ITEM 1. BUSINESS
General
Nicolet Bankshares, Inc. (individually referred to herein as the “Parent Company” and together with all its subsidiaries collectively referred to herein as “Nicolet,” the “Company,” “we,” “us” or “our”) is a registered bank holding company under the Bank Holding Company Act of 1956, as amended, and under the bank holding company laws of the State of Wisconsin. At December 31, 2017, Nicolet had total assets of $2.9 billion, loans of $2.1 billion, deposits of $2.5 billion and total stockholders’ equity of $364 million. For the year ended December 31, 2017, Nicolet earned net income of $33.1 million, or $3.33 per diluted common share. For 2017, Nicolet’s return on average assets was 1.25%.
The Parent Company is a Wisconsin corporation, originally incorporated on April 5, 2000 as Green Bay Financial Corporation, a Wisconsin corporation, to serve as the holding company for and the sole shareholder of Nicolet National Bank. It amended and restated its articles of incorporation and changed its name to Nicolet Bankshares, Inc. on March 14, 2002. It subsequently became the holding company for Nicolet National Bank upon the completion of the bank’s reorganization into a holding company structure on June 6, 2002. Nicolet elected to become a financial holding company in 2008.
Nicolet conducts its primary operations through its wholly owned subsidiary, Nicolet National Bank, a commercial bank which was organized in 2000 as a national bank under the laws of the United States and opened for business, in Green Bay, Brown County, Wisconsin, on November 1, 2000 (referred to herein as the “Bank”). Structurally, the Parent Company also wholly owns a registered investment advisory firm, Brookfield Investment Partners, LLC (“Brookfield”), that principally provides investment strategy and transactional services to select community banks, wholly owns a registered investment advisory firm, Nicolet Advisory Services, LLC (“Nicolet Advisory”), that conducts brokerage and financial advisory services primarily to individual consumers, and entered into a joint venture that provides for 50% ownership of the building in which Nicolet is headquartered. Structurally, the Bank wholly owns an investment subsidiary based in Nevada, a subsidiary in Green Bay that provides a web-based investment management platform for financial advisor trades and related activity, and a subsidiary that owns a for-sale Green Bay property that is partially leased, and the Bank owns 99.2% of United Financial Services, Inc (“UFS Inc.”) which in turn owns 50.2% of UFS, LLC, a data processing services company located in Grafton, Wisconsin (collectively referred to herein as “UFS”). Other than the Bank, these subsidiaries are closely related to or incidental to the business of banking and none are individually or collectively significant to Nicolet’s financial position or results as of December 31, 2017.
Nicolet’s profitability is significantly dependent upon net interest income (interest income earned on loans and other interest-earning assets such as investments, net of interest expense on deposits and other borrowed funds), and noninterest income sources (including but not limited to service charges on deposits, trust and brokerage fees, and mortgage income from sales of residential mortgages into the secondary market), offset by the level of the provision for loan losses, noninterest expenses (largely employee compensation and overhead expenses tied to processing and operating the Bank’s business), and income taxes.
Since its opening in late 2000, Nicolet has supplemented its organic growth with branch purchase and acquisition transactions. Most recently, the Company completed a merger transaction with First Menasha Bancshares, Inc. (“First Menasha”) consummated on April 28, 2017. During 2016, the Company completed two transactions (collectively the “2016 acquisitions”) consisting of a private transaction to hire a select group of financial advisors and to purchase their respective books of business and operating platform completed on April 1, 2016 and the merger transaction with Baylake Corp. (“Baylake”) consummated on April 29, 2016. For additional information, see Note 2, “Acquisitions,” of the Notes to Consolidated Financial Statements under Part II, Item 8.
Products and Services Overview
Nicolet’s principal business is banking, consisting of lending and deposit gathering, as well as ancillary banking-related products and services, to businesses and individuals of the communities it serves, and the operational support to deliver, fund and manage such banking products and services. Additionally, through the Bank and Nicolet Advisory, trust, brokerage and other investment management services for individuals and retirement plan services for business customers are offered. Nicolet delivers its products and services principally through 38 bank branch locations, on-line banking, mobile banking and an interactive website. Nicolet’s call center also services customers.
Nicolet offers a variety of loans, deposits and related services to business customers (especially small and medium-sized businesses and professional concerns), including but not limited to: business checking and other business deposit products and cash management services, international banking services, business loans, lines of credit, commercial real estate financing, construction loans, agricultural real estate or production loans, and letters of credit, as well as retirement plan services. Similarly, Nicolet offers a variety of banking products and services to consumers, including but not limited to: residential mortgage loans and mortgage refinancing, home equity loans and lines of credit, residential construction loans, personal loans, checking, savings and money market accounts, various certificates of deposit and individual retirement accounts, safe deposit boxes, and personal brokerage, trust and fiduciary services. Nicolet also provides on-line services including commercial, retail and trust on-line banking, automated bill payment, mobile banking deposits and account access, remote deposit capture, and telephone banking, and other services such as wire transfers, debit cards, credit cards, pre-paid gift cards, direct deposit, and official bank checks.
Lending is critical to Nicolet’s balance sheet and earnings potential. Nicolet seeks creditworthy borrowers principally within the geographic area of its branch locations. As a community bank with experienced commercial lenders and residential mortgage lenders, the primary lending function is to make loans in the following categories:
·commercial-related loans, consisting of:
ocommercial, industrial, and business loans and lines of credit;
oowner-occupied commercial real estate (“owner-occupied CRE”);
oagricultural (“AG”) production and AG real estate;
ocommercial real estate investment loans (“CRE investment”);
oconstruction and land development loans);
·residential real estate loans, consisting of:
oresidential first lien mortgages;
ojunior lien mortgages;
ohome equity loans and lines of credit;
oresidential construction loans; and
·other loans (mainly consumer in nature).
Lending involves credit risk. Nicolet has and follows extensive loan policies and procedures to standardize processes, meet compliance requirements and prudently manage underwriting, credit and other risks. Credit risk is further controlled and monitored through active asset quality management including the use of lending standards, thorough review of current and potential borrowers through Nicolet’s underwriting process, close relationships with and regular check-ins with borrowers, and active asset quality administration. For further discussion of the loan portfolio composition and credit risk management, see “Management’s Discussion and Analysis of Financial Condition and Results of Operation,” under Part II, Item 7.
Employees
At December 31, 2017, Nicolet had approximately 535 full-time equivalent employees. None of our employees are represented by unions.
Market Area and Competition
The Bank is a full-service community bank, providing a full range of traditional commercial, wealth and retail banking products and services throughout northeastern and central Wisconsin and in Menominee, Michigan. Nicolet markets its services to owner-managed companies, the individual owners of these businesses, and other residents of its market area, which at December 31, 2017 is through 38 branches located principally in its trade area of northeastern and central Wisconsin, and in Menominee, Michigan. Based on deposit market share data published by the FDIC as of June 30, 2017, the Bank ranks in the top three of market share for Brown, Door, Kewaunee, Taylor and Clark counties and in the top five for Menominee, Marinette and Winnebago counties.
The financial services industry is highly competitive. Nicolet competes for loans, deposits and wealth management or financial services in all its principal markets. Nicolet competes directly with other bank and nonbank institutions located within our markets (some that may have an established customer base or name recognition), internet-based banks, out-of-market banks that advertise or otherwise serve its markets, money market and other mutual funds, brokerage houses, mortgage companies, insurance companies or other commercial entities that offer financial services products. Competition involves efforts to retain current or procure new customers, obtain new loans and deposits, increase the scope and type of products or services offered, and offer competitive interest rates paid on deposits or earned on loans, as well as to deliver other aspects of banking competitively. Many of Nicolet’s competitors may enjoy competitive advantages, including greater financial resources, broader geographic presence, more accessible branches or more advanced technologic delivery of products or services, more favorable pricing alternatives and lower origination or operating costs.
We believe our competitive pricing, personalized service and community engagement enable us to effectively compete in our markets. Nicolet employs seasoned banking and wealth management professionals with experience in its market areas and who are active in their communities. Nicolet’s emphasis on meeting customer needs in a relationship-focused manner, combined with local decision making on extensions of credit, distinguishes Nicolet from its competitors, particularly in the case of large financial institutions. Nicolet believes it further distinguishes itself by providing a range of products and services characteristic of a large financial institution while providing the personalized service, real conversation, and convenience characteristic of a local, community bank.
Supervision and Regulation
Set forth below is an explanation of the major pieces of legislation and regulation affecting the banking industry and how that legislation and regulation affects Nicolet’s business. The following summary is qualified by reference to the statutory and regulatory provisions discussed. Changes in applicable laws or regulations may have a material effect on the business and prospects of Nicolet or the Bank, and legislative changes and the policies of various regulatory authorities may significantly affect their operations. We cannot predict the effect that fiscal or monetary policies, or new federal or state legislation or regulation may have on the future business and earnings of Nicolet or the Bank.
Uncertainty remains as to the ultimate impact of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), which could have a material adverse impact on the financial services industry as a whole or on Nicolet’s and the Bank’s business, results of operations, and financial condition. Many aspects of the Dodd-Frank Act are in the process of being implemented while other aspects remain subject to further rulemaking. These regulations are scheduled to take effect over several years, making it difficult to anticipate the overall financial impact on Nicolet, its customers or the financial industry more generally. However, full implementation of the Dodd-Frank Act would likely increase the regulatory burden, compliance costs and interest expense for Nicolet and the Bank. Some of the rules that have been adopted to comply with the Dodd-Frank Act’s mandates are discussed below.
Regulation of Nicolet
Because Nicolet owns all of the capital stock of the Bank, it is a bank holding company under the federal Bank Holding Company Act of 1956, as amended (the “Bank Holding Company Act”). As a result, Nicolet is primarily subject to the supervision, examination, and reporting requirements of the Bank Holding Company Act and the regulations of the Board of Governors of the Federal Reserve System (the “Federal Reserve”). As a bank holding company located in Wisconsin, the Wisconsin Department of Financial Institutions (the “WDFI”) also regulates and monitors all significant aspects of its operations.
Acquisitions of Banks. The Bank Holding Company Act requires every bank holding company to obtain the prior approval of the Federal Reserve before:
·acquiring direct or indirect ownership or control of any voting shares of any bank if, after the acquisition, the bank holding company will directly or indirectly own or control more than 5% of the bank’s voting shares;
·acquiring all or substantially all of the assets of any bank; or
·merging or consolidating with any other bank holding company.
Additionally, the Bank Holding Company Act provides that the Federal Reserve may not approve any of these transactions if it would result in or tend to create a monopoly, substantially lessen competition, or otherwise function as a restraint of trade, unless the anti-competitive effects of the proposed transaction are clearly outweighed by the public interest in meeting the convenience and needs of the community to be served. The Federal Reserve is also required to consider the financial and managerial resources and future prospects of the bank holding companies and banks involved in the transaction and the convenience and needs of the community to be served. The Federal Reserve’s consideration of financial resources generally focuses on capital adequacy, which is discussed below.
Change in Bank Control. Subject to various exceptions, the Bank Holding Company Act and the Change in Bank Control Act, together with related regulations, require Federal Reserve approval prior to any person or company acquiring “control” of a bank holding company. Control is conclusively presumed to exist if an individual or company acquires 25% or more of any class of voting securities of the bank holding company. Control is rebuttably presumed to exist if a person or company acquires 10% or more, but less than 25%, of any class of voting securities of the bank holding company. The regulations provide a procedure for challenging rebuttable presumptions of control.
Permitted Activities. The Bank Holding Company Act has generally prohibited a bank holding company from engaging in activities other than banking or managing or controlling banks or other permissible subsidiaries and from acquiring or retaining direct or indirect control of any company engaged in any activities other than those determined by the Federal Reserve to be closely related to banking or managing or controlling banks as to be a proper incident thereto. Provisions of the Gramm-Leach-Bliley Act have expanded the permissible activities of a bank holding company that qualifies as a financial holding company to engage in activities that are financial in nature or incidental or complementary to financial activities. Those activities include, among other activities, certain insurance, advisory and security activities.
Nicolet meets the qualification standards applicable to financial holding companies, and elected to become a financial holding company in 2008. In order to remain a financial holding company, Nicolet must continue to be considered well managed and well capitalized by the Federal Reserve, and the Bank must continue to be considered well managed and well capitalized by the Office of the Comptroller of the Currency (the “OCC”) and have at least a “satisfactory” rating under the Community Reinvestment Act.
Support of Subsidiary Institutions. Under Federal Reserve policy and the Dodd-Frank Act, Nicolet is expected to act as a source of financial strength for the Bank and to commit resources to support the Bank. This support may be required at times when, without this Federal Reserve policy or the related rules, Nicolet might not be inclined to provide it.
In addition, any capital loans made by Nicolet to the Bank will be repaid only after the Bank’s deposits and various other obligations are repaid in full.
Capital Adequacy. Nicolet is subject to capital requirements applied on a consolidated basis, which are substantially similar to those required of the Bank, which are summarized under “Regulation of the Bank” below.
Dividend Restrictions. Under Federal Reserve policies, bank holding companies may pay cash dividends on common stock only out of income available over the past year if prospective earnings retention is consistent with the organization's expected future needs and financial condition and if the organization is not in danger of not meeting its minimum regulatory capital requirements. Federal Reserve policy also provides that bank holding companies should not maintain a level of cash dividends that undermines the bank holding company's ability to serve as a source of strength to its banking subsidiaries.
Regulation of the Bank
Because the Bank is chartered as a national bank, it is primarily subject to the supervision, examination, and reporting requirements of the National Bank Act and the regulations of the OCC. The OCC regularly examines the Bank’s operations and has the authority to approve or disapprove mergers, the establishment of branches and similar corporate actions. The OCC also has the power to prevent the continuance or development of unsafe or unsound banking practices or other violations of law. Because the Bank’s deposits are insured by the FDIC to the maximum extent provided by law, it is also subject to certain FDIC regulations and the FDIC also has examination authority and back-up enforcement power over the Bank. The Bank is also subject to numerous state and federal statutes and regulations that affect Nicolet, its business, activities, and operations.
Branching. National banks are required by the National Bank Act to adhere to branching laws applicable to state banks in the states in which they are located. Under Wisconsin law and the Dodd-Frank Act, and with the prior approval of the OCC, the Bank may open branch offices within or outside of Wisconsin, provided that a state bank chartered by the state in which the branch is to be located would also be permitted to establish a branch. In addition, with prior regulatory approval, the Bank may acquire branches of existing banks located in Wisconsin or other states.
Capital Adequacy. Banks and bank holding companies, as regulated institutions, are required to maintain minimum levels of capital. The Federal Reserve and the OCC have adopted minimum risk-based capital requirements (Tier 1 capital, common equity Tier 1 capital (“CET1”) and total capital) and leverage capital requirements, as well as guidelines that define components of the calculation of capital and the level of risk associated with various types of assets. Financial institutions are expected to maintain a level of capital commensurate with the risk profile assigned to their assets in accordance with the guidelines.
In addition to the minimum risk-based capital and leverage ratios, banking organizations must maintain a “capital conservation buffer” consisting of CET1 in an amount equal to 2.5% of risk-weighted assets in order to avoid restrictions on their ability to make capital distributions and to pay certain discretionary bonus payments to executive officers. In order to avoid those restrictions, the capital conservation buffer effectively increases the minimum CET1 capital, Tier 1 capital, and total capital ratios for U.S. banking organizations to 7.0%, 8.5%, and 10.5%, respectively. Banking organizations with capital levels that fall within the buffer will be required to limit dividends, share repurchases or redemptions (unless replaced within the same calendar quarter by capital instruments of equal or higher quality), and discretionary bonus payments. The capital conservation buffer will be fully phased in on January 1, 2019.
The following table presents the risk-based and leverage capital requirements applicable to the Bank:
Although capital instruments such as trust preferred securities and cumulative preferred shares were required by the Dodd-Frank Act to be phased-out of Tier 1 capital by January 1, 2016, for certain larger banking organizations, Nicolet’s trust preferred securities are permanently grandfathered as Tier 1 capital (provided they do not exceed 25% of Tier 1 capital) as a result of Nicolet qualifying as a smaller entity.
The capital rules require that goodwill and other intangible assets (other than mortgage servicing assets), net of associated deferred tax liabilities (“DTLs”), be deducted from CET1 capital. Additionally, deferred tax assets (“DTAs”) that arise from net operating loss and tax credit carryforwards, net of associated DTLs and valuation allowances, are fully deducted from CET1 capital. However, DTAs arising from temporary differences that could not be realized through net operating loss carrybacks, along with mortgage servicing assets and “significant” (defined as greater than 10% of the issued and outstanding common stock of the unconsolidated financial institution) investments in the common stock of unconsolidated “financial institutions” are partially includible in CET1 capital, subject to deductions defined in the rules.
The OCC also considers interest rate risk (arising when the interest rate sensitivity of the Bank’s assets does not match the sensitivity of its liabilities or its off-balance-sheet position) in the evaluation of the bank’s capital adequacy. Banks with excessive interest rate risk exposure are required to hold additional amounts of capital against their exposure to losses resulting from that risk. Through the risk-weighting of assets, the regulators also require banks to incorporate market risk components into their risk-based capital. Under these market risk requirements, capital is allocated to support the amount of market risk related to a bank’s lending and trading activities.
The Bank’s capital categories are determined solely for the purpose of applying the “prompt corrective action” rules described below and they are not necessarily an accurate representation of its overall financial condition or prospects for other purposes. Failure to meet capital guidelines could subject a bank or bank holding company to a variety of enforcement remedies, including issuance of a capital directive, the termination of deposit insurance by the FDIC, a prohibition on accepting brokered deposits, and certain other restrictions on its business. See “Prompt Corrective Action” below.
Prompt Corrective Action. The Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”) establishes a system of prompt corrective action to resolve the problems of undercapitalized financial institutions. Under this system, the federal banking regulators have established five capital categories: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized, in which all institutions are placed. The federal banking agencies have also specified by regulation the relevant capital levels for each category.
A “well-capitalized” bank is one that is not required to meet and maintain a specific capital level for any capital measure pursuant to any written agreement, order, capital directive, or prompt corrective action directive, and has a total risk-based capital ratio of at least 10%, a Tier 1 risk-based capital ratio of at least 8%, a CET1 capital ratio of at least 6.5%, and a Tier 1 leverage ratio of at least 5%. Generally, a classification as well capitalized will place a bank outside of the regulatory zone for purposes of prompt corrective action. However, a well-capitalized bank may be reclassified as “adequately capitalized” based on criteria other than capital, if the federal regulator determines that a bank is in an unsafe or unsound condition, or is engaged in unsafe or unsound practices, which requires certain remedial action.
As of December 31, 2017, the Bank satisfied the requirements of “well-capitalized” under the regulatory framework for prompt corrective action. See Note 19, “Regulatory Capital Requirements and Restrictions of Dividends,” in the Notes to Consolidated Financial Statements, under Part II, Item 8, for Nicolet and the Bank regulatory capital ratios.
As a bank’s capital position deteriorates, federal banking regulators are required to take various mandatory supervisory actions and are authorized to take other discretionary actions with respect to institutions in the three undercapitalized categories: undercapitalized, significantly undercapitalized, and critically undercapitalized. The severity of the action depends upon the capital category in which the institution is placed. Generally, subject to a narrow exception, the banking regulator must appoint a receiver or conservator for an institution that is critically undercapitalized.
FDIC Insurance Assessments. The Bank’s deposits are insured by the Deposit Insurance Fund of the FDIC up to the maximum amount permitted by law, which was permanently increased to $250,000 by the Dodd-Frank Act. The FDIC uses the Deposit Insurance Fund to protect against the loss of insured deposits if an FDIC-insured bank or savings association fails. The Bank is thus subject to FDIC deposit premium assessments. The cost of premium assessments are impacted by, among other things, a bank’s capital category under the prompt corrective action system.
Commercial Real Estate Lending. The federal banking regulators have issued the following guidance to help identify institutions that are potentially exposed to significant commercial real estate lending risk and may warrant greater supervisory scrutiny:
·total reported loans for construction, land development and other land represent 100% or more of the institution’s total capital, or
·total commercial real estate loans represent 300% or more of the institution’s total capital, and the outstanding balance of the institution’s commercial real estate loan portfolio has increased by 50% or more.
At December 31, 2017 the Bank’s commercial real estate lending levels are below the guidance levels noted above.
Enforcement Powers. The Financial Institution Reform Recovery and Enforcement Act (“FIRREA”) expanded and increased civil and criminal penalties available for use by the federal regulatory agencies against depository institutions and certain “institution-affiliated parties.” Institution-affiliated parties primarily include management, employees, and agents of a financial institution, as well as independent contractors and consultants such as attorneys and accountants and others who participate in the conduct of the financial institution’s affairs. These practices can include the failure of an institution to timely file required reports or the filing of false or misleading information or the submission of inaccurate reports. Civil penalties may be as high as $1,963,870 per day for such violations. Criminal penalties for some financial institution crimes have been increased to 20 years.
Community Reinvestment Act. The Community Reinvestment Act requires that, in connection with examinations of financial institutions within their respective jurisdictions, the federal banking agencies evaluate the record of each financial institution in meeting the credit needs of its local community, including low- and moderate-income neighborhoods. These facts are also considered in evaluating mergers, acquisitions, and applications to open a branch or facility. Failure to adequately meet these criteria could impose additional requirements and limitations on the Bank. Additionally, the Bank must publicly disclose the terms of various Community Reinvestment Act-related agreements.
Payment of Dividends. Statutory and regulatory limitations apply to the Bank’s payment of dividends to the Parent Company. If, in the opinion of the OCC, the Bank were engaged in or about to engage in an unsafe or unsound practice, the OCC could require that the Bank stop or refrain from engaging in the practice. The federal banking agencies have indicated that paying dividends that deplete a depository institution’s capital base to an inadequate level would be an unsafe and unsound banking practice.
The Bank is required by federal law to obtain prior approval of the OCC for payments of dividends if the total of all dividends declared by the Bank in any year will exceed (1) the total of the Bank’s net profits for that year, plus (2) the Bank’s retained net profits of the preceding two years. The payment of dividends may also be affected by other factors, such as the requirement to maintain adequate capital above regulatory guidelines or any conditions or restrictions that may be imposed by regulatory authorities.
Transactions with Affiliates and Insiders. The Bank is subject to the provisions of Regulation W promulgated by the Federal Reserve, which implements Sections 23A and 23B of the Federal Reserve Act. Regulation W places limits and conditions on the amount of loans or extensions of credit to, investments in, or certain other transactions with, affiliates and on the amount of advances to third parties collateralized by the securities or obligations of affiliates. Regulation W also prohibits, among other things, an institution from engaging in certain transactions with certain affiliates unless the transactions are on terms substantially the same, or at least as favorable to such institution or its subsidiaries, as those prevailing at the time for comparable transactions with nonaffiliated companies. Federal law also places restrictions on the Bank’s ability to extend credit to its executive officers, directors, principal shareholders and their related interests. These extensions of credit must be made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unrelated third parties; and must not involve more than the normal risk of repayment or present other unfavorable features.
USA PATRIOT Act. The Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the "USA PATRIOT Act") requires each financial institution to: (i) establish an anti-money laundering program; and (ii) establish due diligence policies, procedures and controls with respect to its private and correspondent banking accounts involving foreign individuals and certain foreign banks. In addition, the USA PATRIOT Act encourages cooperation among financial institutions, regulatory authorities and law enforcement authorities with respect to individuals, entities and organizations engaged in, or reasonably suspected of engaging in, terrorist acts or money laundering activities.
Customer Protection. The Bank is also subject to consumer laws and regulations intended to protect consumers in transactions with depository institutions, as well as other laws or regulations affecting customers of financial institutions generally. While the list set forth herein is not exhaustive, these laws and regulations include the Truth in Lending Act, the Truth in Savings Act, the Electronic Funds Transfer Act, the Expedited Funds Availability Act, the Equal Credit Opportunity Act, the Fair Housing Act, the Real Estate Settlement and Procedures Act, the Fair Credit Reporting Act and the Federal Trade Commission Act, among others. These laws and regulations mandate certain disclosure requirements and regulate the manner in which financial institutions must deal with customers when taking deposits or making loans to such customers.
