10-K 1 t78323_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, 2013
 
o 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 333-90052
NICOLET BANKSHARES, INC.
(Exact name of registrant as specified in its charter)
 
WISCONSIN
(State or other jurisdiction of incorporation or organization)
47-0871001
(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: None
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 o No x
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d). Yes o 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 o
 
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 preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o
 
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. x
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer o Accelerated filer o
Non-accelerated filer o (Do not check if a smaller reporting company) Smaller reporting company x
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
 
As of June 30, 2013, (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 $57.4 million based on the closing sale price of $16.50 per share as reported on the OTCQB on June 28, 2013.
 
As of February 28, 2014, 4,232,584 shares of common stock were outstanding.
 
 

 

 
Nicolet Bankshares, Inc.
 
TABLE OF CONTENTS
       
PART I
 
PAGE
     
 
Item 1.
Business
3-11
       
 
Item 1A.
Risk Factors
11
       
 
Item 1B.
Unresolved Staff Comments
11
       
 
Item 2.
Properties
12
       
 
Item 3.
Legal Proceedings
12
       
 
Item 4.
Mine Safety Disclosures
12
       
PART II
   
     
 
Item 5.
Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
13
       
 
Item 6.
Selected Financial Data
13-14
       
 
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operation
15-38
       
 
Item 7A.
Quantitative and Qualitative Disclosures about Market Risk
38
       
 
Item 8.
Financial Statements and Supplementary Data
39-85
       
 
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
86
       
 
Item 9A.
Controls and Procedures
86
       
 
Item 9B.
Other Information
86
       
PART III
     
       
 
Item 10.
Directors, Executive Officers and Corporate Governance
86-87
       
 
Item 11.
Executive Compensation
88-90
       
 
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
91
       
 
Item 13.
Certain Relationships and Related Transactions, and Director Independence
92
       
 
Item 14.
Principal Accountant Fees and Services
92
       
PART IV
     
       
 
Item 15.
Exhibits and Financial Statement Schedules
93
       
 
Signatures
 
94
 
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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 statement made herein.  These risks and uncertainties involve general economic trends and changes in interest rates, increased competition, regulatory or legislative developments affecting the financial industry generally or Nicolet Bankshares, Inc. specifically, changes in consumer demand for financial services, the possibility of unforeseen events affecting the industry generally or Nicolet Bankshares, Inc. specifically, the uncertainties associated with newly developed or acquired operations and market disruptions.  Nicolet Bankshares, Inc. undertakes no obligation to release revisions to these forward-looking statements publicly to reflect events or circumstances after the date hereof or to reflect the occurrence of unforeseen events, except as required to be reported under the rules and regulations of the Securities and Exchange Commission (“SEC”).
 
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.
 
Nicolet is a Wisconsin corporation, originally incorporated on April 5, 2000 as Green Bay Financial Corporation, a Wisconsin corporation, to serve as the holding company for and the sole shareholder of Nicolet National Bank.  It amended and restated its articles of incorporation and changed its name to Nicolet Bankshares, Inc. on March 14, 2002. It subsequently became the holding company for Nicolet National Bank upon the completion of the bank’s reorganization into a holding company structure on June 6, 2002.
 
Nicolet conducts operations through its wholly owned subsidiary, Nicolet National Bank, a commercial bank which was organized in 2000 as a national bank under the laws of the United States and opened for business, in Green Bay, Brown County, Wisconsin, on November 1, 2000 (referred to herein as “Nicolet National Bank,” or the “Bank”).  Structurally, Nicolet also wholly owns a registered investment advisory firm that principally provides investment strategy and transactional services to select community banks, wholly owns an investment subsidiary of the Bank that is based in Nevada, and entered into a joint venture that provides for 50% ownership of the building in which Nicolet is headquartered.  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.
 
Nicolet National Bank is a full-service community bank, offering traditional banking products and services, and wealth management products and services, to businesses and individuals in the markets it serves, delivered through a branch network serving northeast and central Wisconsin communities and Menominee, Michigan, as well as through on-line and mobile banking capabilities.
 
Since its opening in late 2000, Nicolet has grown to $1.2 billion in assets as of December 31, 2013.  Over this time, Nicolet supplemented its organic growth with the December 2003 purchase of a branch and deposits in Menominee, Michigan, the July 2010 purchase of 4 branches and deposits in Brown County, the April 2013 merger transaction with Mid-Wisconsin Financial Services, Inc. (“Mid-Wisconsin”), and the August 2013 acquisition of selected assets and liabilities of Bank of Wausau through a transaction with the Federal Deposit Insurance Corporation (“FDIC”).
 
At December 31, 2013, Nicolet had total assets of $1.2 billion, loans of $847 million, deposits of $1.0 billion and total shareholders’ equity of $105 million.  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 fee 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.  For the year ended December 31, 2013, Nicolet earned net income of $16.1 million, and after $1.0 million of preferred stock dividends, net income available to common shareholders was $15.1 million or $3.80 per diluted common share.
 
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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, the Bank offers trust and investment management services for individuals and retirement plan services business customers.  Nicolet delivers its products and services through 23 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, courier services, debit cards, credit cards, pre-paid gift cards, direct deposit, official bank checks and U.S. Savings bonds.
 
Lending is critical to Nicolet’s balance sheet and earnings potential. Nicolet seeks creditworthy borrowers principally within the geographic area of its branch locations.  As a community bank with experienced commercial lenders and residential mortgage lenders, the Bank’s primary lending function is to make commercial loans (consisting of commercial, industrial, and business loans, owner-occupied commercial real estate, and agricultural production and real estate loans); commercial real estate (“CRE”) loans (consisting of investment real estate loans and construction and land development loans); residential real estate loans (consisting of residential first lien mortgages, junior lien mortgages such as home equity loans and lines of credit, and to a lesser degree residential construction loans; and other loans, mainly consumer in nature.  As of December 31, 2013, Nicolet’s loan portfolio mix was as follows:
 
 
Loan category
 
% of Total Loans
   
 
Commercial and industrial
    30 %    
 
Owner-occupied CRE
    22 %    
 
Agricultural production and real estate
    6 %    
 
   Total commercial loans
    58 %    
 
CRE-investment
    11 %    
 
Construction and land development
    5 %    
 
   Total CRE loans
    16 %    
 
Residential first mortgages
    18 %    
 
Residential junior mortgages
    6 %    
 
Residential construction
    1 %    
 
   Total residential real estate loans
    25 %    
 
Other
    1 %    
 
Lending involves credit risk.  Nicolet has and follows extensive loan policies and procedures to standardize processes, meet compliance requirements and prudently manage underwriting, credit and other risks.  Credit risk is further controlled and monitored through active asset quality management including the use of lending standards, thorough review of current and potential borrowers through Nicolet’s underwriting process, close relationships with and regular check-ins with borrowers, and active asset quality administration.  For further discussion of credit risk management, see “Management’s Discussion and Analysis of Financial Condition and Results of Operation,” under Part II, Item 7.
 
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Employees
 
At December 31, 2013, Nicolet had approximately 290 full-time equivalent employees.  None of our employees are represented by unions.
 
