Loans, Allowance for Credit Losses - Loans, and Credit Quality

The loan composition is summarized as follows.



	March 31, 2020					December 31, 2019
(in thousands)	Amount			% of Total		Amount			% of Total
Commercial & industrial	$	831,257		32	%	$	806,189		31	%
Owner-occupied CRE	499,705			19		496,372			19
Agricultural	95,991			3		95,450			4
CRE investment	448,758			17		443,218			17
Construction & land development	96,055			4		92,970			4
Residential construction	52,945			2		54,403			2
Residential first mortgage	432,126			17		432,167			17
Residential junior mortgage	121,105			5		122,771			5
Retail & other	29,482			1		30,211			1
Loans	2,607,424			100	%	2,573,751			100	%
Less allowance for credit losses - Loans (“ACL-Loans”)	26,202					13,972
Loans, net	$	2,581,222				$	2,559,779
Allowance for credit losses - Loans to loans	1.00		%			0.54		%

Accrued interest on loans of $7 million at both March 31, 2020 and December 31, 2019 is included in accrued interest receivable and other assets on the consolidated balance sheets. See Note 1 for for the Company's accounting policy on accrued interest with respect to loans and the allowance for credit losses.

Allowance for Credit Losses-Loans:

The majority of the Company’s loans, commitments, and letters of credit have been granted to customers in the Company’s market area. Although the Company has a diversified loan portfolio, the credit risk in the loan portfolio is largely influenced by general economic conditions and trends of the counties and markets in which the debtors operate, and the resulting impact on the operations of borrowers or on the value of underlying collateral, if any.

A roll forward of the allowance for credit losses is summarized as follows.



	Three Months Ended						Year Ended
(in thousands)	March 31, 2020			March 31, 2019			December 31, 2019
Beginning balance	$	13,972		$	13,153		$	13,153
Adoption of CECL	8,488			—			—
Initial PCD ACL	797			—			—
Total impact for adoption of CECL	9,285			—			—
Provision for credit losses	3,000			200			1,200
Charge-offs	(93		)	(10		)	(927		)
Recoveries	38			27			546
Net (charge-offs) recoveries	(55		)	17			(381		)
Ending balance	$	26,202		$	13,370		$	13,972

The following table presents the balance and activity in the ACL-Loans by portfolio segment.



	TOTAL – Three Months Ended March 31, 2020
(in thousands)	Commercial & industrial			Owner- occupied CRE			Agricultural			CRE investment			Construction & land development			Residential construction			Residential first mortgage			Residential junior mortgage			Retail & other			Total
ACL-Loans:
Beginning balance	$	5,471		$	3,010		$	579		$	1,600		$	414		$	368		$	1,669		$	517		$	344		$	13,972
Adoption of CECL	2,962			1,249			361			1,970			51			124			1,286			351			134			8,488
Initial PCD ACL	797			—			—			—			—			—			—			—			—			797
Provision	1,253			163			95			795			82			(50		)	533			102			27			3,000
Charge-offs	—			—			—			(20		)	—			—			—			—			(73		)	(93		)
Recoveries	30			—			—			—			—			—			1			3			4			38
Net (charge-offs) recoveries	30			—			—			(20		)	—			—			1			3			(69		)	(55		)
Ending balance	$	10,513		$	4,422		$	1,035		$	4,345		$	547		$	442		$	3,489		$	973		$	436		$	26,202
As % of ACL-Loans	40		%	17		%	4		%	16		%	2		%	2		%	13		%	4		%	2		%	100		%

For comparison purposes, the following table presents the balance and activity in the ACL-Loans by portfolio segment for the prior year-end period.