Consumer Financial Protection Bureau. The Dodd-Frank Act centralized responsibility for consumer financial protection including implementing, examining and enforcing compliance with federal consumer financial laws with the Consumer Financial Protection Bureau (the “CFPB”). Depository institutions with less than $10 billion in assets, such as the Bank, are subject to rules promulgated by the CFPB but will continue to be examined and supervised by federal banking regulators for consumer compliance purposes.
UDAP and UDAAP. Bank regulatory agencies have increasingly used a general consumer protection statute to address "unethical" or otherwise "bad" business practices that may not necessarily fall directly under the purview of a specific banking or consumer finance law. The law of choice for enforcement against such business practices has been Section 5 of the Federal Trade Commission Act-the primary federal law that prohibits unfair or deceptive acts or practices and unfair methods of competition in or affecting commerce ("UDAP" or "FTC Act"). "Unjustified consumer injury" is the principal focus of the FTC Act. Prior to the Dodd-Frank Act, there was little formal guidance to provide insight to the parameters for compliance with the UDAP law. However, the UDAP provisions have been expanded under the Dodd-Frank Act to apply to "unfair, deceptive or abusive acts or practices" ("UDAAP"). The CFPB has brought a variety of enforcement actions for violations of UDAAP provisions and CFPB guidance continues to evolve.
Mortgage Reform. The CFPB has adopted final rules implementing minimum standards for the origination of residential mortgages, including standards regarding a customer's ability to repay, restricting variable-rate lending by requiring that the ability to repay variable-rate loans be determined by using the maximum rate that will apply during the first five years of a variable-rate loan term, and making more loans subject to provisions for higher cost loans, new disclosures, and certain other revisions. In addition, the Dodd-Frank Act allows borrowers to raise certain defenses to foreclosure if they receive any loan other than a “qualified mortgage” as defined by the CFPB.
Available Information
Nicolet became a public reporting company under Section 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) on March 26, 2013, when Nicolet’s registration statement related to its acquisition of Mid-Wisconsin Financial Services, Inc. (Registration Statement on Form S-4, Regis. No. 333-186401) became effective. Nicolet registered its common stock under Section 12(b) of the Exchange Act on February 24, 2016 in connection with listing on the Nasdaq Capital Market. Nicolet files annual, quarterly, and current reports, and other information with the SEC. These filings are available to the public on the Internet at the SEC’s website at www.sec.gov. Shareholders may also read and copy any document that we file at the SEC’s public reference rooms located at 100 F Street, NE, Washington, DC 20549. Shareholders may call the SEC at 1-800-SEC-0330 for further information on the public reference room.
Nicolet’s internet address is www.nicoletbank.com. We make available free of charge on or through our website our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC.
ITEM 1A.
ITEM 1A. RISK FACTORS
An investment in our common stock involves risks. If any of the following risks, or other risks which have not been identified or which we may believe are immaterial or unlikely, actually occurs, our business, financial condition and results of operations could be harmed. In such a case, the trading price of our common stock could decline, and you could lose all or part of your investment. The risks discussed below also include forward-looking statements, and our actual results may differ substantially from those discussed in these forward-looking statements.
Risks Relating to Nicolet’s Business
Nicolet may not be able to sustain its historical rate of growth, or may encounter issues associated with its growth, either of which could adversely affect our financial condition, results of operations, and share price.
We have grown over the past several years and intend to continue to pursue a significant growth strategy for our business. Our prospects must be considered in light of the risks, expenses and difficulties frequently encountered by companies in significant growth stages of development. We may not be able to further expand our market presence in existing markets or to enter new markets successfully, nor can we guarantee that any such expansion would not adversely affect our results of operations. Failure to manage growth effectively could have a material adverse effect on the business, future prospects, financial condition or results of our operations, and could adversely affect our ability to successfully implement business strategies. Also, if such growth occurs more slowly than anticipated or declines, our operating results could be materially adversely affected.
Our ability to grow successfully will depend on a variety of factors including the continued availability of desirable business opportunities, the competitive responses from other financial institutions in our market areas and the ability to manage our growth. While we believe we have the management resources and internal systems in place to manage future growth successfully, there can be no assurance that growth opportunities will be available or that any growth will be managed successfully. In addition, our recent growth may distort some of our historical financial ratios and statistics.
As part of our growth strategy, we regularly evaluate merger and acquisition opportunities and conduct due diligence activities related to possible transactions with other financial institutions and financial services companies. As a result, negotiations may take place and future mergers or acquisitions involving cash, debt, or equity securities may occur at any time. We seek merger or acquisition partners that are culturally similar, have experienced management, and possess either significant market presence or have potential for improved profitability through financial management, economies of scale, or expanded services.
As noted above in Item 1, Business, Nicolet completed its acquisition of First Menasha on April 28, 2017. In addition, Nicolet completed its acquisition of Baylake on April 29, 2016, and completed the hiring of a select group of financial advisors and purchase of their respective books of business and operating platform on April 1, 2016. As evidenced by these acquisitions, we intend to continue pursuing a growth strategy for our business through attractive acquisition opportunities.
Acquiring other banks, businesses, or branches involves potential adverse impact to our financial results and various other risks commonly associated with acquisitions, including, among other things, difficulty in estimating the value of the target company, payment of a premium over book and market values that may dilute our tangible book value and earnings per share in the short and long term, potential exposure to unknown or contingent liabilities of the target company, exposure to potential asset quality issues of the target company, potential volatility in reported income as goodwill impairment losses could occur irregularly and in varying amounts, difficulty and expense of integrating the operations and personnel of the target company, inability to realize the expected revenue increases, cost savings, increases in geographic or product presence, and / or other projected benefits, potential disruption to our business, potential diversion of our management’s time and attention, and the possible loss of key employees and customers of the target company.
As a community bank, Nicolet’s success depends upon local and regional economic conditions and has different lending risks than larger banks.
We provide services to our local communities. Our ability to diversify economic risks is limited by our own local markets and economies. We lend primarily to individuals and small- to medium-sized businesses, which may expose us to greater lending risks than those of banks lending to larger, better-capitalized businesses with longer operating histories.
We manage our credit exposure through careful monitoring of loan applicants and loan concentrations in particular industries, and through loan approval and review procedures. We have established an evaluation process designed to determine the appropriateness of our allowance for loan losses. While this evaluation process uses historical and other objective information, the classification of loans and the establishment of loan losses is an estimate based on experience, judgment and expectations regarding borrowers and economic conditions, as well as regulator judgments. We can make no assurance that our loan loss reserves will be sufficient to absorb future loan losses or prevent a material adverse effect on our business, profitability or financial condition.
The core industries in our market area are manufacturing, wholesaling, paper, packaging, food production and processing, agriculture, forest products, retail, service, and businesses supporting the general building industry. The area has a broad range of diversified equipment manufacturing services related to these core industries and others. The residential and commercial real estate markets throughout these areas depend primarily on the strength of these core industries. A material decline in any of these sectors will affect the communities we serve and could negatively impact our financial results and have a negative impact on profitability.
If the communities in which we operate do not grow or if the prevailing economic conditions locally or nationally are less favorable than we have assumed, our ability to maintain our low volume of nonperforming loans and other real estate owned and implement our business strategies may be adversely affected and our actual financial performance may be materially different from our projections.
Nicolet may experience increased delinquencies and credit losses, which could have a material adverse effect on our capital, financial condition, results of operations, and share price.
Our success depends to a significant extent upon the quality of our assets, particularly loans. In originating loans, there is a substantial likelihood that we will experience credit losses. The risk of loss will vary with, among other things, general economic conditions, the type of loan, the creditworthiness of the borrower over the term of the loan, and, in the case of a collateralized loan, the quality of the collateral for the loan.
Our loan customers may not repay their loans according to the terms of these loans, and the collateral securing the payment of these loans may be insufficient to assure repayment. As a result, we may experience significant loan losses, which could have a material adverse effect on our operating results. Management makes various assumptions and judgments about the collectability of our loan portfolio, including the creditworthiness of our borrowers and the value of the real estate and other assets serving as collateral for the repayment of many of our loans. We maintain an allowance for loan losses in an attempt to cover any loan losses that may occur. In determining the size of the allowance, we rely on an analysis of our loan portfolio based on historical loss experience, volume and types of loans, trends in classification, volume and trends in delinquencies and nonaccruals, national and local economic conditions, and other pertinent information.
If management’s assumptions are wrong, our current allowance may not be sufficient to cover future loan losses, and we may need to make adjustments to allow for different economic conditions or adverse developments in our loan portfolio. Material additions to our allowance would materially decrease net income. We expect our allowance to continue to fluctuate; however, given current and future market conditions, we can make no assurance that our allowance will be appropriate to cover future loan losses.
In addition, the market value of the real estate securing our loans as collateral could be adversely affected by the economy and unfavorable changes in economic conditions in our market areas. As of December 31, 2017, approximately 40% of our loans were secured by commercial-based real estate, 2% of loans were secured by agriculture-based real estate, and 24% of our loans were secured by residential real estate. Any sustained period of increased payment delinquencies, foreclosures, or losses caused by adverse market and economic conditions, including another downturn in the real estate market, in our markets could adversely affect the value of our assets, results of operations, and financial condition.
Nicolet is subject to extensive regulation that could limit or restrict our activities, which could have a material adverse effect on our results of operations or share price.
We operate in a highly regulated industry and are subject to examination, supervision, and comprehensive regulation by various regulatory agencies. Our compliance with these regulations, including compliance with regulatory commitments, is costly and restricts certain of our activities, including the declaration and payment of cash dividends to stockholders, mergers and acquisitions, investments, loans and interest rates charged, interest rates paid on deposits, and locations of offices. We are also subject to capitalization guidelines established by our regulators, which require us to maintain adequate capital to support our growth and operations.
The laws and regulations applicable to the banking industry have recently changed and may continue to change, and we cannot predict the effects of these changes on our business and profitability. Some or all of the changes, including the rulemaking authority granted to the CFPB, may result in greater reporting requirements, assessment fees, operational restrictions, capital requirements, and other regulatory burdens for us, and many of our competitors that are not banks or bank holding companies may remain free from such limitations. This could affect our ability to attract and retain depositors, to offer competitive products and services, and to expand our business. Because government regulation greatly affects the business and financial results of all commercial banks and bank holding companies, the cost of compliance could adversely affect our ability to operate profitably.
Congress may consider additional proposals to substantially change the financial institution regulatory system and to expand or contract the powers of banking institutions, bank holding companies and financial holding companies. Such legislation may change existing banking statutes and regulations, as well as the current operating environment significantly. If enacted, such legislation could increase or decrease the cost of doing business, limit or expand permissible activities, or affect the competitive balance among banks, savings associations, credit unions, and other financial institutions. We cannot predict whether new legislation will be enacted and, if enacted, the effect that it, or any regulations, would have on our business, financial condition, or results of operations.
Nicolet’s profitability is sensitive to changes in the interest rate environment.
As a financial institution, our earnings significantly depend on net interest income, which is the difference between the interest income that we earn on interest-earning assets, such as investment securities and loans, and the interest expense that we pay on interest-bearing liabilities, such as deposits and borrowings. Therefore, any change in general market interest rates, including changes in federal fiscal and monetary policies, affects us more than non-financial institutions and can have a significant effect on our net interest income and total income. Our assets and liabilities may react differently to changes in overall market rates or conditions because there may be mismatches between the repricing or maturity characteristics of the assets and liabilities. As a result, an increase or decrease in market interest rates could have material adverse effects on our net interest margin and results of operations.
In addition, we cannot predict whether interest rates will continue to remain at present levels, or the timing of any anticipated changes. Changes in interest rates may cause significant changes, up or down, in our net interest income. Depending on our portfolio of loans and investments, our results of operations may be adversely affected by changes in interest rates. If there is a substantial increase in interest rates, our investment portfolio is at risk of experiencing price declines that may negatively impact our total capital position through changes in other comprehensive income. In addition, any significant increase in prevailing interest rates could adversely affect our mortgage banking business because higher interest rates could cause customers to request fewer refinancing and purchase money mortgage originations.
We rely on other companies to provide key components of our business infrastructure.
Third party vendors provide key components of our business infrastructure such as internet connections, network access and core application processing. While we have selected these third party vendors carefully, we do not control their actions. Any problems caused by these third parties, including as a result of their not providing us their services for any reason or their performing their services poorly, could adversely affect our ability to deliver products and services to our customers and otherwise to conduct our business. Replacing these third party vendors could also entail significant delay and expense.
Negative publicity could damage our reputation.
Reputation risk, or the risk to our earnings and capital from negative public opinion, is inherent in our business. Negative public opinion could adversely affect our ability to keep and attract customers and expose us to adverse legal and regulatory consequences. Negative public opinion could result from our actual or alleged conduct in any number of activities, including lending or foreclosure practices, corporate governance, regulatory compliance, mergers and acquisitions, and disclosure, sharing or inadequate protection of customer information, and from actions taken by government regulators and community organizations in response to that conduct.
Competition in the banking industry is intense and Nicolet faces strong competition from larger, more established competitors.
The banking business is highly competitive, and we experience strong competition from many other financial institutions. We compete with commercial banks, credit unions, savings and loan associations, mortgage banking firms, consumer finance companies, securities brokerage firms, insurance companies, money market funds, and other financial institutions that operate in our primary market areas and elsewhere.
We compete with these institutions both in attracting deposits and in making loans. In addition, we have to attract our customer base from other existing financial institutions and from new residents. Many of our competitors are well-established, much larger financial institutions. While we believe we can and do successfully compete with these other financial institutions, we may face a competitive disadvantage as compared to large national or regional banks as a result of our smaller size and relative lack of geographic diversification.
Although we compete by concentrating our marketing efforts in our primary market area with local advertisements, personal contacts, and greater flexibility in working with local customers, we can give no assurance that this strategy will be successful.
Nicolet continually encounters technological change and we may have fewer resources than our competition to continue to invest in technological improvements, and Nicolet’s information systems may experience an interruption or breach in security.
The banking and financial services industry is undergoing rapid technological changes, with frequent introductions of new technology-driven products and services. In addition to better serving customers, the effective use of technology increases efficiency and enables financial institutions to reduce costs. Our future success will depend, in part, upon our ability to address the needs of our customers by using technology to provide products and services that enhance customer convenience, as well as create additional efficiencies in operations. Many of our competitors have greater resources to invest in technological improvements, and we may not be able to effectively implement new technology-driving products and services, which could reduce our ability to effectively compete.
In addition, we rely heavily on communications and information systems to conduct our business. Any failure, interruption or breach in security of these systems could result in failures or disruptions in customer relationship management, general ledger, deposit, loan functionality and the effective operation of other systems. While we have policies and procedures designed to prevent or limit the effect of a failure, interruption or security breach of our information systems, there can be no assurance that any such failures, interruptions or security breaches will not occur or, if they do occur, that they will be adequately addressed. The occurrence of any failures, interruptions or security breaches of our information systems could damage our reputation, result in a loss of customer business, subject us to additional regulatory scrutiny, or expose us to civil litigation and possible financial liability, any of which could have a material adverse effect on our financial condition and results of operations.
Risks Related to Ownership of Nicolet’s Common Stock
Our stock price can be volatile.
Stock price volatility may make it more difficult for you to sell your common stock when you want and at prices you find attractive. Our stock price can fluctuate widely in response to a variety of factors including, among other things:
•actual or anticipated variations in quarterly results of operations or financial condition;
•operating results and stock price performance of other companies that investors deem comparable to us;
•news reports relating to trends, concerns, and other issues in the financial services industry;
•perceptions in the marketplace regarding us and / or our competitors;
•new technology used or services offered by competitors;
•significant acquisitions or business combinations, strategic partnerships, joint ventures, or capital commitments by or involving us or our competitors;
•failure to integrate acquisitions or realize anticipated benefits from acquisitions;
•changes in government regulations;
•geopolitical conditions such as acts or threats of terrorism or military conflicts;
•available supply and demand of investors interested in trading our common stock;
•our own participation in the market through our buyback program; and
•recommendations by securities analysts.
General market fluctuations, industry factors, and general economic and political conditions and events, such as economic slowdowns or recessions, interest rate changes, or credit loss trends, could also cause our stock price to decrease regardless of our operating results.
Nicolet has not historically paid dividends to our common shareholders, and we cannot guarantee that it will pay dividends to such shareholders in the future.
The holders of our common stock receive dividends if and when declared by the Nicolet board of directors out of legally available funds. Nicolet’s board of directors has not declared a dividend on the common stock since our inception in 2000 and does not expect to do so in the foreseeable future. Any future determination relating to dividend policy will be made at the discretion of Nicolet’s board of directors and will depend on a number of factors, including the company’s future earnings, capital requirements, financial condition, future prospects, regulatory restrictions and other factors that the board of directors may deem relevant.
Our principal business operations are conducted through the Bank. Cash available to pay dividends to our shareholders is derived primarily, if not entirely, from dividends paid by the Bank. The ability of the Bank to pay dividends to us, as well as our ability to pay dividends to our shareholders, is subject to and limited by certain legal and regulatory restrictions, as well as contractual restrictions related to our junior subordinated debentures. Further, any lenders making loans to us may impose financial covenants that may be more restrictive than regulatory requirements with respect to the payment of dividends by us. There can be no assurance of whether or when we may pay dividends in the future.
Nicolet may need to raise additional capital in the future but that capital may not be available when it is needed or may be dilutive to our shareholders.
We are required by federal and state regulatory authorities to maintain adequate capital levels to support our operations. In order to support our operations and comply with regulatory standards, we may need to raise capital in the future. Our ability to raise additional capital will depend on conditions in the capital markets at that time, which are outside our control, and on our financial performance. Accordingly, we cannot assure you of our ability to raise additional capital, if needed, on favorable terms. The capital and credit markets have experienced significant volatility in recent years. In some cases, the markets have produced downward pressure on stock prices and credit availability for certain issuers without regard to those issuers’ underlying financial strength. If current levels of volatility worsen, our ability to raise additional capital may be disrupted. If we cannot raise additional capital when needed, our results of operations and financial condition may be adversely affected, and our banking regulators may subject us to regulatory enforcement action, including receivership. In addition, the issuance of additional shares of our equity securities will dilute the economic ownership interest of our common shareholders.
Nicolet’s directors and executive officers own a significant portion of our common stock and can influence shareholder decisions.
Our directors and executive officers, as a group, beneficially owned approximately 16% of our fully diluted issued and outstanding common stock as of December 31, 2017. As a result of their ownership, our directors and executive officers have the ability, if they voted their shares in concert, to influence the outcome of matters submitted to our shareholders for approval, including the election of directors.
Holders of Nicolet’s subordinated debentures have rights that are senior to those of its common shareholders.
We have supported our continued growth by issuing trust preferred securities and accompanying junior subordinated debentures and by assuming the trust preferred securities and accompanying junior subordinated debentures issued by companies we have acquired. As of December 31, 2017, we had outstanding trust preferred securities and associated junior subordinated debentures with an aggregate par principal amount of approximately $37.1 million and $38.2 million, respectively.
We have unconditionally guaranteed the payment of principal and interest on our trust preferred securities. Also, the junior debentures issued to the special purpose trusts that relate to those trust preferred securities are senior to our common stock. As a result, we must make payments on the junior subordinated debentures before we can pay any dividends on our common stock, and in the event of our bankruptcy, dissolution or liquidation, holders of our junior subordinated debentures must be satisfied before any distributions can be made on our common stock. We do have the right to defer distributions on our junior subordinated debentures (and related trust preferred securities) for up to five years, but during that time would not be able to pay dividends on our common stock.
Because Nicolet is a regulated bank holding company, your ability to obtain “control” or to act in concert with others to obtain control over Nicolet without the prior consent of the Federal Reserve or other applicable bank regulatory authorities is limited and may subject you to regulatory oversight.
Nicolet is a bank holding company and, as such, is subject to significant regulation of its business and operations. In addition, under the provisions of the Bank Holding Company Act and the Change in Bank Control Act, certain regulatory provisions may become applicable to individuals or groups who are deemed by the regulatory authorities to “control” Nicolet or our subsidiary bank. The Federal Reserve and other bank regulatory authorities have very broad interpretive discretion in this regard and it is possible that the Federal Reserve or some other bank regulatory authority may, whether through a merger or through subsequent acquisition of Nicolet’s shares, deem one or more of Nicolet’s shareholders to control or to be acting in concert for purposes of gaining or exerting control over Nicolet. Such a determination may require a shareholder or group of shareholders, among other things, to make voluminous regulatory filings under the Change in Bank Control Act, including disclosure to the regulatory authorities of significant amounts of confidential personal or corporate financial information. In addition, certain groups or entities may also be required to either register as a bank holding company under the Bank Holding Company Act, becoming themselves subject to regulation by the Federal Reserve under that Act and the rules and regulations promulgated thereunder, which may include requirements to materially limit other operations or divest other business concerns, or to divest immediately their investments in Nicolet.
In addition, these limitations on the acquisition of our stock may generally serve to reduce the potential acquirers of our stock or to reduce the volume of our stock that any potential acquirer may be able to acquire. These restrictions may serve to generally limit the liquidity of our stock and, consequently, may adversely affect its value.
We are an emerging growth company and we cannot be certain if the reduced disclosure requirements applicable to emerging growth companies will make our common stock less attractive.
We are an “emerging growth company,” as defined in the Jumpstart Our Business Startups Act of 2012 (the “JOBS Act”), and we have taken advantage of certain exemptions from various reporting requirements that are applicable to other public companies that are not emerging growth companies, including, but not limited to, reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements, and exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and shareholder approval of any golden parachute payments not previously approved. In addition, even if we comply with the greater obligations of public companies that are not emerging growth companies, we may avail ourselves of the reduced requirements applicable to emerging growth companies from time to time in the future, so long as we are an emerging growth company. We will remain an emerging growth company for up to five years following the first sale of our common stock pursuant to an effective registration statement filed under the Securities Act, though we may cease to be an emerging growth company earlier under certain circumstances, including if, before the end of such five years, we are deemed to be a large accelerated filer under the rules of the SEC (which depends on, among other things, having a market value of common stock held by non-affiliates in excess of $700 million) or if our total annual gross revenues equal or exceed $1 billion in a fiscal year. We cannot predict if investors will find our common stock less attractive because we will rely on these exemptions. If some investors find our common stock less attractive as a result, there may be a less active trading market for our common stock and our stock price may be more volatile.
Nicolet’s securities are not FDIC insured.
Our securities are not savings or deposit accounts or other obligations of the Bank, and are not insured by the Deposit Insurance Fund, or any other agency or private entity and are subject to investment risk, including the possible loss of some or all of the value of your investment.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2.
ITEM 2. PROPERTIES
The corporate headquarters of both the Parent Company and the Bank are located at 111 North Washington Street, Green Bay, Wisconsin. At year-end 2017, including the main office, the Bank operated 38 bank branch locations, 29 of which are owned and nine that are leased. In addition, we have one leased location solely related to Nicolet Advisory. In addition, Nicolet owns or leases other real property that, when considered in aggregate, is not significant to its financial position. Most of the offices are free-standing, newer buildings that provide adequate access, customer parking, and drive-through and/or ATM services. The properties are in good condition and considered adequate for present and near term requirements. None of the owned properties are subject to a mortgage or similar encumbrance.
Three of the leased locations involve directors, executive officers, or direct relatives of a director or executive officer, each with lease terms that management considers arms-length. For additional disclosure, see Note 17, “Related Party Transactions,” of the Notes to Consolidated Financial Statements under Part II, Item 8.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
We and our subsidiaries may be involved from time to time in various routine legal proceedings incidental to our respective businesses. Neither we nor any of our subsidiaries are currently engaged in any legal proceedings that are expected to have a material adverse effect on our results of operations or financial position.
ITEM 4.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Nicolet registered its common stock under Section 12(b) of the Exchange Act on February 24, 2016, in connection with listing on the Nasdaq Capital Market, and trades under the symbol “NCBS”. Prior to February 24, 2016, Nicolet’s common stock was traded on the Over-The-Counter Markets (“OTCBB”), also under the symbol “NCBS”. The trading volume of Nicolet’s common stock is less than that of banks with larger market capitalizations, even though Nicolet has improved accessibility to its common stock first through the OTCBB and more recently through its listing on Nasdaq. As of February 28, 2018, Nicolet had approximately 2,250 shareholders of record.