Market Area and Competition
 
Nicolet National Bank is a full-service community bank, providing a full range of traditional commercial and retail banking services, as well as wealth management services, throughout northeastern and central Wisconsin and the upper peninsula of Michigan.  Nicolet markets its services to owner-managed companies, the individual owners of these businesses, and other residents of its market area, which at December 31, 2013 is through 23 branches located within 10 Wisconsin counties (Brown, Outagamie, Marinette, Taylor, Clark, Marathon, Oneida, Price, Vilas, and Eau Claire) and in Menominee, Michigan. Based on deposit market share data published by the FDIC as of June 30, 2013, the Bank ranks in the top three of market share for Brown, Taylor and Clark counties and in the top six for Menominee, Marinette and Price counties.
 
The financial services industry is highly competitive. Nicolet competes for loans, deposits and wealth management or financial services in all its principal markets.  Nicolet competes directly with other bank and nonbank institutions located within our markets (some that may have an established customer base or name recognition), internet-based banks, out-of-market banks that advertise or otherwise serve its markets, money market and other mutual funds, brokerage houses, mortgage companies, insurance companies or other commercial entities that offer financial services products.  Competition involves efforts to retain current or procure new customers, obtain new loans and deposits, increase the scope and type of products or services offered, and offer competitive interest rates paid on deposits or charged 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 actions. 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 Nicolet National Bank, and legislative changes and the policies of various regulatory authorities may significantly affect their operations. We cannot predict the effect that fiscal or monetary policies, or new federal or state legislation may have on the future business and earnings of Nicolet or Nicolet National Bank.
 
Regulation of Nicolet
 
Because Nicolet owns all of the capital stock of Nicolet National Bank, it is a bank holding company under the federal Bank Holding Company Act of 1956 (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.
 
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Acquisitions of Banks.  The Bank Holding Company Act requires every bank holding company to obtain the prior approval of the Federal Reserve before:
 
 
acquiring direct or indirect ownership or control of any voting shares of any bank if, after the acquisition, the bank holding company will directly or indirectly own or control more than 5% of the bank’s voting shares;
 
acquiring all or substantially all of the assets of any bank; or
 
merging or consolidating with any other bank holding company.
 
Additionally, The Bank Holding Company Act provides that the Federal Reserve may not approve any of these transactions if it would result in or tend to create a monopoly, substantially lessen competition, or otherwise function as a restraint of trade, unless the anti-competitive effects of the proposed transaction are clearly outweighed by the public interest in meeting the convenience and needs of the community to be served.  The Federal Reserve is also required to consider the financial and managerial resources and future prospects of the bank holding companies and banks involved in the transaction and the convenience and needs of the community to be served.  The Federal Reserve’s consideration of financial resources generally focuses on capital adequacy, which is discussed below.
 
Under The Bank Holding Company Act, if adequately capitalized and adequately managed, Nicolet or any other bank holding company located in Wisconsin may purchase a bank located outside of Wisconsin.  Conversely, an adequately capitalized and adequately managed bank holding company located outside of Wisconsin may purchase a bank located inside Wisconsin.  In each case, however, restrictions may be placed on the acquisition of a bank that has only been in existence for a limited amount of time or will result in specified concentrations of deposits.  
 
Change in Bank Control.   Subject to various exceptions, The Bank Holding Company Act and the Change in Bank Control Act, together with related regulations, require Federal Reserve approval prior to any person or company acquiring “control” of a bank holding company.  Control is conclusively presumed to exist if an individual or company acquires 25% or more of any class of voting securities of the bank holding company.  Control is rebuttably presumed to exist if a person or company acquires 10% or more, but less than 25%, of any class of voting securities of the bank holding company.  The regulations provide a procedure for challenging rebuttable presumptions of control.
 
Permitted Activities.  The Bank Holding Company Act has generally prohibited a bank holding company from engaging in activities other than banking or managing or controlling banks or other permissible subsidiaries and from acquiring or retaining direct or indirect control of any company engaged in any activities other than those determined by the Federal Reserve to be closely related to banking or managing or controlling banks as to be a proper incident thereto.  Provisions of the Gramm-Leach-Bliley Act have expanded the permissible activities of a bank holding company that qualifies as a financial holding company.  While Nicolet meets the qualification standards applicable to financial holding companies, Nicolet has not elected to become a financial holding company at this time.
 
Support of Subsidiary Institutions.   Under Federal Reserve policy and the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), Nicolet is expected to act as a source of financial strength for Nicolet National Bank and to commit resources to support Nicolet National Bank.  This support may be required at times when, without this Federal Reserve policy or the impending rules, Nicolet might not be inclined to provide it. In addition, any capital loans made by Nicolet to Nicolet National Bank will be repaid only after Nicolet National 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 Nicolet National Bank, which are summarized below.
 
Dividend Restrictions.  Under Federal Reserve policies, bank holding companies may pay cash dividends on common stock only out of income available over the past year if prospective earnings retention is consistent with the organization’s expected future needs and financial condition and if the organization is not in danger of not meeting its minimum regulatory capital requirements.  Federal Reserve policy also provides that bank holding companies should not maintain a level of cash dividends that undermines the bank holding company’s ability to serve as a source of strength to its banking subsidiaries.
 
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In addition, when Nicolet received its capital investment from the U.S. Department of the Treasury (the “Treasury”) under the Small Business Lending Fund (the “SBLF”) on September 1, 2011, it became subject to certain contractual limitations on the payment of dividends.  These limitations require, among other things, that (1) all dividends for the SBLF Preferred Stock paid before other dividends can be paid and (2) no dividends on or repurchases of Nicolet common stock will be permitted if the payment or dividends would result in a reduction of Nicolet’s Tier 1 capital from the level on the SBLF closing date by more than 10%.
 
Regulation of Nicolet National Bank
 
Because Nicolet National 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 Office of the Comptroller of the Currency (the “OCC”).  The OCC regularly examines Nicolet National 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 Nicolet National 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 Nicolet National Bank.  Nicolet National 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, Nicolet National 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, Nicolet National Bank may acquire branches of existing banks located in Wisconsin or other states.
 
Capital Adequacy. The Federal Reserve Board has established a risk-based and a leverage measure of capital adequacy for bank holding companies.  Nicolet National Bank is also subject to risk-based and leverage capital requirements adopted by the OCC, which are substantially similar to those adopted by the Federal Reserve Board for bank holding companies.  Under the OCC’s risk-based capital measure, the minimum ratio of a bank’s total capital to risk-weighted assets (including various off-balance-sheet items, such as standby letters of credit) is 8.0%.  At least half of total capital must be composed of “Tier 1 Capital.” Tier 1 Capital includes common equity, undivided profits, minority interests in the equity accounts of consolidated subsidiaries, qualifying noncumulative perpetual preferred stock, and a limited amount of cumulative perpetual preferred stock, less goodwill and various other intangible assets.  The remainder of total capital may consist of “Tier 2 Capital” which includes certain subordinated debt, certain hybrid capital instruments and other qualifying preferred stock, and a limited amount of loan loss reserves.  A bank that does not satisfy minimum capital requirements may be required to adopt and implement a plan acceptable to its federal banking regulator to achieve an adequate level of capital.
 
Under the leverage capital measure, the minimum ratio of Tier 1 Capital to average assets, less goodwill and various other intangible assets, generally is 4.0%.  The regulatory guidelines also provide that banks experiencing internal, growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum levels without significant reliance on intangible assets, and a bank’s “Tangible Leverage Ratio” (determined by deducting all intangible assets) and other indicators of a bank’s capital strength also are taken into consideration by banking regulators in evaluating proposals for expansion or new activities.
 
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.
 
