table presents the balance and activity in the ALLL by portfolio segment and the recorded investment in loans by portfolio at or for the nine months ended September 30, 2015.
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The following table presents nonaccrual loans by portfolio segment in total and then as a further breakdown by originated or acquired as of September 30, 2016 and December 31, 2015.
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The following tables present total past due loans by portfolio segment as of September 30, 2016 and December 31, 2015:
A description of the loan risk categories used by the Company follows:
1-4 Pass: Credits exhibit adequate cash flows, appropriate management and financial ratios within industry norms and/or are supported by sufficient collateral. Some credits in these rating categories may require a need for monitoring but elements of concern are not severe enough to warrant an elevated rating.
5 Watch: Credits with this rating are adequately secured and performing but are being monitored due to the presence of various short-term weaknesses which may include unexpected, short-term adverse financial performance, managerial problems, potential impact of a decline in the entire industry or local economy and delinquency issues. Loans to individuals or loans supported by guarantors with marginal net worth or collateral may be included in this rating category.
6 Special Mention: Credits with this rating have potential weaknesses that, without the Company’s attention and correction may result in deterioration of repayment prospects. These assets are considered Criticized Assets. Potential weaknesses may include adverse financial trends for the borrower or industry, repeated lack of compliance with Company requests, increasing debt to net worth, serious management conditions and decreasing cash flow.
7 Substandard: Assets with this rating are characterized by the distinct possibility the Company will sustain some loss if deficiencies are not corrected. All foreclosures, liquidations, and non-accrual loans are considered to be categorized in this rating, regardless of collateral sufficiency.
8 Doubtful: Assets with this rating exhibit all the weaknesses as one rated Substandard with the added characteristic that such weaknesses make collection or liquidation in full highly questionable.
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9 Loss: Assets in this category are considered uncollectible. Pursuing any recovery or salvage value is impractical but does not preclude partial recovery in the future.
The following tables present total loans by loan grade as of September 30, 2016 and December 31, 2015:
Management considers a loan to be impaired when it is probable the Company will be unable to collect all contractual principal and interest payments due in accordance with the terms of the loan agreement. For determining the adequacy of the ALLL, management defines impaired loans as nonaccrual credit relationships over $250,000, plus additional loans with impairment risk characteristics. At the time an individual loan goes into nonaccrual status, however, management evaluates the loan for impairment and possible charge-off regardless of loan size.
In determining the appropriateness of the ALLL, management includes allocations for specifically identified impaired loans and loss factor allocations for all remaining loans, with a component primarily based on historical loss rates and another component primarily based on other qualitative factors. Impaired loans are individually assessed and are measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate or, as a practical expedient, at the loan’s observable market price or the fair value of the collateral if the loan is collateral dependent.
Loans that are determined not to be impaired are collectively evaluated for impairment, stratified by type and allocated loss ranges based on the Company’s actual historical loss ratios for each strata, and adjustments are also provided for certain current environmental and qualitative factors. An internal loan review function rates loans using a grading system based on nine different categories. Loans with grades of seven or higher (“classified loans”) represent loans with a greater risk of loss and may be assigned allocations for loss based on specific review of the weaknesses observed in the individual credits if classified as impaired. Classified loans are constantly monitored by the loan review function to ensure early identification of any deterioration.
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The following tables present impaired loans as of September 30, 2016 and December 31, 2015. As a further breakdown, impaired loans are also summarized by originated and acquired for the periods presented. In April 2016, the Baylake merger added purchased credit impaired loans at a fair value of $20.8 million, net of an initial $12.9 million non-accretable mark. Including these credit impaired loans acquired in the Baylake merger, total purchased credit impaired loans acquired in aggregate were initially recorded at a fair value of $37.5 million on their respective acquisition dates, net of an initial $25.1 million non-accretable mark and a zero accretable mark. At September 30, 2016, $20.0 million of the $37.5 million remain in impaired loans and $0.3 million of acquired loans have subsequently become impaired, bringing acquired impaired loans to $20.3 million.
As a further breakdown, impaired loans as of September 30, 2016 are summarized by originated and acquired as follows:
*One commercial & industrial loan with a balance of $0.3 million had a specific reserve of $96,000. No other loans had a related allowance at September 30, 2016 and, therefore, the above disclosure was not expanded to include loans with and without a related allowance.
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As a further breakdown, impaired loans as of December 31, 2015 are summarized by originated and acquired as follows:
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Troubled Debt Restructurings
At September 30, 2016, there were four loans classified as troubled debt restructurings totaling $340,000. These four loans had a combined premodification balance of $468,000. There were no other loans which were modified and classified as troubled debt restructurings at September 30, 2016. There were no loans classified as troubled debt restructurings during the previous twelve months that subsequently defaulted as of September 30, 2016. Loans which were considered troubled debt restructurings by Baylake prior to the acquisition are not required to be classified as troubled debt restructurings in the Company’s consolidated financial statements unless and until such loans would subsequently meet criteria to be classified as such, since acquired loans were recorded at their estimated fair values at the time of the acquisition.
Note 7 – Goodwill and Intangible Assets and Mortgage Servicing Rights
The excess of the purchase price in an acquisition over the fair value of net assets acquired consists primarily of goodwill, core deposit intangibles and other identifiable intangibles (primarily related to customer relationships acquired). Goodwill is not amortized but is instead subject to impairment tests on at least an annual basis. Core deposit intangibles, which arise from value ascribed to the deposit base of a bank acquired, have estimated finite lives and are amortized on an accelerated basis to expense over a 10-year period. The other intangibles, which represent value ascribed to financial advisor books of business purchased in 2016 in a private transaction, have estimated finite lives and are amortized on a straight-line basis to expense over their weighted average life (of approximately 12 years for 2016).
Management periodically reviews the carrying value of its long-lived and intangible assets to determine if any impairment has occurred, in which case an impairment charge would be recorded as an expense in the period of impairment, or whether changes in circumstances have occurred that would require a revision to the remaining useful life which would impact expense prospectively. In making such determination, management evaluates whether there are any adverse qualitative factors indicating that an impairment may exist, as well as the performance, on an undiscounted basis, of the underlying operations or assets which give rise to the intangible. The Company’s annual assessments indicated no impairment charge on goodwill or core deposit intangible was required for 2015 or the first nine months of 2016.
Goodwill: Goodwill was $66.7 million at September 30, 2016 and $0.8 million at December 31, 2015. There were additions to the carrying amount of goodwill in 2016 of $0.4 million related to the acquisition of financial advisor business and of approximately $65.5 million related to the Baylake merger. See Note 2 for additional information on the 2016 acquisitions.
Other intangible assets: Other intangible assets, consisting of core deposit intangibles and other intangibles (related to the customer relationships acquired in connection with the 2016 acquisition of financial advisor business), are amortized over their estimated finite lives. Due to the 2016 acquisitions, there was an addition to the gross carrying amount of core deposit intangibles of $17.3 million and of other intangibles of $4.4 million. Amortization on core deposit intangibles was $1.1 million and $2.1 million for the three and nine months ended September 30, 2016, respectively, and $0.3 million and $1.0 million for the three and nine months ended September 30, 2015, respectively. Amortization on other intangible assets was $0.2 million for both the three and nine months ended September 30, 2016 and zero in 2015. See Note 2 for additional information on the 2016 acquisitions.
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Note 7 – Goodwill and Intangible Assets and Mortgage Servicing Rights, continued
Mortgage servicing rights: The Company may sell originated residential mortgage loans into the secondary market. If the Company retains the right to service these loans sold, a mortgage servicing right is capitalized upon sale (recorded in mortgage income, net, in the consolidated income statements), which represents the then-current estimated fair value of future net cash flows expected to be realized for performing the servicing activities. Mortgage servicing rights, when purchased (as in the case of the 2016 Baylake merger), are initially recorded at their then-estimated fair value. As the Company has not elected to subsequently measure any class of servicing assets under the fair value measurement method, the Company follows the amortization method. Mortgage servicing rights are amortized in proportion to and over the period of estimated net servicing income, and assessed for impairment at each reporting date, with the amortization recorded in mortgage income, net, in the consolidated income statements. Mortgage servicing rights are carried at the lower of the initial capitalized amount, net of accumulated amortization, or estimated fair value, and are included in other assets in the consolidated balance sheets.
The Company periodically evaluates its mortgage servicing rights asset for impairment. At each reporting date, impairment is assessed based on estimated fair value using estimated prepayment speeds of the underlying mortgage loans serviced and stratifications based on the risk characteristics of the underlying loans serviced (predominantly loan type and note interest rate). A valuation allowance is established through a charge to earnings (which would be included in mortgage income, net, in the consolidated income statements) to the extent the amortized cost of the mortgage servicing rights exceeds the estimated fair value by stratification. If it is later determined that all or a portion of the temporary impairment no longer exists for a stratification, the valuation is reduced through a recovery to earnings, though not beyond the net amortized cost carried. An other-than-temporary impairment (i.e. recoverability is considered remote when considering interest rates and loan payoff activity) is recognized as a write-down of the MSR asset and the related valuation allowance (to the extent a valuation allowance is available) and then against earnings. A direct write-down permanently reduces the carrying value of the MSR asset and valuation allowance, precluding subsequent recoveries.
The following table shows the estimated future amortization expense for amortizing intangible assets. The projections are based on existing asset balances, the current interest rate environment and prepayment speeds as of the September 30, 2016. The actual amortization expense the Company recognizes in any given period may be significantly different depending upon acquisition or sale activities, changes in interest rates, prepayment speeds, market conditions, regulatory requirements and events or circumstances that indicate the carrying amount of an asset may not be recoverable.
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Note 8- Notes Payable
The Company had the following long-term notes payable:
At the completion of the construction of the Company’s headquarters building in 2005 and as part of a joint venture investment related to the building, the Company and the other joint venture partners guaranteed a joint venture note to finance certain costs of the building. The joint venture note was secured by the building, bore a fixed rate of 5.81% and required monthly principal and interest payments until its maturity on June 1, 2016. In April of 2016, this note was refinanced with Nicolet National Bank and is therefore eliminated through the consolidation process.
The FHLB advance bears a fixed rate, requires interest-only monthly payment, and has a maturity in February 2018. The weighted average rates of FHLB advances was 1.17% and 0.83% at September 30, 2016 and December 31, 2015, respectively. FHLB advances are collateralized by a blanket lien on qualifying first mortgages, home equity loans, multi-family loans and certain farmland loans which totaled approximately $297.8 million and $154.3 million at September 30, 2016 and December 31, 2015, respectively.
The following table shows the maturity schedule of the notes payable as of September 30, 2016:
The Company has a $10 million line of credit with a third party bank, bearing a variable rate of interest based on one-month LIBOR plus a margin, but subject to a floor rate, with quarterly payments of interest only. At September 30, 2016, the available line was $10 million, the rate was one-month LIBOR plus 2.25% with a 3.25% floor. The outstanding balance was zero at September 30, 2016 and December 31, 2015, and the line was not used during 2016 or 2015.