The following table sets forth the high and low sales prices (beginning February 24, 2016) or the high and low bid prices (prior to February 24, 2016) and quarter end closing prices of Nicolet’s common stock as reported by Nasdaq and the OTCBB for the periods presented, as well as Nicolet’s quarter end book value per share for the periods presented.
Nicolet has not paid dividends on its common stock since its inception in 2000, nor does it currently have any plans to pay dividends on Nicolet common stock in the foreseeable future. Any cash dividends paid by Nicolet on its common stock must comply with applicable Federal Reserve policies described further in “Business-Regulation of Nicolet-Dividend Restrictions.” The Bank is also subject to regulatory restrictions on the amount of dividends it is permitted to pay to Nicolet as further described in “Business-Regulation of the Bank - Payment of Dividends” and in Note 19, “Regulatory Capital Requirements and Restrictions of Dividends,” in the Notes to Consolidated Financial Statements under Part II, Item 8.
Following are Nicolet’s monthly common stock purchases during the fourth quarter of 2017.
(a) During the fourth quarter of 2017, the Company repurchased 713 and 80,979 shares for minimum tax withholding settlements on restricted stock and net settlements of stock options, respectively. These purchases do not count against the maximum number of shares that may yet be purchased under the board of directors’ authorization.
(b) During early 2014, a common stock repurchase program was approved which authorized, with subsequent modifications through December 31, 2017, the use of up to $30 million to repurchase up to 1,050,000 shares of outstanding common stock. The common stock repurchase program has no expiration date. During 2017 and 2016, Nicolet spent $10.0 million and $4.4 million to repurchase and cancel 188,554 and 114,914 shares, respectively, at a weighted average price per share of $52.87 and $37.98, respectively, including commissions. Since the commencement of the common stock repurchase program through December 31, 2017, Nicolet has used $24.1 million to repurchase and cancel 707,163 shares at a weighted average price per share of $34.12 including commissions. Using the last closing stock price prior to December 31, 2017 of $54.74, a total of approximately 107,000 shares of common stock could be repurchased under this plan as of December 31, 2017. Subsequent to year-end 2017, on February 20, 2018, the stock repurchase program was further modified, adding $12 million more to repurchase up to 200,000 shares of outstanding common stock. Including this subsequent modification, the Board has authorized the Company the use of up to $42 million to repurchase and cancel 1,250,000 shares of Nicolet common stock.
Performance Graph
The following graph shows the cumulative stockholder return on our common stock for the period of May 17, 2013 to December 31, 2017, compared with the KBW NASDAQ Bank Index and the S&P 500 Index. The graph assumes a $100 investment on May 17, 2013, the date Nicolet began trading on the OTCBB.
Source: S&P Global Market Intelligence
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The selected consolidated financial data presented as of December 31, 2017 and 2016 and for each of the years in the three-year period ended December 31, 2017 is derived from the audited consolidated financial statements and related notes included in this report and should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” The selected consolidated financial data for all other periods shown is derived from audited consolidated financial statements that are not required to be included in this report.
EARNINGS SUMMARY AND SELECTED FINANCIAL DATA
ITEM 7.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion is management’s analysis to assist in the understanding and evaluation of the consolidated financial condition and results of operations of Nicolet. It should be read in conjunction with the consolidated financial statements and footnotes and the selected financial data presented elsewhere in this report.
The detailed financial discussion that follows focuses on 2017 results compared to 2016. See “2016 Compared to 2015” for the summary comparing 2016 and 2015 results. Some tabular information is shown for trends of three years or for five years as required under SEC regulations.
Evaluation of financial performance and average balances between 2017 and 2016 was impacted in general from the timing and sizes of the 2017 and 2016 acquisitions. The inclusion of the Baylake balance sheet (at about 80% of Nicolet’s then pre-merger asset size) and operational results for 12 months in 2017 and 8 months in 2016, and to a lesser extent, the inclusion of the First Menasha balance sheet (at about 20% of Nicolet’s then pre-merger asset size) and operational results for approximately 8 months in 2017, analytically explains most of the increase in certain average balances and income statement line items between 2017 and 2016. The 2016 financial advisory business acquisition primarily impacts the brokerage fee income, personnel expense and certain other expense line items. Lastly, the 2017 and 2016 acquisitions impacted pre-tax net income by inclusion of non-recurring direct merger expenses of approximately $0.5 million in 2017 ($0.2 million and $0.3 million in the first and second quarters, respectively) and approximately $1.3 million in 2016 ($0.4 million, $0.4 million, $0.1 million and $0.4 million in first through fourth quarters, respectively), along with a $1.7 million lease termination charge in second quarter 2016 related to a Nicolet branch closed concurrent with the Baylake merger.
Overview
Nicolet provides a diversified range of traditional commercial and retail banking services, as well as wealth management services, to individuals, business owners, and businesses in its market area primarily through, as of year-end 2017, the 38 bank branch offices of its banking subsidiary, located in northeast and central Wisconsin and Menominee, Michigan.
In 2017 Nicolet delivered on growth, profitability, and capital management. At December 31, 2017 Nicolet had total assets of $2.9 billion, loans of $2.1 billion, deposits of $2.5 billion and stockholders’ equity of $364 million, representing increases over December 31, 2016 of 27%, 33%, 25% and 32% in assets, loans, deposits and total equity, respectively. This balance sheet growth was predominantly attributable to the April 2017 First Menasha transaction, which added assets of $480 million (about 20% of Nicolet’s pre-merger asset size), loans of $351 million, deposits of $375 million, core deposit intangible of $4 million and goodwill of $41 million, for a total purchase price that included the issuance of $62 million of common equity (or 1.3 million shares) and $19 million of cash. Nicolet has used acquisitions as part of its growth strategy over the past few years and has successfully integrated and realized cost efficiencies related to scale fairly quickly after each acquisition. Asset quality remained strong on declining nonperforming assets, with net charge-offs to average loans of 0.08% for 2017 and nonperforming assets to assets of 0.49% at December 31, 2017 (down from 0.97% at year-end 2016). With total stockholders’ equity to assets of 12.42% at year-end 2017 (largely from common stock issued in recent transactions and earnings exceeding stock repurchases), Nicolet has capacity to act on targets of interest in relevant markets that provide a path to or support our position as the lead-local community bank.
For 2017, net income attributable to Nicolet was $33.1 million (80% higher than 2016), and return on average assets was 1.25% (compared to 0.95% for 2016). The improved performance between 2017 and 2016 was largely attributable to the timing of the acquisitions in both years, benefits from strong organic loan and deposit growth (of 11% and 6%, respectively, excluding the First Menasha balances at acquisition), $5.8 million of higher aggregate discount accretion on purchased loans (included in the $30.6 million or 45% increase in net interest income between the years), growth in noninterest revenue sources, effective cost management, and $2.5 million lower direct merger-related costs between the years. Additionally, income tax expense included a favorable tax benefit of $1.9 million (the tax impact of large option exercises, particularly in the fourth quarter of 2017), and $0.9 million of tax expense related to Nicolet’s current evaluation of the impact of the Tax Cuts and Jobs Act enacted on December 22, 2017 on its then outstanding deferred tax assets and liabilities. Diluted earnings per common share for 2017 was $3.33 ($0.96 or 41% higher than 2016), aided by strong net earnings and no preferred stock dividends, but impacted in part by an increase of approximately 30% in diluted average shares mostly due to the stock consideration issued in the 2016 and 2017 acquisitions. Capital management for 2017 included the closure of three branches (one in an outlier and two in overlapping geographies) as well as the repurchase of approximately 188,600 shares of common stock for $10.0 million under Nicolet’s common stock repurchase program. At December 31, 2017 there remains $5.9 million authorized under the repurchase program which Nicolet may from time to time repurchase shares in the open market or through block transactions as market conditions warrant or in private transactions as an alternative use of capital.
For 2018, Nicolet’s focus will remain on achieving strong organic growth in loans, deposits and wealth management services within all our markets, though particularly in the expanded Green Bay to Oshkosh corridor, in a cost-effective, profitable manner to sustain a healthy return on average assets. After rapid execution on cost saves and efficiencies related to the 2016 and 2017 acquisitions (including 10 branch closures cumulatively during those years), additional resources are planned for personnel expenses (market-based and competitive wage increases in support of growing talent, leadership and performance, including expense of equity and other incentives that started in 2017), and for capital investment on complete renovations of two branch locations (in Sturgeon Bay and Rhinelander) in 2018. Further, we expect that the tax reform enacted in December 2017 (which includes many broad and complex changes to the U.S. tax code, including the corporate tax rate reduction from 35% to 21%) to provide significant benefit to net earnings in 2018 (by reducing our estimated 2018 effective tax rate to approximately 25%), while also providing consumer and corporate stimulus as the general benefits of tax cuts spread deeper into the economy. Nicolet believes delivering strong earnings, return on assets, and capital management in 2018 will provide upward pressure on our common stock performance throughout the year.
Performance Summary
Net income attributable to Nicolet was $33.1 million for 2017, or $3.33 per diluted common share. Comparatively, 2016 net income attributable to Nicolet was $18.5 million, and after $633,000 of preferred stock dividends, diluted earnings per common share was $2.37. Nicolet redeemed its outstanding preferred stock in full in September 2016, explaining the absence of preferred stock dividends in 2017. Return on average assets was 1.25% and 0.95% for 2017 and 2016, respectively, while return on average common equity was 9.96% for 2017 and 8.20% for 2016. Book value per common share was $37.09 at December 31, 2017, up 15% over $32.26 at December 31, 2016. Key factors contributing to these results are discussed below.
• Net interest income was $98.7 million for 2017, an increase of $30.6 million or 45% compared to 2016. The improvement was primarily the result of favorable volume and mix variances (driven by the addition of acquired net interest-earning assets, as well as strong organic growth), and net favorable rate variances, largely from higher earning asset yields partially offset by a higher cost of funds. The earning asset yield was 4.75% for 2017 and 4.44% for 2016, influenced mainly by the earning asset mix and higher aggregate discount accretion income. The cost of funds was 0.60% for 2017, 4 basis points (“bps”) higher than 2016. As a result, the interest rate spread was 4.15% for 2017, 27 bps higher than 2016. The net interest margin was 4.30% for 2017 compared to 4.01% for 2016, with a 2 bps higher contribution from net free funds as well as the increase in interest rate spread. For additional information regarding net interest income, see “Net Interest Income”.
• Loans were $2.1 billion at December 31, 2017, up $0.5 billion or 33% over December 31, 2016. Excluding the impact of the First Menasha loans added at acquisition, loans increased $168 million or 11% since year-end 2016. Average loans were $1.9 billion in 2017 yielding 5.31%, compared to $1.3 billion in 2016 yielding 5.11%, a 41% increase in average balances. For additional information regarding loans, see “Loans”.
• Total deposits were $2.5 billion at December 31, 2017, up $0.5 billion or 25% over December 31, 2016. Excluding the impact of the First Menasha deposits added at acquisition, deposits grew $126 million or 6%. Between 2017 and 2016, average deposits were up $0.6 billion or 36%, with noninterest-bearing deposits representing 24% and 23% of total deposits for 2017 and 2016, respectively. For additional information regarding deposits, see “Deposits”.
• Asset quality measures remained strong. Nonperforming assets declined to $14 million, representing 0.49% of total assets at December 31, 2017, down favorably from 0.97% at December 31, 2016. For 2017, the provision for loan losses was $2.3 million compared to net charge-offs of $1.5 million, versus provision of $1.8 million and net charge-offs of $0.3 million for 2016. The allowance for loan losses (“ALLL”) was $12.7 million at December 31, 2017 (representing 0.61% of loans), compared to $11.8 million (representing 0.75% of loans) at December 31, 2016. The decline in the ratio of the ALLL to loans resulted from recording the First Menasha loan portfolio at fair value with no carryover of its allowance at the time of the merger. For additional information regarding asset quality measures, see “Allowance for Loan Losses,” and “Nonperforming Assets.”
• Noninterest income was $34.6 million (including $2.0 million of net gain on sale, disposal or write-down of assets), compared to $26.7 million for 2016 (including $0.1 million of net gain on sale, disposal or write-down of assets). Removing these net gains, noninterest income was up $6.0 million or 23%, with increases in all line items, except mortgage income, largely attributable to the timing of the 2016 and 2017 acquisitions. For additional information regarding noninterest income, see “Noninterest Income”.
• Noninterest expense was $81.4 million, an increase of $16.4 million or 25% compared to 2016. The increase was commensurate with the larger operating base and timing of the 2016 and 2017 acquisitions. For additional information regarding noninterest expense, see “Noninterest Expense”.
INCOME STATEMENT ANALYSIS
Net Interest Income
Net interest income in the consolidated statements of income (which excludes any taxable equivalent adjustments) was $98.7 million in 2017, up $30.6 million or 45% compared to $68.1 million in 2016, including $5.8 million higher aggregate discount accretion between the years and impacted by the timing of the 2017 and 2016 acquisitions. Taxable equivalent adjustments (adjustments to bring tax-exempt interest to a level that would yield the same after-tax income had that been subject to a 35% tax rate) were $2.4 million for 2017 and $1.9 million for 2016, resulting in taxable equivalent net interest income of $101.1 million for 2017 and $70.0 million for 2016.
Taxable equivalent net interest income is a non-GAAP measure, but is a preferred industry measurement of net interest income (and its use in calculating a net interest margin) as it enhances the comparability of net interest income arising from taxable and tax-exempt sources.
Net interest income is the primary source of Nicolet’s revenue, and is the difference between interest income on earning assets, such as loans and investment securities, and interest expense on interest-bearing liabilities, such as deposits and other borrowings. Net interest income is directly impacted by the sensitivity of the balance sheet to changes in interest rates and by the amount, mix and composition of interest-earning assets and interest-bearing liabilities, including characteristics such as the fixed or variable nature of the financial instruments, contractual maturities, and repricing frequencies.
Tables 1, 2, and 3 present information to facilitate the review and discussion of selected average balance sheet items, taxable equivalent net interest income, interest rate spread and net interest margin.
Table 1: Average Balance Sheet and Net Interest Income Analysis - Taxable-Equivalent Basis
(dollars in thousands)
(1)Nonaccrual loans and loans held for sale are included in the daily average loan balances outstanding.
(2)The yield on tax-exempt loans and tax-exempt investment securities is computed on a tax-equivalent basis using a federal tax rate of 35% and adjusted for the disallowance of interest expense.
(3)Interest income includes loan fees of $1.5 million in 2017, $1.6 million in 2016 and $0.7 million in 2015.
Table 2: Volume/Rate Variance - Taxable-Equivalent Basis
(dollars in thousands)
*Nonaccrual loans and loans held for sale are included in the daily average loan balances outstanding.
(1)The change in interest due to both rate and volume has been allocated in proportion to the relationship of dollar amounts of change in each.
(2)The yield on tax-exempt loans and tax-exempt investment securities is computed on a tax-equivalent basis using a federal tax rate of 35% and adjusted for the disallowance of interest expense.
Table 3: Interest Rate Spread, Margin and Average Balance Mix - Taxable-Equivalent Basis
(dollars in thousands)
Comparison of 2017 versus 2016
Taxable-equivalent net interest income was $101.1 million for 2017, up $31.1 million or 44%, compared to 2016, with $28.3 million from net favorable volume and mix variances (predominantly due to the addition of acquired net interest-earning assets, as well as organic growth), and $2.8 million from net favorable rate variances (predominantly from a higher earning asset yield, mostly from loans, offset partly by a higher overall cost of funds) between the periods. Taxable-equivalent interest income on earning assets increased $34.3 million between the years, with $31.2 million more interest from loans ($28.6 million from greater volume and $2.6 million from rates (with $5.8 million in higher aggregate discount accretion income, attributable to added discounts on the 2017 acquired loan portfolio and $4.9 million higher discount income related to favorably resolved purchased credit impaired loans, more than offsetting lower underlying loan yields mainly from the acquired portfolios)), $2.8 million more interest from total investments (mostly volume-based), and $0.3 million more interest from other earning assets (mostly rate-based). Interest expense increased $3.2 million, led by $2.5 million higher interest on interest-bearing liabilities due to volume and mix variances (mostly acquired deposits and a higher proportion of brokered deposits), and $0.7 million higher interest from net unfavorable rate variances due to higher cost funding (largely from higher-costing First Menasha deposits acquired, an increase in select deposit rates that began in July 2017, and general rate pressures influenced by a 100 bps increase in the federal funds rate since January 1, 2016).
The taxable-equivalent net interest margin was 4.30% for 2017, up 29 bps versus 2016. The interest rate spread increased 27 bps between the periods, with a favorable increase in the earning asset yield (up 31 bps to 4.75% for 2017), partially offset by an increase in the cost of funds (up 4 bps to 0.60% for 2017). The contribution from net free funds increased 2 bps, mostly due to the increase in noninterest-bearing demand deposits. Since January 1, 2016, the Federal Reserve raised short-term interest rates by 100 bps to 1.50% as of December 31, 2017 (up 25 bps in each of December 2016, March 2017, June 2017, and December 2017). These increases have impacted the rate earned on cash and the cost of shorter-term deposits and borrowings, but have not proportionately influenced rates further out on the yield curve; and thus, have impacted new investment yields and new loan pricing to a lesser degree. Additionally, while both 2017 and 2016 periods are experiencing favorable income from discount accretion on acquired loans, particularly where such loans pay or resolve at better than their carrying values, such favorable interest flow can be sporadic and will diminish over time.
The earning asset yield was influenced largely by the mix of underlying earning assets, particularly carrying a higher proportion of loans and investments (each at higher yields in 2017 than 2016) and a lower proportion of low-earning cash. Loans, investments and other interest earning assets (mostly low-earning cash) represented 81%, 17% and 2% of average earning assets, respectively, for 2017, and 78%, 17%, and 5%, respectively, for 2016. Loans yielded 5.31% and 5.11%, respectively, for 2017 and 2016, while non-loan earning assets combined yielded 2.37% and 2.03%, respectively, for the years. The 20 bps increase in loan yield between the years was largely due to the higher aggregate discount accretion on acquired loans between periods, more than offsetting lower underlying loan yields mainly from the acquired loan portfolios and competitive pricing.
Average interest-earning assets were $2.4 billion for 2017, $628 million, or 36% higher than 2016, largely attributable to acquired balances as well as strong organic loan growth. The change consisted of a $553 million increase in average loans (up 41% to $1.9 billion), a $108 million increase in investment securities (up 37% to $399 million) and a $33 million decrease in other interest-earning assets, predominantly low earning cash.
Nicolet’s cost of funds increased 4 bps to 0.60% for 2017 compared to 2016. The average cost of interest-bearing deposits (which represented 96% of average interest-bearing liabilities for both 2017 and 2016), was 0.46% for 2017, up 5 bps from 2016, largely influenced by the higher-costing First Menasha deposits acquired, an increase in select deposit rates that began in July 2017, and general rate pressures influenced by a 100 bps increase in the federal funds rate since January 1, 2016.
Average interest-bearing liabilities were $1.8 billion for 2017, up $443 million or 34% from 2016, predominantly attributable to acquired balances and organic deposit growth. Interest-bearing deposits represented 96% of average interest-bearing liabilities for both 2017 and 2016, while the mix of average interest-bearing deposits moved from higher costing core time deposits to lower costing transaction accounts. Average brokered deposits were $119 million for 2017, up $91 million from 2016 (largely due to brokered deposits assumed in the 2017 acquisition), with average rates declining from 1.12% to 0.65%, as a larger proportion of brokered deposits were lower-costing transaction-based deposits versus term.
Provision for Loan Losses
The provision for loan losses in 2017 was $2.3 million, exceeding $1.5 million of net charge-offs. Comparatively, 2016 provision and net charge-offs were $1.8 million and $0.3 million, respectively. The higher provision in 2017 was largely attributable to a $1.0 million commercial loan charge-off. At December 31, 2017, the ALLL was $12.7 million or 0.61% of loans compared to $11.8 million or 0.75% of loans at December 31, 2016. The decline in this ratio was mainly a result of recording acquired loans at their fair value with no carryover of its allowance at the time of 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 appropriateness of the ALLL. The appropriateness of the ALLL is affected by changes in the size and character of the loan portfolio, changes in levels of impaired and other nonperforming loans, historical losses and delinquencies in each portfolio segment, the risk inherent in specific loans, concentrations of loans to specific borrowers or industries, existing and future economic conditions, the fair value of underlying collateral, and other factors which could affect potential credit losses. For additional information regarding asset quality and the ALLL, see “Balance Sheet Analysis - Loans,” and “- Allowance for Loan Losses” and “-Nonperforming Assets.”
Noninterest Income
Table 4: Noninterest Income
(dollars in thousands)
N/M means not meaningful.
Comparison of 2017 versus 2016
Noninterest income grew $8.0 million or 30% over 2016, with increases in most line items, aided largely by the 2016 and 2017 acquisitions. Removing net gains from sale of assets from both periods, noninterest income increased $6.0 million or 23%. Notable contributions to the change in noninterest income were:
·Service charges on deposit accounts for 2017 were $4.6 million, up $1.0 million or 29% over 2016, resulting from an increased number of accounts (most attributable to the bank acquisitions) and an increase to the fee charged on overdrafts implemented during 2017.
·Mortgage income represents net gains received from the sale of residential real estate loans service-released and service-retained into the secondary market, capitalized gains on mortgage servicing rights (“MSRs”), servicing fees, offsetting MSR amortization, valuation changes if any, and to a smaller degree some related income. Net mortgage income was $5.4 million for 2017, down slightly from 2016, due to a decline in gains from lower volumes and higher MSR amortization, partially offset by higher servicing fees on the growing portfolio of mortgage loans serviced for others. Secondary mortgage production of $220 million, was down 13% from production of $254 million for 2016.
·Trust service fees were $6.0 million for 2017, up $0.6 million or 11% over 2016, due to higher assets under management.
·Brokerage fee income was $5.7 million for 2017, up $2.1 million or 58% over 2016, attributable to the 2016 financial advisor business acquisition as well as subsequent growth and improved pricing.
·Card interchange income grew $1.5 million or 47% to $4.6 million in 2017 due to higher volume and activity.
·BOLI income was $1.8 million, up $0.5 million or 38% over 2016 commensurate with the growth in average BOLI investments, including additional insurance purchases in 2016.
·Other income was $2.8 million, up $0.3 million or 14% over 2016, with the majority of the increase due to income from equity in UFS.
·Net gain on sale, disposal or write-down of assets in 2017 was $2.0 million, compared to $0.1 million in 2016. The 2017 activity consisted largely of a $1.2 million gain to record the fair value of Nicolet’s pre-acquisition interest in First Menasha and a $0.7 million gain on the sale or disposition of assets. The 2016 activity consisted mainly of a $0.5 million other-than-temporary impairment loss on an other investment security and $0.7 million in net gains from the sale of OREO. Additional information on the net gains is also included in Note 18, “Gain on Sale, Disposal or Write-Down of Assets, Net,” in the Notes to Consolidated Financial Statements, under Part II, Item 8.
Noninterest Expense
Table 5: Noninterest Expense
(dollars in thousands)
Comparison of 2017 versus 2016
Noninterest expense increased $16.4 million or 25%, primarily attributable to the larger operating base resulting from the 2016 and 2017 acquisitions. Notable contributions to the change in noninterest expense were:
·Personnel expense (including salaries, brokerage variable pay, overtime, cash and equity incentives, and employee benefit and payroll-related expenses) was $44.5 million for 2017, up $10.4 million or 31% over 2016, largely due to the expanded workforce, with average full-time equivalent employees up 26%. Also contributing to the increase were merit increases between the years, higher incentives given strong results (including a discretionary 401k profit sharing contribution of $0.5 million in 2017), and higher health and other benefit costs in line with the expanded workforce. Notably, expense related to equity awards increased $1.5 million over 2016, mostly attributable to sizable option grants made to a broad group in the second quarter of 2017 rewarding current performance and aligning incentives with future strategic goals. See Note 13, “Stock-Based Compensation,” in the Notes to Consolidated Financial Statements, under Part II, Item 8, for additional disclosures relative to the 2017 equity awards.
·Occupancy, equipment and office expense was $13.3 million for 2017, up $3.0 million or 30% from 2016, primarily the result of the larger operating base and software needs, offset partly by branch closure savings.