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Prompt Corrective Action.  The Federal Deposit Insurance Corporation Improvement Act of 1991 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 6%, 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, 2013, Nicolet National Bank satisfied the requirements of “well-capitalized” under the regulatory framework for prompt corrective action.  See Note 17, “Regulatory Capital Requirements and Restrictions of Dividends,” in the Notes to Consolidated Financial Statements, under Part II, Item 9, for Nicolet and Nicolet National Bank regulatory capital ratios.
 
As a bank’s capital position deteriorates, federal banking regulators are required to take various mandatory supervisory actions and are authorized to take other discretionary actions with respect to institutions in the three undercapitalized categories:  undercapitalized, significantly undercapitalized, and critically undercapitalized.  The severity of the action depends upon the capital category in which the institution is placed.  Generally, subject to a narrow exception, the banking regulator must appoint a receiver or conservator for an institution that is critically undercapitalized.
 
FDIC Insurance Assessments. Nicolet National 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.  Nicolet National 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.  In 2006, the federal banking regulators issued the following final 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.
 
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 $1,100,000 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 Nicolet National Bank.  Additionally, Nicolet National Bank must publicly disclose the terms of various Community Reinvestment Act-related agreements.
 
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Payment of Dividends.  Statutory and regulatory limitations apply to Nicolet National Bank’s payment of dividends to Nicolet.  If, in the opinion of the OCC, Nicolet National Bank were engaged in or about to engage in an unsafe or unsound practice, the OCC could require that Nicolet National 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.
 
Nicolet National 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 Nicolet National Bank in any year will exceed (1) the total of Nicolet National Bank’s net profits for that year, plus (2) Nicolet National Bank’s retained net profits of the preceding two years, less any required transfers to surplus.  The payment of dividends may also be affected by other factors, such as the requirement to maintain adequate capital above regulatory guidelines or any conditions or restrictions that may be imposed by regulatory authorities.
 
Transactions with Affiliates and Insiders. Nicolet National Bank is subject to the provisions of Regulation W promulgated by the Federal Reserve, which encompasses Sections 23A and 23B of the Federal Reserve Act.  Regulation W places limits and conditions on the amount of loans or extensions of credit to, investments in, or certain other transactions with, affiliates and on the amount of advances to third parties collateralized by the securities or obligations of affiliates.  Regulation W also prohibits, among other things, an institution from engaging in certain transactions with certain affiliates unless the transactions are on terms substantially the same, or at least as favorable to such institution or its subsidiaries, as those prevailing at the time for comparable transactions with nonaffiliated companies.  Federal law also places restrictions on Nicolet National Bank’s ability to extend credit to its executive officers, directors, principal shareholders and their related interests.  These extensions of credit: must be made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unrelated third parties; and must not involve more than the normal risk of repayment or present other unfavorable features.
 
USA Patriot Act. The Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the “USA PATRIOT Act”) requires each financial institution to: (i) establish an anti-money laundering program; and (ii) establish due diligence policies, procedures and controls with respect to its private and correspondent banking accounts involving foreign individuals and certain foreign banks.  In addition, the USA PATRIOT Act encourages cooperation among financial institutions, regulatory authorities and law enforcement authorities with respect to individuals, entities and organizations engaged in, or reasonably suspected of engaging in, terrorist acts or money laundering activities.
 
Customer Protection.  Nicolet National 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.
 
Financial Regulatory Reform
 
On July 21, 2010, the President signed into law the Dodd-Frank Act, which contains a comprehensive set of provisions designed to govern the practices and oversight of financial institutions and other participants in the financial markets. The Dodd-Frank Act made extensive changes in the regulation of financial institutions and their holding companies. It requires various federal agencies to adopt a broad range of new rules and regulations, and to prepare numerous studies and reports for Congress. These studies could potentially result in additional legislative or regulatory action.
 
Uncertainty remains as to the ultimate impact of the Dodd-Frank Act, which could have a material adverse impact on the financial services industry as a whole or on Nicolet’s and Nicolet National Bank’s business, results of operations, and financial condition.  Many aspects of the Dodd-Frank Act are subject to rulemaking and will take effect over several years, making it difficult to anticipate the overall financial impact on the Company, its customers or the financial industry more generally.  However, it is likely that the Dodd-Frank Act will increase the regulatory burden, compliance costs and interest expense for Nicolet and Nicolet National Bank.  Some of the rules that have been adopted to comply with the Dodd-Frank Act’s mandates are discussed below.
 
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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 Nicolet National Bank, will be subject to rules promulgated by the CFPB but will continue to be examined and supervised by federal banking regulators for consumer compliance purposes.
 
UDAP and UDAAP. Recently, banking regulatory agencies have increasingly used a general consumer protection statute to address “unethical” or otherwise “bad” business practices that may not necessarily fall directly under the purview of a specific banking or consumer finance law. The law of choice for enforcement against such business practices has been Section 5 of the Federal Trade Commission Act—the primary federal law that prohibits unfair or deceptive acts or practices and unfair methods of competition in or affecting commerce (“UDAP” or “FTC Act”). “Unjustified consumer injury” is the principal focus of the FTC Act. Prior to the Dodd-Frank Act, there was little formal guidance to provide insight to the parameters for compliance with the UDAP law. However, the UDAP provisions have been expanded under the Dodd-Frank Act to apply to “unfair, deceptive or abusive acts or practices” (“UDAAP”), which has been delegated to the CFPB for supervision. The CFPB has published its first Supervision and Examination Manual that addresses compliance with and the examination of UDAAP.
 
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.
 
Deposit Insurance and Assessments.  The $250,000 limit for federal deposit insurance for noninterest-bearing demand transaction accounts at all insured depository institutions was made permanent by the Dodd-Frank Act.  The Dodd-Frank Act also changed the assessment base for federal deposit insurance from the amount of insured deposits to consolidated assets less tangible capital, eliminated the ceiling on the size of the Deposit Insurance Fund and increased the floor on the size of the Deposit Insurance Fund.
 
Demand Deposits. The Dodd-Frank Act repealed the federal prohibitions on the payment of interest on demand deposits, thereby permitting depository institutions to pay interest on business transactions and other accounts.
 
Interchange Fees.  The Federal Reserve has issued final rules limiting the amount of any debit card interchange fee that an issuer may receive or charge with respect to electronic debit card transactions to be reasonable and proportional to the cost incurred by the issuer with respect to the transaction.
 
Volcker Rule.  On December 10, 2013, the federal regulators adopted final regulations to implement the proprietary trading and private fund prohibitions of the Volcker Rule under the Dodd-Frank Act.  Under the final regulations, which will become effective on April 1, 2014, banking entities are generally prohibited, subject to significant exceptions from: (i) short-term proprietary trading as principal in securities and other financial instruments, and (ii) sponsoring or acquiring or retaining an ownership interest  in private equity and hedge funds.  The Federal Reserve has granted an extension for compliance with the Volcker Rule until July 21, 2015.  Nicolet National Bank believes there will be no significant impact of the Volcker Rule on its investment portfolio.
 
Basel III
 
On July 2, 2013, the Federal Reserve approved a final rule to establish a new comprehensive regulatory capital framework for all US banking organizations.  On July 9, 2013, the final rule was approved (as an interim final rule) by the FDIC.  The Regulatory Capital Framework (Basel III) implements several changes to the U.S. regulatory capital framework required by the Dodd-Frank Act. The new US capital framework imposes higher minimum capital requirements, additional capital buffers above those minimum requirements, a more restrictive definition of capital, and higher risk weights for various enumerated classifications of assets, the combined impact of which effectively results in substantially more demanding capital standards for US banking organizations.
 
