10-K 1 tv487136_10k.htm FORM 10-K

 

 

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-K

 

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

 

For the fiscal year ended December 31, 2017

 

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

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

 

Commission file number 001-37700

 

NICOLET BANKSHARES, INC.

(Exact name of registrant as specified in its charter)

 

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

 

111 North Washington Street

Green Bay, Wisconsin 54301

(920) 430-1400

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

 

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

 

Title of each class   Name of each exchange on which registered
Common Stock, par value $0.01 per share   The NASDAQ Stock Market LLC

 

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No x

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No x

 

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

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨

 

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

Large accelerated filer ¨ Accelerated filer x

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

Emerging growth company x

 

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

 

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

 

As of June 30, 2017, (the last business day of the registrant’s most recently completed second fiscal quarter) the aggregate market value of the common stock held by nonaffiliates of the registrant was approximately $453.3 million based on the closing sale price of $54.71 per share as reported on Nasdaq on June 30, 2017. The registrant’s common stock commenced trading on the Nasdaq Capital Market on February 24, 2016.

 

As of February 28, 2018 9,742,160 shares of common stock were outstanding.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Part III of Form 10-K – Portions of the Proxy Statement for the 2018 Annual Meeting of Shareholders. 

 

 

 

 

 

 

Nicolet Bankshares, Inc.

 

TABLE OF CONTENTS

 

      PAGE
PART I
       
  Item 1. Business 3-9
       
  Item 1A. Risk Factors 10-15
       
  Item 1B. Unresolved Staff Comments 15
       
  Item 2. Properties 15
       
  Item 3. Legal Proceedings 15
       
  Item 4. Mine Safety Disclosures 15
       
PART II
     
  Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities 16-17
       
  Item 6. Selected Financial Data 17-18
       
  Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations 19-45
       
  Item 7A. Quantitative and Qualitative Disclosures about Market Risk 45
       
  Item 8. Financial Statements and Supplementary Data 46-95
       
  Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 96
       
  Item 9A. Controls and Procedures 96
       
  Item 9B. Other Information 96
       
PART III
       
  Item 10. Directors, Executive Officers and Corporate Governance 97
       
  Item 11. Executive Compensation 97
       
  Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters 97
       
  Item 13. Certain Relationships and Related Transactions, and Director Independence 97
       
  Item 14. Principal Accounting Fees and Services 97
       
PART IV
       
  Item 15. Exhibits, Financial Statement Schedules 98-99
       
  Item 16. Form 10-K Summary 99
       
  Signatures   100

 

 2 

 

 

Forward-Looking Statements

 

This Annual Report on Form 10-K contains forward-looking statements within the meaning of the federal securities law. Statements in this report that are not strictly historical are forward-looking and based upon current expectations that may differ materially from actual results. These forward-looking statements, identified by words such as “will”, “expect”, “believe” and “prospects”, involve risks and uncertainties that could cause actual results to differ materially from those anticipated by the statements made herein. These risks and uncertainties include, but are not limited to, general economic trends and changes in interest rates, increased competition, regulatory or legislative developments affecting the financial industry generally or Nicolet Bankshares, Inc. specifically, the interpretations and impact of recently enacted tax legislation, changes in consumer demand for financial services, the possibility of unforeseen events affecting the industry generally or Nicolet Bankshares, Inc. specifically, the uncertainties associated with newly developed or acquired operations and market disruptions. Nicolet Bankshares, Inc. undertakes no obligation to release revisions to these forward-looking statements publicly to reflect events or circumstances after the date hereof or to reflect the occurrence of unforeseen events, except as required to be reported under the rules and regulations of the Securities and Exchange Commission (“SEC”).

 

PART I

 

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.

 

 3 

 

 

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.

 

 4 

 

 

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.

 

 5 

 

 

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.

 

 6 

 

 

The following table presents the risk-based and leverage capital requirements applicable to the Bank:

 

   Adequately Capitalized
Requirement
   Well-Capitalized
Requirement
   Well-Capitalized
with Buffer, fully
phased in 2019
 
Leverage   4.0%   5.0%   5.0%
CET1   4.5%   6.5%   7.0%
Tier 1   6.0%   8.0%   8.5%
Total Capital   8.0%   10.0%   10.5%

 

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.

 

 7 

 

 

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.

 

 8 

 

 

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.

 

 9 

 

 

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.

 

 10 

 

 

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.

 

 11 

 

 

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.

 

 12 

 

 

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.