·Business development and marketing expense was $4.7 million for 2017, up $1.2 million or 35%, largely due to the expanded operating base and branding efforts influencing additional marketing, promotions and media.
·Data processing expenses, which are primarily volume-based, were $8.7 million for 2017, up $2.3 million or 37% over 2016, in line with a higher number of accounts and volumes processed due to the acquisitions and expanded functionalities.
·Intangible amortization increased $1.2 million or 36%, fully attributable to the timing of and addition of intangibles recorded as part of the acquisitions.
·Other expense was $4.7 million for 2017, down $1.7 million or 27%, due primarily to $2.5 million lower merger-related expenses, partially offset by an $0.8 million increase in all other costs, (largely a function of higher other operating costs and the implementation of a customer relationship system).
Income Taxes
Income tax expense was $16.3 million for 2017 and $9.4 million for 2016. The effective tax rate was 32.7% for 2017 and 33.4% for 2016, including, among other items, both years benefitting from tax-exempt interest income. As detailed further below, income tax expense between the years was significantly impacted by a new accounting standard and the impact of the Tax Cuts and Jobs Act signed into law on December 22, 2017. The net deferred tax asset was $5.0 million at December 31, 2017 compared to $10.9 million at the end of 2016. The $5.9 million decrease in the net deferred tax asset was primarily attributable to approximately $4 million in reductions from purchase accounting items, $1 million related to net operating losses subject to Internal Revenue Code section 382 restrictions and $0.9 million related to the write-down of deferred tax assets in conjunction with the Tax Cuts and Jobs Act, discussed further below.
The accounting for income taxes requires deferred income taxes to 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. This analysis involves the use of estimates, assumptions, interpretation, and judgment concerning accounting pronouncements and federal and state tax codes; therefore, income taxes are considered a critical accounting policy. At December 31, 2017 and 2016, no valuation allowance was determined to be necessary. Additional information on the subjectivity of income taxes is discussed further under “Critical Accounting Policies-Income Taxes.” The Company’s accounting policy for income taxes are described in Note 1, “Nature of Business and Significant Accounting Policies,” and additional disclosures relative to income taxes are included in Note 15, “Income Taxes” in the Notes to Consolidated Financial Statements, under Part II, Item 8.
The Company adopted a new accounting standard as required effective January 1, 2017, which requires the tax impact of stock option exercises to be recorded as a reduction to income tax expense rather than to stockholders’ equity directly. As a result of this accounting change and particularly large option exercises during the year, income tax expense for 2017 included a favorable tax benefit of $1.9 million for the tax impact of stock option exercises. See Note 1, “Nature of Business and Significant Accounting Policies - Recent Accounting Pronouncements Adopted,” in the Notes to Consolidated Financial Statements, under Part II, Item 8 for additional information about this new accounting standard.
On December 22, 2017, the Tax Cuts and Jobs Act was signed into law, necessitating that all companies evaluate deferred tax asset and liability positions for year-end 2017 under the lower corporate tax rate, as well as other impacts. Income tax expense included $0.9 million additional expense in 2017 related to the Company’s current evaluation of this tax law change, and was comprised of a $532,000 net write-down on deferred tax assets and $353,000 net write-down on the permanent difference for investment securities. If, in the future, the interpretations of the new tax law were to change, the Company’s current estimates may require adjustments.
BALANCE SHEET ANALYSIS
Loans
Nicolet services a diverse customer base throughout northeastern and central Wisconsin and in Menominee, Michigan including the following industries: manufacturing, wholesaling, paper, packaging, food production and processing, agriculture, forest products, retail, service, and businesses supporting the general building industry. It continues to concentrate its efforts in originating loans in its local markets and assisting its current loan customers. It actively utilizes government loan programs such as those provided by the U.S. Small Business Administration to help customers weather current economic conditions and position their businesses for the future. In addition to the discussion that follows, accounting policies behind loans are described in Note 1, “Nature of Business and Significant Accounting Policies,” and additional disclosures are included in Note 4, “Loans and Allowance for Loan Losses,” in the Notes to Consolidated Financial Statements, under Part II, Item 8.
Table 6: Loan Composition
As of December 31,
(dollars in thousands)
Total loans were $2.1 billion at December 31, 2017, an increase of $519 million, or 33%, compared to total loans of $1.6 billion at December 31, 2016. Excluding the $351 million loans added at acquisition in 2017, loans increased $168 million or 11%. As noted in Table 6 above, year-end 2017 loans were broadly 75% commercial-based and 25% retail-based compared to 73% commercial-based and 27% retail-based at year-end 2016. Commercial-based loans are considered to have more inherent risk of default than retail-based loans, in part because the commercial balance per borrower is typically larger than that for retail-based loans, implying higher potential losses on an individual customer basis.
Commercial and industrial loans consist primarily of commercial loans to small businesses and, to a lesser degree, to municipalities within a diverse range of industries. The credit risk related to commercial and industrial loans is largely influenced by general economic conditions and the resulting impact on a borrower’s operations, or on the value of underlying collateral, if any. Commercial and industrial loans continue to be the largest segment of Nicolet’s portfolio, increasing to 30.5% of the portfolio at year-end 2017, due to strong organic loan growth.
Owner-occupied CRE loans decreased to 20.6% of loans at year-end 2017 compared to 23.0% of loans at year-end 2016. This category primarily consists of loans within a diverse range of industries secured by business real estate that is occupied by borrowers who operate their businesses out of the underlying collateral and who may also have commercial and industrial loans. The credit risk related to owner-occupied CRE loans is largely influenced by general economic conditions and the resulting impact on a borrower’s operations, or on the value of underlying collateral.
Agricultural production and agricultural real estate loans consist of loans secured by farmland and related farming operations. The credit risk related to agricultural loans is largely influenced by the prices farmers can get for their production and/or the underlying value of the farmland. Combined, these loans decreased to 4.2% of loans at year-end 2017 compared to 5.1% of loans at year-end 2016.
The CRE investment loan classification primarily includes commercial-based mortgage loans that are secured by non-owner occupied, nonfarm/nonresidential real estate properties, and multi-family residential properties. Lending in this segment has been focused on loans that are secured by commercial income-producing properties as opposed to speculative real estate development. From December 31, 2016 to December 31, 2017, these loans increased to represent 15.1% of loans, mostly due to the 2017 acquired loan mix, compared to 12.5% a year ago.
Loans in the construction and land development portfolio represented 4.3% of total loans at year-end 2017 compared to 4.8% at year-end 2016. Construction and land development loans provide financing for the development of commercial income properties, multi-family residential development, and land designated for future development. Nicolet controls the credit risk on these types of loans by making loans in familiar markets, reviewing the merits of individual projects, controlling loan structure, and monitoring the progress of projects through the analysis of construction advances. Credit risk is managed by employing sound underwriting guidelines, lending primarily to borrowers in local markets, periodically evaluating the underlying collateral, and formally reviewing the borrower’s financial soundness and relationships on an ongoing basis.
On a combined basis, Nicolet’s residential real estate loans represented 24.3% of total loans at year-end 2017 compared to 26.4% of total loans at year-end 2016. Residential first mortgage loans include conventional first-lien home mortgages. Residential junior mortgage real estate loans consist of home equity lines and term loans secured by junior mortgage liens. Nicolet has not experienced significant losses in its residential real estate loans; however, if declines in market values in the residential real estate markets worsen, particularly in Nicolet’s market area, the value of collateral securing its real estate loans could decline, which could cause an increase in the provision for loan losses. As part of its management of originating residential mortgage loans, the vast majority of Nicolet’s long-term, fixed-rate residential real estate mortgage loans are sold in the secondary market with or without retaining the servicing rights. Nicolet’s mortgage loans have historically had low net charge-off rates and typically are of high quality.
Loans in the retail and other classification represent approximately 1% of the total loan portfolio, and include predominantly short-term and other personal installment loans not secured by real estate. Credit risk is primarily controlled by reviewing the creditworthiness of the borrowers, monitoring payment histories, and taking appropriate collateral and/or guaranty positions.
Factors that are important to managing overall credit quality are sound loan underwriting and administration, systematic monitoring of existing loans and commitments, effective loan review on an ongoing basis, early problem loan identification and remedial action to minimize losses, an appropriate ALLL, and sound nonaccrual and charge-off policies. An active credit risk management process is used for commercial loans to further ensure that sound and consistent credit decisions are made. The credit management process is regularly reviewed and the process has been modified over the past several years to further strengthen the controls.
The loan portfolio is widely diversified by types of borrowers, industry groups, and market areas. Significant loan concentrations are considered to exist for a financial institution when there are amounts loaned to multiple numbers of borrowers engaged in similar activities that would cause them to be similarly impacted by economic or other conditions. At December 31, 2017, no significant industry concentrations existed in Nicolet’s portfolio in excess of 10% of total loans. Nicolet has also developed guidelines to manage its exposure to various types of concentration risks.
Table 7: Loan Maturity Distribution
The following table presents the maturity distribution of the loan portfolio at December 31, 2017:
(dollars in thousands)
Allowance for Loan Losses
In addition to the discussion that follows, accounting policies behind the allowance for loan losses are described in Note 1, “Nature of Business and Significant Accounting Policies,” and additional disclosures are included in Note 4, “Loans and Allowance for Loan Losses,” in the Notes to Consolidated Financial Statements, under Part II, Item 8.
Credit risks within the loan portfolio are inherently different for each loan type as described under “Balance Sheet Analysis - Loans.” Credit risk is controlled and monitored through the use of lending standards, a thorough review of potential borrowers, and ongoing review of loan payment performance. Active asset quality administration, including early problem loan identification and timely resolution of problems, aids in the management of credit risk and minimization of loan losses.
The ALLL is established through a provision for loan losses charged to expense to appropriately provide for potential credit losses in the existing loan portfolio. Loans are charged against the ALLL when management believes that the collection of principal is unlikely. The level of the ALLL represents management’s estimate of an amount of reserves that provides for estimated probable credit losses in the loan portfolio at the balance sheet date. To assess the ALLL, an allocation methodology is applied by Nicolet which focuses on evaluation of qualitative and environmental factors, including but not limited to: (i) evaluation of facts and issues related to specific loans; (ii) management’s ongoing review and grading of the loan portfolio; (iii) consideration of historical loan loss and delinquency experience on each portfolio segment; (iv) trends in past due and nonperforming loans; (v) the risk characteristics of the various loan segments; (vi) changes in the size and character of the loan portfolio; (vii) concentrations of loans to specific borrowers or industries; (viii) existing and forecasted economic conditions; (ix) the fair value of underlying collateral; and (x) other qualitative and quantitative factors which could affect potential credit losses. Assessing these factors involves significant judgment; therefore, management considers the ALLL a critical accounting policy, as further discussed under “Critical Accounting Policies - Allowance for Loan Losses.”
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. For determining the appropriateness of the ALLL, management defines impaired loans as nonaccrual credit relationships over $250,000, all loans determined to be troubled debt restructurings (“restructured loans”), plus additional loans with impairment risk characteristics. Second, management allocates ALLL with historical loss rates by loan segment. The loss factors applied in the methodology are periodically re-evaluated and adjusted to reflect changes in historical loss levels on an annual basis. The lookback period on which the average historical loss rates are determined is a rolling 20-quarter (5 year) average. Lastly, management allocates ALLL to the remaining loan portfolio using the qualitative factors mentioned above. Consideration is given to those current qualitative or environmental factors that are likely to cause estimated credit losses as of the evaluation date to differ from the historical loss experience of each loan segment. Management conducts its allocation methodology on both the originated loans and on the acquired loans separately to account for differences, such as different loss histories and qualitative factors, between the two segments.
Management performs ongoing intensive analyses of its loan portfolio to allow for early identification of customers experiencing financial difficulties, maintains prudent underwriting standards, understands the economy in its markets, and considers the trend of deterioration in loan quality in establishing the level of the ALLL.
In addition, various regulatory agencies periodically review the ALLL. These agencies may require the Company to make additions to the ALLL or may require that certain loan balances be charged off or downgraded into classified loan categories when their credit evaluations differ from those of management based on their judgments of collectability from information available to them at the time of their examination.
At December 31, 2017, the ALLL was $12.7 million compared to $11.8 million at December 31, 2016. The components of the ALLL are detailed further in Tables 8 and 9 below. Net charge-offs as a percent of average loans were 0.08% in 2017 compared to 0.02% in 2016. 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 appropriateness of the allowance, including, but not limited to, consideration of the amount of net charge-offs, loan growth, levels of nonperforming loans, and trends in the risk profile of the loan portfolio.
The ratio of the ALLL as a percentage of period-end loans was 0.61% at December 31, 2017 and 0.75% at December 31, 2016. The ALLL to loans ratio is impacted by the accounting treatment of Nicolet’s bank acquisitions, which combined at their acquisition dates (from 2013 to 2017) added no ALLL to the numerator and $1.3 billion of loans into the denominator (with $351 million added in 2017). Remaining acquired loans were $844 million (40% of total loans) and $667 million (43% of total loans) at December 31, 2017 and 2016, respectively, with the $177 million increase a result of the loans added from the 2017 acquisition offset largely by amortization, refinances and payoffs. Events occurring in the acquired loan portfolio post acquisition, do result in the recording of an ALLL for this portfolio. At December 31, 2017, the $12.7 million ALLL was comprised of $2.1 million for acquired loans (0.25% of acquired loans) and $10.5 million for originated loans (0.85% of originated loans). In comparison, the $11.8 million ALLL at December 31, 2016 was comprised of $2.4 million for acquired loans (0.36% of acquired loans) and $9.4 million for originated loans (1.05% of originated loans). The change in the ALLL to loans ratio was driven by the increase in the denominator from the 2017 acquired loans.
Table 8: Loan Loss Experience
For the Years Ended December 31,
(dollars in thousands)
The allocation of the ALLL for each of the past five years is based on Nicolet’s estimate of loss exposure by category of loans and is shown in Table 9. The largest portions of the ALLL were allocated to commercial & industrial loans and owner-occupied CRE loans combined, representing 59.6% and 57.5% of the ALLL at December 31, 2017 and 2016, respectively. Most notably since December 31, 2016, the increased allocations to commercial & industrial (from 33.2% to 39.0%), and the decreased allocations in owner-occupied CRE (from 24.3% to 20.6%) was largely the result of changes to allowance allocations in conjunction with changes in past due and loss histories and balance mix changes. The large $1.0 million charge-off in 2017 was an originated commercial & industrial loan. The remaining allocated ALLL balances were consistent with changes in outstanding loan balances at December 31, 2017.
Table 9: Allocation of the Allowance for Loan Losses
As of December 31,
(dollars in thousands)
Nonperforming Assets
As part of its overall credit risk management process, management is 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 $13.1 million (consisting of $3.3 million originated loans and $9.8 million acquired loans) at December 31, 2017, compared to $20.3 million (consisting of $0.3 million originated loans and $20.0 million acquired loans) at December 31, 2016. Nonperforming assets (which include nonperforming loans and other real estate owned “OREO”) were $14.4 million at December 31, 2017, compared to $22.3 million at December 31, 2016. OREO was $1.3 million at December 31, 2017, down from $2.1 million at year-end 2016, the majority of which is closed bank branch property. Nonperforming assets as a percent of total assets decreased to 0.49% at December 31, 2017 compared to 0.97% at December 31, 2016.
The level of potential problem loans is another predominant factor in determining the relative level of risk in the loan portfolio and in determining the appropriate level of the ALLL. Potential problem loans are generally defined by management to include loans rated as Substandard by management but that are in performing status; however, there are circumstances present which might adversely affect the ability of the borrower to comply with present repayment terms. The decision of management to include performing loans in potential problem loans does not necessarily mean that Nicolet expects losses to occur, but that management recognizes a higher degree of risk associated with these loans. The loans that have been reported as potential problem loans are predominantly commercial-based loans covering a diverse range of businesses and real estate property types. Potential problem loans totaled $13.6 million (0.7% of total loans) and $12.6 million (0.8% of total loans) at December 31, 2017 and 2016, respectively. Potential problem loans require a heightened management review of the pace at which a credit may deteriorate, the duration of asset quality stress, and uncertainty around the magnitude and scope of economic stress that may be felt by Nicolet’s customers and on underlying real estate values.
Table 10: Nonperforming Assets
As of December 31,
(dollars in thousands)
Table 11 shows the approximate gross interest that would have been recorded if the loans accounted for on a nonaccrual basis at the end of each year shown had performed in accordance with their original terms, in contrast to the amount of interest income that was included in interest income on such loans for the period. The interest income recognized generally includes cash interest received and potentially includes prior nonaccrual interest on acquired loans which existed at acquisition and was subsequently collected.
Table 11: Foregone Loan Interest
For the Years Ended December 31,
(dollars in thousands)
Investment Securities Portfolio
The investment securities portfolio is intended to provide Nicolet with adequate liquidity, flexible asset/liability management and a source of stable income. The portfolio is structured with minimal credit exposure to Nicolet. All securities are classified as available for sale (“AFS”) and are carried at fair value. In addition to the discussion that follows, the investment securities portfolio accounting policies are described in Note 1, “Nature of Business and Significant Accounting Policies,” and additional disclosures are included in Note 3, “Securities Available for Sale,” in the Notes to Consolidated Financial Statements, under Part II, Item 8.
Table 12: Investment Securities Portfolio
As of December 31,
(dollars in thousands)
At December 31, 2017, the total fair value of investment securities was $405.2 million, up from $365.3 million at December 31, 2016, and represented 13.8% and 15.9% of total assets at December 31, 2017 and 2016, respectively. The $39.9 million increase since December 31, 2016 was largely attributable to securities acquired in the 2017 acquisition. At December 31, 2017, the securities portfolio did not contain securities of any single issuer, including any securities issued by a state or political subdivision that were payable from and secured by the same source of revenue or taxing authority where the aggregate carrying value of such securities exceeded 10% of stockholders’ equity.
In addition to AFS securities, Nicolet had other investments of $14.8 million and $17.5 million at December 31, 2017 and 2016, respectively, consisting of capital stock in the Federal Reserve, Federal Agricultural Mortgage Corporation, and the Federal Home Loan Bank (“FHLB”) (required as members of the Federal Reserve Bank System and the FHLB System), and to a lesser degree equity investments in other private companies. The FHLB and Federal Reserve investments are “restricted” in that they can only be sold back to the respective institutions or another member institution at par, and are thus not liquid, have no ready market or quoted market value, and are carried at cost. The remaining investments have no quoted market prices, and are carried at cost less other than temporarily impaired (“OTTI”) charges, if any. These other investments are evaluated periodically for impairment, considering financial condition and other available relevant information. A $0.5 million OTTI charge was recorded in fourth quarter 2016 related to a private company equity investment based on circumstances arising at year end which management determined would likely impact the future earning capacity of the underlying operating company. There were no OTTI charges recorded in 2017.
Table 13: Investment Securities Portfolio Maturity Distribution (1)
As of December 31, 2017
(dollars in thousands)
(1)The yield on tax-exempt investment securities is computed on a tax-equivalent basis using a federal tax rate of 35% adjusted for the disallowance of interest expense.
Deposits
Deposits represent Nicolet’s largest source of funds. Nicolet competes with other bank and nonbank institutions for deposits, as well as with a growing number of non-deposit investment alternatives available to depositors, such as mutual funds, money market funds, annuities, and other brokerage investment products. Challenges to deposit growth include competitive deposit product features, price changes on deposit products given movements in the rate environment and other competitive pricing pressures, and customer preferences regarding higher-costing deposit products or non-deposit investment alternatives. Additional disclosures on deposits are included in Note 8, “Deposits,” in the Notes to Consolidated Financial Statements, under Part II, Item 8.
Table 14: Deposits
At December 31,
(dollars in thousands)
Total deposits were $2.5 billion at December 31, 2017, an increase of $501 million or 25% over December 31, 2016; however, excluding the impact of $375 million deposits added at acquisition in 2017, deposits grew 6%. Brokered deposits increased to 4.9% of total deposits primarily due to the 2017 acquisition. On average, deposits grew $587 million or 36% between 2017 and 2016, and the mix of deposits changed (as detailed in Table 15 below).
Table 15: Average Deposits
For the Years Ended December 31,
(dollars in thousands)
Table 16: Maturity Distribution of Certificates of Deposit of $100,000 or More
At December 31,
(dollars in thousands)
Other Funding Sources
Other funding sources include short-term borrowings (zero at both December 31, 2017 and 2016) and long-term borrowings (totaling $78.0 million and $37.6 million at December 31, 2017 and 2016, respectively). Short-term borrowings consist mainly of customer repurchase agreements maturing in less than nine months or federal funds purchased. Long-term borrowings include FHLB advances, 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). The interest on all long-term borrowings is current, and while the various junior subordinated debentures are callable at par plus any accrued but unpaid interest, there are no current plans to redeem these debentures early. See Note 9, “Notes Payable,” Note 10, “Junior Subordinated Debentures,” and Note 11, “Subordinated Notes” of the Notes to Consolidated Financial Statements under Part II, Item 8 for additional details.
Additional funding sources at December 31, 2017 consist of a $10 million available and unused line of credit at the holding company, $158 million of available and unused Federal funds lines, available borrowing capacity at the FHLB of $125 million, and borrowing capacity in the brokered deposit market.
Off-Balance Sheet Obligations
As of December 31, 2017 and 2016, Nicolet had the following lending-related commitments that did not appear on its balance sheet:
Table 17: Commitments
As of December 31,
(dollars in thousands)
Interest rate lock commitments to originate residential mortgage loans held for sale (included above in commitments to extend credit) and forward commitments to sell residential mortgage loans held for sale are considered derivative instruments and represented $28.0 million and $1.8 million, respectively, at December 31, 2017.
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Further information and discussion of these commitments is included in Note 16, “Commitments and Contingencies” of the Notes to Consolidated Financial Statements, under Part II, Item 8.
Contractual Obligations
Nicolet is party to various contractual obligations requiring the use of funds as part of its normal operations. The table below outlines principal amounts and timing of these contractual obligations. The amounts presented below exclude amounts due for interest, if applicable, and include any unamortized premiums / discounts or other similar carrying value adjustments. Most of these obligations are routinely refinanced into similar replacement obligations. However, renewal of these obligations is dependent on the ability to procure competitive interest rates, liquidity needs, availability of collateral for pledging purposes supporting the long-term advances, or other borrowing alternatives.
Table 18: Contractual Obligations
As of December 31, 2017
(dollars in thousands)
Liquidity
Liquidity management refers to the ability to ensure that cash is available in a timely and cost-effective manner to meet cash flow requirements of depositors and borrowers and to meet other commitments as they fall due, including the ability to pay dividends to shareholders, service debt, invest in subsidiaries, repurchase common stock, and satisfy other operating requirements.
Funds are available from a number of basic banking activity sources including, but not limited to, the core deposit base; repayment and maturity of loans; maturing investments and investments sales; and procurement of brokered deposits. All investment securities are classified as available for sale and are reported at fair value on the consolidated balance sheet. At December 31, 2017, approximately 35% of the $405.2 million investment securities carrying value was pledged to secure public deposits and short-term borrowings, as applicable, and for other purposes as required by law. Other funding sources available include the ability to procure short-term borrowings, federal funds purchased, and long-term borrowings (such as FHLB advances).
Dividends from the Bank represent a significant source of cash flow for the Parent Company. The Bank is required by federal law to obtain prior approval of the OCC for payments of dividends if the total of all dividends declared by the Bank in any year will exceed certain thresholds, as more fully described in “Business-Regulation of the Bank - Payment of Dividends” and in Note 19, “Regulatory Capital Requirements and Restrictions of Dividends,” in the Notes to the Consolidated Financial Statements under Part II, Item 8. Management does not believe that regulatory restrictions on dividends from the Bank will adversely affect its ability to meet its cash obligations.
Cash and cash equivalents at December 31, 2017 and 2016 were approximately $154.9 million and $129.1 million, respectively. The increased cash and cash equivalents for 2017 when compared to historical levels was predominantly due to strong customer deposit growth. The $25.8 million increase in cash and cash equivalents since year end 2016 included $40.7 million net cash provided by operating activities and $136.1 million from financing activities (mostly due strong deposit growth), exceeding the $151.0 million net cash used in investing activities (primarily from strong loan growth). Nicolet’s liquidity resources were sufficient as of December 31, 2017 to fund loans, accommodate deposit trends and cycles, and to meet other cash needs as necessary.