The Basel III final rule establishes a new common equity Tier 1 capital (“CET1”) requirement, an increase in the Tier 1 capital requirement from 4.0% to 6.0% and maintains the current 8.0% total capital requirement.  The new CET1 and minimum Tier 1 capital requirements are effective January 1, 2015.  In addition to these minimum risk-based capital ratios, the Basel final rule requires that all banking organizations maintain a “capital conservation buffer” consisting of common equity Tier 1 capital (“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 US banking organizations to 7.0%, 8.5%, and 10.5%, respectively. Banking organizations with capital levels that fall within the buffer will be required to limit dividends, share repurchases or redemptions (unless replaced within the same calendar quarter by capital instruments of equal or higher quality), and discretionary bonus payments.  The capital conservation buffer is phased in over a 5-year period beginning January 1, 2016.
 
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As required by Dodd-Frank, the Basel III final rule requires that capital instruments such as trust preferred securities and cumulative preferred shares be phased-out of Tier 1 capital by January 1, 2016, for banking organizations that had $15 billion or more in total consolidated assets as of December 31, 2009 and permanently grandfathers as Tier 1 capital such instruments issued by these smaller entities prior to May 19, 2010 (provided they do not exceed 25 percent of Tier 1 capital). Nicolet’s trust preferred securities are grandfathered under this provision.
 
The Basel III final rule provides banking organizations under $250 billion in total consolidated assets or under $10 billion in foreign exposures with a one-time “opt-out” right to continue excluding Accumulated Other Comprehensive Income from CET1 capital.  The election to opt out must be made on the banking organization’s first Call Report filed after January 1, 2015.
 
The Basel III final rule requires 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 final rule.
 
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 files annual, quarterly, and current reports, and other information with the SEC.  These filings are available to the public on the Internet at the SEC’s website at www.sec.gov.  Shareholders may also read and copy any document that we file at the SEC’s public reference rooms located at 100 F Street, NE, Washington, DC 20549.  Shareholders may call the SEC at 1-800-SEC-0330 for further information on the public reference room.
 
Nicolet’s internet address is www.nicoletbank.com.  We make available free of charge on or through our website our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC.
 
ITEM 1A.      RISK FACTORS
 
Not applicable for smaller reporting companies.
 
ITEM 1B.      UNRESOLVED STAFF COMMENTS
 
None.
 
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ITEM 2.         PROPERTIES
 
The headquarters of both Nicolet and Nicolet National Bank is located at 111 North Washington Street, Green Bay, Wisconsin.  Including the main office, Nicolet National Bank operates 23 owned or leased branch locations noted below, most of which are free-standing, newer buildings that provide adequate access, customer parking, and drive-through and/or ATM services. In addition, Nicolet owns or leases other real property that, when considered in aggregate, is not significant to its financial position.  No property listed below as owned is subject to a mortgage or similar encumbrance.
 
Green Bay (main office)
 
111 N. Washington Street
 
Green Bay
 
WI
 
Leased*
De Pere
 
1011 N. Broadway Avenue
 
De Pere
 
WI
 
Owned
West De Pere
 
1610 Lawrence Drive
 
De Pere
 
WI
 
Leased
Howard
 
2380 Duck Creek Parkway
 
Green Bay
 
WI
 
Owned
Ashwaubenon
 
2363 Holmgren Way
 
Green Bay
 
WI
 
Leased
Bellevue
 
2082 Monroe Road
 
De Pere
 
WI
 
Leased
Appleton
 
900 W. College Avenue
 
Appleton
 
WI
 
Leased
Appleton - Kensington
 
2400 S. Kensington Drive, Suite 100
 
Appleton
 
WI
 
Leased*
Crivitz
 
315 US Hwy 141 N.
 
Crivitz
 
WI
 
Owned
Marinette
 
2009 Hall Avenue
 
Marinette
 
WI
 
Owned
Menominee
 
1015 10th Avenue
 
Menominee
 
MI
 
Owned
Eagle River
 
325 W. Pine Street
 
Eagle River
 
WI
 
Leased
Minocqua
 
8744 US Hwy 51 N.
 
Minocqua
 
WI
 
Leased
Rhinelander
 
2170 Lincoln Street
 
Rhinelander
 
WI
 
Owned
Phillips
 
864 N. Lake Avenue
 
Phillips
 
WI
 
Owned
Rib Lake
 
717 McComb Avenue
 
Rib Lake
 
WI
 
Owned
Medford
 
134 S. 8th Street
 
Medford
 
WI
 
Owned
Wausau
 
2100 Stewart Avenue, Suite 100
 
Wausau
 
WI
 
Leased*
Rib Mountain
 
3845 Rib Mountain Drive
 
Wausau
 
WI
 
Owned
Abbotsford
 
119 N. First Street
 
Abbotsford
 
WI
 
Owned
Colby
 
101 S. First Street
 
Colby
 
WI
 
Owned
Neillsville
 
500 West Street
 
Neillsville
 
WI
 
Owned
Fairchild
 
111 N. Front Street
 
Fairchild
 
WI
 
Owned
 
*These leased locations involve related parties. For additional disclosure, see Note 15, “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.
 
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PART II
 
ITEM 5.          MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
 
Nicolet’s common stock is traded on the Over-The-Counter Markets (“OTCQB”) under the symbol “NCBS”.  The common stock was authorized to commence trading on the OTCQB  on April 26, 2013, with the first trade completed on May 12, 2013.  Prior to such trading, there was no established market for Nicolet’s common stock. Although the common stock is currently traded on the OTCQB, the trading volume is less than that of banks with larger market capitalizations. As of February 28, 2014, Nicolet had approximately 690 shareholders of record.
 
The following table sets forth the high and low bid prices and quarter end closing prices of Nicolet’s common stock as reported by the OTCQB for the periods indicated on or after April 26, 2013.  High and low prices noted for the periods prior to April 26, 2013 represent sales prices for the common stock, to the extent known by management.
 
For The Quarter Ended 
     
 
 
High Bid
Prices
   
Low Bid
Prices
   
Closing
Sales Prices
 
                   
December 31, 2013
  $ 17.00     $ 15.71     $ 16.54  
September 30, 2013
    17.00       15.77       16.51  
June 30, 2013
    17.50       15.80       16.50  
March 31, 2013
    16.50       16.50          
                         
December 31, 2012
  $ 16.50     $ 16.50          
September 30, 2012
    16.50       16.50          
June 30, 2012
    16.50       16.50          
March 31, 2012
    16.50       16.50          
 
Nicolet has not paid dividends on its common stock since its inception in 2000, nor does it currently have any plans to pay dividends on Nicolet common stock in the foreseeable future. Future determinations regarding dividend policy will be made at the discretion of Nicolet’s board of directors based on factors they deem relevant at this time, including but not limited to, earnings, capital requirements, support to Nicolet’s operations and/or to finance growth and development of its business. Any cash dividends paid by Nicolet on its common stock must comply with applicable Federal Reserve policies and with certain contractual limitations on the payment of dividends related to the SBLF, both described further in “Business—Regulation of Nicolet—Dividend Restrictions.”  Nicolet National Bank is also subject to regulatory restrictions on the amount of dividends it is permitted to pay to Nicolet as further described in Note 17, “Regulatory Capital Requirements and Restrictions on Dividends,” in the Notes to Consolidated Financial Statements under Item 8.
 