	TOTAL – Year Ended December 31, 2019
(in thousands)	Commercial & industrial			Owner- occupied CRE			Agricultural			CRE investment			Construction & land development			Residential construction			Residential first mortgage			Residential junior mortgage			Retail & other			Total
ACL-Loans:
Beginning balance	$	5,271		$	2,847		$	422		$	1,470		$	510		$	211		$	1,646		$	472		$	304		$	13,153
Provision	(61		)	254			157			130			(96		)	383			9			86			338			1,200
Charge-offs	(159		)	(93		)	—			—			—			(226		)	(22		)	(80		)	(347		)	(927		)
Recoveries	420			2			—			—			—			—			36			39			49			546
Net (charge-offs) recoveries	261			(91		)	—			—			—			(226		)	14			(41		)	(298		)	(381		)
Ending balance	$	5,471		$	3,010		$	579		$	1,600		$	414		$	368		$	1,669		$	517		$	344		$	13,972
As % of ACL-Loans	39		%	22		%	4		%	11		%	3		%	3		%	12		%	4		%	2		%	100		%

The ACL-Loans at March 31, 2020 was estimated using the current expected credit loss model. See Note 1 for the Company's accounting policy on loans and the allowance for credit losses.

The ACL-Loans represents management’s estimate of expected credit losses in the Company’s loan portfolio at the balance sheet date. To assess the appropriateness of the ACL-Loans, 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 economic conditions; (ix) the fair value of underlying collateral; and (x) other qualitative and quantitative factors which could affect expected credit losses. Assessing these numerous factors involves significant judgment.

Management allocates the ACL-Loans by pools of risk within each loan portfolio segment. The allocation methodology consists of the following components. First, a specific reserve is established for individually evaluated credit-deteriorated loans, which management defines as nonaccrual credit relationships over $250,000, all loans determined to be troubled debt restructurings (“restructured loans”), plus other loans with evidence of credit deterioration. The specific reserve in the ACL-Loans for these credit deteriorated loans is equal to the aggregate collateral or discounted cash flow shortfall. Second, management allocates the ACL-Loans with historical loss rates by loan segment. The loss factors are measured on a quarterly basis and applied to each loan segment based on current loan balances and projected for their expected remaining life. Next, management allocates ACL-Loans 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. Lastly, management considers reasonable and supportable forecasts to assess the collectability of future cash flows.

A loan is considered collateral dependent when the borrower is experiencing financial difficulty and repayment is expected to be provided substantially through the operation or sale of the collateral. The following table presents collateral dependent loans by portfolio segment and collateral type, including those loans with and without a related allowance allocation as of March 31, 2020.



March 31, 2020	Collateral Type
(in thousands)	Real Estate		Other Business Assets		Total		Without an Allowance		With an Allowance		Allowance Allocation
Commercial & industrial	$	—	$	5,544	$	5,544	$	978	$	4,566	$	1,683
Owner-occupied CRE	3,168		—		3,168		3,168		—		—
Agricultural	611		921		1,532		663		869		61
CRE investment	1,029		—		1,029		1,029		—		—
Construction & land development	533		—		533		533		—		—
Residential construction	—		—		—		—		—		—
Residential first mortgage	—		—		—		—		—		—
Residential junior mortgage	—		—		—		—		—		—
Retail & other	—		—		—		—		—		—
Total loans	$	5,341	$	6,465	$	11,806	$	6,371	$	5,435	$	1,744

The following table presents impaired loans and their respective allowance for credit loss allocations at December 31, 2019, as determined in accordance with historical accounting guidance.



	Total Impaired Loans – December 31, 2019
(in thousands)	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
Commercial & industrial	$	5,932	$	7,950	$	625	$	5,405	$	1,170
Owner-occupied CRE	3,430		4,016		—		3,677		256
Agricultural	2,134		2,172		116		2,311		37
CRE investment	2,426		2,790		—		2,497		364
Construction & land development	382		382		—		460		—
Residential construction	—		—		—		—		—
Residential first mortgage	2,357		2,629		—		2,412		178
Residential junior mortgage	218		349		—		224		58
Retail & other	12		12		—		12		—
Total	$	16,891	$	20,300	$	741	$	16,998	$	2,063

Past Due and Nonaccrual Loans:

The following tables present past due loans by portfolio segment.