Note 9 – Junior Subordinated Debentures
The Company’s carrying value of junior subordinated debentures was $24.6 million at September 30, 2016 and $12.5 million at December 31, 2015. In July 2004 Nicolet Bankshares Statutory Trust I (the “Statutory Trust”), issued $6.0 million of guaranteed preferred beneficial interests (“trust preferred securities”) that qualify asTier 1 capital under Federal Reserve Board guidelines. All of the common securities of the Statutory Trust are owned by the Company. The proceeds from the issuance of the common securities and the trust preferred securities were used by the Statutory Trust to purchase $6.2 million of junior subordinated debentures of the Company, which pay an 8% fixed rate. Interest on these debentures is current. The debentures may be redeemed in part or in full, on or after July 15, 2009 at par plus any accrued but unpaid interest. The maturity date of the debenture, if not redeemed, is July 15, 2034.
As part of the 2013 acquisition of Mid-Wisconsin Financial Services, Inc., the Company assumed $10.3 million of junior subordinated debentures related to $10.0 million of issued trust preferred securities. The trust preferred securities and the debentures mature on December 15, 2035 and have a floating rate of the three-month LIBOR plus 1.43% adjusted quarterly. Interest on these debentures is current. The debentures may be called at par in part or in full, on or after December 15, 2010 or within 120 days of certain events. At acquisition in April 2013 the debentures were recorded at a fair value of $5.8 million, with the discount being accreted to interest expense over the remaining life of the debentures. At September 30, 2016, the carrying value of these junior debentures was $6.5 million, and the $6.2 million carrying value of related trust preferred securities qualifies as Tier 1 capital.
As part of the 2016 acquisition of Baylake, the Company assumed $16.6 million of junior subordinated debentures related to $16.1 million of issued trust preferred securities. The trust preferred securities and the debentures mature on September 30, 2036 and have a floating rate of three-month LIBOR plus 1.35% adjusted quarterly. Interest on these debentures is current. The debentures may be redeemed on any interest payment date at par in part or in full, on or after June 30, 2011. At acquisition in April 2016 the debentures were recorded at fair value of $11.8 million, with the discount being accreted to interest expense over the remaining life of the debentures. At September 30, 2016, the carrying value of these junior debentures was $11.9 million, and the $11.4 million carrying value of related trust preferred securities qualifies as Tier 1 capital.
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Note 10 – Subordinated Notes
In 2015 the Company placed an aggregate of $12 million in subordinated Notes in private placements with certain accredited investors. All Notes were issued with 10-year maturities, have a fixed annual interest rate of 5% payable quarterly, are callable on or after the fifth anniversary of their respective issuances dates, and qualify for Tier 2 capital for regulatory purposes.
The $0.2 million debt issuance costs associated with the $12 million Notes are being amortized on a straight line basis over the first five years, representing the no-call periods, as additional interest expense. As of September 30, 2016 and December 31, 2015, respectively, the $0.1 million and $0.2 million, of unamortized debt issuance costs remain and are reflected as a deduction to the carrying value of the outstanding Notes.
Note 11 – Fair Value Measurements
As provided for by accounting standards, the Company records and/or discloses financial instruments on a fair value basis. These financial assets and financial liabilities are measured at fair value in three levels, based on the markets in which the assets and liabilities are traded and the observability of the assumptions used to determine fair value. These levels are: Level 1 - quoted market prices in active markets for identical assets or liabilities that a company has the ability to access at the measurement date; Level 2 - inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly; Level 3 – significant unobservable inputs for the asset or liability, which are typically based on an entity’s own assumptions, as there is little, if any, related market activity. In instances where the fair value measurement is based on inputs from different levels, the level within which the entire fair value measurement will be categorized is based on the lowest level input that is significant to the fair value measurement in its entirety; this assessment of the significance of an input requires management judgment.
Disclosure of the fair value of financial instruments, whether recognized or not recognized in the balance sheet, is required for those instruments for which it is practicable to estimate that value, with the exception of certain financial instruments and all nonfinancial instruments as provided for by the accounting standards. For financial instruments recognized at fair value in the consolidated balance sheets, the fair value disclosure requirements also apply.
Fair value (i.e. the price that would be received in an orderly transaction that is not a forced liquidation or distressed sale at the measurement date), among other things, is based on exit price versus entry price, should include assumptions about risk such as nonperformance risk in liability fair values, and is a market-based measurement versus an entity-specific measurement.
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Note 11 – Fair Value Measurements, continued
The following table presents the balances of assets and liabilities measured at fair value on a recurring basis for the periods presented. One security classified as Level 3 was purchased for $0.6 million during the first quarter of 2016.
The following is a description of the valuation methodologies used by the Company for the Securities AFS noted in the tables of this footnote. Where quoted market prices on securities exchanges are available, the investment is classified as Level 1. Level 1 investments primarily include exchange-traded equity securities available for sale. If quoted market prices are not available, fair value is generally determined using prices obtained from independent pricing vendors who use pricing models (with typical inputs including benchmark yields, reported trades for similar securities, issuer spreads or relationship to other benchmark quoted securities), or discounted cash flows, and are classified as Level 2. Examples of these investments include mortgage-related securities and obligations of state, county and municipals. Finally, in certain cases where there is limited activity or less transparency around inputs to the estimated fair value, investments are classified within Level 3 of the hierarchy. Examples of these include private municipal bonds and corporate debt securities, which include trust preferred security investments. At September 30, 2016 and December 31, 2015, it was determined that carrying value was the best approximation of fair value for these Level 3 securities, based primarily on the internal analysis on these securities.
The following table presents the Company’s impaired loans and other real estate owned (“OREO”) measured at fair value on a nonrecurring basis for the periods presented. The additions to the Level 3 category were predominantly due to the April 2016 Baylake merger.
Measured at Fair Value on a Nonrecurring Basis
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The following is a description of the valuation methodologies used by the Company for the items noted in the table above, including the general classification of such instruments in the fair value hierarchy. For individually evaluated impaired loans, the amount of impairment is based upon the present value of expected future cash flows discounted at the loan’s effective interest rate, the estimated fair value of the underlying collateral for collateral-dependent loans, or the estimated liquidity of the note. For OREO, the fair value is based upon the estimated fair value of the underlying collateral adjusted for the expected costs to sell.
The carrying amounts and estimated fair values of the Company’s financial instruments at September 30, 2016 and December 31, 2015 are shown below.
Not all the financial instruments listed in the table above are subject to the disclosure provisions of Accounting Standards Codification (“ASC”) 820, as certain assets and liabilities result in their carrying value approximating fair value. These include cash and cash equivalents, other investments, bank owned life insurance, short-term borrowings, and nonmaturing deposits. For those financial instruments not previously disclosed the following is a description of the evaluation methodologies used.
Certificates of deposits in other banks:Fair values are estimated using discounted cash flow analysis based on current interest rates being offered by instruments with similar terms and represents a Level 2 measurement.
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Other investments: The carrying amount of Federal Reserve Bank, Bankers Bank, Farmer Mac, and FHLB stock is a reasonably accepted fair value estimate given their restricted nature. Fair value is the redeemable (carrying) value based on the redemption provisions of the instruments which is considered a Level 2 measurement. The carrying amount of the remaining other investments (particularly common stocks of companies or other banks that are not publicly traded) approximates their fair value, determined primarily by analysis of company financial statements and recent capital issuances of the respective companies or banks, if any, and represents a Level 3 measurement.
Loans held for sale: The fair value estimation process for the loans held for sale portfolio is segregated by loan type. The estimated fair value was based on what secondary markets are currently offering for portfolios with similar characteristics and represents a Level 2 measurement.
Loans, net: For variable-rate loans that reprice frequently and with no significant change in credit risk or other optionality, fair values are based on carrying values. Fair values for all other loans are estimated by discounting contractual cash flows using estimated market discount rates, which reflect the credit and interest rate risk inherent in the loan. Collateral-dependent impaired loans are included in loans, net. The fair value of loans is considered to be a Level 3 measurement due to internally developed discounted cash flow measurements.
Mortgage servicing rights asset:To estimate the fair value of the MSR asset, the underlying serviced loan pools are stratified by interest rate tranche and term of the loan, and a valuation model is used to calculate the present value of expected future cash flows for each stratum. When the carrying value of the MSR asset related to a stratum exceeds its fair value, the stratum is recorded at fair value. The valuation model incorporates assumptions that market participants would use in estimating future net servicing income, such as costs to service, a discount rate, ancillary income, default rates and losses, and prepayment speeds. Although some of these assumptions are based on observable market data, other assumptions are based on unobservable estimates of what market participants would use to measure fair value. As a result, the fair value measurement of mortgage servicing rights is considered a Level 3 measurement and represents an income approach to fair value.
Deposits: The fair value of deposits with no stated maturity (such as demand deposits, savings, interest and non-interest checking, and money market accounts) is, by definition, equal to the amount payable on demand at the reporting date. Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered in the market place on certificates of similar remaining maturities. Use of internal discounted cash flows provides a Level 3 fair value measurement.
Notes payable: The fair value of the Federal Home Loan Bank advances is obtained from the Federal Home Loan Bank which uses a discounted cash flow analysis based on current market rates of similar maturity debt securities and represents a Level 2 measurement. The fair values of remaining notes payable are estimated using discounted cash flow analysis based on current interest rates being offered by instruments with similar terms and credit quality which represents a Level 3 measurement.
Junior subordinated debentures and subordinated notes: The fair values of these debt instruments utilize a discounted cash flow analysis based on an estimate of current interest rates being offered by instruments with similar terms and credit quality. Since the market for these instruments is limited, the internal evaluation represents a Level 3 measurement.
Off-balance-sheet instruments: The estimated fair value of letters of credit at September 30, 2016 and December 31, 2015 was insignificant. Loan commitments on which the committed interest rate is less than the current market rate are also insignificant at September 30, 2016 and December 31, 2015.
Limitations: Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of a particular financial instrument. Fair value estimates may not be realizable in an immediate settlement of the instrument. In some instances, there are no quoted market prices for the Company’s various financial instruments, in which case fair values may be based on estimates using present value or other valuation techniques, or based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of the financial instruments, or other factors. Those techniques are significantly affected by the assumptions used, including the discount rate and estimate of future cash flows. Subsequent changes in assumptions could significantly affect the estimates.
Note 12 – Pending Merger Transaction On November 4, 2016 Nicolet announced the signing of a definitive merger agreement (“Merger Agreement”) with First Menasha Bancshares, Inc., (“First Menasha”) (OTCQX:FMBJ) under which First Menasha will merge with and into Nicolet. Based upon the financial results as of September 30, 2016, the combined company would have total assets of approximately $2.7 billion, deposits of $2.3 billion and loans of $1.9 billion. The merger transaction is expected to close in the second quarter of 2017.
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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Nicolet Bankshares, Inc. is a bank holding company headquartered in Green Bay, Wisconsin, providing a diversified range of traditional banking and wealth management services to individuals and businesses in its market area through the 42 branch offices of its banking subsidiary, Nicolet National Bank, in northeastern and central Wisconsin and Menominee, Michigan.