Interest Rate Sensitivity Management
A reasonable balance between interest rate risk, credit risk, liquidity risk and maintenance of yield, is highly important to Nicolet’s business success and profitability. As an ongoing part of its financial strategy and risk management, Nicolet attempts to understand and manage the impact of fluctuations in market interest rates on its net interest income. The consolidated balance sheet consists mainly of interest-earning assets (loans, investments and cash) which are primarily funded by interest-bearing liabilities (deposits and other borrowings). Such financial instruments have varying levels of sensitivity to changes in market rates of interest. Market rates are highly sensitive to many factors beyond our control, including but not limited to general economic conditions and policies of governmental and regulatory authorities. Our operating income and net income depends, to a substantial extent, on “rate spread” (i.e., the difference between the income earned on loans, investments and other earning assets and the interest expense paid to obtain deposits and other funding liabilities).
Asset-liability management policies establish guidelines for acceptable limits on the sensitivity to changes in interest rates on earnings and market value of assets and liabilities. Such policies are set and monitored by management and the board of directors’ Asset and Liability Committee.
To understand and manage the impact of fluctuations in market interest rates on net interest income, Nicolet measures its overall interest rate sensitivity through a net interest income analysis, which calculates the change in net interest income in the event of hypothetical changes in interest rates under different scenarios versus a baseline scenario. Such scenarios can involve static balance sheets, balance sheets with projected growth, parallel (or non-parallel) yield curve slope changes, immediate or gradual changes in market interest rates, and one-year or longer time horizons. The simulation modeling uses assumptions involving market spreads, prepayments of rate-sensitive instruments, renewal rates on maturing or new loans, deposit retention rates, and other assumptions.
Nicolet assessed the impact on net interest income in the event of a gradual +/-100 bps and +/-200 bps change in market rates (parallel to the change in prime rate) over a one-year time horizon to a static (flat) balance sheet. The interest rate scenarios are used for analytical purposes only and do not necessarily represent management’s view of future market interest rate movements. Based on financial data at December 31, 2017 and 2016, the projected changes in net interest income over a one-year time horizon, versus the baseline, are presented in Table 19 below. The results were within Nicolet’s guidelines of not greater than -10% for +/- 100 bps and not greater than -15% for +/- 200 bps.
Table 19: Interest Rate Sensitivity
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.
Capital balances and changes in capital are presented in the Consolidated Statements of Changes in Stockholders’ Equity in Part II, Item 8. Further discussion of capital components is included in Note 14, “Stockholders’ Equity,” and a summary of dividend restrictions, as well as regulatory capital amounts and ratios for Nicolet and the Bank is presented in Note 19, “Regulatory Capital Requirements and Restrictions of Dividends” of the Notes to Consolidated Financial Statements under Part II, Item 8.
At December 31, 2017, Nicolet’s total capital was $364.2 million, compared to $275.9 million at year-end 2016. The increase in total equity since year-end 2016 was mostly due to stock issued in connection with the 2017 acquisition and net income. Common equity to total assets at December 31, 2017 was 12.4%, up from 12.0% at December 31, 2016, and continues to reflect capacity to capitalize on opportunities. Book value per common share increased to $37.09 at year end 2017, up 15% over $32.26 at year end 2016. Common shares outstanding increased 1.3 million to 9.8 million at December 31, 2017 as the Company issued 1.3 million shares of common stock (for common stock consideration of $62.2 million) in connection with the acquisition of First Menasha on April 28, 2017.
As shown in Table 20, the Company’s regulatory capital ratios remain well above minimum regulatory ratios. Also, at December 31, 2017, the Bank’s regulatory capital ratios 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 and in strategic growth. For a discussion of the regulatory restrictions applicable to the Company and the Bank, see section “Business-Regulation of Nicolet” and “Business-Regulation of the Bank,” included within Part I, Item 1.
Table 20: Capital
In managing capital for optimal return, we evaluate capital sources and uses, pricing and availability of our stock in the market, and alternative uses of capital (such as the level of organic growth or acquisition opportunities) in light of strategic plans. In early 2014, a common stock repurchase program was authorized and with subsequent modifications through December 31, 2017, the Board has authorized the use of up to $30 million to repurchase up to 1,050,000 shares of Nicolet common stock as an alternative use of capital. During 2017, $10.0 million was used to repurchase and cancel approximately 188,600 shares at a weighted average price per share of $52.87 including commissions, bringing the life-to-date totals through December 31, 2017, to $24.1 million used to repurchase and cancel just over 700,000 shares at a weighted average price per share of $34.12 including commissions. Subsequently, on February 20, 2018, the stock repurchase program was further modified, adding $12 million more to repurchase up to 200,000 shares of outstanding common stock. Including this subsequent modification, the Board has authorized the Company the use of up to $42 million to repurchase and cancel 1,250,000 shares of Nicolet common stock.
Effects of Inflation
The effect of inflation on a financial institution differs significantly from the effect on an industrial company. While a financial institution’s operating expenses, particularly salary and employee benefits, are affected by general inflation, the asset and liability structure of a financial institution consists largely of monetary items. Monetary items, such as cash, investments, loans, deposits and other borrowings, are those assets and liabilities which are or will be converted into a fixed number of dollars regardless of changes in prices. As a result, changes in interest rates have a more significant impact on a financial institution’s performance than does general inflation. For additional information regarding interest rates and changes in net interest income see “Interest Rate Sensitivity Management.” Inflation may have impacts on the Bank’s customers, on businesses and consumers and their ability or willingness to invest, save or spend, and perhaps on their ability to repay loans. As such, there would likely be impacts on the general appetite of banking products and the credit health of the Bank’s customer base.
Fourth Quarter 2017 Results
Nicolet recorded net income of $9.1 million for the fourth quarter of 2017, or $0.88 for diluted earnings per common share, compared to $6.1 million, or $0.68, respectively for the fourth quarter of 2016. Between the comparable quarters, net income was up 50%, while diluted weighted average shares were up 16%, resulting in a 29% increase in diluted earnings per common share. See Table 21 for selected quarterly information.
Taxable equivalent net interest income for the fourth quarter of 2017 was $27.1 million, compared to $20.6 million for the same quarter of 2016. Positive changes from balance sheet volume added $6.4 million to net interest income and were predominantly due to the First Menasha merger and organic loan growth, while favorable changes in rates added $0.1 million to net interest income. The net interest margin between the comparable quarters was up 16 bps to 4.21% in the fourth quarter of 2017, comprised of an 8 bps higher interest rate spread (to 4.01%, as the yield on earning assets increased 30 bps and the rate on interest-bearing liabilities increased 22 bps) and an 8 bps higher contribution from net free funds (mainly from higher noninterest-bearing deposits).
Average interest-earning assets were $2.5 billion for the fourth quarter of 2017 compared to $2.0 billion for the fourth quarter of 2016, mainly due to a $507 million increase in average loans. The mix of earning assets shifted from 78% in loans and 22% in nonloan earning assets (including a higher proportion of low interest earning cash assets) to 82% in average loans and 18% in nonloan earning assets for fourth quarter 2017. On the funding side, average interest-bearing deposits were up $305 million, average demand deposits increased $148 million, and average short and long-term funding balances increased $45 million.
The provision for loan losses was $0.5 million for both fourth quarter periods, while net charge-offs were $0.4 million for fourth quarter 2017 and $0.1 million for fourth quarter 2016.
Noninterest income for the fourth quarter of 2017 increased $0.7 million (9%) to $8.6 million versus the fourth quarter of 2016. Net loss on sale, disposal or write-down of assets was $0.5 million for fourth quarter 2016 due to an OTTI charge on a private company equity investment, compared to minimal amounts for fourth quarter 2017, for a $0.5 million favorable variance between quarters. Other increases were primarily commensurate with the larger volumes due to the 2017 acquisition, notably card interchange income increased $0.3 million, service charges on deposits increased $0.2 million, and trust fees increased $0.2 million. Partially offsetting these increases was a $0.4 million reduction in mortgage income, net due to lower secondary mortgage production.
On a comparable quarter basis, noninterest expense increased $3.5 million (19%) to $21.9 million in the fourth quarter of 2017. Personnel expense of $12.1 million, increased $2.8 million (30%) over fourth quarter 2016, primarily due to higher equity awards and merit increases, as well as the larger workforce after the 2017 acquisition (with full-time equivalent employees up 11% between December 31, 2017 and 2016). All nonpersonnel expense categories combined were up $0.7 million, primarily commensurate with the larger operating base after the 2017 acquisition, but most notably occupancy up $0.7 million and data processing up $0.3 million, partially offset by a reduction in other expense of $0.4 million due to merger-based expenses incurred in fourth quarter 2016 (versus none in fourth quarter 2017).
For the fourth quarter of 2017, Nicolet recognized income tax expense of $3.7 million with an effective tax rate of 28.6%, compared to income tax expense of $2.9 million with an effective tax rate of 32.4% for the fourth quarter of 2016. The change in income tax was attributable to the level of pretax income between the comparable quarters, as well as the impact of two new tax items: (1) the adoption of a new accounting standard in 2017 which requires the tax impact of stock option exercises to be recorded as an adjustment to income tax expense and (2) the tax law change in December 2017 which lowered the corporate tax rate. The first tax item reduced income tax expense $1.7 million in fourth quarter 2017, primarily due to large option exercises during the period, while the second tax item increased income tax expense $0.9 million. Additional information on income taxes, including the new tax items, is also included in “Income Taxes,” and Note 15, “Income Taxes” in the Notes to Consolidated Financial Statements, under Part II, Item 8.
Selected Quarterly Financial Data
The following is selected financial data summarizing the results of operations for each quarter in the years ended December 31, 2017 and 2016.
Table 21: Selected Quarterly Financial Data
(dollars in thousands, except per share data)
*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.
2016 Compared to 2015
Net income attributable to Nicolet was $18.5 million for 2016, and after $0.6 million of preferred stock dividends, net income available to common shareholders was $17.9 million, or $2.37 per diluted common share. Comparatively, 2015 net income attributable to Nicolet was $11.4 million, and after $0.2 million of preferred stock dividends, net income available to common shareholders was $11.2 million or $2.57 per diluted common share. Between the years, net income increased 62%, predominantly due to inclusion of results from the 2016 acquisitions, and diluted earnings per common share decreased 8%, largely attributable to a 72% increase in diluted weighted average shares and higher preferred stock dividends. Return on average assets was 0.95% and 0.96% for 2016 and 2015, respectively, while return on average common equity was 8.20% for 2016 and 12.35% for 2015, with the 2016 ratios absorbing higher merger and integration costs and new shares from the 2016 acquisitions. Book value per common share was $32.26 at December 31, 2016, up 38% over $23.42 at December 31, 2015. Affecting total capital and the amount of preferred stock dividends between the years were the rate on and amount of preferred stock outstanding. Beginning March 1, 2016, the annual dividend rate on preferred stock moved from 1% to 9% in accordance with contractual terms. In advance of such increase, Nicolet redeemed $12.2 million (half) of its then outstanding preferred stock in September 2015 and redeemed the remaining half in September 2016, eliminating preferred stock and preferred dividends going forward.
The timing of the 2016 Baylake merger analytically explains most of the increase in certain average balances and income statement line items, while the timing of the financial advisors acquisition mostly impacts brokerage fee income, personnel expense and certain other expense between 2016 and 2015. Key factors contributing to the 2016 versus 2015 results are discussed below.
• Net interest income was $68.1 million for 2016, an increase of $26.7 million or 65% compared to 2015. The improvement was primarily the result of favorable volume variances, driven by the addition of Baylake net interest-earning assets, and net favorable rate variances, predominantly from lower cost of funds. The earning asset yield was 4.44% for 2016 and 4.54% for 2015, influenced mainly by the earning asset mix, with more balances in lower-yielding assets. Loans, investments and other interest-earning assets (mostly low-earning cash) represented 78%, 17% and 5% of average earning assets, respectively for 2016, compared to 82%, 15% and 3%, respectively, for 2015. The cost of funds was 0.56% for 2016, 28 bps lower than 2015, driven by a lower cost of deposits between the years. As a result, the interest rate spread was 3.88% for 2016, 18 bps higher than 2015. The net interest margin was 4.01% for 2016 compared to 3.88% for 2015, with a lower contribution from net free funds partly offsetting the increase in interest rate spread. Tables 1, 2, and 3 show additional average balance sheet, net interest income, and net interest margin information.
• Loans were $1.6 billion at December 31, 2016, up $0.7 billion or 78% over December 31, 2015; however, excluding the impact of the $0.7 billion loans added at acquisition in 2016, loans were essentially unchanged (up 0.1%) with underlying organic growth replacing acquired loan run off. Average loans were $1.3 billion in 2016 yielding 5.11%, compared to $884 million in 2015 yielding 5.12%, a 52% increase in average balances. The minimal change in loan yield was due to downward pressure on rates of new and renewing loans in the 2016 competitive rate environment offset by $3.9 million higher aggregate discount accretion on acquired loans between 2016 and 2015. Table 6 shows additional information on loans.
• Total deposits were $2.0 billion at December 31, 2016, up $0.9 billion or 86% over December 31, 2015. Excluding the impact of the $0.8 billion deposits added at acquisition in 2016, deposits grew 8.7%. Between 2016 and 2015, average deposits were up $0.6 billion or 61%, with noninterest-bearing deposits representing 23% and 21% of total deposits for 2016 and 2015, respectively. Interest-bearing deposits cost 0.41% for 2016 and 0.64% for 2015 benefiting from deposit product rate changes in December 2015 and inclusion of Baylake deposits carrying a lower overall cost. Tables 14, 15, and 16 show additional information on deposits.
• The most notable capital-related actions in 2016 were: 1) on February 24, 2016, Nicolet’s common stock moved off the OTCBB and began trading on the Nasdaq Capital Market under the trading symbol “NCBS”, 2) the April 2016 issuance of common stock in connection with the Baylake merger and acquisition of a financial advisor business, 3) the September 2016 redemption of the final $12.2 million of its preferred stock, and 4) common stock repurchases. The most notable capital-related actions in 2015 were: 1) the issuance of $12 million in 5% fixed rate, 10-year subordinated debt during the first half of 2015 (which qualifies as Tier 2 regulatory capital), 2) the September 2015 partial redemption of $12.2 million, or half, of its preferred stock at par, and 3) common stock repurchases.
• Asset quality measures remained strong, despite some elevation in nonperforming assets due to assets acquired in the Baylake merger. Nonperforming assets were $22.3 million (or 0.97% of total assets) at December 31, 2016, compared to the pre-merger level of $3.9 million (or 0.32% of assets) at December 31, 2015. For 2016, the provision for loan losses was $1.8 million, exceeding net charge-offs of $0.3 million, versus provision of $1.8 million and net charge-offs of $0.8 million for 2015. The ALLL was $11.8 million at December 31, 2016 (representing 0.75% of loans), compared to $10.3 million (representing 1.18% of loans) at December 31, 2015. The decline in the ratio of the ALLL to loans resulted from recording the Baylake loan portfolio at fair value with no carryover of its allowance at the time of the merger. Tables 8, 9, 10, and 11 show additional information on asset quality measures.
• Noninterest income was $26.7 million (including $0.1 million of net gain on sale, disposal or write-down of assets), compared to $17.7 million for 2015 (including $1.7 million of net gain on sale, disposal or write-down of assets). Removing these net gains, noninterest income was up $10.6 million or 67%, with increases in all line items, except rental income, aided largely by the 2016 acquisitions and higher volumes over a broader geographic footprint. The most notable increase over prior year was brokerage fee income (up $3.0 million or 441%), directly related to the 2016 financial advisor business acquisition. Net mortgage income was up $2.2 million or 69% due to gains on increased volumes and higher servicing fees related to the acquired servicing portfolio. Card interchange income grew $1.6 million on higher volume and activity between the years. Service charges on deposit accounts increased $1.2 million or 52% from higher overdraft activity and the higher number transaction accounts. Other income was up $1.7 million, mostly attributable to income from equity in UFS, a data processing company interest acquired in the Baylake merger (up $1.0 million). Table 4 shows additional noninterest income information.
• Noninterest expense was $64.9 million (which included $1.3 million direct merger-related expenses and a non-recurring $1.7 million lease termination charge), compared to $39.6 million for 2015 (which included $0.8 million merger-related expenses). Removing these noted merger-related and lease charge expenses from both years, noninterest expense was up approximately $23.1 million or 59%, commensurate with the larger operating base and timing of the 2016 acquisitions. Personnel expense was $34.0 million for 2016, up $11.5 million or 51.1% over 2015. In addition to merit increases, higher overtime and higher incentives and equity award costs between the years, salaries and benefits increased largely due to the 48% increase in average full-time equivalent employees from the 2016 acquisitions. Additionally, the $2.4 million increase in intangibles amortization was exclusively attributable to the 2016 acquisitions, and $0.2 million in other expenses was related to the in-process implementation of a customer relationship management system. Table 5 shows additional noninterest expense information.
Critical Accounting Policies
The consolidated financial statements of Nicolet are prepared in conformity with U.S. generally accepted accounting principles (“GAAP”) and follow general practices within the industry in which it operates. This preparation requires management to make estimates, assumptions and judgments that affect the amounts reported in the consolidated financial statements and accompanying notes. These estimates, assumptions and judgments are based on information available as of the date of the consolidated financial statements; accordingly, as this information changes, actual results could differ from the estimates, assumptions and judgments reflected in the consolidated financial statements. Certain policies inherently have a greater reliance on the use of estimates, assumptions and judgments and, as such, have a greater possibility of producing results that could be materially different than originally reported. Estimates that are particularly susceptible to significant change include the valuation of loan acquisition transactions, as well as the determination of the allowance for loan losses and income taxes and, therefore, are critical accounting policies. The critical accounting policies are discussed directly with Nicolet’s Audit Committee. In addition to the discussion that follows, these critical accounting policies are further described in Note 1, “Nature of Business and Significant Accounting Policies,” in the Notes to Consolidated Financial Statements, under Part II, Item 8.
Business Combinations and Valuation of Loans Acquired in Business Combinations
We account for acquisitions under Financial Accounting Standards Board (“FASB”) ASC Topic 805, Business Combinations, which requires the use of the acquisition method of accounting. Assets acquired and liabilities assumed in a business combination are recorded at estimated fair value on their purchase date. As provided for under GAAP, management has up to 12 months following the date of the acquisition to finalize the fair values of acquired assets and assumed liabilities, where it was not possible to estimate the acquisition date fair value upon consummation. Management finalized the fair values of acquired assets and assumed liabilities within this 12-month period and management currently considers such values to be the Day 1 Fair Values for the acquisition transactions.
In particular, the valuation of acquired loans involves significant estimates, assumptions and judgment based on information available as of the acquisition date. Substantially all loans acquired in the transaction are evaluated either individually or in pools of loans with similar characteristics; and since the estimated fair value of acquired loans includes a credit consideration, no carryover of any previously recorded allowance for loan losses is recorded at acquisition. A number of factors are considered in determining the estimated fair value of purchased loans including, among other things, the remaining life of the acquired loans, estimated prepayments, estimated loss ratios, estimated value of the underlying collateral, estimated holding periods, contractual interest rates compared to market interest rates, and net present value of cash flows expected to be received.
In determining the Day 1 Fair Values of acquired loans, management calculates a nonaccretable difference (the credit mark component of the acquired loans) and an accretable difference (the market rate or yield component of the acquired loans). The nonaccretable difference is the difference between the undiscounted contractually required payments and the undiscounted cash flows expected to be collected in accordance with management’s determination of the Day 1 Fair Values. Subsequent decreases to the expected cash flows will generally result in a provision for loan losses; while subsequent increases in cash flows will result in a reversal of the provision for loan losses to the extent of prior charges and then an adjustment to accretable yield, and nonaccretable difference which would have a positive impact on interest income.
The accretable yield on acquired loans is the difference between the expected cash flows and the initial investment in the acquired loans. The accretable yield is recognized into earnings using the effective yield method over the term of the loans. Management separately monitors the acquired loan portfolio and periodically reviews loans contained within this portfolio against the factors and assumptions used in determining the Day 1 Fair Values.
Allowance for Loan Losses
Management’s evaluation process used to determine the appropriateness of the ALLL is subject to the use of estimates, assumptions, and judgment. The evaluation process involves gathering and interpreting many qualitative and quantitative factors which could affect probable credit losses. Because interpretation and analysis involves judgment, current economic or business conditions can change, and future events are inherently difficult to predict, the anticipated amount of estimated loan losses and therefore the appropriateness of the ALLL could change significantly.
The allocation methodology applied by Nicolet is designed to assess the appropriateness of the ALLL and includes allocations for specifically identified impaired loans and loss factor allocations for all remaining loans, with a component primarily based on historical loss rates and a component primarily based on other qualitative factors. The methodology includes evaluation and consideration of several factors, such as, but not limited to, management’s ongoing review and grading of loans, facts and issues related to specific loans, historical loan loss and delinquency experience, trends in past due and nonaccrual loans, existing risk characteristics of specific loans or loan pools, the fair value of underlying collateral, current economic conditions and other qualitative and quantitative factors which could affect potential credit losses. While management uses the best information available to make its evaluation, future adjustments to the allowance may be necessary if there are significant changes in economic conditions or circumstances underlying the collectability of loans. Because each of the criteria used is subject to change, the allocation of the ALLL is made for analytical purposes and is not necessarily indicative of the trend of future loan losses in any particular loan category. The total allowance is available to absorb losses from any segment of the loan portfolio. Management believes the ALLL is appropriate at December 31, 2017. The allowance analysis is reviewed by the board of directors on a quarterly basis in compliance with regulatory requirements.
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.
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 quarterly 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 uncertainty in income taxes. Unrecognized tax benefits represent the differences between a tax position taken or expected to be taken in a tax return and the benefit recognized and measured in the financial statements. Penalties related to unrecognized tax benefits are classified as income tax expense.
Future Accounting Pronouncements
Recent accounting pronouncements adopted are included in Note 1, “Nature of Business and Significant Accounting Policies” of the Notes to Consolidated Financial Statements.
In August 2017, the FASB issued ASU 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities. ASU 2017-12 expands the activities that qualify for hedge accounting and simplifies the rules for reporting hedging transactions. The updated guidance is effective for interim and annual reporting periods beginning after December 15, 2018, with early adoption permitted. The Company is currently assessing the impact of the new guidance on its consolidated financial statements, and it is not expected to have a significant impact on its consolidated financial statements because the Company does not have any significant derivatives and does not currently apply hedge accounting to derivatives.
In May 2017, the FASB issued ASU 2017-09, Compensation - Stock Compensation (Topic 718). ASU 2017-09 applies to entities that change the terms or conditions of a share-based payment award to provide clarity and reduce diversity in practice as well as cost and complexity when applying the guidance in Topic 718 to the modification to the terms and conditions of a share-based payment award. The updated guidance is effective for interim and annual reporting periods beginning after December 15, 2017. The Company has determined the new guidance will not have a material impact on its consolidated financial statements.
In November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash to provide guidance on the presentation of restricted cash or restricted cash equivalents in the statement of cash flows to reduce diversity in practice. The amendment requires that a statement of cash flow explain the change during the period in the total cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. Therefore, amounts generally described as restricted cash or restricted cash equivalents should be include in cash and cash equivalents when reconciling the beginning and end of period total amounts shown on the statement of cash flow. This amendment is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Entities should apply the amendment retrospectively to each period presented. Upon adoption, the new guidance will result in a slight change in presentation and an immaterial impact 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. The Company has determined the new guidance will not have a material impact on its consolidated financial statements.
In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments intended to improve the financial reporting by requiring timelier recording of credit losses on loans and other financial instruments held by financial institutions and other organizations. The ASU requires the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Financial institutions and other organizations will now use forward-looking information to better inform their credit loss estimates. The ASU is effective for SEC filers for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. Entities should apply the amendment by means of a cumulative-effect adjustment to retained earnings as of the beginning of the fiscal year of adoption. Early application will be permitted for all organizations for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. The Company expects to adopt the new accounting standard in 2020, as required, and is currently assessing the impact of the new guidance on its consolidated financial statements. A cross-functional team has been established to assess and implement the new standard.