 

 13 

 

 

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.

 

 14 

 

 

Nicolet’s securities are not FDIC insured.

 

Our securities are not savings or deposit accounts or other obligations of the Bank, and are not insured by the Deposit Insurance Fund, or any other agency or private entity and are subject to investment risk, including the possible loss of some or all of the value of your investment.

 

ITEM 1B. UNRESOLVED STAFF COMMENTS

 

None.

 

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. LEGAL PROCEEDINGS

 

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

 

ITEM 4. MINE SAFETY DISCLOSURES

 

Not applicable.

 

 15 

 

 

PART II

 

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.

 

For The Quarter Ended  High Sales/Bid
Prices
   Low Sales/ Bid
Prices
   Closing 
Sales Prices
   Book
Value Per
Common
Share
 
                 
December 31, 2017  $61.89   $53.31   $54.74   $37.09 
September 30, 2017   61.98    51.21    57.53    36.78 
June 30, 2017   55.83    45.00    54.71    35.73 
March 31, 2017   49.75    45.50    47.34    33.12 
                     
December 31, 2016  $48.00   $37.21   $47.69   $32.26 
September 30, 2016   39.91    35.63    38.35    32.19 
June 30, 2016   47.00    33.72    38.08    31.61 
March 31, 2016   38.91    30.51    38.85    24.36 

 

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.

 

   Total Number of
Shares Purchased
   Average Price
Paid per Share
   Total Number of
Shares Purchased as
Part of Publicly
Announced Plans
or Programs
   Maximum Number of
Shares that May Yet
Be Purchased Under
the Plans
or Programs (a)
 
   (#)   ($)   (#)   (#) 
Period                    
October 1 – October 31, 2017      $        391,000 
November 1– November 30, 2017   121,759   $56.38    47,180    344,000 
December 1 – December 31, 2017   8,313   $55.07    1,200    343,000 
Total   130,072   $56.30    48,380    343,000 

 

(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.

 

 16 

 

 

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.

 

 

   Period Ending 
Index  05/17/13   12/31/13   12/31/14   12/31/15   12/31/16   12/31/17 
Nicolet Bankshares, Inc.  $100.00   $103.38   $156.25   $198.69   $298.06   $342.13 
S&P 500 Index   100.00    112.30    127.67    129.43    144.91    176.55 
KBW Nasdaq Bank Index   100.00    114.66    125.40    126.02    161.95    192.06 

Source: S&P Global Market Intelligence

 

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.

 

 17 

 

  

EARNINGS SUMMARY AND SELECTED FINANCIAL DATA

 