Overview
At September 30, 2016, Nicolet Bankshares, Inc. and its subsidiaries (“Nicolet” or the “Company”) had total assets of $2.3 billion, loans of $1.6 billion, deposits of $1.9 billion and total stockholders’ equity of $277 million, representing increases over December 31, 2015 of 87%, 77%, 83% and 152% in assets, loans, deposits and total equity, respectively. This growth was predominantly attributable to two transactions completed in the first half of 2016 (the “2016 acquisitions”), which are detailed in Note 2, “Acquisitions” of the notes to unaudited consolidated financial statements. On April 29, 2016, Nicolet completed its transformative stock-for-stock merger with Baylake Corp. (“Baylake”), which added 21 branches and a dominant position in Door County, Wisconsin, based on deposit market share. At the time of the Baylake merger and based on estimated fair values, assets of $1.0 billion, loans of $0.7 billion, deposits of $0.8 billion, core deposit intangible of $17 million and goodwill of $66 million were added to the consolidated balance sheet, for a total purchase price of approximately $164 million, including the issuance of 4.3 million shares of Nicolet common stock and assumption of outstanding Baylake equity awards. On a smaller scale, Nicolet completed on April 1, 2016 its private transaction to hire a select group of financial advisors and to purchase their respective books of business and operating platform, to enhance the leadership and future growth of Nicolet’s wealth management business. In this transaction, Nicolet paid total initial consideration of $4.9 million (including $2.6 million in common stock), accrued an earn-out liability of $1.5 million, recorded $0.4 million of goodwill, $0.2 million of fixed assets and $4.3 million of customer relationship intangibles.
For the nine months ended September 30, 2016, net income was $12.4 million, and after $0.6 million of preferred stock dividends, net income available to common shareholders was $11.7 million or $1.67 per diluted common share. Evaluation of financial performance between 2016 and 2015 periods was impacted in general from the timing of the two 2016 acquisitions, and inclusion of non-recurring merger-based expenses and integration costs, as described under the section “Management’s Discussion and Analysis.”
Nicolet’s profitability is significantly dependent upon net interest income (interest income earned on loans and other interest-earning assets such as investments, net of interest expense on deposits and other borrowed funds), and noninterest income sources (including but not limited to service charges on deposits, trust and brokerage fees, mortgage income from sales of residential mortgages into the secondary market, and other fees or revenue from financial services provided to customers or ancillary to loans and deposits), offset by the level of the provision for loan losses, noninterest expenses (largely employee compensation and overhead expenses tied to processing and operating the Bank’s business), and income taxes. Business volumes and pricing drive revenue potential and tend to be influenced by overall economic factors, including market interest rates, business spending, consumer confidence, economic growth and competitive conditions within the marketplace.
Forward-Looking Statements
Statements made in this document and in any documents that are incorporated by reference which are not purely historical are forward-looking statements, as defined in the Private Securities Litigation Reform Act of 1995, including any statements regarding descriptions of management’s plans, objectives, or goals for future operations, products or services, and forecasts of its revenues, earnings, or other measures of performance. Forward-looking statements are based on current management expectations and, by their nature, are subject to risks and uncertainties. These statements generally may be identified by the use of words such as “believe,” “expect,” “anticipate,” “plan,” “estimate,” “should,” “will,” “intend,” or similar expressions. Shareholders should note that many factors, some of which are discussed elsewhere in this document, could affect the future financial results of Nicolet and could cause those results to differ materially from those expressed in forward-looking statements contained in this document. These factors, many of which are beyond Nicolet’s control, include, but are not necessarily limited to the following:
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These factors should be considered in evaluating the forward-looking statements, and you should not place undue reliance on such statements. Nicolet specifically disclaims any obligation to update factors or to publicly announce the results of revisions to any of the forward-looking statements or comments included herein to reflect future events or developments.
Branch Closures
In September 2016, Nicolet announced that it will close six branches that are in close proximity to other Nicolet branches by the end of 2016. The first of these branches was closed on October 28, 2016. The primary reason for the closures is to eliminate the costs associated with the branches in overlapping geographies that resulted from its recent acquisitions. Following the closings Nicolet will operate 36 branches in Northeast and Central Wisconsin and the upper peninsula of Michigan.
Critical Accounting Policies
The consolidated financial statements of Nicolet are prepared in conformity with U.S. GAAP and follow general practices within the industry in which it operates. This preparation requires management to make estimates, assumptions and judgments that affect the amounts reported in the consolidated financial statements and accompanying notes. These estimates, assumptions and judgments are based on information available as of the date of the consolidated financial statements; accordingly, as this information changes, actual results could differ from the estimates, assumptions and judgments reflected in the consolidated financial statements. Certain policies inherently have a greater reliance on the use of estimates, assumptions and judgments and, as such, have a greater possibility of producing results that could be materially different than originally reported. Estimates that are particularly susceptible to significant change include the valuation of loans acquired in business combinations, as well as the determination of the allowance for loan losses and income taxes and, therefore, are critical accounting policies.
Valuation of Loans Acquired in Business Combinations
Acquisitions accounted for under Financial Accounting Standards Board (“FASB”) ASC Topic 805, Business Combinations, require the use of the acquisition method of accounting. Assets acquired and liabilities assumed in a business combination are recorded at estimated fair value on their purchase date. In particular, the valuation of acquired loans involves significant estimates, assumptions and judgment based on information available as of the acquisition date. Substantially all loans acquired in the transaction are evaluated either individually or in pools of loans with similar characteristics; and since the estimated fair value of acquired loans includes a credit consideration, no carryover of any previously recorded allowance for loan losses is recorded at acquisition. A number of factors are considered in determining the estimated fair value of purchased loans including, among other things, the remaining life of the acquired loans, estimated prepayments, estimated loss ratios, estimated value of the underlying collateral, estimated holding periods, contractual interest rates compared to market interest rates, and net present value of cash flows expected to be received.
In determining the Day 1 Fair Values of acquired loans, management calculates a non-accretable difference (the credit mark component of the acquired loans) and an accretable difference (the market rate or yield component of the acquired loans). The non-accretable difference is the difference between the undiscounted contractually required payments and the undiscounted cash flows expected to be collected in accordance with management’s determination of the Day 1 Fair Values. Subsequent decreases to the expected cash flows will generally result in a provision for loan losses. Subsequent increases in cash flows will result in a reversal of the provision for loan losses to the extent of prior charges and then an adjustment to the accretable and non-accretable differences, which would have a positive impact on interest income.
The accretable yield on acquired loans is the difference between the expected cash flows and the initial investment in the acquired loans. The accretable yield is recognized into earnings through interest income using the effective yield method over the term of the loans. Management separately monitors the acquired loan portfolio and periodically reviews loans contained within this portfolio against the factors and assumptions used in determining the Day 1 Fair Values.
Allowance for Loan Losses (“ALLL”)
The ALLL is a reserve for estimated credit losses on individually evaluated loans determined to be impaired as well as estimated credit losses inherent in the loan portfolio. Actual credit losses, net of recoveries, are deducted from the ALLL. Loans are charged off when management believes that the collectability of the principal is unlikely. Subsequent recoveries, if any, are credited to the ALLL. A provision for loan losses, which is a charge against earnings, is recorded to bring the ALLL to a level that, in management’s judgment, is adequate to absorb probable losses in the loan portfolio. Management’s evaluation process used to determine the appropriateness of the ALLL is subject to the use of estimates, assumptions, and judgment. The evaluation process involves gathering and interpreting many qualitative and quantitative factors which could affect probable credit losses. Because interpretation and analysis involves judgment, current economic or business conditions can change, and future events are inherently difficult to predict, the anticipated amount of estimated loan losses and therefore the appropriateness of the ALLL could change significantly.
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The allocation methodology applied by Nicolet is designed to assess the appropriateness of the ALLL and includes allocations for specifically identified impaired loans and loss factor allocations for all remaining loans, with a component primarily based on historical loss rates and a component primarily based on other qualitative factors. The methodology includes evaluation and consideration of several factors, such as, but not limited to, management’s ongoing review and grading of loans, facts and issues related to specific loans, historical loan loss and delinquency experience, trends in past due and nonaccrual loans, existing risk characteristics of specific loans or loan pools, the fair value of underlying collateral, current economic conditions and other qualitative and quantitative factors which could affect potential credit losses. While management uses the best information available to make its evaluation, future adjustments to the allowance may be necessary if there are significant changes in economic conditions or circumstances underlying the collectability of loans. Because each of the criteria used is subject to change, the allocation of the ALLL is made for analytical purposes and is not necessarily indicative of the trend of future loan losses in any particular loan category. The total allowance is available to absorb losses from any segment of the loan portfolio. Management believes the ALLL is appropriate at September 30, 2016. The allowance analysis is reviewed by the board of directors on a quarterly basis in compliance with regulatory requirements. In addition, various regulatory agencies periodically review the ALLL. These agencies may require Nicolet to make additions to the ALLL based on their judgments of collectability based on information available to them at the time of their examination. Acquired loans were purchased at fair value without any ALLL, and subsequent to acquisition such acquired loans will be evaluated and ALLL will be recorded on them to the extent necessary.
Income taxes
The assessment of income tax assets and liabilities involves the use of estimates, assumptions, interpretation, and judgment concerning certain accounting pronouncements and federal and state tax codes. There can be no assurance that future events, such as court decisions or positions of federal and state taxing authorities, will not differ from management’s current assessment, the impact of which could be significant to the consolidated results of operations and reported earnings.
Nicolet files a consolidated federal income tax return and a combined state income tax return (both of which include Nicolet and its wholly owned subsidiaries). Accordingly, amounts equal to tax benefits of those companies having taxable federal losses or credits are reimbursed by the companies that incur federal tax liabilities. Amounts provided for income tax expense are based on income reported for financial statement purposes and do not necessarily represent amounts currently payable under tax laws. Deferred income tax assets and liabilities are computed annually for differences between the financial statement and tax bases of assets and liabilities that will result in taxable or deductible amounts in the future based on enacted tax law rates applicable to the periods in which the differences are expected to affect taxable income. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through provision for income tax expense. Valuation allowances are established when it is more likely than not that a portion of the full amount of the deferred tax asset will not be realized. In assessing the ability to realize deferred tax assets, management considers the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies. Nicolet may also recognize a liability for unrecognized tax benefits from uncertain tax positions. Unrecognized tax benefits represent the differences between a tax position taken or expected to be taken in a tax return and the benefit recognized and measured in the financial statements. Penalties related to unrecognized tax benefits are classified as income tax expense.
Management’s Discussion and Analysis
The following discussion is Nicolet management’s analysis of the consolidated financial condition as of September 30, 2016 and December 31, 2015 and results of operations for the three and nine-month periods ended September 30, 2016 and 2015. It should be read in conjunction with Nicolet’s audited consolidated financial statements as of December 31, 2015 and 2014, and for the three years ended December 31, 2015, included in Nicolet’s Annual Report on Form 10-K for the year ended December 31, 2015.