On January 21, 2014, Nicolet’s board of directors approved a resolution authorizing a stock repurchase program whereby Nicolet may utilize up to $6 million to purchase up to 350,000 shares of its outstanding common stock from time to time in the open market or block transactions as market conditions warrant or in private transactions.
 
ITEM 6.          SELECTED FINANCIAL DATA
 
The selected consolidated financial data presented as of December 31, 2013 and 2012 and for each of the years in the two-year period ended December 31, 2013 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 as of December 31, 2011, 2010 and 2009 is derived from audited consolidated financial statements that are not required to be included in this report.
 
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EARNINGS SUMMARY AND SELECTED FINANCIAL DATA
(In thousands, except per share data)
 
At and for the year ended December 31,
 
   
2013
   
2012
   
2011
   
2010
   
2009
 
Results of operations:
     
Interest income
  $ 43,196     $ 28,795     $ 29,830     $ 31,420     $ 31,582  
Interest expense
    6,292       6,530       8,383       11,291       15,218  
Net interest income
    36,904       22,265       21,447       20,129       16,364  
Provision for loan losses
    6,200       4,325       6,600       8,500       6,000  
Net interest income after provision for loan losses
    30,704       17,940       14,847       11,629       10,364  
Other income
    25,736       10,744       8,444       8,968       7,531  
Other expense
    36,431       24,062       21,443       19,316       16,684  
Income before income taxes
    20,009       4,622       1,848       1,281       1,211  
Income tax expense
    3,837       1,529       318       136       45  
Net income
    16,172       3,093       1,530       1,145       1,166  
Net income (loss) attributable to noncontrolling interest
    31       57       40       35       (11 )
Net income attributable to Nicolet Bankshares, Inc.
    16,141       3,036       1,490       1,110       1,177  
Preferred stock dividends and discount accretion
    976       1,220       1,461       985       1,001  
Net income available to common equity
  $ 15,165     $ 1,816     $ 29     $ 125     $ 176  
Earnings per common share:
                                       
Basic
  $ 3.81     $ 0.53     $ 0.01     $ 0.04     $ 0.05  
Diluted
    3.80       0.53       0.01       0.04       0.05  
Weighted average common shares outstanding:
                                       
Basic
    3,977       3,440       3,469       3,452       3,500  
Diluted
    3,988       3,442       3,488       3,481       3,528  
Year-End Balances:
                                       
Loans
  $ 847,358     $ 552,601     $ 472,489     $ 513,761     $ 486,571  
Allowance for loan losses
    9,232       7,120       5,899       8,635       6,232  
Investment securities available-for-sale, at fair value
    127,515       55,901       56,759       52,388       54,273  
Total assets
    1,198,803       745,255       678,249       674,754       675,403  
Deposits
    1,034,834       616,093       551,536       558,464       556,984  
Other debt
    39,538       39,190       39,506       39,972       43,486  
Junior subordinated debentures
    12,128       6,186       6,186       6,186       6,186  
Common equity
    80,462       52,933       51,623       50,417       49,790  
Stockholders’ equity
    104,862       77,333       76,023       65,620       64,824  
Book value per common share
    18.97       15.45       14.83       14.57       14.47  
Average Balances:
                                       
Loans
  $ 753,284     $ 521,209     $ 503,362     $ 499,193     $ 478,267  
Earning assets
    913,104       614,252       582,486       603,182       579,803  
Total assets
    997,372       674,222       642,353       653,710       633,284  
Deposits
    830,884       545,896       522,297       530,682       510,741  
Interest-bearing liabilities
    756,606       511,572       500,895       524,461       507,223  
Common equity
    70,737       52,135       50,968       51,661       50,441  
Stockholders’ equity
    95,137       76,535       69,284       66,923       65,387  
Financial Ratios:
                                       
Return on average assets
    1.62 %     0.45 %     0.23 %     0.17 %     0.19 %
Return on average equity
    16.97 %     3.97 %     2.15 %     1.66 %     1.80 %
Return on average common equity
    21.44 %     3.48 %     0.06 %     0.24 %     0.35 %
Average equity to average assets
    9.54 %     11.35 %     10.79 %     10.22 %     10.32 %
Net interest margin
    4.06 %     3.67 %     3.75 %     3.39 %     2.89 %
Stockholders’ equity to assets
    8.75 %     10.38 %     11.21 %     9.73 %     9.60 %
Net loan charge-offs to average loans
    0.54 %     0.60 %     1.85 %     1.22 %     1.11 %
Nonperforming loans to total loans
    1.21 %     1.27 %     2.01 %     2.10 %     1.69 %
Nonperforming assets to total assets
    1.02 %     0.97 %     1.49 %     1.81 %     1.42 %
 
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ITEM 7.          MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION
 
The following discussion is management’s analysis to assist in the understanding and evaluation of the consolidated financial condition and results of operations of Nicolet.  It should be read in conjunction with the consolidated financial statements and footnotes and the selected financial data presented elsewhere in this report.
 
The detailed financial discussion that follows focuses on 2013 results compared to 2012, as required for smaller reporting companies.  Some tabular information is shown for trends of three years or for five years as required under SEC regulations.
 
Overview
 
Nicolet is a bank holding company headquartered in Green Bay, Wisconsin, providing a diversified range of traditional commercial and retail banking services, as well as wealth management services, to individuals, business owners, and businesses in its market area through the 23 branch offices of its banking subsidiary, Nicolet National Bank, located within 10 Wisconsin counties (Brown, Outagamie, Marinette, Taylor, Clark, Marathon, Oneida, Price, Vilas and Eau Claire) and in Menominee, Michigan.
 
Nicolet’s primary revenue sources are net interest income, representing interest income from loans and other interest earning assets such as investments, less interest expense on deposits and other borrowings, and noninterest income, including, among others, trust and brokerage fees, service charges on deposit accounts, secondary mortgage income and other fees or revenue from financial services provided to customers or ancillary to loans and deposits. Business volumes and pricing drive revenue potential and tend to be influenced by overall economic factors, including market interest rates, business spending, consumer confidence, economic growth and competitive conditions within the marketplace.
 
2013 was a year for execution on strategic growth initiatives.  At December 31, 2013, total assets were $1.2 billion, up $454 million or 61% over year end 2012, and book value per common share was $18.97, up $3.52 or 23% from December 31, 2012.  Net income attributable to Nicolet was $16.1 million for 2013, and after $1.0 million of preferred stock dividends, net income available to common shareholders was $15.1 million or $3.80 per diluted common share, compared to diluted earnings per common share of $0.53 for 2012.  Financial results for 2013 were largely impacted by Nicolet’s 2013 acquisitions of two distressed financial institutions – the predominantly stock-for-stock merger with Mid-Wisconsin announced in November 2012 and consummated in April 2013 and the smaller FDIC-assisted acquisition of Bank of Wausau announced and completed in August 2013 (collectively the “2013 acquisitions”).  Combined, as of their respective acquisition dates, these transactions added 12 branch locations to Nicolet’s footprint and approximately $483 million in assets, $284 million in loans and $388 million in deposits.  Also, 2013 results included approximately eight months of Mid-Wisconsin operations, five months of Bank of Wausau operations, and combined related non-recurring bargain purchase gains of $11.9 million and direct merger expenses of $1.9 million pre-tax.  Nonperforming assets to total assets were 1.02% at December 31, 2013, even with acquiring $284 million in loans, reflecting Nicolet’s commitment to immediate and dedicated work on asset resolution, particularly on acquired nonperforming assets. For additional details, see Note 2, “Acquisitions,” in the Notes to Consolidated Financial Statements, under Part II, Item 8.
 