   At and for the year ended December 31, 
(In thousands, except per share data)  2017   2016   2015   2014   2013 
Results of operations:                         
Interest income  $109,253   $75,467   $48,597   $48,949   $43,196 
Interest expense   10,511    7,334    7,213    7,067    6,292 
Net interest income   98,742    68,133    41,384    41,882    36,904 
Provision for loan losses   2,325    1,800    1,800    2,700    6,200 
Net interest income after provision for loan losses   96,417    66,333    39,584    39,182    30,704 
Noninterest income   34,639    26,674    17,708    14,185    25,736 
Noninterest expense   81,356    64,942    39,648    38,709    36,431 
Income before income tax expense   49,700    28,065    17,644    14,658    20,009 
Income tax expense   16,267    9,371    6,089    4,607    3,837 
Net income   33,433    18,694    11,555    10,051    16,172 
Net income attributable to noncontrolling interest   283    232    127    102    31 
Net income attributable to Nicolet Bankshares, Inc.   33,150    18,462    11,428    9,949    16,141 
Preferred stock dividends   -    633    212    244    976 
Net income available to common shareholders  $33,150   $17,829   $11,216   $9,705   $15,165 
Earnings per common share:                         
Basic  $3.51   $2.49   $2.80   $2.33   $3.81 
Diluted   3.33    2.37    2.57    2.25    3.80 
Weighted average common shares outstanding:                         
Basic   9,440    7,158    4,004    4,165    3,977 
Diluted   9,958    7,514    4,362    4,311    3,988 
Year-End Balances:                         
Loans  $2,087,925   $1,568,907   $877,061   $883,341   $847,358 
Allowance for loan losses   12,653    11,820    10,307    9,288    9,232 
Securities available for sale, at fair value   405,153    365,287    172,596    168,475    127,515 
Total assets   2,932,433    2,300,879    1,214,439    1,215,285    1,198,803 
Deposits   2,471,064    1,969,986    1,056,417    1,059,903    1,034,834 
Notes payable   36,509    1,000    15,412    21,175    39,538 
Junior subordinated debentures   29,616    24,732    12,527    12,328    12,128 
Subordinated notes   11,921    11,885    11,849    -    - 
Common equity   364,178    275,947    97,301    86,608    80,462 
Stockholders’ equity   364,178    275,947    109,501    111,008    104,862 
Book value per common share   37.09    32.26    23.42    21.34    18.97 
Average Balances:                         
Loans  $1,899,225   $1,346,304   $883,904   $859,256   $753,284 
Interest-earning assets   2,351,451    1,723,600    1,083,967    1,084,408    913,104 
Total assets   2,648,754    1,934,770    1,185,921    1,191,348    997,372 
Deposits   2,228,408    1,641,894    1,021,155    1,028,336    830,884 
Interest-bearing liabilities   1,750,099    1,307,471    851,957    892,872    756,606 
Common equity   332,897    217,432    90,787    84,033    70,737 
Stockholders’ equity   332,897    226,265    112,012    108,433    95,137 
Financial Ratios:                         
Return on average assets   1.25%   0.95%   0.96%   0.84%   1.62%
Return on average equity   9.96%   8.16%   10.20%   9.18%   16.97%
Return on average common equity   9.96%   8.20%   12.35%   11.55%   21.44%
Average equity to average assets   12.57%   11.69%   9.45%   9.10%   9.54%
Net interest margin   4.30%   4.01%   3.88%   3.89%   4.06%
Stockholders’ equity to assets   12.42%   11.99%   9.02%   9.13%   8.75%
Net loan charge-offs to average loans   0.08%   0.02%   0.09%   0.31%   0.54%
Nonperforming loans to total loans   0.63%   1.29%   0.40%   0.61%   1.21%
Nonperforming assets to total assets   0.49%   0.97%   0.32%   0.61%   1.02%

 

 18 

 

 

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.

 

 19 

 

 

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”.

 

 20 

 

 

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.

 

 21 

 

 

Table 1: Average Balance Sheet and Net Interest Income Analysis — Taxable-Equivalent Basis

(dollars in thousands)

 

   Years Ended December 31, 
   2017   2016   2015 
   Average
Balance
   Interest   Average
Yield/Rate
   Average
Balance
   Interest   Average
Yield/Rate
   Average
Balance
   Interest   Average
Yield/Rate
 
ASSETS                                    
Earning assets                                             
Loans (1)(2)(3)  $1,899,225   $100,905    5.31%  $1,346,304   $69,687    5.11%  $883,904   $45,745    5.12%
Investment securities:                                             
Taxable   238,433    4,728    1.98%   159,421    3,029    1.90%   75,069    1,460    1.94%
Tax-exempt (2)   160,328    4,365    2.72%   131,250    3,292    2.51%   87,609    2,083    2.38%
Other interest-earning assets   53,465    1,624    3.04%   86,625    1,327    1.53%   37,385    443    1.18%
Total interest-earning assets   2,351,451   $111,622    4.75%   1,723,600   $77,335    4.44%   1,083,967   $49,731    4.54%
Other assets, net   297,303              211,170              101,954           
Total assets  $2,648,754             $1,934,770             $1,185,921           
LIABILITIES AND STOCKHOLDERS’ EQUITY                                             
Interest-bearing liabilities                                             
Savings  $254,961   $405    0.16%  $193,933   $221    0.11%  $126,894   $305    0.24%
Interest-bearing demand   432,513    2,408    0.56%   325,383    1,786    0.55%   204,844    1,703    0.83%
Money market (“MMA”)   583,708    1,781    0.31%   451,373    599    0.13%   250,500    557    0.22%
Core time deposits   292,084    2,323    0.80%   259,730    2,220    0.85%   197,862    2,211    1.12%
Brokered deposits   119,234    769    0.65%   28,329    318    1.12%   29,431    414    1.41%
Total interest-bearing deposits   1,682,500    7,686    0.46%   1,258,748    5,144    0.41%   809,531    5,190    0.64%
Other interest-bearing liabilities   67,599    2,825    4.18%   48,723    2,190    4.44%   42,426    2,023    4.72%
Total interest-bearing liabilities   1,750,099    10,511    0.60%   1,307,471    7,334    0.56%   851,957    7,213    0.84%
Noninterest-bearing demand   545,908              383,146              211,624           
Other liabilities   19,850              17,888              10,328           
Stockholders’ equity   332,897              226,265              112,012           
Total liabilities and stockholders’ equity  $2,648,754             $1,934,770             $1,185,921           
Net interest income and rate spread       $101,111    4.15%       $70,001    3.88%       $42,518    3.70%
Net interest margin             4.30%             4.01%             3.88%

 

(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.