Evaluation of financial performance between 2016 and 2015 periods was impacted in general from the timing of Nicolet’s two 2016 acquisitions. Since the balances and results of operations of the acquired entities prior to consummation are appropriately not included in the accompanying consolidated financial statements, income statement results and average balances for 2016 included partial period contributions from the 2016 acquisitions versus no contribution in 2015 periods. The inclusion of the Baylake balance sheet and operational results for approximately five months in 2016 analytically explains roughly 45% of the increase in certain average balances and income statement line items between the nine month periods ended September 30, 2016 and 2015, while the financial advisory business acquisition primarily impacts the brokerage fee income, personnel expense and certain other expense line items. In addition, the 2016 acquisitions impacted pre-tax net income by inclusion of non-recurring direct merger expenses of approximately $0.1 million, $0.7 million, $0.4 million and $0.4 million in third quarter 2015, fourth quarter 2015, first quarter 2016 and second quarter 2016, respectively, along with a $1.7 million pre-tax lease termination charge in the second quarter of 2016 related to the closure of a Nicolet branch concurrent with the Baylake merger.
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Performance Summary
Nicolet reported net income of $12.4 million for the nine months ended September 30, 2016, compared to $8.6 million for the first nine months of 2015. After $0.6 million of preferred stock dividends, net income available to common shareholders was $11.8 million, or $1.67 per diluted common share for the first nine months of 2016. Comparatively, after $0.2 million of preferred stock dividends, net income available to common shareholders was $8.4 million, or $1.93 per diluted common share for the first nine months of 2015. Beginning March 1, 2016, the annual dividend rate on preferred stock moved from 1% to 9% in accordance with the contractual terms. In advance of such increase, Nicolet redeemed half of its then outstanding preferred stock in September 2015. The remaining half was redeemed in the third quarter of 2016. As a result, Nicolet will not pay preferred dividends going forward. The changes in rate and preferred stock outstanding affected the preferred stock dividends between the comparable nine-month periods.
Net income for the first nine months of 2016 includes combined operating results following the consummation dates of the 2016 acquisitions, and compares favorably to net income for the first nine months of 2015, considering that pre-tax net income for 2016 also includes non-recurring direct merger expenses of $0.8 million and a lease termination charge of $1.7 million as compared to non-recurring direct merger expenses of $0.1 million in pre-tax net income for 2015.
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Net Interest Income
Nicolet’s earnings are substantially dependent on net interest income. Net interest income is the primary source of Nicolet’s revenue and is the difference between interest income earned on interest earning assets, such as loans and investments, and interest expense on interest-bearing liabilities, such as deposits and other borrowings. Net interest income is directly impacted by the sensitivity of the balance sheet to changes in interest rates and by the amount and composition of earning assets and interest-bearing liabilities, including characteristics such as the fixed or variable nature of the financial instruments, contractual maturities, and repricing frequencies.
Net interest income in the consolidated statements of income (which excludes any taxable equivalent adjustment) was $48.1 million in the first nine months of 2016, $17.4 million or 57% higher than $30.7 million in the first nine months of 2015, largely impacted by the five months of additional net interest income resulting from the merger. Taxable equivalent adjustments (adjustments to bring tax-exempt interest to a level that would yield the same after-tax income had that been subject to a 34% tax rate) were $1.3 million and $0.9 million for the first nine months of 2016 and 2015, respectively, resulting in taxable equivalent net interest income of $49.4 million and $31.6 million, respectively.
Taxable equivalent net interest income is a non-GAAP measure, but is a preferred industry measurement of net interest income (and its use in calculating a net interest margin) as it enhances the comparability of net interest income arising from taxable and tax-exempt sources.
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Table 1: Year-To-Date Net Interest Income Analysis
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Table 2: Year-To-Date Volume/Rate Variance
Comparison of the nine months ended September 30, 2016 versus the nine months ended September 30, 2015 follows:
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Table 3: Quarterly Net Interest Income Analysis
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Table 4: Quarterly Volume/Rate Variance
Comparison of the three months ended September 30, 2016 versus the three months ended September 30, 2015 follows:
Table 5: Interest Rate Spread, Margin and Average Balance Mix — Taxable Equivalent Basis
Taxable equivalent net interest income was $49.4 million for the first nine months of 2016, an increase of $17.8 million or 56% over the same period in 2015, largely impacted by the five months of net interest income added from the Baylake merger. Taxable equivalent interest income increased $17.9 million (or 48%) between the nine-month periods, including $17.4 million more interest income from favorable earning asset volumes (driven by inclusion of the Baylake earning assets) and $0.5 million net favorable rate variances. Interest expense remained consistent between the nine-month periods at $5.5 million for 2016 compared to $5.4 million for 2015. While higher funding volumes added $1.5 million interest expense, a lower cost of funds (mostly attributable to the lower overall cost of funds on acquired balances from Baylake and deposit product rate changes implemented in December 2015) reduced interest expense by $1.4 million.
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The taxable equivalent net interest margin was 3.99% for the first nine months of 2016, up 14 bps versus the first nine months of 2015. With a decrease in earning asset yield to 4.44% (down 7 bps) and a 26 bps decline in the cost of funds (to 0.58%), the interest rate spread improved by 19 bps between the first nine-month periods. There has been and will continue to be underlying downward margin pressure as assets mature in this prolonged low-rate environment, with current reinvestment rates substantially lower than previous rates and less opportunity to offset such with similar changes in the already low cost of funds. However, this negative impact for 2016 was partially offset by the merger which added a lower cost of funds and additional favorable income from discount accretion.
The 7 bps decline in earning asset yield was influenced mainly by an increase in loan yield (up 4 bps to 5.13%), though more than offset by a lower proportion of loans in average earning assets (78% versus 82% for the nine-months in 2016 and 2015, respectively). The 4 bps increase in loan yield between the nine-month periods was largely due to higher aggregate discount accretion on loans (including $1.6 million of from three favorably resolved discounted loans in third quarter 2016), partially offset by the addition of Baylake loans carrying a lower overall yield and underlying rate pressure on loan yields from competition and the low rate environment. The earning asset yield decline was also impacted by non-loan earning assets yielding 1.95% for the nine-months of 2016 (down 4 bps from the comparable 2015 period, mostly due to a higher proportion of low-earning cash than the prior year) and representing 22% of average earning assets (versus 18% for the comparable nine-month period in 2015).
Nicolet’s cost of funds decreased 26 bps to 0.58% for the first nine months of 2016 compared to a year ago, driven primarily by deposit funding. The average cost of interest-bearing deposits (which represent approximately 95% of average interest-bearing liabilities for both periods), was 0.43% for the first nine months of 2016, down 22 bps from the first nine months of 2015. The cost of interest-bearing deposits decreased as a result of rate decreases initiated in December 2015, from the lower cost of funds on acquired balances, and a favorable fair value interest mark on acquired CDs. Average other interest-bearing liabilities (comprised of short- and long-term borrowings) increased $9 million but cost 44 bps less between the nine-month periods, as higher cost advances matured and were not renewed, certain acquired advances were paid off in the quarter acquired, and lower-cost variable-rate trust preferred securities were added to the funding mix with the Baylake acquisition in the first nine months of 2016.
Average interest-earning assets were $1.6 billion and $1.1 billion for the first nine months of 2016 and 2015, respectively, for an increase of 51%, predominantly attributable to five months of acquired balances. While the balance of average interest-earning assets increased, the mix of loans declined from 82% to 78% and the securities and other earning assets increased from 18% to 22%. Average total loans increased by $391 million (to $1.3 billion, up 44%) and average non-loan earning assets increased by $159 million (comprised of a $41 million increase in interest-bearing cash and a $118 million increase in investments) to $358 million.
Average interest-bearing liabilities were $1.2 billion, up $393 million or 46% versus the first nine months of 2015, predominantly attributable to five months of acquired balances. Interest-bearing deposits represented 96% and 95% of average interest-bearing liabilities for the first nine months of 2016 and 2015, respectively, while the mix of average interest-bearing deposits moved more to lower-costing MMA deposits and less in higher costing core CDs improving the overall deposit cost between nine-month periods.
Provision for Loan Losses
The provision for loan losses for the nine months ended September 30, 2016 and 2015 was $1.4 million for each period, respectively, exceeding net charge offs of $0.2 million and $0.6 million, respectively. Asset quality measures were elevated at September 30, 2016, impacted by the Baylake merger, but remained strong with continued resolutions of problem loans. The ALLL was $11.5 million (0.74% of loans) at September 30, 2016, compared to $10.3 million (1.18% of loans) at December 31, 2015 and $10.0 million (1.13% of loans) at September 30, 2015. The decline in the ratio was a result of recording the Baylake loan portfolio at fair value with no carryover of its allowance at the time of the merger.
The provision for loan losses is predominantly a function of Nicolet’s methodology and judgment as to qualitative and quantitative factors used to determine the adequacy of the ALLL. The adequacy of the ALLL is affected by changes in the size and character of the loan portfolio, changes in levels of impaired and other nonperforming loans, historical losses and delinquencies in each portfolio segment, the risk inherent in specific loans, concentrations of loans to specific borrowers or industries, existing and future economic conditions, the fair value of underlying collateral, and other factors which could affect potential credit losses. For additional information regarding asset quality and the ALLL, see “Balance Sheet Analysis — Loans,” “— Allowance for Loan and Lease Losses,” and “— Impaired Loans and Nonperforming Assets.”
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Noninterest Income
Table 6: Noninterest Income
Comparison of the nine months ending September 30, 2016 versus 2015
Noninterest income was $18.8 million for the first nine months of 2016 (including $0.5 million net gain on sales or write-downs of assets) compared to $13.1 million for the first nine months of 2015 (which included $1.0 million net gain on sales or write-downs of assets). Removing these net gains, noninterest income was up $6.1 million or 51% between the nine-month periods, aided by the 2016 acquisitions. The most notable increase over prior year was brokerage fee income which more than quadrupled between the nine-month periods and was directly related to the 2016 financial advisor business acquisition. Since the year-to-date 2016 results reflect only five months of combined noninterest income activity, comparisons to prior period operating results are expected to widen in the future.
Net gain on sale or write-down of assets was $0.5 million and $1.0 million for the nine months of 2016 and 2015, respectively. The 2016 activity consisted of $0.1 million net gains on sales of investments and $0.4 million net gains on sales of OREO and other assets while the 2015 activity consisted of $0.6 million net gains on the sale of investments and $0.4 million net gains on sales of OREO.
Service charges on deposit accounts were $2.5 million for the first nine months of 2016, up $0.8 million (or 44%) over the comparable period of 2015, given the increase in deposit balances and accounts mainly from the Baylake merger, and higher non-sufficient funds (“NSF”) volumes.