	March 31, 2020
(in thousands)	30-89 Days Past Due (accruing)			90 Days & Over or nonaccrual			Current			Total
Commercial & industrial	$	1,060		$	6,050		$	824,147		$	831,257
Owner-occupied CRE	1,961			3,837			493,907			499,705
Agricultural	1			1,801			94,189			95,991
CRE investment	484			1,029			447,245			448,758
Construction & land development	210			533			95,312			96,055
Residential construction	100			—			52,845			52,945
Residential first mortgage	1,985			953			429,188			432,126
Residential junior mortgage	249			566			120,290			121,105
Retail & other	80			—			29,402			29,482
Total loans	$	6,130		$	14,769		$	2,586,525		$	2,607,424
Percent of total loans	0.2		%	0.6		%	99.2		%	100.0		%



	December 31, 2019
(in thousands)	30-89 Days Past Due (accruing)			90 Days & Over or nonaccrual			Current			Total
Commercial & industrial	$	1,729		$	6,249		$	798,211		$	806,189
Owner-occupied CRE	112			3,311			492,949			496,372
Agricultural	—			1,898			93,552			95,450
CRE investment	—			1,073			442,145			443,218
Construction & land development	2,063			20			90,887			92,970
Residential construction	302			—			54,101			54,403
Residential first mortgage	2,736			1,090			428,341			432,167
Residential junior mortgage	217			480			122,074			122,771
Retail & other	110			1			30,100			30,211
Total loans	$	7,269		$	14,122		$	2,552,360		$	2,573,751
Percent of total loans	0.3		%	0.5		%	99.2		%	100.0		%

The following table presents nonaccrual loans by portfolio segment. The nonaccrual loans without a related allowance for credit losses have been reflected in the collateral dependent loans table above.



	March 31, 2020					December 31, 2019
(in thousands)	Nonaccrual Loans			% of Total		Nonaccrual Loans			% of Total
Commercial & industrial	$	6,050		41	%	$	6,249		44	%
Owner-occupied CRE	3,837			26		3,311			23
Agricultural	1,801			12		1,898			14
CRE investment	1,029			7		1,073			8
Construction & land development	533			4		20			—
Residential construction	—			—		—			—
Residential first mortgage	953			6		1,090			8
Residential junior mortgage	566			4		480			3
Retail & other	—			—		1			—
Nonaccrual loans	$	14,769		100	%	$	14,122		100	%
Percent of total loans	0.6		%			0.5		%

Credit Quality Information:

The following table presents total loans by risk categories and year of origination.



March 31, 2020	Amortized Cost Basis by Origination Year
(in thousands)	2020		2019		2018		2017		2016		Prior		Revolving		Revolving to Term		TOTAL
Commercial & industrial
Grades 1-4	$	45,598	$	151,079	$	118,171	$	77,690	$	31,727	$	64,618	$	291,990	$	—	$	780,873
Grade 5	39		3,470		7,446		576		1,479		2,830		7,845		—		23,685
Grade 6	—		23		823		4		1		37		4,946		—		5,834
Grade 7	113		2,078		1,115		1,404		1,372		7,393		7,390		—		20,865
Total	$	45,750	$	156,650	$	127,555	$	79,674	$	34,579	$	74,878	$	312,171	$	—	$	831,257

Owner-occupied CRE
Grades 1-4	$	21,337	$	68,525	$	84,981	$	64,514	$	50,402	$	175,204	$	2,340	$	—	$	467,303
Grade 5	—		576		1,706		7,882		396		6,676		488		—		17,724
Grade 6	—		—		—		1,749		—		56		—		—		1,805
Grade 7	—		168		285		2,197		1,797		8,426		—		—		12,873
Total	$	21,337	$	69,269	$	86,972	$	76,342	$	52,595	$	190,362	$	2,828	$	—	$	499,705