Performance Summary
 
Net income attributable to Nicolet was $16.1 million for 2013, and after $1.0 million of preferred stock dividends, net income available to common shareholders was $15.1 million, or $3.80 per diluted common share.  Comparatively, 2012 net income was $3.0 million, and after $1.2 million of preferred stock dividends, net income available to common shareholders was $1.8 million or $0.53 per diluted common share for 2012.  Income statement results and average balances for 2013 include approximately eight months of Mid-Wisconsin and five months of Bank of Wausau activity (as the results of operations of both entities prior to consummation are appropriately not included in the accompanying consolidated financial statements); thus, analytically, roughly 40% increases in certain average balances and certain income statement lines between 2013 and 2012 would be explainable from inclusion of the 2013 acquisitions.  Results of 2013 also included total bargain purchase gains of $11.9 million and pre-tax, non-recurring expenses of approximately $1.9 million specifically related to the consummation and integration of the 2013 acquisitions.  Beginning in the fourth quarter of 2013, given growth in qualifying small business loans, Nicolet qualified for a 1% annual dividend rate on its preferred stock issued to the Treasury related to its participation in the Small Business Lending Fund (“SBLF”), compared to the previous 5% annual rate, resulting in the $0.2 million reduction in preferred stock dividends between 2013 and 2012.
 
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Net interest income was $36.9 million for 2013, an increase of $14.6 million or 66% compared to 2012.   The improvement was primarily volume related, with average interest-earning assets up $299 million or 49%, at an improved interest rate spread (up 46 basis points (“bps”)) between 2013 and 2012, driven mainly by a continued reduction in the cost of funds.  On a tax-equivalent basis, the 2013 net interest margin was 4.06%, up 39 bps over 3.67% in 2012.  The cost of interest-bearing liabilities was 0.83%, 44 bps lower than 2012, while the average yield on earning assets was 4.75%, 2 bps higher than in 2012, resulting in a 46 bps improvement in the interest rate spread.
 
 
Loans were $847 million at December 31, 2013, up $294 million or 53% over December 31, 2012. Removing the $284 million of loans added at acquisition (i.e. $272 million from Mid-Wisconsin and $12 million from Bank of Wausau), loans grew organically 2% over year end 2012.  Average loans were $753 million in 2013 yielding 5.40%, compared to $521 million in 2012 yielding 5.17%, an increase of 45% in average balances.
 
 
Total deposits were $1.0 billion at December 31, 2013, an increase of $419 million or 68% over December 31, 2012.  Removing the $370 million of deposits added at acquisition (i.e. $346 million from Mid-Wisconsin and $24 million net deposits acquired from Bank of Wausau given the quick redemption of $18 million of rate-sensitive certificates of deposit), deposits grew organically 8% over year end 2012.  Between 2013 and 2012, average deposits were up $285 million or 52%, with 2013 average total deposits of $831 million and interest-bearing deposits costing 0.63%, compared to 2012 average deposits of $546 million and interest-bearing deposits costing 1.01%.
 
 
Asset quality measures remained relatively strong.  Nonperforming assets were 0.97% of assets at  December 31, 2012, peaked at 1.88% of assets at September 30, 2013 (shortly following the consummation of the acquisitions), and were 1.02% of assets at year end 2013, a result of dedicated work on asset resolution.  For 2013, the provision for loan losses was $6.2 million, exceeding net charge offs of $4.1 million.  For 2012 the provision for loan losses was $4.3 million against $3.1 million in net charge offs.  The allowance for loan losses (“ALLL”) was $9.2 million or 1.09% of loans at December 31, 2013 (impacted by the 2013 acquisitions adding no ALLL while adding $284 million to loans at acquisitions), compared to an ALLL of $7.1 million representing 1.29% of loans at December 31, 2012.
 
 
Noninterest income was $25.7 million for 2013, up $15.0 million or 140% over 2012, with $11.9 million of this variance attributable to the bargain purchase gains recorded in conjunction with the 2013 acquisitions.  Excluding the bargain purchase gains, noninterest income was up $3.1 million or 29% over 2012.  Notable increases over last year, largely due to increased business from the expanded size of the Company, were seen in service charges on deposits (up $0.6 million or 55%), trust fee income (up $1.1 million or 35%), net gains on sale of assets (up $1.2 million, mainly from favorable sale resolutions of other real estate owned), and other income (up $0.6 million, of which $0.4 million of the increase is due to income from higher debit card volumes). Mortgage income was $0.8 million or 24% lower than 2012, resulting from a significant decline in mortgage production, concentrated in the second half of 2013 in response to rising mortgage rates and uncertainties in economic and political environments impacting consumer confidence.
 
 
Noninterest expense was $36.4 million for 2013, up $12.4 million or 51% over 2012, as the 2013 period included increased operations for approximately eight months from the Mid-Wisconsin and five months from the Bank of Wausau transactions and approximately $1.9 million of non-recurring merger-related expenses.  Excluding the $1.9 million of merger-related expenses, noninterest expense was up $10.5 million or 44%.  Most notably, salaries and employee benefits accounted for $6.5 million of the variance between 2013 and 2012 (of which approximately $1 million was attributable to non-recurring merger expenses), other expenses increased $1.8 million (of which nearly $0.9 million was attributable to non-recurring merger expenses), and core deposit intangible amortization increased $0.5 million, fully attributable to the Mid-Wisconsin merger.
 
Net Interest Income
 
Net interest income in the consolidated statements of income (which excludes any taxable equivalent adjustments) was $36.9 million in 2013, compared to $22.3 million in 2012. Taxable equivalent adjustments (adjustments to bring tax-exempt interest to a level that would yield the same after-tax income had that been subject to a 34% tax rate) were $608,000 and $590,000, for 2013 and 2012, respectively, resulting in taxable equivalent net interest income of $37.5 million for 2013 and $22.9 million for 2012.
 
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Taxable equivalent net interest income is a non-GAAP measure, but is a preferred industry measurement of net interest income (and its use in calculating a net interest margin) as it enhances the comparability of net interest income arising from taxable and tax-exempt sources.
 
Net interest income is the primary source of Nicolet’s revenue, and is the difference between interest income on earning assets, such as loans and investment securities, and interest expense on interest-bearing liabilities, such as deposits and other borrowings. Net interest income is directly impacted by the sensitivity of the balance sheet to changes in interest rates and by the amount, mix and composition of interest earning assets and interest-bearing liabilities, including characteristics such as the fixed or variable nature of the financial instruments, contractual maturities, and repricing frequencies.
 
Tables 1, 2, and 3 present information to facilitate the review and discussion of selected average balance sheet items, taxable equivalent net interest income, interest rate spread and net interest margin.
 