Trust service fees increased to $4.0 million for the first nine months of 2016, up $0.4 million (or 10%) over the comparable 2015 period, on market improvements and net new business with only a modest increase attributable to the Baylake merger. Brokerage fees were $2.1 million, up 311% over the first nine months of 2015, directly attributable to the 2016 financial advisor business acquisition and hiring of selected advisors. Both the financial advisor acquisition as well as the expanded footprint from the Baylake merger will provide growth potential for wealth management in future periods.
Mortgage income, net includes predominantly net gains received from the sale of residential real estate loans service-released into the secondary market, as well as net revenue related to mortgages sold servicing retained, including net gains on mortgages sold, capitalized mortgage servicing gains and servicing fees, net of MSR asset amortization. Mortgage income, net was $3.7 million for first nine months of 2016 compared to $2.7 million for first nine months of 2015, up $1.0 million or 39% between the nine-month periods. The increase between the nine-month periods is attributable to higher sales volume producing higher cash and capitalized gains and a larger mortgage portfolio serviced for others (including the Baylake servicing portfolio acquired) increasing servicing fees , offset partly by higher MSR amortization. The first nine months of 2016 had 27% higher secondary mortgage production with nine-month originations of $181 million for 2016 versus $143 million for 2015.
BOLI income was $0.9 million for the first nine months of 2016, up 18% over the comparable period in 2015 while average BOLI balances increased 26%. A BOLI investment of $25.4 million was added at acquisition in the Baylake merger (impacting the nine-month average balance comparison), at a lower overall earning rate. During June 2016, $21.5 million of the acquired BOLI was surrendered. In September 2016, additional BOLI of $20.0 million was purchased.
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Rent income and investment advisory fees were unaffected by the 2016 acquisitions and showed slight changes between the nine-month periods. Other noninterest income increased $2.3 million (or 142%) between the nine-month periods, mostly attributable to ancillary fees tied to deposit-related products, such as a $1.2 million increase in interchange income (mostly higher volumes from debit cards, but also from credit cards usage given the decision in late 2015 to issue credit cards directly to customers rather than through a third party) and $0.2 million higher wire fee income on the expanded customer base, as well as the addition of $0.6 million from a processing business interest in UFS, Inc. (accounted for under the equity method of accounting) acquired in the Baylake merger.
Noninterest Expense
Table 7: Noninterest Expense
Noninterest expense was $46.6 million for the first nine months of 2016, up $17.2 million or 59% over the first nine months of 2015, predominantly attributable to the larger operating base from the 2016 acquisitions and non-recurring merger-related charges in the 2016 period. Direct merger expenses in the first nine months of 2016 consisted of approximately $0.8 million ($0.1 million in personnel, $0.3 million in processing and $0.4 million in other expense), and a $1.7 million lease termination charge in other expense, compared to $0.1 million direct merger expense in the comparable 2015 period. Since the year-to-date 2016 results reflect only five months of combined noninterest expense activity, comparisons to prior period operating results are expected to widen in the future.
Salaries and employee benefits expense was $24.7 million for the first nine months of 2016, up $7.8 million or 46% compared to the first nine months of 2015. In addition to merit increases, higher overtime and higher equity award and incentive costs between the years, salaries and benefits were up largely as a result of an increase in average full time equivalent employees from the 2016 acquisitions, at 393 for the first nine months of 2016, up 39% over 282 for the comparable 2015 period.
Occupancy, equipment and office expense increased $2.1 million to $7.3 million for the first nine months of 2016 compared to 2015. This 39% increase was in line with the 2016 net addition of 21 branches which doubled the branch facilities, an expanded operations facility and a financial advisors location. Utilities, rent, and other occupancy expenses increased proportionately in conjunction with the 2016 acquisitions.
Business development and marketing expense increased $0.8 million (or 49%) between the comparable nine-month periods, with higher spending on promotional materials, media advertising and donations as emphasis was focused on expanded and new markets.
Data processing expenses, which are primarily volume-based, rose $1.8 million or 71% between the nine-month periods, including approximately $0.3 million of direct merger expenses, continued integration costs, increased services, and five of nine months of combined operations in 2016 increasing the number of accounts and volumes processed.
FDIC assessments were higher between the nine-month periods mostly due to a higher assessment base. Intangibles amortization increased due to the addition of $17.3 million of core deposit intangible from the Baylake merger being amortized on an accelerated basis over a 10-year period, and $4.3 million of customer relationship intangibles amortizing straight line over a 12-year average period. Other expense increased $3.1 million (or 183%), primarily due to inclusion of a $1.7 million lease termination charge and $0.4 million of direct merger expenses, in addition to the larger operating base.
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Income Taxes
For the nine-month periods ending September 30, 2016 and 2015, income tax expense was $6.4 million and $4.5 million, respectively. The effective tax rates were 33.9% and 33.8%, respectively (with 2016 tax rate partly impacted by the merger). GAAP requires that deferred income taxes be analyzed to determine if a valuation allowance is required. A valuation allowance is required if it is more likely than not that some portion of the deferred tax asset will not be realized. No valuation allowance was determined to be necessary as of September 30, 2016 or December 31, 2015.
Comparison of the three months ending September 30, 2016 versus 2015
Nicolet reported net income of $6.5 million for the three months ended September 30, 2016, up $3.9 million or 149% over $2.6 million for the comparable period of 2015. Net income available to common shareholders for the third quarter of 2016 was $6.2 million, or $0.69 per diluted common share, compared to net income available to common shareholders of $2.5 million, or $0.58 per diluted common share, for the third quarter of 2015.
Net interest income in the consolidated statements of income (which excludes any taxable equivalent adjustment) was $20.9 million in the third quarter of 2016 versus $10.0 million in the third quarter of 2015. Taxable equivalent adjustments (adjustments to bring tax-exempt interest to a level that would yield the same after-tax income had that been subject to a 34% tax rate) were $0.6 million and $0.3 million for the three months ended September 30, 2016 and 2015, respectively, resulting in taxable equivalent net interest income of $21.5 million and $10.3 million, respectively. Taxable equivalent net interest income for third quarter 2016 was up $11.2 million or 109% versus third quarter 2015, with $9.6 million of the increase due to net favorable volume variances (predominately due to the Baylake merger included for the three months in 2016 versus zero in 2015), and $1.6 million increase from net favorable rate variances (especially in higher loan yields and lower cost of funds).
The earning asset yield was 4.57% for third quarter 2016, 11 bps higher than third quarter 2015, mainly due to an increase in the yield on loans (up 34 bps to 5.32% for third quarter 2016), though partially offset by a lower proportion of loans in average earning assets (78% versus 82% for third quarter 2016 and 2015, respectively). The 34 bps increase in loan yield between the three-month periods was largely due to higher aggregate discount accretion on loans (including $1.6 million from three favorably resolved discounted loans) partially offset by the addition of Baylake loans carrying a lower overall yield and underlying rate pressure on loan yields from competition and the low rate environment. Non-loan earning assets which earn less than loan assets represented 22% of average earning assets for third quarter 2016 (including higher low-earning cash) and earned 1.89%, versus 18% of earning assets yielding 2.01% for third quarter 2015.
The cost of funds was 0.50% for third quarter 2016, 38 bps lower than third quarter 2015, driven by a decline in the cost of deposits (down 29 bps to 0.37% for third quarter 2016) and a higher proportion of deposits in average interest-bearing liabilities (97% versus 94% for third quarter 2016 and 2015, respectively). The decrease in the cost of deposits resulted from product rate decreases initiated in the fourth quarter of 2015, lower overall rates on Baylake deposits acquired, and a favorable fair value interest mark on acquired CDs. The cost of other interest-bearing liabilities increased 77 bps to 5.35% between the third quarter periods, mostly due to a lower proportion of low-cost funding in the mix (such as fed funds purchased and other notes payable).
Noninterest income was $8.5 million for third quarter 2016, up $4.3 million from $4.2 million for the third quarter 2015. Noninterest income without net gains was up $4.0 million or 97%, largely due to mortgage income (up $1.2 million given higher production over a broader geographic footprint), service charges on deposits (up $0.4 million given the larger deposit base), and trust and brokerage fees (up $1.0 million combined, mostly attributable to the 2016 financial advisor business acquisition and market improvements). Net gain on sale or write-down of assets for third quarter 2016 consisted of a $0.5 million net gain on OREO resolutions, while third quarter 2015 included a $0.1 million net gain on OREO resolutions and gains on sales of assets. The $1.3 million increase in other noninterest income between the third quarter periods included interchange income up $0.6 million and wire fee income up $0.1 million on higher volumes, and UFS, Inc. income up $0.4 million due to the acquisition of this processing business as part of the Baylake merger in April 2016.
Noninterest expense was $19.0 million for the third quarter of 2016, up $9.2 million or 93% from third quarter 2015Non-recurring Baylake merger-based expenses were $0.1 million in third quarter 2015 and zero in the third quarter of 2016. Salaries and employee benefits for the third quarter of 2016 were $10.5 million or 87% higher than the third quarter of 2015. In addition to merit increases, higher overtime and higher equity award and incentive costs between the comparable third quarter periods, salaries and benefits were up largely from a 75% increase in average full time equivalent employees attributable to the 2016 acquisitions. Occupancy expense was $1.3 million higher due to the increased office locations. Data processing was $1.0 million higher than third quarter 2015 from increased accounts, rate increases and higher plastics processing costs. Amortization of intangibles was $0.9 million higher due to the added intangibles from the 2016 acquisitions.
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The provision for loan losses was $0.5 million for third quarter 2016 and 2015. Net charge offs for the quarter ending September 30, 2015 were $0.2 million compared to a net recovery of $0.1 million for the third quarter of 2016. At September 30, 2016, the ALLL was $11.5 million (or 0.74% of total loans) compared to $10.0 million (or 1.13% of total loans) at September 30, 2015. The decline in the ratio was a result of recording the Baylake loan portfolio at fair value with no carryover of its allowance at the time of the merger.
Income tax expense was $3.4 million and $1.3 million for the third quarters of 2016 and 2015, respectively. The effective tax rates were 34.5% for third quarter 2016 (partly impacted by the merger) and 32.8% for third quarter 2015.
BALANCE SHEET ANALYSIS
Loans
Nicolet services a diverse customer base throughout Northeast and Central Wisconsin and in Menominee, Michigan including the following industries: manufacturing, agriculture, wholesaling, retail, service, and businesses supporting the general building industry. It continues to concentrate its efforts in originating loans in its local markets and assisting its current loan customers. It actively utilizes government loan programs such as those provided by the U.S. Small Business Administration to help customers weather current economic conditions and position their businesses for the future.
Nicolet’s primary lending function is to make 1) commercial loans, consisting of commercial and industrial business loans, agricultural (“AG”) production, and owner-occupied commercial real estate (“CRE”) loans; 2) CRE loans, consisting of commercial investment real estate loans, AG real estate, and construction and land development loans; 3) residential real estate loans, including residential first mortgages, residential junior mortgages (such as home equity loans and lines), and residential construction loans; and 4) retail and other loans. Using these four broad groups the mix of loans at September 30, 2016 was 53% commercial, 20% CRE loans, 26% residential real estate, and 1% retail and other loans; and grouped further the loan mix was 73% commercial-based and 27% retail-based.