Agricultural
Grades 1-4	$	4,321	$	7,982	$	7,604	$	10,793	$	3,998	$	26,721	$	20,468	$	—	$	81,887
Grade 5	—		—		38		179		710		4,064		89		—		5,080
Grade 6	—		—		—		329		392		—		49		—		770
Grade 7	—		—		58		117		1,375		5,893		811		—		8,254
Total	$	4,321	$	7,982	$	7,700	$	11,418	$	6,475	$	36,678	$	21,417	$	—	$	95,991

CRE investment
Grades 1-4	$	29,442	$	72,601	$	45,017	$	71,370	$	44,213	$	168,170	$	6,238	$	—	$	437,051
Grade 5	—		—		55		—		394		6,629		—		—		7,078
Grade 6	—		105		—		915		656		—		—		—		1,676
Grade 7	—		—		—		—		146		2,807		—		—		2,953
Total	$	29,442	$	72,706	$	45,072	$	72,285	$	45,409	$	177,606	$	6,238	$	—	$	448,758

Construction & land development
Grades 1-4	$	7,276	$	46,643	$	20,176	$	3,719	$	2,683	$	9,827	$	1,678	$	—	$	92,002
Grade 5	—		219		2,699		45		—		26		—		—		2,989
Grade 6	—		—		—		—		—		—		—		—		—
Grade 7	—		149		—		—		—		915		—		—		1,064
Total	$	7,276	$	47,011	$	22,875	$	3,764	$	2,683	$	10,768	$	1,678	$	—	$	96,055

Residential construction
Grades 1-4	$	3,495	$	44,300	$	3,922	$	466	$	29	$	135	$	—	$	—	$	52,347
Grade 5	—		542		—		56		—		—		—		—		598
Grade 6	—		—		—		—		—		—		—		—		—
Grade 7	—		—		—		—		—		—		—		—		—
Total	$	3,495	$	44,842	$	3,922	$	522	$	29	$	135	$	—	$	—	$	52,945

Residential first mortgage
Grades 1-4	$	24,900	$	79,077	$	59,651	$	56,748	$	60,809	$	142,975	$	1,538	$	1	$	425,699
Grade 5	—		1,215		296		309		697		1,153		—		—		3,670
Grade 6	—		—		—		—		—		2		—		—		2
Grade 7	—		778		198		20		66		1,693		—		—		2,755
Total	$	24,900	$	81,070	$	60,145	$	57,077	$	61,572	$	145,823	$	1,538	$	1	$	432,126

Residential junior mortgage
Grades 1-4	$	927	$	7,017	$	5,941	$	1,856	$	2,021	$	3,844	$	95,033	$	3,861	$	120,500
Grade 5	—		—		—		—		—		34		—		—		34
Grade 6	—		—		—		—		—		—		—		—		—
Grade 7	—		—		—		30		—		355		75		111		571
Total	$	927	$	7,017	$	5,941	$	1,886	$	2,021	$	4,233	$	95,108	$	3,972	$	121,105

Retail & other
Grades 1-4	$	2,438	$	5,605	$	2,658	$	1,161	$	827	$	1,156	$	15,637	$	—	$	29,482
Grade 5	—		—		—		—		—		—		—		—		—
Grade 6	—		—		—		—		—		—		—		—		—
Grade 7	—		—		—		—		—		—		—		—		—
Total	$	2,438	$	5,605	$	2,658	$	1,161	$	827	$	1,156	$	15,637	$	—	$	29,482

Total loans	$	139,886	$	492,152	$	362,840	$	304,129	$	206,190	$	641,639	$	456,615	$	3,973	$	2,607,424

The following tables present total loans by risk categories.