 

 22 

 

 

Table 2: Volume/Rate Variance — Taxable-Equivalent Basis
(dollars in thousands)

 

   2017 Compared to 2016
Increase (Decrease)
Due to Changes in
   2016 Compared to 2015
Increase (Decrease)
Due to Changes in
 
   Volume   Rate*   Net(1)   Volume   Rate*   Net(1) 
Earning assets                              
Loans (2)  $28,599   $2,619   $31,218   $24,046   $(104)  $23,942 
Investment securities:                              
Taxable   1,773    (74)   1,699    1,603    (34)   1,569 
Tax-exempt (2)   774    299    1,073    1,089    120    1,209 
Other interest-earning assets   (400)   697    297    665    219    884 
Total interest-earning assets  $30,746   $3,541   $34,287   $27,403   $201   $27,604 
                               
Interest-bearing liabilities                              
Savings  $82   $102   $184   $118   $(202)  $(84)
Interest-bearing demand   596    26    622    786    (703)   83 
MMA   218    964    1,182    327    (285)   42 
Core time deposits   264    (161)   103    599    (590)   9 
Brokered deposits   637    (186)   451    (15)   (81)   (96)
Total interest-bearing deposits   1,797    745    2,542    1,815    (1,861)   (46)
Other interest-bearing liabilities   656    (21)   635    344    (177)   167 
Total interest-bearing liabilities   2,453    724    3,177    2,159    (2,038)   121 
Net interest income  $28,293   $2,817   $31,110   $25,244   $2,239   $27,483 

 

*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)

 

   Years Ended December 31, 
   2017 Average   2016 Average   2015 Average 
   Balance   % of
Earning
Assets
   Yield/Rate   Balance   % of
Earning
Assets
   Yield/Rate   Balance   % of
Earning
Assets
   Yield/Rate 
Total loans  $1,899,225    80.8%   5.31%  $1,346,304    78.1%   5.11%  $883,904    81.5%   5.12%
Securities and other earning assets   452,226    19.2%   2.37%   377,296    21.9%   2.03%   200,063    18.5%   1.99%
Total interest-earning assets  $2,351,451    100.0%   4.75%  $1,723,600    100.0%   4.44%  $1,083,967    100.0%   4.54%
                                              
Interest-bearing liabilities  $1,750,099    74.4%   0.60%  $1,307,471    75.9%   0.56%  $851,957    78.6%   0.84%
Noninterest-bearing funds, net   601,352    25.6%        416,129    24.1%        232,010    21.4%     
Total funds sources  $2,351,451    100.0%   0.47%  $1,723,600    100.0%   0.41%  $1,083,967    100.0%   0.64%
Interest rate spread             4.15%             3.88%             3.70%
Contribution from net free funds             0.15%             0.13%             0.18%
Net interest margin             4.30%             4.01%             3.88%

 

 23 

 

 

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.

 

 24 

 

 

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) 

 

   Years Ended December 31,   Change From Prior Year 
   2017   2016   2015   $ Change
2017
   % Change
2017
   $ Change
2016
   % Change
2016
 
                             
Service charges on deposit accounts  $4,604   $3,571   $2,348   $1,033    28.9%  $1,223    52.1%
Mortgage income, net   5,361    5,494    3,258    (133)   (2.4)   2,236    68.6 
Trust services fee income   6,031    5,435    4,822    596    11.0    613    12.7 
Brokerage fee income   5,736    3,624    670    2,112    58.3    2,954    440.9 
Card interchange income   4,646    3,167    1,566    1,479    46.7    1,601    102.2 
Bank owned life insurance (“BOLI”) income   1,778    1,284    996    494    38.5    288    28.9 
Rent income   1,146    1,090    1,156    56    5.1    (66)   (5.7)
Investment advisory fees   464    452    408    12    2.7    44    10.8 
Other income   2,844    2,503    758    341    13.6    1,745    230.2 
Noninterest income without net gains  $32,610   $26,620   $15,982   $5,990    22.5%  $10,638    66.6%
Gain on sale, disposal or write-down of assets, net   2,029    54    1,726    1,975    N/M    (1,672)   (96.9)
Total noninterest income  $34,639   $26,674   $17,708   $7,965    29.9%  $8,966    50.6%

 

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.