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). The core principle of the guidance is a lessee should recognize the assets and liabilities that arise from leases. The recognition, measurement, and presentation of expenses and cash flows arising from a lease by a lessee primarily will depend on its classification as a finance or operating lease. However, unlike current GAAP which requires only capital leases to be recognized on the balance sheet, the new standard will require both types of leases to be recognized on the balances sheet. The updated guidance is effective for annual reporting periods beginning after December 15, 2018. Early application is permitted. The Company will adopt the new accounting standard in 2019, as required, and is currently assessing the impact of the new guidance on its consolidated financial statements.
In January 2016, the FASB issued ASU 2016-01, Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities, to address certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. This amendment supersedes the guidance to classify equity securities with readily determinable fair values into different categories, requires equity securities to be measured at fair value with changes in the fair value recognized through net income, and simplifies the impairment assessment of equity investments without readily determinable fair values. The amendment also requires public business entities that are required to disclose the fair value of financial instruments measured at amortized cost on the balance sheet to measure that fair value using the exit price notion. The amendment requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset on the balance sheet or in the accompanying notes to the financial statements. This amendment is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Entities are required to apply the amendment by means of a cumulative-effect adjustment as of the beginning of the fiscal year of adoption, with the exception of the amendment related to equity securities without readily determinable fair values, which should be applied prospectively to equity investments that exist as of the date of adoption. Upon adoption in the first quarter of 2018, the Company will recognize a cumulative-effect adjustment of approximately $1.3 million for the unrealized gain on equity securities.
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 will adopt the new accounting standard in 2018, as required, and has determined the new guidance will not have a material impact on its consolidated financial statements.
ITEM 7A.
ITEM 7A.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
For additional disclosure, see section, “Interest Rate Sensitivity Management,” of the Management’s Discussion and Analysis of Financial Condition and Results of Operation under Part II, Item 7.
ITEM 8.
ITEM 8.FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
NICOLET BANKSHARES, INC.
Consolidated Balance Sheets
December 31,
See Accompanying Notes to Consolidated Financial Statements.
NICOLET BANKSHARES, INC.
Consolidated Statements of Income
Years Ended December 31,
See Accompanying Notes to Consolidated Financial Statements.
NICOLET BANKSHARES, INC.
Consolidated Statements of Comprehensive Income
Years Ended December 31,
See Accompanying Notes to Consolidated Financial Statements.
NICOLET BANKSHARES, INC.
Consolidated Statements of Changes in Stockholders’ Equity
Years Ended December 31, 2017, 2016 and 2015
See Accompanying Notes to Consolidated Financial Statements.
NICOLET BANKSHARES, INC.
Consolidated Statements of Cash Flows
Years Ended December 31,
(continued)
NICOLET BANKSHARES, INC.
Consolidated Statements of Cash Flows - continued
Years Ended December 31,
See Accompanying Notes to Consolidated Financial Statements.
NICOLET BANKSHARES, INC.
Notes to Consolidated Financial Statements
NOTE 1.Nature of Business and Significant Accounting Policies
Nature of Banking Activities and Subsidiaries: Nicolet Bankshares, Inc. (the “Company” or “Nicolet”) was incorporated on April 5, 2000, to serve as the holding company and sole shareholder of Nicolet National Bank (the “Bank”). The Bank opened for business on November 1, 2000. Since its opening in late 2000, Nicolet has supplemented its organic growth with branch purchase and acquisition transactions. Most recently, the Company completed a merger transaction with First Menasha Bancshares, Inc. (“First Menasha”) consummated on April 28, 2017. During 2016, the Company completed two transactions (collectively the “2016 acquisitions”) consisting of a private transaction to hire a select group of financial advisors and to purchase their respective books of business and operating platform completed on April 1, 2016 and the merger transaction with Baylake Corp. (“Baylake”) consummated on April 29, 2016. See Note 2 for additional information on the Company’s recent acquisitions.
The Company is part of a joint venture, Nicolet Joint Ventures, LLC (the “JV”), with a real estate development and investment firm (the “Firm”) established to develop and own the Company’s headquarters facility. The Firm is considered a related party, as one of its principals is a Board member and shareholder of the Company. The JV involves a 50% ownership by the Company. See Note 17 for additional related party disclosures.
The Company also owns Brookfield Investment Partners, LLC (“Brookfield Investments”), an investment advisory firm that provides investment strategy and transactional services to financial institutions. During late 2016, the Company capitalized Nicolet Advisory Services, LLC (“Nicolet Advisory”), a wholly owned registered investment advisor subsidiary to provide brokerage and investment advisory services to customers.
Through its acquisition of Baylake in 2016, the Bank owns a 49.8% indirect interest in United Financial Services, LLC (“UFS, LLC”), a data processing service and e-banking entity, through its 99.2% ownership of United Financial Services, Inc. (“UFS, Inc.”). Collectively, UFS, Inc. and UFS, LLC are referred to as “UFS”. The investment in UFS is carried in other assets under the equity method of accounting, and the Bank’s pro rata share of UFS income is included in other noninterest income. Income in equity of UFS recognized by the Bank was $1.3 million and $1.0 million for the years ended December 31, 2017 and 2016, respectively. Amounts paid to UFS for data processing services by the Bank were $2.6 million and $1.6 million in 2017 and 2016, respectively. The carrying value of the Bank’s investment in UFS was $9.7 million and $8.3 million at December 31, 2017 and 2016, respectively.
Principles of Consolidation: The consolidated financial statements of the Company include the accounts of the Bank, Brookfield Investments, Nicolet Advisory and the JV. The consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”) and conform to general practices within the banking industry. All significant intercompany accounts and transactions have been eliminated in the consolidated financial statements. Results of operations of companies purchased, if any, are included from the date of acquisition.
Operating Segment: The consolidated income of the Company is derived principally from the Bank, which conducts lending (primarily commercial-based loans, as well as residential and consumer loans) and deposit gathering (including other banking- and deposit-related products and services, such as ATMs, safe deposit boxes, check-cashing, wires, and debit cards) to businesses, consumers and governmental units principally in its trade area of northeastern and central Wisconsin, and Menominee, Michigan, trust services, brokerage services (delivered through the Bank and Nicolet Advisory), and the support to deliver, fund and manage all such banking and wealth management services to its customer base. The contribution of the JV, Brookfield Investments and Nicolet Advisory were not significant to the consolidated balance sheet or net income for 2017, 2016, or 2015. 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.
NICOLET BANKSHARES, INC.
Notes to Consolidated Financial Statements
NOTE 1. Nature of Business and Significant Accounting Policies (CONTINUED)
Use of 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, valuation of loans in acquisition transactions, useful lives for depreciation and amortization, fair value of financial instruments, other-than-temporary impairment calculations, valuation of 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, determination and assessment of deferred tax assets and liabilities, and the valuation of loans acquired in acquisition transactions; 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 or tax 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.
Business Combinations: The Company accounts for business combinations under the acquisition method of accounting in accordance with Accounting Standards Codification (“ASC”) 805, Business Combinations (“ASC 805”). The Company recognizes the full fair value of the assets acquired and liabilities assumed and immediately expenses transaction costs. There is no separate recognition of the acquired allowance for loan losses on the acquirer’s balance sheet as credit related factors are incorporated directly into the fair value of the net tangible and intangible assets acquired. If the amount of consideration exceeds the fair value of assets purchased less the fair value of liabilities assumed, goodwill is recorded. Alternatively, if the amount by which the fair value of assets purchased exceeds the fair value of liabilities assumed and consideration paid, a gain (“bargain purchase gain”) is recorded. Fair values are subject to refinement for up to one year after the closing date of an acquisition as information relative to closing date fair values becomes available. Results of operations of the acquired business are included in the statement of income from the effective date of the acquisition. Additional information regarding acquisitions is provided in Note 2.
Cash and Cash Equivalents: For purposes of the consolidated statements of cash flows, cash and cash equivalents include cash and due from banks, interest-earning deposits in other banks with original maturities of less than 90 days, if any, and federal funds sold. The Bank maintains amounts in due from banks which, at times, may exceed federally insured limits. Management monitors these correspondent relationships. The Bank has not experienced any losses in such accounts. The Bank may have restrictions on cash and due from banks as it is required to maintain certain vault cash and reserve balances with the Federal Reserve Bank to meet specific reserve requirements. At December 31, 2017, the reserve balance required with the Federal Reserve Bank approximated $5 million, of which there was sufficient cash to cover the reserve requirement. There was no reserve balance required at December 31, 2016.
Securities Available for Sale: Securities classified as AFS are those securities that the Company intends to hold for an indefinite period of time, but not necessarily to maturity. Any decision to sell a security classified as AFS would be based on various factors, including significant movements in interest rates, changes in the maturity mix of the Company’s assets and liabilities, liquidity needs, regulatory capital considerations, and other similar factors. Securities classified as AFS are carried at fair value, with unrealized gains or losses, net of related deferred income taxes, reported as increases or decreases in accumulated other comprehensive income. See Note 3 for additional disclosures on AFS securities.
Realized gains or losses on securities sales (using the specific identification method) and declines in value judged to be other-than-temporary are included in the consolidated statements of income under gain on sale, disposal or write-down of assets, net. Premiums and discounts are amortized or accreted into interest income over the life of the related securities using the effective interest method.
Management evaluates investment securities for other-than-temporary impairment on at least an annual basis. A decline in the market value of any investment below amortized cost that is deemed other-than-temporary is charged to earnings for the decline in value deemed to be credit related and a new cost basis in the security is established. The decline in value attributed to non-credit related factors considered temporary in nature is recognized in other comprehensive income. In evaluating other-than-temporary impairment, management considers the length of time and extent to which the fair value has been less than cost, and the financial condition and near-term prospects of the issuer for a period sufficient to allow for any anticipated recovery in fair value in the near term.
NICOLET BANKSHARES, INC.
Notes to Consolidated Financial Statements
NOTE 1. Nature of Business and Significant Accounting Policies (CONTINUED)
Other Investments: As a member of the Federal Reserve Bank System, Federal Agricultural Mortgage Corporation, and the Federal Home Loan Bank (“FHLB”) System, the Bank is required to maintain an investment in the capital stock of these entities. These equity securities are “restricted” in that they can only be sold back to the respective institutions or another member institution at par. Therefore, they are less liquid than other tradable AFS securities. As no ready market exists for these stocks, and they have no quoted market value, these investments are carried at cost. Also included are investments in other private companies that do not have quoted market prices, which are carried at cost less other-than-temporary impairment charges, if any. Management’s evaluation of these other investments for impairment includes consideration of the financial condition and other available relevant information of the issuer.
Loans Held for Sale: Loans originated and intended for sale in the secondary market are carried at the lower of cost or estimated fair value as determined on an aggregate basis and generally consist of current production of certain fixed-rate residential first mortgages. The amount by which cost exceeds market value is recorded as a valuation allowance and charged to earnings. Changes, if any, in the valuation allowance are also included in earnings in the period in which the change occurs. As of December 31, 2017 and 2016, no valuation allowance was necessary. Loans held for sale may be sold servicing retained or servicing released, and are generally sold without recourse. The carrying value of mortgage loans sold with servicing retained is reduced by the amount allocated to the servicing right at the time of sale. Gains and losses on sales of mortgage loans held for sale are included in earnings in mortgage income, net.
Loans and Allowance for Loan Losses (“ALLL”) - Originated Loans: Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are carried at their principal amount outstanding, net of deferred loan fees and costs. Interest income is accrued on the unpaid principal balance using the simple interest method. The accrual of interest income on loans is discontinued when, in the opinion of management, there is reasonable doubt as to the borrower’s ability to meet payment of interest or principal when due. Loans are generally placed on nonaccrual status when contractually past due 90 days or more as to interest or principal, though may be placed in such status earlier based on the circumstances. Loans past due 90 days or more may continue on accrual only when they are well secured and/or in process of collection or renewal. When interest accrual is discontinued, all previously accrued but uncollected interest is reversed against current period interest income. Except in very limited circumstances, cash collections on nonaccrual loans are credited to the loan receivable balance and no interest income is recognized on those loans until the principal balance is paid in full. Accrual of interest may be resumed when the customer is current on all principal and interest payments and has been paying on a timely basis for a sustained period of time. See Note 4 for additional information and disclosures on originated loans.
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 appropriateness of the ALLL, management defines impaired loans as nonaccrual credit relationships over $250,000, all loans determined to be troubled debt restructurings, plus additional loans with impairment risk characteristics. At the time an individual loan goes into nonaccrual status, management evaluates the loan for impairment and possible charge-off regardless of loan size. Typically, impairment amounts for loans under the scope criteria are charged off when the impairment amount is determined.
The 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. 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 appropriate to absorb probable losses in the loan portfolio.
The allocation methodology applied by the Company is designed to assess the overall appropriateness of the ALLL and includes allocations for specifically identified impaired loans and loss factors 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.
NICOLET BANKSHARES, INC.
Notes to Consolidated Financial Statements
NOTE 1. Nature of Business and Significant Accounting Policies (CONTINUED)
Loans and ALLL - Originated Loans (Continued):
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.
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 allowance analysis is reviewed by the Board on a quarterly basis in compliance with internal and regulatory requirements.
Loans and ALLL - Acquired Loans: The loans purchased in acquisition transactions are acquired loans. Acquired loans are recorded at their estimated fair value at the acquisition date, and are initially classified as either purchase credit impaired (“PCI”) loans (i.e. loans that reflect credit deterioration since origination and it is probable at acquisition that the Company will be unable to collect all contractually required payments) or purchased non-impaired loans (i.e., “performing acquired loans”). See Note 4 for additional information and disclosures on acquired loans.
PCI loans are accounted for under the accounting guidance for loans and debt securities acquired with deteriorated credit quality, found in Financial Accounting Standards Board (“FASB”) ASC Topic 310-30, Receivables-Loans and Debt Securities Acquired with Deteriorated Credit Quality. The Company estimates the amount and timing of expected principal, interest and other cash flows for each loan or pool of loans meeting the criteria above, and determines the excess of the loan’s scheduled contractual principal and contractual interest payments over all cash flows expected to be collected at acquisition as an amount that should not be accreted. These credit discounts (“nonaccretable marks”) are included in the determination of the initial fair value for acquired loans; therefore, an allowance for loan losses is not recorded at the acquisition date. Differences between the estimated fair values and expected cash flows of acquired loans at the acquisition date that are not credit-based (“accretable marks”) are subsequently accreted to interest income over the estimated life of the loans using a method that approximates a level yield method if the timing and amount of the future cash flows is reasonably estimable. Subsequent to the acquisition date for PCI loans, increases in cash flows over those expected at the acquisition date result in a move of the discount from nonaccretable to accretable. Decreases in expected cash flows after the acquisition date are recognized through the provision for loan losses. All fair value discounts initially recorded on PCI loans were deemed to be credit related.
Performing acquired loans are accounted for under FASB ASC Topic 310-20, Receivables-Nonrefundable Fees and Other Costs. Performance of certain loans may be monitored, and based on management’s assessment of the cash flows and other facts available, portions of the accretable difference may be delayed or suspended if management deems appropriate. The Company’s policy for determining when to discontinue accruing interest on performing acquired loans and the subsequent accounting for such loans is essentially the same as the policy for originated loans described above.
An ALLL is calculated using a methodology similar to that described for originated loans. Performing acquired loans are subsequently evaluated for any required allowance at each reporting date. Such required allowance for each loan pool is compared to the remaining fair value discount for that pool. If greater, the excess is recognized as an addition to the allowance through a provision for loan losses. If less than the discount, no additional allowance is recorded. Charge-offs and losses first reduce any remaining fair value discount for the loan pool and once the discount is depleted, losses are applied against the allowance established for that pool.
NICOLET BANKSHARES, INC.
Notes to Consolidated Financial Statements
NOTE 1. Nature of Business and Significant Accounting Policies (CONTINUED)
Loans and ALLL - Acquired Loans (Continued):
For PCI loans after acquisition, cash flows expected to be collected are recast for each loan periodically as determined appropriate by management. If the present value of expected cash flows for a loan is less than its carrying value, impairment is reflected by an increase in the ALLL and a charge to the provision for loan losses. If the present value of the expected cash flows for a loan is greater than its carrying value, any previously established ALLL is reversed and any remaining difference increases the accretable yield which will be taken into income over the remaining life of the loan. Loans which were considered troubled debt restructurings prior to the acquisition transaction are not required to be classified as troubled debt restructurings in the Company’s consolidated financial statements unless or 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.
Credit-Related Financial Instruments: In the ordinary course of business the Company has entered into financial instruments consisting of commitments to extend credit, financial standby letters of credit, and performance standby letters of credit. Financial standby letters of credit are issued specifically to facilitate commerce and typically result in the commitment being drawn on when the underlying transaction is consummated between the customer and the third party, while performance standby letters of credit generally are contingent upon the failure of the customer to perform according to the terms of the underlying contract with the third party. Such financial instruments are recorded in the consolidated financial statements when they are funded. See Note 16 for additional information and disclosures on credit-related financial instruments.
Transfers of Financial Assets: Transfers of financial assets, primarily in loan participation activities, are accounted for as sales only when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of the right) to pledge or exchange the transferred assets, and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity or the ability to unilaterally cause the holder to return assets.
Premises and Equipment: Premises and equipment are stated at cost less accumulated depreciation and amortization. Premises and equipment from acquisitions were recorded at estimated fair value on the respective dates of acquisition. Depreciation is computed on straight-line and accelerated methods over the estimated useful lives of the related assets. Leasehold improvements are amortized on the straight-line method over the shorter of the estimated useful lives of the improvements or the terms of the related leases. Maintenance and repairs are expensed as incurred. See Note 5 for additional information on premises and equipment.
Estimated useful lives of new premises and equipment generally range as follows:
Building and improvements
25 - 39 years
Leasehold improvements
5 - 15 years
Furniture and equipment
3 - 10 years
Other Real Estate Owned (“OREO”): OREO acquired through partial or total satisfaction of loans or bank facilities no longer in use are carried at fair value less estimated costs to sell. Any write-down in the carrying value of loans or vacated bank premises at the time of transfer to OREO is charged to the ALLL or to write-down of assets, respectively. OREO properties acquired in conjunction with the acquisition transactions were recorded at fair value on the date of acquisition. Any subsequent write-downs to reflect current fair market value, as well as gains or losses on disposition and revenues and expenses incurred to hold and maintain such properties, are treated as period costs.
Goodwill and Other Intangibles: Goodwill represents the excess of the purchase price over the fair value of the net identifiable assets acquired. Goodwill is not amortized but is subject to impairment tests on at least an annual basis. Other intangibles include core deposit intangibles and customer list intangibles. Core deposit base premiums represent the value of acquired customer core deposit bases. The core deposit intangibles have an estimated finite life, are amortized on an accelerated basis over a 10-year period, and are subject to periodic impairment evaluation. Customer relationships were acquired in the financial advisor business acquisition in 2016. The customer list intangibles have finite lives and are amortized on a straight-line basis to expense over their initial weighted average life of approximately 12 years as of acquisition. See Note 6 for additional information on goodwill and other intangibles.
NICOLET BANKSHARES, INC.
Notes to Consolidated Financial Statements
NOTE 1. Nature of Business and Significant Accounting Policies (CONTINUED)
Goodwill and Other Intangibles (Continued):
Management periodically reviews the carrying value of its long-lived and intangible assets to determine if any impairment has occurred, in which case an impairment charge would be recorded as an expense in the period of impairment, or whether changes in circumstances have occurred that would require a revision to the remaining useful life which would impact expense prospectively. In making such determination, management evaluates whether there are any adverse qualitative factors indicating that an impairment may exist, as well as the performance, on an undiscounted basis, of the underlying operations or assets which give rise to the intangible. The Company’s annual assessments indicated no impairment charge on goodwill or other intangibles was required for 2017 or 2016.
Mortgage Servicing Rights (“MSRs”): If the Company sells originated residential mortgages into the secondary market and retains the right to service the loans sold, then a mortgage servicing right asset (liability) is capitalized upon sale with the offsetting effect recorded as a gain (loss) on sale of loans in earnings (included in mortgage income, net), representing the then-current estimated fair value of future net cash flows expected to be realized for performing the servicing activities. MSRs when purchased (including MSRs purchased in acquisitions) are initially recorded at their then-estimated fair value. As the Company has not elected to measure any class of servicing assets under the fair value measurement method, the Company utilizes the amortization method. MSRs are amortized in proportion to and over the period of estimated net servicing income, with the amortization charged to earnings (included in mortgage income, net). MSRs are carried at the lower of initial capitalized amount, net of accumulated amortization, or fair value, and are included in other assets in the consolidated balance sheets. Loan servicing fee income for servicing loans is typically based on a contractual percentage of the outstanding principal. Loan servicing fee income (as well as less material late fees and ancillary fees related to loan servicing) are recorded as income when earned (included in mortgage income, net).
The Company periodically evaluates its MSRs 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 (predominantly loan type and note interest rate). The value of MSRs is adversely affected when mortgage interest rates decline and mortgage loan prepayments increase. A valuation allowance is established through a charge to earnings (included in mortgage income, net) to the extent the amortized cost of the MSRs 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 MSRs 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 MSRs and valuation allowance, precluding subsequent recoveries. No valuation allowance or impairment charge was recorded for 2017 or 2016. See Note 6 for additional information on MSRs.
Bank-owned Life Insurance (“BOLI”): The Company owns BOLI on certain executives and employees. BOLI balances are recorded at their cash surrender values. Changes in the cash surrender values are included in noninterest income.
Short-term Borrowings: Short-term borrowings consist primarily of overnight Federal funds purchased and securities sold under agreements to repurchase (“repos”), or other short-term borrowing arrangements with an original maturity of one year or less. Repos are with commercial deposit customers, and are treated as financing activities carried at the amounts that will be subsequently repurchased as specified in the respective agreements. Repos generally mature within one to four days from the transaction date. The Company may be required to provide additional collateral based on the fair value of the underlying securities. There were no outstanding agreements at December 31, 2017 and 2016. The weighted average rate for repurchase agreements transacted during 2016 was 0.08% for the year based on average balances of $6.1 million. There were no repurchase agreements transacted during 2017.
Stock-based Compensation Plans: Share-based payments to employees, including grants of restricted stock or stock options, are valued at fair value of the award on the date of grant and expensed on a straight-line basis as compensation expense over the applicable vesting period. 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 fair value of restricted stock awards. See Note 13 for additional information on stock-based compensation and see Recent Accounting Pronouncements Adopted within Note 1 for the impact of recent accounting guidance on stock-based compensation.
NICOLET BANKSHARES, INC.
Notes to Consolidated Financial Statements
NOTE 1. Nature of Business and Significant Accounting Policies (CONTINUED)
Income Taxes: The Company files a consolidated federal income tax return and a combined state income tax return (both of which include the Company 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 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 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.
At acquisition, deferred taxes were evaluated in respect to the acquired assets and assumed liabilities (including the acquired net operating losses), and a net deferred tax asset was recorded. Certain limitations within the provisions of the tax code are placed on the amount of net operating losses which can be utilized as part of acquisition accounting rules and were incorporated into the calculation of the deferred tax asset. In addition, a portion of the fair market value discounts on PCI loans which resolved in the first twelve months after the acquisition were disallowed under provisions of the tax code.
The Company may also recognize a liability for unrecognized tax benefits from uncertainty in income 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 consolidated financial statements. At December 31, 2017, the Company determined it had no significant uncertainty in income tax positions. Interest and penalties related to unrecognized tax benefits are classified as income tax expense.
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 common share are calculated by dividing net income available to common shareholders by the weighted average number of common shares adjusted for the dilutive effect of outstanding common stock awards, if any. See Note 22 for additional information on earnings per common share.
Treasury Stock: Treasury stock is accounted for at cost on a first-in-first-out basis. It is the Company’s general practice to cancel treasury stock shares in the same year as purchased, and thus, not carry a treasury stock balance.
Comprehensive Income: Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income. Certain changes in assets and liabilities, such as unrealized gains and losses on AFS securities, bypass the statement of income and instead are reported in accumulated other comprehensive income, as a separate component of the equity section of the balance sheet. Realized gains or losses are reclassified to current period income. Changes in these items, along with net income, are components of comprehensive income. The Company presents comprehensive income in a separate consolidated statement of comprehensive income.