Total loans were $1.6 billion at September 30, 2016 compared to $877 million at December 31, 2015. Compared to September 30, 2015, loans grew $670 million or 76%, primarily as a result of the $691 million loans added fromBaylake at acquisition in April 2016. On average, loans were $1.3 billion and $884 million for the first nine months of 2016 and 2015, respectively, up 44%, largely attributable to the inclusion of acquired loans for five of nine months in 2016. At the time of the merger, the acquired Baylake loan portfolio was somewhat similar to Nicolet’s pre-merger loan mix, with the most notable differences being a higher mix in owner-occupied CRE and CRE investment and a lower mix in commercial and industrial loans.
Table 8: Period End Loan Composition
Broadly, loans were 73% commercial-based and 27% retail-based at September 30, 2016 compared to 74% commercial-based and 26% retail-based at December 31, 2015. Commercial-based loans are considered to have more inherent risk of default than retail-based loans, in part because of the broader list of factors that could impact a commercial borrower negatively as well as the commercial balance per borrower is typically larger than that for retail-based loans, implying higher potential losses on an individual customer basis.
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Commercial and industrial loans consist primarily of commercial loans to small businesses and, to a lesser degree, to municipalities within a diverse range of industries. The credit risk related to commercial and industrial loans is largely influenced by general economic conditions and the resulting impact on a borrower’s operations, or on the value of underlying collateral, if any. Commercial and industrial loans increased $129 million to $424 million since year end 2015. Commercial and industrial loans continue to be the largest segment of Nicolet’s portfolio but decreased to 27.3% of the total portfolio at September 30, 2016, down from 33.6% at December 31, 2015, largely attributable to the acquired Baylake loan mix.
Owner-occupied CRE loans increased to 23.3% of loans at September 30, 2016 from 21.1% at December 31, 2015, largely attributable to the acquired Baylake loan mix. Owner-occupied CRE loans primarily consist of loans within a diverse range of industries secured by business real estate that is occupied by borrowers (i.e. who operate their businesses out of the underlying collateral) and who may also have commercial and industrial loans. The credit risk related to owner-occupied CRE loans is largely influenced by general economic conditions and the resulting impact on a borrower’s operations, or on the value of underlying collateral.
AG production and AG real estate loans combined consist of loans secured by farmland and related farming operations. The credit risk related to agricultural loans is largely influenced by the prices farmers can get for their production and/or the underlying value of the farmland. In total, agricultural loans increased $21 million since year end 2015, representing 5.1% of total loans at September 30, 2016, versus 6.6% at December 31, 2015.
The CRE investment loan classification primarily includes commercial-based mortgage loans that are secured by non-owner occupied, nonfarm/nonresidential real estate properties, and multi-family residential properties. Lending in this segment has been focused on loans that are secured by commercial income-producing properties as opposed to speculative real estate development. The balance of these loans increased $119 million since year end 2015, representing 12.7% of total loans at September 30, 2016 compared to 9.0% of total loans at December 31, 2015, largely attributable to the acquired Baylake loan mix.
Loans in the construction and land development portfolio provide financing for the development of commercial income properties, multi-family residential development, and land designated for future development. Nicolet controls the credit risk on these types of loans by making loans in familiar markets, reviewing the merits of individual projects, controlling loan structure, and monitoring the progress of projects through the analysis of construction advances. Credit risk is managed by employing sound underwriting guidelines, lending primarily to borrowers in local markets, periodically evaluating the underlying collateral, and formally reviewing the borrower’s financial soundness and relationships on an ongoing basis. Lending on originated loans in this category has remained relatively steady as a percent of loans. Since December 31, 2015, balances have increased $31 million, and this category represented 4.4% and 4.2% of total loans at September 30, 2016 and year-end 2015, respectively.
On a combined basis, Nicolet’s residential real estate loans represent 26.3% of total loans at September 30, 2016, up from 24.7% at December 31, 2015. Residential first mortgage loans include conventional first-lien home mortgages. Residential junior mortgage real estate loans consist mainly of home equity lines and term loans secured by junior mortgage liens. Across the industry, home equities generally involve loans that are in second or junior lien positions, but Nicolet has secured many such loans in a first lien position, further mitigating the portfolio risks. Nicolet has not experienced significant losses in its residential real estate loans; however, if market values in the residential real estate markets decline, particularly in Nicolet’s market area, rising loan-to-value ratios could cause an increase in the provision for loan losses. As part of its management of originating residential mortgage loans, the vast majority of Nicolet’s long-term, fixed-rate residential real estate mortgage loans are sold in the secondary market without retaining the servicing rights. Mortgage loans retained in the portfolio are typically of high quality and have historically had low net charge off rates.
Loans in the retail and other classification represent less than 1% of the total loan portfolio, and include predominantly short-term and other personal installment loans not secured by real estate. Credit risk is primarily controlled by reviewing the creditworthiness of the borrowers, monitoring payment histories, and taking appropriate collateral and/or guaranty positions. The loan balances in this portfolio increased $8 million from December 31, 2015 to September 30, 2016.
Factors that are important to managing overall credit quality are sound loan underwriting and administration, systematic monitoring of existing loans and commitments, effective loan review on an ongoing basis, early problem loan identification and remedial action to minimize losses, an adequate ALLL, and sound nonaccrual and charge-off policies. An active credit risk management process is used for commercial loans to further ensure that sound and consistent credit decisions are made. The credit management process is regularly reviewed and the process has been modified over the past several years to further strengthen the controls.
The loan portfolio is widely diversified by types of borrowers, industry groups, and market areas. Significant loan concentrations are considered to exist for a financial institution when there are amounts loaned to multiple numbers of borrowers engaged in similar activities that would cause them to be similarly impacted by economic or other conditions. At September 30, 2016, no significant industry concentrations existed in Nicolet’s portfolio in excess of 25% of total loans. Nicolet has also developed guidelines to manage its exposure to various types of concentration risks.
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Allowance for Loan and Lease Losses
In addition to the discussion that follows, see also Note 1, “Basis of Presentation,” and Note 6, “Loans, Allowance for Loan Losses and Credit Quality,” in the notes to the unaudited consolidated financial statements and the “Critical Accounting Policies” within management’s discussion and analysis.
Credit risks within the loan portfolio are inherently different for each loan type as described under “Balance Sheet Analysis-Loans.” Credit risk is controlled and monitored through the use of lending standards, a thorough review of potential borrowers, and on-going review of loan payment performance. Active asset quality administration, including early problem loan identification and timely resolution of problems, aids in the management of credit risk and minimization of loan losses.
The ALLL is established through a provision for loan losses charged to expense to appropriately provide for potential credit losses in the existing loan portfolio. Loans are charged off against the ALLL when management believes that the collection of principal is unlikely. The level of the ALLL represents management’s estimate of an amount of reserves that provides for estimated probable credit losses in the loan portfolio at the balance sheet date. To assess the ALLL, an allocation methodology is applied by Nicolet which focuses on evaluation of qualitative and environmental factors, including but not limited to: (i) evaluation of facts and issues related to specific loans; (ii) management’s ongoing review and grading of the loan portfolio; (iii) consideration of historical loan loss and delinquency experience on each portfolio segment; (iv) trends in past due and nonperforming loans; (v) the risk characteristics of the various loan segments; (vi) changes in the size and character of the loan portfolio; (vii) concentrations of loans to specific borrowers or industries; (viii) existing and forecasted economic conditions; (ix) the fair value of underlying collateral; and (x) other qualitative and quantitative factors which could affect potential credit losses. Nicolet’s methodology reflects guidance by regulatory agencies to all financial institutions.
Management allocates the ALLL by pools of risk within each loan portfolio segment. The allocation methodology consists of the following components. First, a specific reserve for the estimated shortfall is established for all loans determined to be impaired. The specific reserve in the ALLL is equal to the aggregate collateral or discounted cash flow shortfall calculated from the impairment analyses. Loans measured for impairment include nonaccrual loans, non-performing troubled debt-restructurings (“restructured loans”), or other loans determined to be impaired by management. Second, Nicolet’s management allocates ALLL with historical loss rates by loan segment. The loss factors applied in the methodology are periodically re-evaluated and adjusted to reflect changes in historical loss levels on an annual basis. Beginning in the first quarter of 2015, management extended the look-back period on which the average historical loss rates are determined, from a prior three-year period to a rolling 20-quarter (five-year) average, as a means of capturing more of a full credit cycle now that recent period loss levels are stabilizing. Contrarily, the six-year average (used by the Company’s methodology during 2009-2013) was considered more appropriate for the severe and prolonged economic downturn particularly evidenced by higher net charge off levels in 2008 through 2011. Lastly, management allocates ALLL to the remaining loan portfolio using the qualitative factors mentioned above. Consideration is given to those current qualitative or environmental factors that are likely to cause estimated credit losses as of the evaluation date to differ from the historical loss experience of each loan segment.
Management performs ongoing intensive analyses of its loan portfolio to allow for early identification of customers experiencing financial difficulties, maintains prudent underwriting standards, understands the economy in its markets, and considers the trend of deterioration in loan quality in establishing the level of the ALLL.
Consolidated net income and stockholders’ equity could be affected if management’s estimate of the ALLL necessary to cover expected losses is subsequently materially different, requiring a change in the level of provision for loan losses to be recorded. While management uses currently available information to recognize losses on loans, future adjustments to the ALLL may be necessary based on newly received appraisals, updated commercial customer financial statements, rapidly deteriorating customer cash flow, and changes in economic conditions that affect Nicolet’s customers. As an integral part of their examination process, federal regulatory agencies also review the ALLL. Such agencies may require additions to the ALLL or may require that certain loan balances be charged-off or downgraded into criticized loan categories when their credit evaluations differ from those of management based on their judgments about information available to them at the time of their examination.
At September 30, 2016, the ALLL was $11.5 million compared to $10.3 million at December 31, 2015. The nine-month increase was a result of a 2016 provision of $1.4 million exceeding 2016 net charge offs of $0.2 million. Comparatively, the provision for loan losses in the first nine months of 2015 was $1.4 million and net charge offs were $0.6 million. Annualized net charge offs as a percent of average loans were 0.02% in the first nine months of 2016 compared to 0.10% for the first nine months of 2015 and 0.09% for the entire 2015 year. Loans charged off are subject to continuous review, and specific efforts are taken to achieve maximum recovery of principal, accrued interest, and related expenses. The level of the provision for loan losses is directly correlated to the assessment of the adequacy of the allowance, including, but not limited to, consideration of the amount of net charge-offs, loan growth, levels of nonperforming loans, and trends in the risk profile of the loan portfolio.