 

 25 

 

 

·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)

 

   Years Ended December 31,   Change From Prior Year 
   2017   2016   2015   Change
2017
   % Change
2017
   Change
2016
   % Change
2016
 
                             
Personnel  $44,458   $34,030   $22,523   $10,428    30.6%  $11,507    51.1%
Occupancy, equipment and office   13,308    10,276    6,928    3,032    29.5    3,348    48.3 
Business development and marketing   4,700    3,488    2,244    1,212    34.7    1,244    55.4 
Data processing   8,715    6,370    3,565    2,345    36.8    2,805    78.7 
FDIC assessments   787    911    615    (124)   (13.6)   296    48.1 
Intangibles amortization   4,695    3,458    1,027    1,237    35.8    2,431    236.7 
Other expense   4,693    6,409    2,746    (1,716)   (26.8)   3,663    133.4 
Total noninterest expense  $81,356   $64,942   $39,648   $16,414    25.3%  $25,294    63.8%
Non-personnel expenses  $36,898   $30,912   $17,125   $5,986    19.4%  $13,787    80.5%
Average full-time equivalent employees   522    415    280    107    25.8%   135    48.2%

 

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.

 

 26 

 

 

·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.

 

 27 

 

 

Table 6: Loan Composition
As of December 31,
(dollars in thousands)

 

   2017   2016   2015   2014   2013 
   Amount   % of
Total
   Amount   % of
Total
   Amount   % of
Total
   Amount   % of
Total
   Amount   % of
Total
 
Commercial & industrial  $637,337    30.5%  $428,270    27.3%  $294,419    33.6%  $289,379    32.7%  $253,674    29.9%
Owner-occupied CRE   430,043    20.6    360,227    23.0    185,285    21.1    182,574    20.7    187,476    22.1 
AG production   35,455    1.7    34,767    2.2    15,018    1.7    14,617    1.6    14,256    1.7 
Commercial   1,102,835    52.8    823,264    52.5    494,722    56.4    486,570    55.0    455,406    53.7 
AG real estate   51,778    2.5    45,234    2.9    43,272    4.9    42,754    4.8    37,057    4.4 
CRE investment   314,463    15.1    195,879    12.5    78,711    9.0    81,873    9.3    90,295    10.7 
Construction & land development   89,660    4.3    74,988    4.8    36,775    4.2    44,114    5.0    42,881    5.1 
Commercial real estate   455,901    21.9    316,101    20.2    158,758    18.1    168,741    19.1    170,233    20.2 
Commercial-based loans   1,558,736    74.7    1,139,365    72.7    653,480    74.5    655,311    74.1    625,639    73.9 
Residential construction   36,995    1.8    23,392    1.5    10,443    1.2    11,333    1.3    12,535    1.5 
Residential first mortgage   363,352    17.4    300,304    19.1    154,658    17.6    158,683    18.0    154,403    18.2 
Residential junior mortgage   106,027    5.1    91,331    5.8    51,967    5.9    52,104    5.9    49,363    5.8 
Residential real estate   506,374    24.3    415,027    26.4    217,068    24.7    222,120    25.2    216,301    25.5 
Retail & other   22,815    1.0    14,515    0.9    6,513    0.8    5,910    0.7    5,418    0.6 
Retail-based loans   529,189    25.3    429,542    27.3    223,581    25.5    228,030    25.9    221,719    26.1 
Total loans  $2,087,925    100.0%  $1,568,907    100.0%  $877,061    100.0%  $883,341    100.0%  $847,358    100.0%

 

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.

 

 28 

 

 

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)

 

   Loan Maturity 
   One Year
or Less
   Over One
Year
to Five Years
   Over
Five Years
   Total 
Commercial & industrial  $275,038   $318,973   $43,326   $637,337 
Owner-occupied CRE   54,582    303,785    71,676    430,043 
AG production   18,877    12,992    3,586    35,455 
AG real estate   11,560    37,516    2,702    51,778 
CRE investment   61,588    213,677    39,198    314,463 
Construction & land development   41,119    38,106    10,435    89,660 
Residential construction   36,357    638    -    36,995 
Residential first mortgage   16,460    73,211    273,681    363,352 
Residential junior mortgage   6,037    17,597    82,393    106,027 
Retail & other   13,126    8,675    1,014    22,815 
Total loans  $534,744   $1,025,170   $528,011   $2,087,925 
Percent by maturity distribution   26%   49%   25%   100%
Fixed rate  $244,041   $916,753   $257,086   $1,417,880 
Floating rate   290,703    108,417    270,925    670,045 
Total  $534,744   $1,025,170   $528,011   $2,087,925 
Fixed rate percent   46%   89%   49%   68%
Floating rate percent   54%   11%   51%   32%

 

 29 

 

 

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.