Reclassifications: Certain amounts in the 2016 and 2015 consolidated financial statements have been reclassified to conform to the 2017 presentation.
NICOLET BANKSHARES, INC.
Notes to Consolidated Financial Statements
NOTE 1. Nature of Business and Significant Accounting Policies (CONTINUED)
Recent Accounting Pronouncements Adopted:
In February 2018, the FASB issued Accounting Standards Update (“ASU”) 2018-02, Income Statement - Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income, to address concerns about the requirement in current GAAP that deferred tax liabilities and assets be adjusted for the effect of a change in tax laws or rates with the effect included in income from continuing operations in the reporting period that included the enactment date. The concern arose because, while the adjustment of deferred taxes due to the reduction of the historical corporate income tax rate to the corporate income tax rate of 21% newly enacted in December 2018 is required to be included in income from continuing operations, the tax effects of items within accumulated other comprehensive income do not reflect the appropriate tax rate. Thus, the amendments in this standard will allow a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the Tax Cuts and Jobs Act. The standard is effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Early adoption is permitted for public business entities for reporting periods for which financial statements have not yet been issued. The Company early adopted this standard in December 2017, and reclassified approximately $353,000 from accumulated other comprehensive income to retained earnings. See the Consolidated Statements of Changes in Stockholders’ Equity for the impact of this reclassification.
In December 2016, the FASB issued ASU 2016-19, Technical Corrections and Improvements to make changes to clarify the Accounting Standards Codification or correct unintended application of guidance that is not expected to have a significant effect on current accounting practice. The ASU is effective for annual periods, including interim periods within those annual periods, beginning after December 15, 2016. The Company adopted the guidance effective January 1, 2017, with no material impact on the Company’s consolidated financial statements.
In March 2016, the FASB issued updated guidance to ASU 2016-09, Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting intended to simplify and improve several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of such awards as either equity or liabilities and classification on the statement of cash flows. The updated guidance is effective for interim and annual reporting periods beginning after December 15, 2016. The Company adopted the pronouncement as required on January 1, 2017, prospectively, which included a reduction to income tax expense of $1.9 million for the year ended December 31, 2017, for deductions attributable to exercised stock options and vesting of restricted stock.
NICOLET BANKSHARES, INC.
Notes to Consolidated Financial Statements
NOTE 2. ACQUISITIONS
First Menasha:
On April 28, 2017, the Company consummated its merger with First Menasha pursuant to the Agreement and Plan of Merger by and between the Company and First Menasha dated November 3, 2016, (the “Merger Agreement”), whereby First Menasha was merged with and into the Company, and The First National Bank-Fox Valley, the wholly owned commercial bank subsidiary of First Menasha serving the Fox Valley area of Wisconsin, was merged with and into the Bank. The system integration was completed, and five branches of First Menasha opened on May 1, 2017, as Nicolet National Bank branches, expanding its presence in Calumet and Winnebago Counties, Wisconsin. The Company closed one of its Calumet County locations concurrently with the First Menasha merger.
The purpose of the merger was to continue Nicolet’s interest in strategic growth, consistent with its plan to improve profitability through efficiency, leverage the strengths of each bank across the combined customer base, and add shareholder value. With the merger, Nicolet became the leading community bank to serve the Fox Valley area of Wisconsin.
Pursuant to the Merger Agreement, the final purchase price consisted of issuing 1,309,885 shares of the Company’s common stock (given the final stock-for-stock exchange ratio of 3.126 except for First Menasha shares owned by the Company immediately prior to the time of the merger), for common stock consideration of $62.2 million (based on $47.52 per share, the volume weighted average closing price of the Company’s common stock over the preceding 20 trading day period) plus cash consideration of $19.3 million. Approximately $0.2 million in direct stock issuance costs for the merger were incurred and charged against additional paid-in capital.
Upon consummation, the Company added $480 million in assets, $351 million in loans, $375 million in deposits, $4 million in core deposit intangible, and $41 million of goodwill. The Company accounted for the transaction under the acquisition method of accounting, and thus, the financial position and results of operations of First Menasha prior to the consummation date were not included in the accompanying consolidated financial statements. The accounting required assets purchased and liabilities assumed to be recorded at their respective estimated fair values at the date of acquisition. During third quarter 2017, adjustments were made to the initial fair value estimates based on additional information and goodwill increased $1 million (to $41 million) to account for the gain in the Company’s pre-acquisition equity interest holding in First Menasha, resulting in a $1.2 million gain in pre-tax earnings. See Note 1 for the Company’s accounting policy on business combinations.
Financial advisor business acquired:
During the first quarter of 2016, Nicolet agreed in a private transaction to hire a select group of financial advisors and purchase their respective books of business, as well as their operating platform, to enhance the leadership and future growth of the Company’s wealth management business. The transaction was effected in phases and completed April 1, 2016. The Company paid $4.9 million total initial consideration, including $0.8 million cash, $2.6 million of Nicolet common stock, and recorded a $1.5 million earn-out liability payable to one principal in the future. The Company initially recorded $0.4 million of goodwill, $0.2 million of fixed assets, and $4.3 million of customer relationship intangibles (a portion amortizing straight-line over 10 years and a portion over 15 years). During 2017, the previously variable earn-out liability was agreed to be modified to a fixed amount. Therefore, the earn-out liability was adjusted to $2.4 million, with a corresponding $0.9 million increase in the customer relationship intangible, being amortized over the original term. The transaction impacts the income statement primarily within brokerage fee income, personnel expense, and intangibles amortization.
Baylake:
On April 29, 2016, the Company consummated its merger with Baylake. The system integration was completed, and 21 branches of Baylake opened, on May 2, 2016, as branches of the Bank, expanding its presence into Door, Kewaunee, and Manitowoc Counties, Wisconsin. The Company closed one of its Brown County locations concurrently with the Baylake merger, and closed an additional six branches in the fourth quarter of 2016.
The purpose of the merger was for strategic reasons beneficial to the Company. The acquisition was consistent with its plan to drive growth and efficiency through increased scale, leverage the strengths of each bank across the combined customer base, enhance profitability, and add liquidity and shareholder value.
NICOLET BANKSHARES, INC.
Notes to Consolidated Financial Statements
NOTE 2. ACQUISITIONS (CONTINUED)
Baylake shareholders received 0.4517 shares of the Company’s common stock for each outstanding share of Baylake common stock (except for Baylake shares owned by the Company at the time of the merger), and cash in lieu of any fractional share. Pre-existing Baylake equity awards (restricted stock units and stock options) immediately vested upon consummation of the merger. The Company issued 0.4517 shares of its common stock for each vesting Baylake restricted stock unit, and Nicolet assumed, after appropriate adjustment by the 0.4517 exchange ratio, all pre-existing Baylake stock options. As a result, the Company issued 4,344,243 shares of the Company’s common stock, for common stock consideration of $163.3 million (based on $37.58 per share, the volume weighted average closing price of the Company’s common stock over the preceding 20 trading day period) and recorded an additional $1.2 million consideration for the assumed stock options. Approximately $0.3 million in direct stock issuance costs for the merger were incurred and charged against additional paid-in capital.
The Company accounted for the transaction under the acquisition method of accounting, and thus, the financial position and results of operations of Baylake prior to the consummation date were not included in the accompanying consolidated financial statements. The fair value of the assets acquired and liabilities assumed on April 29, 2016 was as follows:
The following unaudited pro forma information presents the results of operations for the years ended December 31, 2016 and 2015, as if the acquisition had occurred January 1 of each period. 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.
NICOLET BANKSHARES, INC.
Notes to Consolidated Financial Statements
NOTE 3. SECURITIES AVAILABLE FOR SALE
Amortized costs and fair values of securities AFS are summarized as follows:
The following table presents gross unrealized losses and the related estimated fair value of investment securities available for sale, aggregated by investment category and the length of time the individual securities have been in a continuous unrealized loss position.
NICOLET BANKSHARES, INC.
Notes to Consolidated Financial Statements
NOTE 3. SECURITIES AVAILABLE FOR SALE (CONTINUED)
At December 31, 2017 the Company had $5.0 million of gross unrealized losses related to 687 securities. As of December 31, 2017, the Company does not consider its AFS securities with unrealized losses to be other-than-temporarily impaired as the unrealized losses in each category have occurred as a result of changes in interest rates and current market conditions subsequent to purchase, not credit deterioration. The Company has the ability and intent to hold its securities to maturity. There were no other-than-temporary impairment charges recognized in earnings on securities AFS during 2017, 2016, or 2015. The Company incurred a $0.5 million other-than-temporary impairment charge to earnings related to one private company stock carried in other investments in the consolidated balance sheets during 2016 compared to none in 2017 and 2015.
The amortized cost and fair value of AFS securities by contractual maturity at December 31, 2017 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; as this is particularly inherent in mortgage-backed securities, these securities are not included in the maturity categories below. See Note 20 for additional information on the Company’s fair value measurements.
AFS securities with a carrying value of $140.9 million and $30.3 million as of December 31, 2017 and 2016, respectively, were pledged as collateral on public deposits and for other purposes as required or permitted by law.
Proceeds from sales of securities AFS is summarized as follows:
NICOLET BANKSHARES, INC.
Notes to Consolidated Financial Statements
NOTE 4.LOANS AND ALLOWANCE FOR LOAN LOSSES
The loan composition as of December 31 is summarized as follows:
As a further breakdown, loans as of December 31 are summarized by originated and acquired as follows:
NICOLET BANKSHARES, INC.
Notes to Consolidated Financial Statements
NOTE 4. LOANS AND ALLOWANCE FOR LOAN LOSSES (CONTINUED)
Practically all of the Company’s loans, commitments, and 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. See Note 1 for the Company’s accounting policy on loans and the allowance for loan losses.
The following tables present the balance and activity in the ALLL by portfolio segment and the recorded investment in loans by portfolio segment as of December 31, 2017:
NICOLET BANKSHARES, INC.
Notes to Consolidated Financial Statements
NOTE 4. LOANS AND ALLOWANCE FOR LOAN LOSSES (CONTINUED)
As a further breakdown, the December 31, 2017 ALLL is summarized by originated and acquired as follows:
NICOLET BANKSHARES, INC.
Notes to Consolidated Financial Statements
NOTE 4. LOANS AND ALLOWANCE FOR LOAN LOSSES (CONTINUED)
The following tables present the balance and activity in the ALLL by portfolio segment and the recorded investment in loans by portfolio segment as of December 31, 2016:
NICOLET BANKSHARES, INC.
Notes to Consolidated Financial Statements
NOTE 4. LOANS AND ALLOWANCE FOR LOAN LOSSES (CONTINUED)
As a further breakdown, the December 31, 2016 ALLL is summarized by originated and acquired as follows:
There was no ALLL allocated to individually evaluated loans at December 31, 2016, therefore the table reflecting the ALLL between individually evaluated loans and collectively evaluated loans was omitted.
NICOLET BANKSHARES, INC.
Notes to Consolidated Financial Statements
NOTE 4. LOANS AND ALLOWANCE FOR LOAN LOSSES (CONTINUED)
The following tables present nonaccrual loans by portfolio segment in total and then as a further breakdown by originated or acquired as of December 31, 2017 and 2016.
NICOLET BANKSHARES, INC.
Notes to Consolidated Financial Statements
NOTE 4. LOANS AND ALLOWANCE FOR LOAN LOSSES (CONTINUED)
The following table presents past due loans by portfolio segment as of December 31, 2017:
As a further breakdown, past due loans as of December 31, 2017 are summarized by originated and acquired as follows:
NICOLET BANKSHARES, INC.
Notes to Consolidated Financial Statements
NOTE 4. LOANS AND ALLOWANCE FOR LOAN LOSSES (CONTINUED)
The following table presents past due loans by portfolio segment as of December 31, 2016:
As a further breakdown, past due loans as of December 31, 2016 are summarized by originated and acquired as follows:
NICOLET BANKSHARES, INC.
Notes to Consolidated Financial Statements
NOTE 4. LOANS AND ALLOWANCE FOR LOAN LOSSES (CONTINUED)
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 nonaccrual 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.
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.
NICOLET BANKSHARES, INC.
Notes to Consolidated Financial Statements
NOTE 4. LOANS AND ALLOWANCE FOR LOAN LOSSES (CONTINUED)
The following tables present total loans by risk categories as of December 31, 2017 and 2016:
NICOLET BANKSHARES, INC.
Notes to Consolidated Financial Statements
NOTE 4. LOANS AND ALLOWANCE FOR LOAN LOSSES (CONTINUED)
The following table presents impaired loans and then as a further breakdown by originated or acquired as of December 31, 2017 and 2016:
NICOLET BANKSHARES, INC.
Notes to Consolidated Financial Statements
NOTE 4. LOANS AND ALLOWANCE FOR LOAN LOSSES (CONTINUED)
There were no originated impaired loans as of December 31, 2016. All loans in the table above were acquired loans.
In April 2017, the First Menasha merger added purchased credit impaired loans at a fair value of $5.4 million, net of an initial $5.9 million nonaccretable mark. Also, during the third quarter of 2017 a loan with a fair value of $0.7 million was acquired, net of an initial $2.4 million nonaccretable mark. Including this 2017 activity, total purchased credit impaired loans (in aggregate since the Company’s 2013 acquisitions) were initially recorded at a fair value of $43.6 million on their respective acquisition dates, net of an initial $34.4 million nonaccretable mark and a zero accretable mark. At December 31, 2017, $13.5 million of the $43.6 million remain in impaired loans and $0.7 million of acquired loans have subsequently become impaired, bringing acquired impaired loans to $14.2 million.
Troubled Debt Restructurings
At December 31, 2017, there were eight loans classified as troubled debt restructurings, compared to five loans at December 31, 2016. These eight loans had a pre-modification balance of $6.9 million and at December 31, 2017, had a balance of $5.6 million. There were no loans which were classified as troubled debt restructurings during the previous twelve months that subsequently defaulted during 2017. As of December 31, 2017 there were no commitments to lend additional funds to debtors whose terms have been modified in troubled debt restructurings.
NICOLET BANKSHARES, INC.
Notes to Consolidated Financial Statements
NOTE 5. PREMISES AND EQUIPMENT
Premises and equipment, less accumulated depreciation and amortization, is summarized as follows as of December 31:
Depreciation and amortization expense amounted to $4.2 million in 2017, $3.2 million in 2016, and $2.4 million in 2015. The Company and certain of its subsidiaries are obligated under non-cancelable operating leases for facilities, certain of which provide for increased rentals based upon increases in cost of living adjustments and other indices. Rent expense under leases totaled $1.1 million in 2017, $0.8 million in 2016, and $0.8 million in 2015.
At December 31, 2017, the approximate minimum annual rentals under these non-cancelable lease agreements with remaining terms in excess of one year are as follows:
During the second quarter of 2016, a $1.7 million lease termination liability and charge to other expense was recorded due to the closure of a branch, concurrent with the consummation date of the Baylake merger. Payments are expected to continue to the lessor for the remainder of the lease term. Since the remaining lease payments have been recognized against earnings, the remaining lease payments were excluded from the above table.
NOTE 6. GOODWILL AND OTHER INTANGIBLES AND MORTGAGE SERVICING RIGHTS
A summary of goodwill and other intangibles, as well as the MSR asset which is included in other assets in the consolidated balance sheets, at December 31 is as follows:
Goodwill: Goodwill was $107.4 million at December 31, 2017 and $66.7 million at December 31, 2016. During 2017, goodwill increased due to the First Menasha acquisition. See Note 1 for the Company’s accounting policy for goodwill and see Note 2 for additional information on the Company’s acquisitions.
NICOLET BANKSHARES, INC.
Notes to Consolidated Financial Statements
NOTE 6. GOODWILL AND OTHER INTANGIBLES AND MORTGAGE SERVICING RIGHTS (CONTINUED)
Other intangibles: Other intangible assets, consisting of core deposit intangibles (related to branch or bank acquisitions) and customer list intangibles (related to the customer relationships acquired in the 2016 financial advisor business acquisition), are amortized over their estimated finite lives. During 2017, core deposit intangibles increased due to the First Menasha acquisition and customer list intangibles increased due to a modification to the contingent earn-out payment on the financial advisor business acquired in 2016, fixing the previously variable earn-out payment on a portion of the purchase price. See Note 1 for the Company’s accounting policy for other intangibles and see Note 2 for additional information on the Company’s acquisitions.
Mortgage servicing rights: A summary of the changes in the MSR asset for the periods indicated is as follows:
The Company periodically evaluates its mortgage servicing rights asset for impairment. No valuation allowance or impairment charge was recorded for 2017 or 2016. See Note 1 for the Company’s accounting policy for MSRs, see Note 2 for additional information on the Company’s acquisitions, and see Note 20 for additional information on the fair value of the MSR asset.
NICOLET BANKSHARES, INC.
Notes to Consolidated Financial Statements
NOTE 6. GOODWILL AND OTHER INTANGIBLES AND MORTGAGE SERVICING RIGHTS (CONTINUED)
The following table shows the estimated future amortization expense for amortizing intangible assets. The projections are based on existing asset balances, the current interest rate environment and prepayment speeds as of the December 31, 2017. The actual amortization expense the Company recognizes in any given period may be significantly different depending upon acquisition or sale activities, changes in interest rates, prepayment speeds, market conditions, regulatory requirements and events or circumstances that indicate the carrying amount of an asset may not be recoverable.
NOTE 7. OTHER REAL ESTATE OWNED
A summary of OREO, which is included in other assets in the consolidated balance sheets, for the periods indicated is as follows:
NOTE 8. dEPOSITS
Brokered deposits were $120.8 million and $20.9 million at December 31, 2017 and 2016, respectively. The average rate on brokered deposits was 0.65% and 1.12% for the years ended December 31, 2017 and 2016, respectively.
At December 31, 2017, the scheduled maturities of time deposits were as follows:
The aggregate amount of time deposits, each with a minimum denomination of $250,000, was $50.4 million and $33.0 million at December 31, 2017 and 2016, respectively.
NICOLET BANKSHARES, INC.
Notes to Consolidated Financial Statements
NOTE 9. NOTES PAYABLE
The Company had notes payable of $36.5 million and $1.0 million at December 31, 2017 and 2016, respectively, comprised entirely of FHLB advances. The FHLB advances bear fixed rates, require interest-only monthly payments, and have maturities ranging from February 2018 to November 2022. The weighted average rate of the FHLB advances was 1.71% and 1.17% at December 31, 2017 and 2016, respectively. The FHLB advances are collateralized by a blanket lien on qualifying first mortgages, home equity loans, multi-family loans and certain farmland loans which had a pledged balance of $313.5 million and $283.8 million at December 31, 2017 and 2016, respectively.
The following table shows the maturity schedule of the notes payable as of December 31, 2017.
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 December 31, 2017, the available line was $10 million, the rate was one-month LIBOR plus 2.25% with a 3.25% floor. The outstanding balance was zero at December 31, 2017 and 2016, and the line was not used during 2017 or 2016.
NOTE 10. JUNIOR SUBORDINATED DEBENTURES
The following table shows the breakdown of junior subordinated debentures as of December 31, 2017 and 2016. Interest on all debentures is current. Any applicable discounts (initially recorded to carry an acquired debenture at its then estimated fair market value) are being accreted to interest expense over the remaining life of the debentures. All the debentures below are currently callable and may be redeemed in part or in full plus any accrued but unpaid interest.
(1)The interest rate is 8.00% fixed.
(2)The debentures, assumed in April 2013 as the result of an acquisition, have a floating rate of the three-month LIBOR plus 1.43%, adjusted quarterly. The interest rates were 3.02% and 2.39% as of December 31, 2017 and 2016, respectively.
(3)The debentures, assumed in April 2016 as a result of an acquisition, have a floating rate of the three-month LIBOR plus 1.35%, adjusted quarterly. The interest rates were 3.04% and 2.35% as of December 31, 2017 and 2016, respectively.
(4)The debentures, assumed in April 2017 as the result of an acquisition, have a floating rate of the three-month LIBOR plus 2.79%, adjusted quarterly. The interest rate was 4.39% as of December 31, 2017.
Each of the junior subordinated debentures was issued to an underlying statutory trust (the “statutory trusts”), which issued trust preferred securities and common securities and used the proceeds from the issuance of the common and the trust preferred securities to purchase the junior subordinated debentures of the Company. The debentures represent the sole asset of the statutory trusts. All of the common securities of the statutory trusts are owned by the Company. The statutory trusts are not included in the consolidated financial statements. The net effect of all the documents entered into with respect to the trust preferred securities is that the Company, through payments on its debentures, is liable for the distributions and other payments required on the trust preferred securities. At December 31, 2017 and 2016, $28.5 million and $23.7 million, respectively, of trust preferred securities qualify as Tier 1 capital.
NICOLET BANKSHARES, INC.
Notes to Consolidated Financial Statements
NOTE 11. SUBORDINATED NOTES
In 2015 the Company placed an aggregate of $12 million in subordinated Notes in private placements with certain accredited investors. All Notes were issued with 10-year maturities, have a fixed annual interest rate of 5% payable quarterly, are callable on or after the fifth anniversary of their respective issuances dates, and qualify for Tier 2 capital for regulatory purposes. At December 31, 2017, the carrying value of these subordinated notes was $11.9 million.
The $180,000 debt issuance costs associated with the $12 million Notes are being amortized on a straight line basis over the first five years, representing the no-call periods, as additional interest expense. As of December 31, 2017 and 2016, $79,000 and $115,000, respectively, of unamortized debt issuance costs remain and are reflected as a reduction to the carrying value of the outstanding debt.
NOTE 12. EMPLOYEE AND DIRECTOR BENEFIT PLANS
The Company sponsors two deferred compensation plans, one for certain key management employees and another for directors. Under the management plan, which was amended in 2016, employees designated by the Board of Directors may elect to defer compensation and the Company may at its discretion make nonelective contributions on behalf of one or more eligible plan participants. Upon retirement, termination of employment or at their election, the employee shall become entitled to receive the deferred amounts plus earnings thereon. The liability for the cumulative employee contributions and earnings thereon at December 31, 2017 totaled approximately $152,000 and is included in other liabilities on the consolidated balance sheets. In December 2017, the Company made nonelective contributions totaling $700,000 to selected recipients, to vest and be expensed ratably over five years from the date of grant.
Under the director plan, participating directors may defer up to 100% of their Board compensation towards the purchase of Company common stock at market prices on a quarterly basis that is held in a Rabbi Trust and distributed when each such participating director ends his or her board service. During 2017 and 2016, the director plan purchased 4,427 and 3,796 shares of Company common stock valued at approximately $229,000 and $138,000, respectively. In 2017, common stock valued at approximately $473,000 (and representing 9,900 shares) was distributed to past directors. There were no distributions in 2016. The common stock outstanding and the related director deferred compensation liability are offsetting components of the Company’s equity in the amount of $636,000 at year end 2017 and $641,000 at year end 2016 representing 22,853 shares and 28,510 shares, respectively.
The Company sponsors a 401(k) savings plan under which eligible employees may choose to save up to 100% of salary compensation on either a pre-tax or after-tax basis, subject to certain IRS limits. Under the plan, the Company matches 100% of participating employee contributions up to 6% of the participant’s gross compensation. The Company contribution vests over five years. The Company can make additional annual discretionary profit sharing contributions, as determined by the Board of Directors. During 2017, 2016 and 2015, the Company’s 401(k) expense was approximately $2.0 million (including a $0.5 million profit sharing contribution), $1.2 million and $0.9 million, respectively. During 2016, the plan was amended and participants can no longer elect to buy Company common stock within their 401(k) portfolio.
NICOLET BANKSHARES, INC.
Notes to Consolidated Financial Statements
NOTE 13. STOCK-BASED COMPENSATION
At December 31, 2017, the Company had three stock-based compensation plans. These plans are administered by a committee of the Board of Directors and provide for the granting of various equity awards in accordance with the plan documents to certain officers, employees and directors of the Company.
The Company’s 2002 Stock Incentive Plan initially covered 125,000 shares of the Company’s common stock. The Company, with subsequent shareholder approval, revised this plan to allow for additional shares in 2005 and in 2008, resulting in a total of 1,175,000 shares reserved for potential stock options under the 2002 Plan.