Table 1: Average Balance Sheet and Net Interest Income Analysis — Taxable-Equivalent Basis
(dollars in thousands)
                                                       
   
Years Ended December 31,
 
   
2013
   
2012
   
2011
 
   
Average
Balance
   
Interest
   
Average
Rate
   
Average
Balance
   
Interest
   
Average
Rate
   
Average
Balance
   
Interest
   
Average
Rate
 
ASSETS
                                                     
Earning assets
                                                     
Loans
  $ 753,284     $ 41,119       5.40 %   $ 521,209     $ 27,280       5.17 %   $ 503,362     $ 28,190       5.54 %
Investment securities
                                                                       
Taxable
    76,016       1,107       1.46 %     21,963       625       2.85 %     19,242       725       3.77 %
Tax-exempt
    31,989       1,234       3.86 %     26,396       1,247       4.73 %     26,889       1,408       5.24 %
Other interest-earning assets
    51,815       344       0.66 %     44,684       233       0.52 %     32,993       167       0.51 %
Total interest-earning assets
    913,104     $ 43,804       4.75 %     614,252     $ 29,385       4.73 %     582,486     $ 30,490       5.18 %
Cash and due from banks
    22,178                       15,628                       18,785                  
Other assets
    62,090                       44,342                       41,082                  
Total assets
  $ 997,372                     $ 674,222                     $ 642,353                  
LIABILITIES AND STOCKHOLDERS’ EQUITY
                                                                       
Interest-bearing liabilities
                                                                       
Savings
  $ 79,164     $ 216       0.27 %   $ 33,046     $ 151       0.46 %   $ 16,829     $ 45       0.27 %
Interest-bearing demand
    154,991       1,251       0.81 %     90,666       888       0.98 %     63,346       404       0.64 %
MMA
    222,299       780       0.35 %     167,196       780       0.47 %     156,471       1,142       0.73 %
Core time deposits
    195,226       1,776       0.91 %     133,814       2,373       1.77 %     154,115       2,664       1.73 %
Brokered deposits
    41,029       370       0.90 %     40,203       511       1.27 %     63,749       2,255       3.54 %
Total interest-bearing deposits
    692,709       4,393       0.63 %     464,925       4,703       1.01 %     454,510       6,510       1.43 %
Other interest-bearing liabilities
    63,897       1,899       2.93 %     46,647       1,827       3.85 %     46,385       1,873       3.98 %
Total interest-bearing liabilities
    756,606       6,292       0.83 %     511,572       6,530       1.27 %     500,895       8,383       1.67 %
Noninterest-bearing demand
    138,175                       80,971                       67,787                  
Other liabilities
    7,454                       5,144                       4,387                  
Total equity
    95,137                       76,535                       69,284                  
Total liabilities and stockholders’ equity
  $ 997,372                     $ 674,222                     $ 642,353                  
Net interest income and rate spread
          $ 37,512       3.92 %           $ 22,855       3.46 %           $ 22,107       3.51 %
Net interest margin
                    4.06 %                     3.67 %                     3.75 %
 
   
 
(1)
Nonaccrual loans are included in the daily average loan balances outstanding.
 
(2)
The yield on tax-exempt loans and tax-exempt investment securities is computed on a tax-equivalent basis using a federal tax rate of 34% and adjusted for the disallowance of interest expense.
 
(3)
Interest income includes loan fees of $453,000 in 2013, $128,000 in 2012 and $396,000 in 2011.
 
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Table 2: Volume/Rate Variance — Taxable-Equivalent Basis
(dollars in thousands)
                                     
   
2013 Compared to 2012
Increase (decrease)
Due to Changes in
   
2012 Compared to 2011
Increase (decrease)
Due to Changes in
 
   
Volume
   
Rate*
   
Net(1)
   
Volume
   
Rate*
   
Net(1)
 
Earning assets
                                   
Loans (2)
  $ 12,532     $ 1,307     $ 13,839     $ 974     $ (1,884 )   $ (910 )
Investment securities
                                               
Taxable
    760       (278 )     482       66       (166 )     (100 )
Tax-exempt (2)
    238       (251 )     (13 )     (25 )     (136 )     (161 )
Other interest-earning assets
    89       22       111       32       34       66  
Total interest-earning assets
  $ 13,619     $ 800     $ 14,419     $ 1,047     $ (2,152 )   $ (1,105 )
                                                 
Interest-bearing liabilities
                                               
Interest-bearing demand
  $ 145     $ (80 )   $ 65     $ 61     $ 45     $ 106  
Savings deposits
    541       (178 )     363       216       268       484  
MMA
    220       (220 )     -       74       (436 )     (362 )
Core time deposits
    831       (1,428 )     (597 )     (358 )     67       (291 )
Brokered deposits
    10       (151 )     (141 )     (638 )     (1,106 )     (1,744 )
Total interest-bearing deposits
    1,747       (2,057 )     (310 )     (645 )     (1,162 )     (1,807 )
Other interest-bearing liabilities
    433       (361 )     72       5       (51 )     (46 )
Total interest-bearing liabilities
    2,180       (2,418 )     (238 )     (640 )     (1,213 )     (1,853 )
Net interest income
  $ 11,439     $ 3,218     $ 14,657     $ 1,687     $ (939 )   $ 748  
 
   
 
*
Nonaccrual loans are included in the daily average loan balances outstanding.
 
(1)
The change in interest due to both rate and volume has been allocated in proportion to the relationship of dollar amounts of change in each.
 
(2)
The yield on tax-exempt loans and tax-exempt investment securities is computed on a tax-equivalent basis using a federal tax rate of 34% adjusted for the disallowance of interest expense.
 
Table 3: Interest Rate Spread, Margin and Average Balance Mix — Taxable-Equivalent Basis
(dollars in thousands)
    Years Ended December 31,  
    2013     2012     2011  
         
% of
               
% of
               
% of
       
   
Average
   
Earning
         
Average
   
Earning
         
Average
   
Earning
       
   
Balance
   
Assets
   
Yield/Rate
   
Balance
   
Assets
   
Yield/Rate
   
Balance
   
Assets
   
Yield/Rate
 
Total loans
  $ 753,284       82.5 %     5.40 %   $ 521,209       84.9 %     5.17 %   $ 503,362       86.4 %     5.54 %
Securities and other earning
                                                                     
assets
    159,820       17.5 %     1.68 %     93,043       15.1 %     2.26 %     79,124       13.6 %     2.91 %
Total interest-earning assets
$ 913,104       100.0 %     4.75 %   $ 614,252       100.0 %     4.73 %   $ 582,486       100.0 %     5.18 %
                                                                         
Interest-bearing liabilities
  $ 756,606       82.9 %     0.83 %   $ 511,572       83.3 %     1.27 %   $ 500,895       86.0 %     1.67 %
Noninterest-bearing funds,
                                                                       
net
    156,498       17.1 %             102,680       16.7 %             81,591       14.0 %        
Total funds sources
  $ 913,104       100.0 %     0.69 %   $ 614,252       100.0 %     1.06 %   $ 582,486       100.0 %     1.44 %
Interest rate spread
                    3.92 %                     3.46 %                     3.51 %
Contribution from net
                                                                       
free funds
                    0.14 %                     0.21 %                     0.24 %
Net interest margin
                    4.06 %                     3.67 %                     3.75 %
 
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Comparison of 2013 versus 2012
 
Taxable-equivalent net interest income was $37.5 million for 2013, up $14.7 million or 64%, compared to 2012.  The increase in taxable-equivalent net interest income was predominantly volume related, given the timing of the acquisitions, but was also favorably impacted by an increase in interest rate spread on higher average earning assets as well as a higher level of purchase-accounting loan accretion on acquired loans.  In particular, during the third quarter of 2013, two acquired loans resolved fully at approximately $1.0 million better than their carrying values, improving both interest income and the reported loan yield for the third quarter of 2013 and for the  year ending December 31, 2013.  Taxable equivalent interest income increased $14.4 million between 2012 and 2013 driven by loans (including $12.5 million from higher loan volumes and $1.3 million from higher loan rates, mainly from the two favorably resolved loans noted above).  Interest expense fell $0.2 million between 2012 and 2013 due to beneficial growth in the mix of lower-costing funds (with $2.4 million less interest expense from favorable rate changes, but $2.2 million more interest expense from higher interest-bearing liabilities volume).
 