 

 30 

 

 

Table 8: Loan Loss Experience
For the Years Ended December 31,
(dollars in thousands)

 

   2017   2016   2015   2014   2013 
Allowance for loan losses:                         
Beginning balance  $11,820   $10,307   $9,288   $9,232   $7,120 
Loans charged off:                         
Commercial & industrial   1,442    279    374    1,923    574 
Owner-occupied CRE       108    229    470    1,936 
AG production                    
AG real estate                    
CRE investment           50        992 
Construction & land development   13            12    319 
Residential construction                    
Residential first mortgage   8    80    84    218    156 
Residential junior mortgage   72    57    111    81    190 
Retail & other   69    60    35    39    71 
Total loans charged off   1,604    584    883    2,743    4,238 
Recoveries of loans previously charged off:                         
Commercial & industrial   38    26    36    55    40 
Owner-occupied CRE   30    5    4    17    85 
AG production                    
AG real estate                    
CRE investment   1    221    17    14     
Construction & land development                   15 
Residential construction                    
Residential first mortgage   25    31    20    2    8 
Residential junior mortgage   3    8    12    1    1 
Retail & other   15    6    13    10    1 
Total recoveries   112    297    102    99    150 
Total net charge-offs   1,492    287    781    2,644    4,088 
Provision for loan losses   2,325    1,800    1,800    2,700    6,200 
Ending balance of ALLL  $12,653   $11,820   $10,307   $9,288   $9,232 
Ratios:                         
ALLL to total loans   0.61%   0.75%   1.18%   1.05%   1.09%
ALLL to net charge-offs   848.1%   4,118.5%   1,319.7%   351.3%   225.8%
Net charge-offs to average loans   0.08%   0.02%   0.09%   0.31%   0.54%

 

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.

 

 31 

 

 

Table 9: Allocation of the Allowance for Loan Losses

As of December 31,

(dollars in thousands)

 

   2017   % of
Loan
Type to
Total
Loans
   2016   % of
Loan
Type to
Total
Loans
   2015   % of
Loan
Type to
Total
Loans
   2014   % of
Loan
Type to
Total
Loans
   2013   % of
Loan
Type to
Total
Loans
 
ALLL allocation                                                  
Commercial & industrial  $4,934    30.5%  $3,919    27.3%  $3,721    33.6%  $3,191    32.7%  $1,798    29.9%
Owner-occupied CRE   2,607    20.6    2,867    23.0    1,933    21.1    1,230    20.7    766    22.1 
AG production   129    1.7    150    2.2    85    1.7    53    1.6    18    1.7 
AG real estate   296    2.5    285    2.9    380    4.9    226    4.8    59    4.4 
CRE investment   1,388    15.1    1,124    12.5    785    9.0    511    9.3    505    10.7 
Construction & land development   726    4.3    774    4.8    1,446    4.2    2,685    5.0    4,970    5.1 
Residential construction   251    1.8    304    1.5    147    1.2    140    1.3    229    1.5 
Residential first mortgage   1,609    17.4    1,784    19.1    1,240    17.6    866    18.0    544    18.2 
Residential junior mortgage   488    5.1    461    5.8    496    5.9    337    5.9    321    5.8 
Retail & other   225    1.0    152    0.9    74    0.8    49    0.7    22    0.6 
Total ALLL  $12,653    100.0%  $11,820    100.0%  $10,307    100.0%  $9,288    100.0%  $9,232    100.0%
ALLL category as a percent of total ALLL:                                                  
Commercial & industrial   39.0%        33.2%        36.2%        34.4%        19.5%     
Owner-occupied CRE   20.6         24.3         18.8         13.2         8.3      
AG production   1.0         1.3         0.8         0.6         0.2      
AG real estate   2.3         2.4         3.7         2.4         0.6      
CRE investment   11.0         9.5         7.6         5.5         5.5      
Construction & land development   5.7         6.5         14.0         28.9         53.8      
Residential construction   2.0         2.6         1.4         1.5         2.5      
Residential first mortgage   12.7         15.1         12.0         9.3         5.9      
Residential junior mortgage   3.9         3.9         4.8         3.6         3.5      
Retail & other   1.8         1.2         0.7         0.6         0.2      
Total ALLL   100.0%        100.0%        100.0%        100.0%        100.0%     

 

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.