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The ratio of the ALLL as a percentage of period-end loans was 0.74% at September 30, 2016 (with a 1.05% ratio on originated loans and a 0.36% ratio on acquired loans) compared to 1.18% at December 31, 2015 (with a 1.18% ratio on originated loans and a 1.16% ratio on acquired loans). The ALLL to loans ratio is impacted by the accounting treatment of Nicolet’s 2013 and 2016 bank acquisitions, which combined at their acquisition dates added no ALLL to the numerator and $974 million of loans into the denominator. Acquired loans were $702 million and $137 million at September 30, 2016 and December 31, 2015, respectively. The change in the ALLL to loans ratio was driven by the increase in the denominator from acquired loans in 2016.
The largest portions of the ALLL were allocated to commercial & industrial (“C&I”) loans and owner-occupied CRE loans combined, representing 59.1% and 55.0% of the ALLL at September 30, 2016 and December 31, 2015, respectively. Most notably since December 31, 2015, the increased allocations to C&I (from 36.2% to 36.6%), Owner-occupied CRE (from 18.8% to 22.5%) and CRE investment (from 7.6% to 9.0%) and the decreased allocation in construction and land development (from 14.0% to 7.5%) was largely the result of changes to allowance allocations in conjunction with changes in past due and loss histories and balance mix changes.
Table 9: Loan Loss Experience
September 30,
2016
2015
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The allocation of the ALLL is based on Nicolet’s estimate of loss exposure by category of loans and is shown in Table 10 for September 30, 2016 and December 31, 2015.
Table 10: Allocation of the Allowance for Loan Losses
Impaired Loans and Nonperforming Assets
As part of its overall credit risk management process, Nicolet’s management has been committed to an aggressive problem loan identification philosophy. This philosophy has been implemented through the ongoing monitoring and review of all pools of risk in the loan portfolio to ensure that problem loans are identified early and the risk of loss is minimized.
Nonperforming loans are considered one indicator of potential future loan losses. Nonperforming loans are defined as nonaccrual loans, including those defined as impaired under current accounting standards, and loans 90 days or more past due but still accruing interest. Loans are generally placed on nonaccrual status when contractually past due 90 days or more as to interest or principal payments. Additionally, whenever management becomes aware of facts or circumstances that may adversely impact the collectability of principal or interest on loans, it is management’s practice to place such loans on nonaccrual status immediately. Nonaccrual loans were $21.5 million (consisting of $0.7 million originated loans and $20.8 million acquired loans) at September 30, 2016 compared to $3.5 million at December 31, 2015 (consisting of $0.6 million originated loans and $2.9 million acquired loans). Of the $37.5 million nonaccrual loans initially acquired in the 2016 and 2013 acquisitions, $20.8 million remain and are included in the $21.5 million of nonaccrual loans at September 30, 2016. Nonperforming assets (which include nonperforming loans and OREO) were $23.7 million at September 30, 2016 compared to $3.9 million at December 31, 2015. OREO increased from $0.4 million at year end 2015 to $2.2 million at September 30, 2016 as a result of OREO properties acquired in the Baylake merger. Nonperforming assets as a percent of total assets were 1.04% at September 30, 2016 compared to 0.32% at December 31, 2015.
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The level of potential problem loans is another predominant factor in determining the relative level of risk in the loan portfolio and in determining the adequacy of the ALLL. Potential problem loans are generally defined by management to include loans rated as Substandard by management but that are in performing status; however, there are circumstances present which might adversely affect the ability of the borrower to comply with present repayment terms. The decision of management to include performing loans in potential problem loans does not necessarily mean that Nicolet expects losses to occur, but that management recognizes a higher degree of risk associated with these loans. The loans that have been reported as potential problem loans are predominantly commercial-based loans covering a diverse range of businesses and real estate property types. Potential problem loans were $9.2 million (0.6% of loans) and $9.2 million (1.0% of loans) at September 30, 2016 and December 31, 2015, respectively. Potential problem loans require a heightened management review of the pace at which a credit may deteriorate, the duration of asset quality stress, and uncertainty around the magnitude and scope of economic stress that may be felt by Nicolet’s customers and on underlying real estate values.
Table 11: Nonperforming Assets
Table 12: Investment Securities Portfolio
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At September 30, 2016 the total carrying value of investment securities was $366 million, up from $173 million at December 31, 2015, and represented 16.1% and 14.2% of total assets at September 30, 2016 and December 31, 2015, respectively. The increase since year end 2016 was largely attributable to investment securities added from Baylake at acquisition in April 2016. At September 30, 2016, the securities portfolio did not contain securities of any single issuer that were payable from and secured by the same source of revenue or taxing authority where the aggregate carrying value of such securities exceeded 10% of stockholders’ equity.
In addition to securities available for sale, Nicolet had other investments of $18 million at September 30, 2016 and $8 million at December 31, 2015, consisting of capital stock in the Federal Reserve and the FHLB (required as members of the Federal Reserve Bank System and the Federal Home Loan Bank System), and the Federal Agricultural Mortgage Corporation, as well as equity investments in other privately-traded companies. The FHLB and Federal Reserve investments are “restricted” in that they can only be sold back to the respective institutions or another member institution at par, and are thus not liquid, have no ready market or quoted market value, and are carried at cost. The remaining investments have no quoted market prices, and are carried at cost less other than temporary impairment (“OTTI”) charges, if any. Nicolet’s management evaluates all these other investments periodically for impairment, considering financial condition and other available relevant information. There were no OTTI charges recorded in 2015 or year to date 2016.
Table 13: Investment Securities Portfolio Maturity Distribution
Deposits
Deposits represent Nicolet’s largest source of funds. Nicolet competes with other bank and nonbank institutions for deposits, as well as with a growing number of non-deposit investment alternatives available to depositors, such as mutual funds, money market funds, annuities, and other brokerage investment products. Challenges to deposit growth include price changes on deposit products given movements in the rate environment and other competitive pricing pressures, and customer preferences regarding higher-costing deposit products or non-deposit investment alternatives. Included in total deposits in Table 14 are brokered deposits of $29 million at September 30, 2016 and $31 million at December 31, 2015.
Table 14: Deposits
Total deposits were $1.9 billion at September 30, 2016, up $878 million or 83% since December 31, 2015, largely attributable to the $822 million deposits added from Baylake at acquisition in April 2016. On average for the first nine months of 2016, total deposits were $1.5 billion, up $529 million, or 52%, from the comparable 2015 period, largely attributable to the inclusion of acquired deposits for five of nine months in 2016. On average, the mix of deposits changed between the comparable nine-month periods, with 2016 carrying more in demand (i.e. noninterest bearing) deposits, money market and NOW accounts, and less in savings and time deposits.
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Table 15: Average Deposits
Table 16: Maturity Distribution of Certificates of Deposit of $100,000 or More
Other Funding Sources
Other funding sources include short-term borrowings (zero at September 30, 2016 and December 31, 2015) and long-term borrowings (totaling $37 million at September 30, 2016 and $40 million at December 31, 2015). Short-term borrowings consist mainly of customer repurchase agreements maturing in less than nine months or federal funds purchased. Long-term borrowings include notes payable (consisting of FHLB advances and, prior to its repayment in 2016, a joint venture note), junior subordinated debentures (largely qualifying as Tier 1 capital for regulatory purposes, given their long maturity dates, even though they are redeemable in whole or in part at par), and subordinated debt (issued in 2015 with 10-year maturities, callable on or after the fifth anniversary date of their respective issuance dates, and qualifying as Tier 2 capital for regulatory purposes). During the third quarter of 2016, a $5 million FHLB advance matured and was paid off. Further information regarding these long-term borrowings is included in Note 8 – Notes Payable, Note 9 – Junior Subordinated Debentures, and Note 10 – Subordinated Notes in the notes to the unaudited consolidated financial statements. Given the high level of deposits to assets, other funding sources are currently utilized modestly, mainly for their capital equivalent characteristics and term funding.
Additional funding sources consist of a $10 million available and unused line of credit at the holding company, $143 million of available and unused federal funds purchased lines, and available total borrowing capacity at the FHLB of $298 million of which $9 million was used at September 30, 2016 (consisting of $1 million in outstanding advances and $8 million related to outstanding letters of credits).
Off-Balance Sheet Obligations
As of September 30, 2016 and December 31, 2015, Nicolet had the following commitments that did not appear on its balance sheet:
Table 17: Commitments
Liquidity Management
Liquidity management refers to the ability to ensure that cash is available in a timely and cost-effective manner to meet cash flow requirements of depositors and borrowers and to meet other commitments as they fall due, including the ability to pay dividends to shareholders, service debt, invest in subsidiaries, repurchase common stock, and satisfy other operating requirements.
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Funds are available from a number of basic banking activity sources including but not limited to the core deposit base, the repayment and maturity of loans, investment securities calls, maturities, and sales, and funds obtained through brokered deposits. All investment securities are classified as available for sale and are reported at fair value on the consolidated balance sheet. Approximately $29 million of the $366 million investment securities portfolio at September 30, 2016 was pledged to secure public deposits, short term borrowings, repurchase agreements, or for other purposes as required by law. Other funding sources available include short-term borrowings, federal funds purchased, and long-term borrowings.
Cash and cash equivalents at September 30, 2016 and December 31, 2015 were approximately $104 million and $84 million, respectively. These levels have increased through the first nine months of 2016 with $74 million net cash provided by investing activities (mostly due to net cash acquired with the 2016 acquisitions and a net decline in loans) and $12 million net cash provided by operating activities, exceeding the $65 million net cash used in financing activities (mostly due to reductions in short-term borrowings, notes payable and preferred stock exceeding the net increase in deposits). Nicolet’s liquidity resources were sufficient as of September 30, 2016 to fund loans, accommodate deposit trends and cycles, and to meet other cash needs as necessary.
Interest Rate Sensitivity Management
A reasonable balance between interest rate risk, credit risk, liquidity risk and maintenance of yield, is highly important to Nicolet’s business success and profitability. As an ongoing part of its financial strategy and risk management, Nicolet attempts to understand and manage the impact of fluctuations in market interest rates on its net interest income. The consolidated balance sheet consists mainly of interest-earning assets (loans, investments and cash) which are primarily funded by interest-bearing liabilities (deposits and other borrowings). Such financial instruments have varying levels of sensitivity to changes in market rates of interest. Market rates are highly sensitive to many factors beyond our control, including but not limited to general economic conditions and policies of governmental and regulatory authorities. Our operating income and net income depends, to a substantial extent, on “rate spread” (i.e., the difference between the income earned on loans, investments and other earning assets and the interest expense paid to obtain deposits and other funding liabilities).
Asset-liability management policies establish guidelines for acceptable limits on the sensitivity to changes in interest rates on earnings and market value of assets and liabilities. Such policies are set and monitored by management and the board of directors’ Asset and Liability Committee.
To understand and manage the impact of fluctuations in market interest rates on net interest income, Nicolet measures its overall interest rate sensitivity through a net interest income analysis, which calculates the change in net interest income in the event of hypothetical changes in interest rates under different scenarios versus a baseline scenario. Such scenarios can involve static balance sheets, balance sheets with projected growth, parallel (or non-parallel) yield curve slope changes, immediate or gradual changes in market interest rates, and one-year or longer time horizons. The simulation modeling uses assumptions involving market spreads, prepayments of rate-sensitive instruments, renewal rates on maturing or new loans, deposit retention rates, and other assumptions.