	March 31, 2020
(in thousands)	Grades 1- 4			Grade 5			Grade 6			Grade 7			Total
Commercial & industrial	$	780,873		$	23,685		$	5,834		$	20,865		$	831,257
Owner-occupied CRE	467,303			17,724			1,805			12,873			499,705
Agricultural	81,887			5,080			770			8,254			95,991
CRE investment	437,051			7,078			1,676			2,953			448,758
Construction & land development	92,002			2,989			—			1,064			96,055
Residential construction	52,347			598			—			—			52,945
Residential first mortgage	425,699			3,670			2			2,755			432,126
Residential junior mortgage	120,500			34			—			571			121,105
Retail & other	29,482			—			—			—			29,482
Total loans	$	2,487,144		$	60,858		$	10,087		$	49,335		$	2,607,424
Percent of total	95.4		%	2.3		%	0.4		%	1.9		%	100.0		%



	December 31, 2019
(in thousands)	Grades 1- 4			Grade 5			Grade 6			Grade 7			Total
Commercial & industrial	$	765,073		$	20,199		$	7,663		$	13,254		$	806,189
Owner-occupied CRE	464,661			20,855			953			9,903			496,372
Agricultural	77,082			6,785			3,275			8,308			95,450
CRE investment	430,794			8,085			2,578			1,761			443,218
Construction & land development	90,523			2,213			15			219			92,970
Residential construction	53,286			1,117			—			—			54,403
Residential first mortgage	424,044			4,677			668			2,778			432,167
Residential junior mortgage	122,249			35			—			487			122,771
Retail & other	30,210			—			—			1			30,211
Total loans	$	2,457,922		$	63,966		$	15,152		$	36,711		$	2,573,751
Percent of total	95.5		%	2.5		%	0.6		%	1.4		%	100.0		%

An internal loan review function rates loans using a grading system based on different risk categories. Loans with a Substandard grade are considered to have a greater risk of loss and may be assigned allocations for loss based on specific review of the weaknesses observed in the individual credits. Such loans are constantly monitored by the loan review function to ensure early identification of any deterioration. A description of the loan risk categories used by the Company follows.

Grades 1-4, Pass: Credits exhibit adequate cash flows, appropriate management and financial ratios within industry norms and/or are supported by sufficient collateral. Some credits in these rating categories may require a need for monitoring but elements of concern are not severe enough to warrant an elevated rating.

Grade 5, Watch: Credits with this rating are adequately secured and performing but are being monitored due to the presence of various short-term weaknesses which may include unexpected, short-term adverse financial performance, managerial problems, potential impact of a decline in the entire industry or local economy and delinquency issues. Loans to individuals or loans supported by guarantors with marginal net worth or collateral may be included in this rating category.

Grade 6, Special Mention: Credits with this rating have potential weaknesses that, without the Company’s attention and correction may result in deterioration of repayment prospects. These assets are considered Criticized Assets. Potential weaknesses may include adverse financial trends for the borrower or industry, repeated lack of compliance with Company requests, increasing debt to net worth, serious management conditions and decreasing cash flow.

Grade 7, Substandard: Assets with this rating are characterized by the distinct possibility the Company will sustain some loss if deficiencies are not corrected. All foreclosures, liquidations, and nonaccrual loans are considered to be categorized in this rating, regardless of collateral sufficiency.

Nonaccretable Discount on Purchased Credit Impaired Loans:

The following table summarizes the nonaccretable discount on purchased credit impaired loans prior to the adoption of ASU 2016-13.



	Three Months Ended			Year Ended
(in thousands)	March 31, 2019			December 31, 2019
Balance at beginning of period	$	6,408		$	6,408
Acquired balance, net	—			911
Accretion to loan interest income	(221		)	(4,713		)
Disposals of loans	—			(679		)
Balance at end of period	$	6,187		$	1,927

Troubled Debt Restructurings:

At March 31, 2020, there were four loans classified as troubled debt restructurings with a current outstanding balance of $1.1 million and pre-modification balance of $1.4 million. In comparison, at December 31, 2019, there were five loans classified as troubled debt restructurings with an outstanding balance of $1.1 million and pre-modification balance of $1.4 million. There were no loans classified as troubled debt restructurings during the previous twelve months that subsequently defaulted during the three months ended March 31, 2020. As of March 31, 2020, there were no commitments to lend additional funds to debtors whose terms have been modified in troubled debt restructurings.