 

 32 

 

 

Table 10: Nonperforming Assets

As of December 31,

(dollars in thousands)

   2017   2016   2015   2014   2013 
Nonaccrual assets:                         
Commercial & industrial  $6,016   $358   $204   $171   $68 
Owner-occupied CRE   533    2,894    951    1,667    1,087 
AG production       9    13    21    11 
AG real estate   186    208    230    392    448 
CRE investment   4,531    12,317    1,040    911    4,631 
Construction & land development       1,193    280    934    1,265 
Residential construction   80    260             
Residential first mortgage   1,587    2,990    674    1,155    2,365 
Residential junior mortgage   158    56    141    141    262 
Retail & other   4                129 
 Total nonaccrual loans considered impaired   13,095    20,285    3,533    5,392    10,266 
Accruing loans past due 90 days or more                    
 Total nonperforming loans   13,095    20,285    3,533    5,392    10,266 
Commercial real estate owned   185    304    52    697    935 
Construction & land development real estate owned       687        139    854 
Residential real estate owned   70    29        630    198 
Bank property real estate owned   1,039    1,039    315    500     
 OREO   1,294    2,059    367    1,966    1,987 
 Total nonperforming assets  $14,389   $22,344   $3,900   $7,358   $12,253 
Performing troubled debt restructurings  $   $   $   $3,777   $3,970 
Ratios:                         
Nonperforming loans to total loans   0.63%   1.29%   0.40%   0.61%   1.21%
Nonperforming assets to total loans plus OREO   0.69%   1.42%   0.44%   0.83%   1.44%
Nonperforming assets to total assets   0.49%   0.97%   0.32%   0.61%   1.02%
ALLL to nonperforming loans   96.6%   58.3%   291.7%   172.3%   89.9%
ALLL to total loans   0.61%   0.75%   1.18%   1.05%   1.09%

 

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)

 

   2017   2016   2015 
Interest income in accordance with original terms  $1,405   $1,979   $429 
Interest income recognized   (1,130)   (1,789)   (416)
Reduction in interest income  $275   $190   $13 

 

 33 

 

 

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)

   2017   2016   2015 
   Amortized
Cost
   Fair
Value
   % of
Total
   Amortized
Cost
   Fair
Value
   % of
Total
   Amortized
Cost
   Fair
Value
   % of
Total
 
U.S. government agency securities  $26,586   $26,209    6%  $1,981   $1,963    1%  $287   $294    -%
State, county and municipals   186,128    184,044    46%   191,721    187,243    51%   104,768    105,021    61%
Mortgage-backed securities   157,705    155,532    38%   161,309    159,129    44%   61,600    61,464    36%
Corporate debt securities   36,387    36,797    9%   12,117    12,169    3%   1,140    1,140    1%
Equity securities   1,287    2,571    1%   2,631    4,783    1%   3,196    4,677    2%
Total securities AFS  $408,093   $405,153    100%  $369,759   $365,287    100%  $170,991   $172,596    100%

 

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) 

   Within
One Year
   After One
but Within
Five Years
   After Five
but Within
Ten Years
   After
Ten Years
   Mortgage-
related
and Equity
Securities
   Total
Amortized
Cost
   Total
Fair
Value
 
   Amount   Yield   Amount   Yield   Amount   Yield   Amount   Yield   Amount   Yield   Amount   Yield   Amount 
                                                     
U.S. government agency securities  $    %  $10,480    2.4%  $16,106    2.4%  $    %  $    %  $26,586    2.4%  $26,209 
State, county and municipals   18,990    2.6    68,347    2.7    98,496    2.5    295    2.8            186,128    2.6    184,044 
Mortgage-backed securities                                   157,705    2.9    157,705    2.9    155,532 
Corporate debt securities           19,204    3.7    10,197    3.1    6,986    5.8            36,387    3.9    36,797 
Equity securities                                   1,287    0.0    1,287    0.0    2,571 
Total amortized cost  $18,990    2.6%  $98,031    2.9%  $124,799    2.5%  $7,281    5.7%  $158,992    2.9%  $408,093    2.8%  $405,153 
Total fair value and carrying value  $18,969        $97,683        $122,727        $7,671        $158,103                  $405,153 
    5%        24%        30%        2%        39%                  100%

 

(1)The yield on tax-exempt investment securities is computed on a tax-equivalent basis using a federal tax rate of 35% adjusted for the disallowance of interest expense.