The Company also adopted, with subsequent shareholder approval, the 2011 Long Term Incentive Plan covering up to 500,000 shares of the Company’s common stock. The Company, with subsequent shareholder approval, revised this plan to allow for 1,000,000 additional shares in 2016, resulting in a total of 1,500,000 shares reserved for potential stock-based awards. This plan provides for certain stock-based awards such as, but not limited to, stock options, stock appreciation rights and restricted common stock, as well as cash performance awards.
As part of the 2016 Baylake acquisition, the Company assumed sponsorship of the Baylake Corp. 2010 Equity Incentive Plan and also assumed 91,701 stock options issued under such plan at the acquisition date. The Company amended the plan to rename it the Nicolet Bankshares, Inc. 2010 Equity Incentive Plan and to provide that no further awards be granted under this plan.
In general, for stock options granted the exercise price will not be less than the fair value of the Company’s common stock on the date of grant, the options will become exercisable based upon vesting terms determined by the committee, and the options will expire ten years after the date of grant. In general, for restricted stock granted the shares are issued at the fair value of the Company’s common stock on the date of grant, are restricted as to transfer, but are not restricted as to dividend payments or voting rights, and the transfer restrictions lapse over time, depending upon vesting terms provided for in the grant and contingent upon continued employment.
As of December 31, 2017, approximately 156,000 shares were available for grant under these plans (collectively the “Stock Incentive Plans”).
A Black-Scholes model is utilized to estimate the fair value of stock options. See Note 1 for the Company’s accounting policy on stock-based compensation. The weighted average assumptions used in the model for valuing stock option grants in 2017 and 2016 were as follows:
NICOLET BANKSHARES, INC.
Notes to Consolidated Financial Statements
NOTE 13. STOCK-BASED COMPENSATION (CONTINUED)
Activity of the 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, and accordingly 85,422 shares, 10,244 shares and 167,779 shares were surrendered in 2017, 2016 and 2015, respectively.
The following options were outstanding at December 31, 2017:
NICOLET BANKSHARES, INC.
Notes to Consolidated Financial Statements
NOTE 13. STOCK-BASED COMPENSATION (CONTINUED)
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 2017, 2016 and 2015 was approximately $7.5 million, $1.3 million, and $5.2 million, respectively. The total intrinsic value of exercisable shares at December 31, 2017 was approximately $11.7 million.
*The terms of the restricted stock agreements permit the surrender of shares to the Company upon vesting in order to satisfy applicable tax withholding at the minimum statutory withholding rate, and accordingly 5,266 shares, 7,851 shares and 7,715 shares were surrendered during 2017, 2016 and 2015, respectively.
The Company recognized $3.1 million, $1.6 million and $1.2 million of stock-based compensation expense during the years ended December 31, 2017, 2016 and 2015, respectively, associated with its common stock awards. As of December 31, 2017, there was approximately $17.0 million of unrecognized compensation cost related to equity award grants. The cost is expected to be recognized over the remaining vesting period of approximately three years.
NOTE 14. STOCKHOLDERS’ EQUITY
As of December 31, 2017, the Board of Directors has authorized the use of up to $30 million to repurchase up to 1,050,000 shares of outstanding common stock. Through December 31, 2017, $24.1 million was used to repurchase and cancel 707,163 common shares at a weighted average price of $34.12 per share including commissions.
On April 28, 2017, in connection with its acquisition of First Menasha, the Company issued 1,309,885 shares of its common stock for consideration of $62.2 million plus cash consideration of $19.3 million. Approximately $0.2 million in direct stock issuance costs for the merger were incurred and charged against additional paid-in capital. See Note 2 for additional information on the Company’s acquisitions.
On April 29, 2016, in connection with its acquisition of Baylake, the Company issued 4,344,243 shares of its common stock for consideration of $163.3 million, and recorded $1.2 million consideration for assumed stock options. Approximately $0.3 million in direct stock issuance costs for the merger were incurred and charged against additional paid-in capital. In connection with the financial advisor business acquisition that completed April 1, 2016, the Company issued $2.6 million in common stock consideration. On February 24, 2016, Nicolet’s common stock moved off the OTCBB and began trading on the Nasdaq Capital Market, also under the trading symbol of “NCBS.”
NICOLET BANKSHARES, INC.
Notes to Consolidated Financial Statements
NOTE 15. INCOME TAXES
The current and deferred amounts of income tax expense were as follows:
On December 22, 2017, the Tax Cuts and Jobs Act was signed into law. The new law amends the Internal Revenue Code to reduce corporate tax rates and modify various tax policies, credits, and deductions. The corporate federal tax rate was reduced from a maximum of 35% to a flat 21% rate, which is effective for the Company beginning January 1, 2018. As a result of the corporate tax rate reduction, the Company reduced its net deferred tax asset for the year ended December 31, 2017, by $885,000, which was recognized as additional income tax expense.
The differences between the income tax expense recognized and the amount computed by applying the statutory federal income tax rate of 35% to the income before income taxes, less noncontrolling interest, for the years ended as indicated are included in the following table.
* See Recent Accounting Pronouncements Adopted within Note 1 for additional information on the deduction attributable to share-based payments.
NICOLET BANKSHARES, INC.
Notes to Consolidated Financial Statements
NOTE 15. INCOME TAXES (CONTINUED)
The net deferred tax asset includes the following amounts of deferred tax assets and liabilities at December 31:
A valuation allowance is required if it is more likely than not that some portion of the deferred tax asset will not be realized. At December 31, 2017 and 2016, no valuation allowance was determined to be necessary.
At December 31, 2017, the Company had a federal and state net operating loss carryforward of $4.9 million and $20.3 million, respectively. Of these amounts, the entire $4.9 million of federal net operating loss carryover and $18.0 million of the state net operating loss carryover were the result of the Company’s mergers with Mid-Wisconsin, Baylake, and First Menasha. The federal and state net operating loss carryovers resulting from the mergers have been included in the IRC section 382 limitation calculation and are being limited to the overall amount expected to be realized. The full $2.3 million state net operating loss carried over from the Company’s regular operations is expected to be utilized over the next 14 years and will not expire. The Company’s federal income tax returns are open and subject to examination from the 2014 tax return year and forward. The years open to examination by state and local government authorities varies by jurisdiction.
NICOLET BANKSHARES, INC.
Notes to Consolidated Financial Statements
NOTE 16. COMMITMENTS AND CONTINGENCIES
The Company is party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit, financial guarantees, and standby letters of credit. They involve, to varying degrees, elements of credit risk in excess of amounts recognized on the consolidated balance sheets. See Note 1 for the Company’s accounting policy on commitments and contingencies.
The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instruments for commitments to extend credit and standby letters of credit is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and issuing letters of credit as they do for on-balance-sheet instruments.
A summary of the contract or notional amount of the Company’s exposure to off-balance-sheet risk as of December 31 is as follows:
Interest rate lock commitments to originate residential mortgage loans held for sale and forward commitments to sell residential mortgage loans held for sale are considered derivative instruments and the contractual amounts were $28.0 million and $1.8 million, respectively, at December 31, 2017. The fair value of these commitments was not material at December 31, 2017.
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commercial-related commitments to extend credit represented 78% and 80% of the total year-end commitments for 2017 and 2016, respectively, and were predominantly commercial lines of credit that carry a term of one year or less. The commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.
Financial and performance standby letters of credit are conditional commitments issued to guarantee the performance of a customer to a third party. Financial standby letters of credit are issued specifically to facilitate commerce and typically result in the commitment being drawn on when the underlying transaction is consummated between the customer and the third party, while performance standby letters of credit generally are contingent upon the failure of the customer to perform according to the terms of the underlying contract with the third party. Both of these guarantees are primarily issued to support public and private borrowing arrangements and, generally, have terms of one year or less. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Company holds collateral, which may include accounts receivable, inventory, property, equipment, and income-producing properties, supporting those commitments if deemed necessary. In the event the customer does not perform in accordance with the terms of the agreement with the third-party, the Company would be required to fund the commitment. The maximum potential amount of future payments the Company could be required to make is represented by the contractual amount. If the commitment is funded, the Company would be entitled to seek recovery from the customer. At December 31, 2017 and 2016, no amounts have been recorded as liabilities for the Company’s potential obligations under these guarantees.
The Company has federal funds accommodations with other financial institutions where funds may be borrowed on a short-term basis at the market rate in effect at the time of the borrowing. The total federal funds accommodations as of December 31, 2017 and 2016 were $158 million and $143 million, respectively. At December 31, 2017 and 2016, the Company had no outstanding balance on these lines.
In the normal course of business, the Company is involved in various legal proceedings. In the opinion of management, any liability resulting from such proceedings would not have a material adverse effect on the consolidated financial statements.
NICOLET BANKSHARES, INC.
Notes to Consolidated Financial Statements
NOTE 17. RELATED PARTY TRANSACTIONS
The Company conducts transactions, in the normal course of business, with its directors and officers, including companies in which they have a beneficial interest. It is the Company’s policy to comply with federal regulations that require that these transactions with directors and executive officers be made on substantially the same terms as those prevailing at the time made for comparable transactions to other persons. Related party loans totaled approximately $67.7 million and $54.0 million at December 31, 2017 and 2016, respectively.
As described in Note 1, the Company has a 50% ownership in a joint venture with the Firm in connection with the Company’s headquarters facility. The Firm is considered a related party, as one of its principals is a Board member and shareholder of the Company. During 2017, 2016 and 2015, the Bank incurred approximately $1.1 million, $1.1 million and $1.2 million, respectively, in rent expense to the joint venture. In October 2013, the Company entered into a lease for a new branch location in a facility owned by a different member of the Company’s Board and incurred less than $120,000 annually of rent expense on this facility during 2017, 2016, and 2015. In February 2016, the Company entered into a lease agreement for a non-branch location owned by a relative of a senior management team member and paid approximately $138,000 in 2017 and $100,000 in 2016 to the company owned by the relative. This same relative, who is employed by the Company, received approximately $668,000 in 2017 and $420,000 in 2016 for his compensation as a financial advisor. Another relative of the same senior management team member, who is also employed by the Company, received approximately $257,000 in 2017 and $400,000 in 2016 for his compensation as a financial advisor.
NOTE 18. GAIN ON SALE, DISPOSAL OR WRITE-DOWN OF ASSETS, NET
Components of the net gain on sale, disposal or write-down of assets are as follows for the years ended December 31:
NOTE 19. REGULATORY CAPITAL REQUIREMENTS AND RESTRICTIONS OF DIVIDENDS
The Company (on a consolidated basis) and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company and Bank’s financial statements.
Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk-weightings, and other factors. Prompt corrective action provisions are not applicable to bank holding companies.
NICOLET BANKSHARES, INC.
Notes to Consolidated Financial Statements
NOTE 19. REGULATORY CAPITAL REQUIREMENTS AND RESTRICTIONS OF DIVIDENDS (CONTINUED)
Quantitative measures established by regulation to ensure capital adequacy require the Company and Bank to maintain minimum amounts and ratios of Total, Tier 1 and common equity Tier 1 (“CET1”) capital (as defined in the regulations) to risk-weighted assets (as defined), and Tier 1 capital (as defined) to average assets (as defined). Management believes, as of December 31, 2017 and 2016, that the Company and the Bank met all capital adequacy requirements to which they are subject.
As of December 31, 2017 and 2016, the most recent notifications from the regulatory agencies categorized the Bank as well-capitalized under the regulatory framework for prompt corrective action. To be categorized as well-capitalized, an institution must maintain minimum Total risk-based, Tier 1 risk-based, CET1 risk-based and Tier 1 leverage ratios as set forth in the following table. There are no conditions or events since these notifications that management believes have changed the Bank’s category.
The Company’s and the Bank’s actual regulatory capital amounts and ratios as of December 31, 2017 and 2016 are presented in the following table.
(1)The Total risk-based capital ratio is defined as Tier 1 capital plus tier 2 capital divided by total risk-weighted assets. The Tier 1 risk-based capital ratio is defined as Tier 1 capital divided by total risk-weighted assets. CET1 risk-based capital ratio is defined as Tier 1 capital, with deductions for goodwill and other intangible assets (other than mortgage servicing assets), net of associated deferred tax liabilities, and limitations on the inclusion of deferred tax assets, mortgage servicing assets and investments in other financial institutions, in each case as provided further in the rules, divided by total risk-weighted assets. The Leverage ratio is defined as Tier 1 capital divided by the most recent quarter’s average total assets as adjusted.
(2)Prompt corrective action provisions are not applicable at the bank holding company level.
NICOLET BANKSHARES, INC.
Notes to Consolidated Financial Statements
NOTE 19. REGULATORY CAPITAL REQUIREMENTS AND RESTRICTIONS OF DIVIDENDS (CONTINUED)
A source of income and funds for the Company are dividends from the Bank. Dividends declared by the Bank that exceed the retained net income for the most current year plus retained net income for the preceding two years must be approved by Federal regulatory agencies. During the third quarter of 2016, the Bank requested approval from the regulatory agencies to pay a $15 million special dividend from Bank surplus and it was approved. At December 31, 2017, the Bank had minimal capacity to pay dividends without seeking regulatory approval.
NOTE 20. FAIR VALUE OF FINANCIAL INFORMATION
Fair value represents the estimated price at which an orderly transaction to sell an asset or transfer a liability would take place between market participants at the measurement date under current market conditions (i.e., an exit price concept), and is a market-based measurement versus an entity-specific measurement.
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.
Recurring basis fair value measurements:
The following table presents the balances of assets and liabilities measured at fair value on a recurring basis for the periods presented:
NICOLET BANKSHARES, INC.
Notes to Consolidated Financial Statements
NOTE 20. FAIR VALUE OF FINANCIAL INFORMATION (CONTINUED)
The following table presents the changes in Level 3 assets measured at fair value on a recurring basis during the years ended December 31:
The following is a description of the valuation methodologies used by the Company for the Securities AFS noted in the tables above. 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 U.S. government agency securities, mortgage-backed securities, obligations of state, county and municipals, and certain corporate debt securities. 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 December 31, 2017 and 2016, 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.
Nonrecurring basis fair value measurements:
The following table presents the Company’s assets measured at fair value on a nonrecurring basis as of December 31, 2017 and 2016, aggregated by the level in the fair value hierarchy within which those measurements fall.
The following is a description of the valuation methodologies used by the Company for the items noted in the table above. 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. 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 the expected future cash flows for each stratum.
NICOLET BANKSHARES, INC.
Notes to Consolidated Financial Statements
NOTE 20. FAIR VALUE OF FINANCIAL INFORMATION (CONTINUED)
Financial instruments:
The carrying amounts and estimated fair values of the Company's financial instruments are shown below.
Not all the financial instruments listed in the table above are subject to the disclosure provisions of ASC 820, as certain assets and liabilities result in their carrying value approximating fair value. These include cash and cash equivalents, BOLI, and nonmaturing deposits. For those financial instruments not previously disclosed the following is a description of the evaluation methodologies used.
NICOLET BANKSHARES, INC.
Notes to Consolidated Financial Statements
NOTE 20. FAIR VALUE OF FINANCIAL INFORMATION (CONTINUED)
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.
Other investments: The carrying amount of Federal Reserve Bank, Bankers Bank, Federal Agricultural Mortgage Corporation, 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.
MSR 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, generally through a valuation allowance. 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 of the MSR asset is considered a Level 3 measurement.
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 FHLB advances is obtained from the FHLB which uses a discounted cash flow analysis based on current market rates of similar maturity debt securities and represents a Level 2 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.
NICOLET BANKSHARES, INC.
Notes to Consolidated Financial Statements
NOTE 20. FAIR VALUE OF FINANCIAL INFORMATION (CONTINUED)
Off-balance-sheet financial instruments: At December 31, 2017 and 2016, the estimated fair value of letters of credit, of loan commitments on which the committed interest rate is less than the current market rate, and of outstanding mandatory commitments to sell residential mortgages into the secondary market were not significant.
Limitations: Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of a particular financial instrument. Fair value estimates may not be realizable in an immediate settlement of the instrument. In some instances, there are no quoted market prices for the Company’s various financial instruments, in which case fair values may be based on estimates using present value or other valuation techniques, or based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of the financial instruments, or other factors. Those techniques are significantly affected by the assumptions used, including the discount rate and estimate of future cash flows. Subsequent changes in assumptions could significantly affect the estimates.
NOTE 21. PARENT COMPANY ONLY FINANCIAL INFORMATION
Condensed parent company only financial statements of Nicolet Bankshares, Inc. follow:
NICOLET BANKSHARES, INC.
Notes to Consolidated Financial Statements
NOTE 21. PARENT COMPANY ONLY FINANCIAL INFORMATION (CONTINUED)
NOTE 22. EARNINGS PER COMMON SHARE
See Note 1 for the Company’s accounting policy on earnings per common share. Earnings per common share and related information are summarized as follows:
Options to purchase approximately 0.1 million and 0.2 million shares outstanding for the years ending December 31, 2017 and 2015, respectively, are excluded from the calculation of diluted earnings per common share as the effect of their exercise would have been anti-dilutive. There were no options to purchase shares that were excluded from the calculation of diluted earnings per share for the year ended December 31, 2016.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Stockholders and the Board of Directors of Nicolet Bankshares, Inc.
Opinions on the Consolidated Financial Statements and Internal Control Over Financial Reporting
We have audited the accompanying consolidated balance sheets of Nicolet Bankshares, Inc. and subsidiaries (the “Company”) as of December 31, 2017 and 2016, and the related consolidated statements of income, comprehensive income, changes in stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2017, and the related notes (collectively, the consolidated financial statements). We also have audited the Company’s internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission in 2013.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2017 and 2016, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2017, in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission in 2013.
Basis for Opinions
The Company’s management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Report of Management. Our responsibility is to express an opinion on the Company’s consolidated financial statements and an opinion on the Company’s internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with U.S. federal securities laws and applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.
Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
Definition and Limitations of Internal Control Over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of consolidated financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of consolidated financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on the consolidated financial statements.
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.
We have served as the Company’s auditor since 2005.
Atlanta, Georgia
March 7, 2018
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A.
ITEM 9A.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 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 in timely alerting them to material information relating to Nicolet that is required to be included in Nicolet’s periodic filings with the SEC. During the fourth quarter of 2017 there were no significant changes in the Company’s internal controls that materially affected, or are reasonably likely to materially affect, the Company’s internal control 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.
Management’s Annual Report on Internal Control Over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over financial reporting. The Company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Company’s financial statements for external purposes in accordance with generally accepted accounting principles. Internal control over financial reporting is defined in Rules 13a-15(f) and 15d-15(f) promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”).
As of December 31, 2017, management assessed the effectiveness of the Company’s internal control over financial reporting based on criteria for effective internal control over financial reporting established in “Internal Control - Integrated Framework,” issued by the Committee of Sponsoring Organization of the Treadway Commission (COSO) in 2013. Based on this assessment, management has determined that the Company’s internal control over financial reporting as of December 31, 2017, was effective.
Porter Keadle Moore, LLC, the independent registered public accounting firm that audited the consolidated financial statements of the Company included in this Annual Report on Form 10-K, has issued an attestation report on the effectiveness of the Company’s internal control over financial reporting as of December 31, 2017. The report, which expresses an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting as of December 31, 2017 is included under the heading “Report of Independent Registered Public Accounting Firm.”
ITEM 9B.
ITEM 9B.OTHER INFORMATION
None.
PART III
ITEM 10.
ITEM 10.DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Code of Ethics
The Company has adopted a Code of Ethics that applies to its senior financial officers. A copy is available, without charge, upon telephonic or written request addressed to Ann K. Lawson, Chief Financial Officer, Nicolet Bankshares, Inc., 111 North Washington Street, Green Bay, Wisconsin 54301, telephone (920) 430-1400.
The remaining information required in Part III, Item 10 is incorporated by reference to the registrant’s definitive proxy statement for the 2018 Annual Meeting of Shareholders.
ITEM 11.
ITEM 11.EXECUTIVE COMPENSATION
The information required in Part III, Item 11 is incorporated by reference to the registrant’s definitive proxy statement for the 2018 Annual Meeting of Shareholders.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
Equity Compensation Plan Information
(1) Includes 30,920 shares potentially issuable upon the vesting of outstanding restricted stock.
(2) The weighted average exercise price relates only to the exercise of outstanding options included in column (a).
The remaining information required in Part III, Item 12 is incorporated by reference to the registrant’s definitive proxy statement for the 2018 Annual Meeting of Shareholders.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The information required in Part III, Item 13 is incorporated by reference to the registrant’s definitive proxy statement for the 2018 Annual Meeting of Shareholders.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
The information required in Part III, Item 14 is incorporated by reference to the registrant’s definitive proxy statement for the 2018 Annual Meeting of Shareholders.
PART IV
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
* 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.
(1) Incorporated by reference to the exhibit of the same number in the Registrant’s Registration Statement on Form S-4, filed on November 24, 2015 (Regis. No. 333-208192).
(2) Incorporated by reference to Exhibit 2.1 in the Registrant’s Registration Statement on Form S-4, filed on December 13, 2016 (Regis. No. 333-215057).
(3) Incorporated by reference to Exhibit 3.1 to the Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 2013, filed on March 12, 2014 (File No. 333-90052).
(4) Incorporated by reference to Exhibit 3.1 in the Registrant’s Current Report on Form 8-K filed on May 2, 2016 (File No. 001-37700).
(5) Incorporated by reference to the exhibit of the same number in the Registrant’s Registration Statement on Form S-4, filed on February 1, 2013 (Regis. No. 333-186401).
(6) Incorporated by reference to Exhibit 4.1 to the Registrant’s Current Report on Form 8-K filed on February 17, 2015 (File No. 333-90052).
(7) Incorporated by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed on May 2, 2016 (File No. 001-37700).
(8) Incorporated by reference to the Exhibit 10.4 to the Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 2014, filed on March 9, 2015 (File No. 333-90052).
(9) Incorporated by reference to Appendix A of the Registrant’s Proxy Statement filed June 30, 2016.
(10) Incorporated by reference to Exhibit 10.4 to the Registrant’s Current Report on Form 8-K filed on May 2, 2016 (File No. 001-37700).
(11) Incorporated by reference to Exhibit 10.2 to the Registrant’s Current Report on Form 8-K filed on May 2, 2016 (File No. 001-37700).
(12) Incorporated by reference to Exhibit 10.5 to the Registrant’s Current Report on Form 8-K filed on May 2, 2016 (File No. 001-37700).
(13) Incorporated by reference to Appendix A of the Registrant’s Proxy Statement filed March 7, 2018.
(14) Incorporated by reference to the Exhibit 10.6 to the Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 2016, filed on March 10, 2017 (File No. 001-37700).
ITEM 16. FORM 10-K SUMMARY
None.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
NICOLET BANKSHARES, INC.
March 7, 2018
By: /s/ Robert B. Atwell
Robert B. Atwell, Chairman and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report on Form 10-K has been signed below by the following persons on behalf of the registrant and in the capacities and on the date indicated.
March 7, 2018
/s/ Robert B. Atwell
/s/ Donald J. Long, Jr.
Robert B. Atwell
Donald J. Long, Jr.
Chairman, President and Chief Executive Officer
Director
(Principal Executive Officer)
/s/ Ann K. Lawson
/s/ Dustin J. McClone
Ann K. Lawson
Dustin J. McClone
Chief Financial Officer
Director
(Principal Financial and Accounting Officer)
/s/ Robert W. Agnew
/s/ Susan L. Merkatoris
Robert W. Agnew
Susan L. Merkatoris
Director
Director
/s/ Michael E. Daniels
/s/ Randy J. Rose
Michael E. Daniels
Randy J. Rose
President and Chief Operating Officer, Director
Director
/s/ John N. Dykema
/s/ Oliver Pierce Smith
John N. Dykema
Oliver Pierce Smith
Director
Director
/s/ Terrence R. Fulwiler
/s/ Robert J. Weyers
Terrence R. Fulwiler
Robert J. Weyers
Director
Director
/s/ Christopher J. Ghidorzi
Christopher J. Ghidorzi
Director
/s/ Michael J. Gilson
Michael J. Gilson
Director
/s/ Thomas L. Herlache
Thomas L. Herlache
Director
/s/ Louis J. “Rick” Jeanquart
Louis J. “Rick” Jeanquart
Director