Nicolet assessed the impact on net interest income in the event of a gradual +/-100 bps and +/-200 bps decrease in market rates (parallel to the change in prime rate) over a one-year time horizon to a static (flat) balance sheet. The interest rate scenarios are used for analytical purposes only and do not necessarily represent management’s view of future market interest rate movements. Based on this analysis on financial data at September 30, 2016, the projected changes in net interest income over a one-year time horizon, versus the baseline, was -1.2%, -0.4%, -0.7% and -1.0% for the -200, -100, +100 and +200 bps scenarios, respectively; such results are within Nicolet’s guidelines of not greater than -15% for +/- 100 bps and not greater than -20% for +/- 200 bps.
Actual results may differ from these simulated results due to timing, magnitude and frequency of interest rate changes, as well as changes in market conditions and their impact on customer behavior and management strategies.
Capital
Management regularly reviews the adequacy of its capital to ensure that sufficient capital is available for current and future needs and is in compliance with regulatory guidelines and actively reviews capital strategies in light of perceived business risks associated with current and prospective earning levels, liquidity, asset quality, economic conditions in the markets served, and level of returns available to shareholders. Management intends to maintain an optimal capital and leverage mix for growth and for shareholder return.
At September 30, 2016, Nicolet’s capital structure consisted of $276.3 million of common stock equity. Comparatively, at December 31, 2015, Nicolet’s total stockholders’ equity was $109.5 million, consisting of $12.2 million preferred stock and $97.3 million of common stock equity. During the hird quarter of 2015, Nicolet redeemed $12.2 million of its outstanding Small Business Lending Fund (“SBLF”) Series C Preferred Stock. During the third quarter of 2016, the remaining $12.2 million of preferred stock was fully redeemed. These redemptions were part of an overall capital strategy partially motivated by the adjustment of the rate on the SBLF preferred stock from 1% to 9% effective March 1, 2016, according to the terms of the Securities Purchase Agreement.
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Nicolet’s common equity, representing 12.2% of total assets at September 30, 2016 compared to 8.0% at December 31, 2015, continues to reflect capacity to capitalize on opportunities. Nicolet’s common stock was accepted by shareholders as the primary consideration in the recent predominantly stock-for-stock 2016 acquisitions, as described in Note 2 – “Acquisitions,” in the notes to the unaudited consolidated financial statements. On April 29, 2016 as part of the Baylake merger, Nicolet issued 4,344,243 shares of common stock for common stock consideration of $163.3 million, and recorded $1.2 million consideration for assumed stock options. In connection with the financial advisor business acquisition that completed on April 1, 2016, Nicolet issued $2.6 million in common stock consideration. Further, Nicolet’s investors have demonstrated a strong commitment to capital over time, providing common capital when needed, including a December 2008 private placement raising $9.5 million in common capital as we entered the economic crisis and the April 2013 private placement raising $2.9 million in common capital alongside a predominately stock-for-stock 2013 bank acquisition which added $9.7 million in common capital. Book value per common share increased 37% to $32.19 at September 30, 2016 from $23.42 at year end 2015 aided by the common equity issued in the 2016 acquisitions and retained earnings.
During early 2014, a common stock repurchase program was approved which authorized, with subsequent modifications in 2015, the use of up to $18 million to repurchase up to 800,000 shares of outstanding common stock. Nicolet suspended its repurchase program between announcement (September 8, 2015) and consummation (April 29, 2016) of the Baylake merger transaction. Nicolet resumed its repurchase program in the third quarter of 2016, using $2.5 million to repurchase and cancel 66,227 shares at a weighted average price per share of $37.36 including commissions. During the year ended December 31, 2015, $4.2 million was used to repurchase and cancel 146,404 shares at a weighted average price per share of $28.35 including commissions. Since beginning the repurchase program in February 2014, total shares repurchased through September 30, 2016 were 469,922 utilizing $12.3 million for an average cost of $26.11 per share.
As shown in Table 18, all of Nicolet’s regulatory capital ratios remain strong and are well above the minimum regulatory ratios. In comparing September 30, 2016 to December 31, 2015, certain regulatory capital ratios declined due to the increased asset size and recognition of new intangibles from the 2016 acquisitions; however, all required minimum capital levels were exceeded at September 30, 2016, and Nicolet maintains sufficient regulatory capital for current and future needs. The Bank’s regulatory ratios at September 30, 2016 and December 31, 2015 qualify the Bank as well-capitalized under the prompt-corrective action framework. This strong base of capital has allowed Nicolet to be opportunistic in the current environment.
A source of income and funds for Nicolet as the parent company of Nicolet National Bank are dividends from the Bank. Dividends declared by the Bank that exceed the retained net income for the most current year plus retained net income for the preceding two years must be approved by regulatory agencies. During the first nine months of 2016, the Bank paid dividends of $23 million to Nicolet, $8 million from Bank retained earnings and $15 million from the Bank’s surplus, the latter of which received the requisite pre-approval by regulatory agencies and was requested due to growth in surplus from the 2016 acquisitions. During 2015, the Bank paid $11 million of dividends to the parent company. At September 30, 2016, the Bank could pay dividends of approximately $7 million without seeking regulatory approval.
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A summary of Nicolet’s and Nicolet National Bank’s regulatory capital amounts and ratios as of September 30, 2016 and December 31, 2015 are presented in the following table.
Table 18: Capital
In July 2013, the Federal Reserve Board and the OCC issued final rules implementing the Basel III regulatory capital framework and related Dodd-Frank Act changes. The final rules took effect for the Company and Bank on January 1, 2015, subject to a transition period for certain parts of the rules. The rules permitted certain banking organizations to retain, through a one-time election, the existing treatment for accumulated other comprehensive income. Nicolet and the Bank made the election in 2015 to retain the existing treatment for accumulated other comprehensive income.
The tables above calculate and present regulatory capital based upon the new regulatory capital ratio requirements under Basel III that became effective on January 1, 2015. Beginning in 2016, an additional capital conservation buffer was added to the minimum requirements for capital adequacy purposes, subject to a three year phase-in period. The capital conservation buffer will be fully phased-in on January 1, 2019 at 2.5 percent. A banking organization with a conservation buffer of less than 2.5 percent (or the required phase-in amount in years prior to 2019) will be subject to limitations on capital distributions, including dividend payments and certain discretionary bonus payments to executive officers. At the present time, the ratios for the Company and Bank are sufficient to meet the fully phased-in conservation buffer.
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Future Accounting Pronouncements
In March 2016, the Financial Accounting Standards Board (“FASB”) issued updated guidance to Accounting Standards Update (“ASU”) 2015-09 Stock Compensation Improvements to Employee Share-Based Payment Activity intended to simplify and improve several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of such awards as either equity or liabilities and classification on the statement of cash flows. The updated guidance is effective for interim and annual reporting periods beginning after December 15, 2016, with early adoption permitted. The Company is currently assessing the impact of the new guidance on its consolidated financial statements.
In June 2016, the FASB issued ASU 2016-13,Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments intended to improve the financial reporting by requiring timelier recording of credit losses on loans and other financial instruments held by financial institutions and other organizations. The ASU requires the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Financial institutions and other organizations will now use forward-looking information to better inform their credit loss estimates. The ASU is effective for SEC filers for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. Early application will be permitted for all organizations for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. The Company is currently assessing the impact of the new guidance on its consolidated financial statements.
In August 2016, the FASB issued ASU 2016-15,Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts to address diversity in how certain cash receipts and cash payments are presented and classified in the statement of cash flows. The amendments provide guidance on specific cash flow issues, including: debt prepayment or debt extinguishment costs, contingent consideration payments made after a business combination, proceeds from the settlement of insurance claims, proceeds from the settlement of Corporate-Owned Life Insurance Policies, including Bank-Owned Life Insurance Policies, and distributions received from equity method investees. The amendments are effective for public business entities for fiscal years beginning after December 31, 2017, and interim periods within those fiscal years. Early adoption is permitted including adoption in an interim period. The Company is currently assessing the impact of the new guidance on its consolidated financial statements.
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606). The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods and services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods and services. In August 2015, the FASB issued an amendment to defer the effective date for all entities by one year. The updated guidance is effective for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period. The Company is currently assessing the impact of the new guidance on its consolidated financial statements.
In February 2016, the FASB issued ASU 2016-02,Leases (Topic 842). The core principle of the guidance is a lessee should recognize the assets and liabilities that arise from leases. The updated guidance is effective for annual reporting periods beginning after December 15, 2018. Early application is permitted. The Company is currently assessing the impact of the new guidance on its consolidated financial statements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
See section “Interest Rate Sensitivity Management,” of Management’s Discussion and Analysis under Part I, Item 2.
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ITEM 4. CONTROLS AND PROCEDURES
As of the end of the period covered by this report, management, under the supervision, and with the participation, of our Chief Executive Officer and President and Chief Financial Officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as such term in Rule 13a-15(e) and 15d-15(e) under the Exchange Act pursuant to Exchange Act Rule 13a-15. Based upon, and as of the date of such evaluation, the Chief Executive Officer and President and the Chief Financial Officer concluded that our disclosure controls and procedures were effective.
There have been no changes in the Company’s internal controls or, to the Company’s knowledge, in other factors during the quarter covered by this report that have materially affected, or are reasonably likely to materially affect, the Company’s internal controls over financial reporting. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
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PART II – OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
We and our subsidiaries may be involved from time to time in various routine legal proceedings incidental to our respective businesses. Neither we nor any of our subsidiaries are currently engaged in any legal proceedings that are expected to have a material adverse effect on our results of operations or financial position.
ITEM 1A. RISK FACTORS
There have been no material changes in the risk factors previously disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Commencing on February 24, 2016, Nicolet’s common stock is traded on the Nasdaq Capital Market under the symbol NCBS. Following are Nicolet’s monthly common stock purchases during the third quarter of 2016.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
ITEM 5. OTHER INFORMATION
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ITEM 6. EXHIBITS
The following exhibits are filed herewith:
Agreement and Plan of Merger by and between Nicolet Bankshares, Inc. and First Menasha Bancshares, Inc., dated November 3, 2016 (incorporated by reference to Exhibit 2.1 to the Registrant’s Current Report on Form 8-K filed on November 4, 2016).
Nicolet Bankshares, Inc. 2011 Long Term Incentive Plan, as amended and restated effective April 29, 2016 and approved by the shareholders of Nicolet Bankshares, Inc. on August 10, 2016 (Incorporated by reference to Appendix A of Nicolet’s Proxy Statement filed June 30, 2016).
*Indicates information that is furnished and not filed or a part of a registration statement or prospectus for purposes of sections 11 or 12 of the Securities Act of 1933, is deemed not filed for purposes of section 18 of the Securities Exchange Act of 1934, and otherwise is not subject to liability under these sections.
† Denotes a management compensatory agreement.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
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