 

 34 

 

 

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)

   2017   2016   2015 
   Amount   % of
Total
   Amount   % of
Total
   Amount   % of
Total
 
Demand  $631,831    25.6%  $482,300    24.5%  $226,554    21.5%
Money market and NOW accounts   1,222,401    49.5    964,509    49.0    486,677    46.1 
Savings   269,922    10.9    221,282    11.2    136,733    12.9 
Time   346,910    14.0    301,895    15.3    206,453    19.5 
Total deposits  $2,471,064    100.0%  $1,969,986    100.0%  $1,056,417    100.0%
Brokered transaction accounts  $76,141    3.1%  $-    -%  $-    -%
Brokered time deposits   44,645    1.8    20,868    1.1    26,698    2.5 
Total brokered deposits  $120,786    4.9%  $20,868    1.1%  $26,698    2.5%

 

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)

   2017 Average   2016 Average   2015 Average 
   Amount   % of
Total
   Amount   % of
Total
   Amount   % of
Total
 
Demand  $545,908    24.5%  $383,146    23.4%  $211,624    20.7%
Money market and NOW accounts   1,016,221    45.6    776,756    47.3    455,344    44.6 
Savings   254,961    11.4    193,933    11.8    126,894    12.4 
Time   292,084    13.1    259,730    15.8    197,862    19.4 
Brokered   119,234    5.4    28,329    1.7    29,431    2.9 
Total  $2,228,408    100.0%  $1,641,894    100.0%  $1,021,155    100.0%

 

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

At December 31,

(dollars in thousands)

   2017   2016   2015 
3 months or less  $21,847   $19,058   $6,856 
Over 3 months through 6 months   15,552    11,428    5,733 
Over 6 months through 12 months   40,226    31,569    19,319 
Over 12 months   54,319    59,208    58,934 
Total  $131,944   $121,263   $90,842 

 

 35 

 

 

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)

   2017   2016 
Commitments to extend credit  $680,307   $554,980 
Financial standby letters of credit   8,783    12,444 
Performance standby letters of credit   9,080    4,898 

 

 

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)

   Note   Maturity by Years 
   Reference   Total   1 or less   1-3   3-5   Over 5 
Junior subordinated debentures   10   $29,616   $   $   $   $29,616 
Subordinated notes   11    11,921                11,921 
Notes payable   9    36,509    1,019    10,000    25,490     
Operating leases   5    6,512    1,264    2,445    1,754    1,049 
Total long-term contractual obligations       $84,558   $2,283   $12,445   $27,244   $42,586 

 

 36 

 

 

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.

 

 37 

 

 

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

   December 31, 2017   December 31, 2016 
200 bps decrease in interest rates   (1.0)%   (1.7)%
100 bps decrease in interest rates   (0.2)%   (0.8)%
100 bps increase in interest rates   (0.1)%   (0.6)%
200 bps increase in interest rates   (0.2)%   (1.1)%

 

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.

 

 38 

 

 

Table 20: Capital

   December 31, 2017   December 31, 2016 
Company:          
Total risk-based capital  $299,043   $249,723 
Tier 1 risk-based capital   274,469    226,018 
Common equity Tier 1 capital   245,214    202,313 
Total capital ratio   12.8%   13.9%
Tier 1 capital ratio   11.8%   12.5%
Common equity tier 1 capital ratio   10.5%   11.2%
Tier 1 leverage ratio   10.0%   10.3%
Bank:          
Total risk-based capital  $267,165   $217,682 
Tier 1 risk-based capital   254,512    205,862 
Common equity Tier 1 capital   254,512    205,862 
Total capital ratio   11.5%   12.1%
Tier 1 capital ratio   10.9%   11.4%
Common equity tier 1 capital ratio   10.9%   11.4%
Tier 1 leverage ratio   9.3%   9.4%

 

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.

 

 39 

 

 

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.

 

 40 

 

 

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)

   2017 Quarter Ended 
   December 31,   September 30,   June 30,   March 31, 
Interest income  $29,836   $29,454   $26,880   $23,083 
Interest expense