The taxable-equivalent net interest margin was 4.06% for 2013, up 39 bps over 2012, with improvement in the cost of funds at 0.83% (down 44 bps), a higher earning asset yield of 4.75% (up 2 bps) and a 7 bps decrease in net free funds.  In general, there has been and will be underlying downward margin pressure as assets mature in this prolonged low-rate environment, with current reinvestment rates substantially lower than previous rates and less opportunity to offset such with similar changes in the already low cost of funds; however, in 2013 such pressure was partially mitigated by the favorable income from acquired loans.
 
The earning asset yield was comprised mainly of loans, representing 83% of average earning assets and yielding 5.40% for 2013, compared to 85% and 5.17%, respectively, for 2012.  The 23 bps improvement in loan yield between the years was aided in part by the positive rate profile of acquired loans and by the two favorably resolved loans during third quarter 2013 noted above as acquired loans marked to estimated fair value at acquisition resolve more favorably than originally anticipated.  All other interest earning assets combined yielded 1.68%, down 58 bps compared to 2012, though aided in part by a higher mix of investments (representing 12% of average earning assets in 2013, versus 8% for 2012) that earn more than the other cash-equivalent earning assets.
 
Nicolet’s cost of funds continued its favorable decline during the low-rate environment, at 0.83% for 2013, 44 bps lower than 2012. The average cost of interest-bearing deposits (which represent over 90% of average interest-bearing liabilities for both years), was 0.63% for 2013, down 38 bps versus 2012 with favorable rate variances in all deposit categories.  Lower-costing transactional deposits (savings, checking and MMA) saw rate declines in response to reductions made across products between the years while overall balances continued to rise. Average brokered deposit balances remained stable for the comparable twelve-month periods, however, their cost decreased from 1.27% in 2012 to 0.90% in 2013, as a significant portion of the higher rate brokered deposit balances matured since December 31, 2012, and were replaced with less-costly brokered deposits in the lower rate environment.   The cost of other interest-bearing liabilities (comprised of short- and long-term borrowings) decreased to 2.93%, down 92 bps between the twelve-month periods, mainly from favorable rates on new advances, the prepayment of $10 million in higher-costing advances during first quarter 2013, and the acquisition at fair value of a lower-rate junior subordinated debenture in second quarter 2013.
 
Average interest-earning assets were $913 million for 2013, $299 million or 49% higher than 2012, led by a $232 million increase in average loans (to $753 million or 83% of interest earning assets) and a $60 million increase in average investments (to $108 million or 12% of earning assets), both heavily influenced by the size and timing of the acquisitions in 2013.
 
Average interest-bearing liabilities were $757 million, up $245 million or 48% over 2012, led by a $227 million increase in non-brokered interest-bearing deposits (to $652 million or 86% of average interest-bearing liabilities) and an $17 million increase in average other interest-bearing liabilities (to $64 million), both heavily influenced by the size and timing of the acquisitions in 2013.
 
Provision for Loan Losses
 
The provision for loan losses in 2013 was $6.2 million, compared to $4.3 million in 2012. The higher provision in 2013 was primarily due to two significant credit relationships with $1.0 million provided on a construction and land development relationship that experienced deteriorating performance and resulted in the recording of a $3.9 million troubled debt restructuring in third quarter 2013, and $1.8 million provided to cover the charge off taken in the fourth quarter on a fully resolved grain credit acquired with Mid-Wisconsin that was not marked initially at acquisition.  Net charge offs were $4.1 million in 2013 (which includes the $1.8 million charge off related to the grain credit noted above) and $3.1 million in 2012.  Aside from the two credits noted above, asset quality trends remained relatively strong.  At December 31, 2012 the ALLL was $7.1 million or 1.29% of loans.  At December 31, 2013, the ALLL was $9.2 million or 1.09% of loans, impacted most notably by the 2013 acquisitions which added no allowance for loan losses to the numerator at acquisition and $284 million of loans into the denominator as of the dates of their acquisition.  As events occur in the acquired loan portfolio, an ALLL will be established for this pool of assets as appropriate.
 
19
 

 

 
Nonperforming loans were improving prior to the acquisitions, starting at $7.0 million (or 1.3% of total loans) at December 31, 2012, decreasing to $2.7 million (or 0.5% of loans) at March 31, 2013, increasing to $17.4 million (or 2.0% of loans) at September 30, 2013 which included both 2013 acquisitions, and declining to $10.3 million (or 1.2% of loans) at December 31, 2013.  The reduction in nonperforming loans was the result of commitment to work distressed assets to resolution, particularly acquired nonaccrual loans.  Of the nonaccrual loans initially acquired in the 2013 acquisitions, $9.5 million remain included in the $10.3 million of nonaccruals at December 31, 2013.
 
The provision for loan losses is predominantly a function of Nicolet’s methodology and judgment as to qualitative and quantitative factors used to determine the adequacy of the ALLL. The adequacy of the ALLL is affected by changes in the size and character of the loan portfolio, changes in levels of impaired and other nonperforming loans, historical losses and delinquencies in each portfolio segment, the risk inherent in specific loans, concentrations of loans to specific borrowers or industries, existing and future economic conditions, the fair value of underlying collateral, and other factors which could affect potential credit losses. For additional information regarding asset quality and the ALLL, see “Balance Sheet Analysis — Loans,” and “— Allowance for Loan and Lease Losses” and “—Nonperforming Assets.”
 
Noninterest Income
 
Table 4: Noninterest Income
(dollars in thousands)
       
   
Years ended December 31,
   
2013 Compared to 2012
 
   
2013
   
2012
   
$ Change
   
% Change
 
                         
Service charges on deposit accounts
  $ 1,793     $ 1,159     $ 634       54.7 %
Trust services fee income
    4,028       2,975       1,053       35.4  
Mortgage income
    2,336       3,090       (754 )     (24.4 )
Brokerage fee income
    477       323       154       47.7  
Bank owned life insurance (“BOLI”)
    825       710       115       16.2  
Rent income
    1,036       1,003       33       3.3  
Investment advisory fees
    348       343       5       1.5  
Gain on sale, disposal and writedown of assets, net
    1,669       448       1,221       272.5  
Bargain purchase gains (“BPG”)
    11,915       -       11,915       N/M *
Other income
    1,309       693       616       88.9  
Total noninterest income
  $ 25,736     $ 10,744     $ 14,992       139.5 %
Noninterest income without BPG
  $ 13,821     $ 10,744     $ 3,077       28.6 %
Noninterest income without BPG and net gains
  $ 12,152     $ 10,296     $ 1,856       18.0 %
 
*N/M means not meaningful
 
Comparison of 2013 versus 2012
 
Noninterest income was $25.7 million for 2013, up $15.0 million over 2012, with $11.9 million of this variance attributable to the BPG recorded in connection with the 2013 acquisitions.  BPG is calculated as the net difference in the fair value of the net assets acquired less the consideration paid, which resulted in a BPG of $9.5 million for Mid-Wisconsin and $2.4 million for Bank of Wausau.  For additional details, see Note 2, “Acquisitions,” of the Notes to Consolidated Financial Statements, under Part II, Item 8.  Removing the 2013 BPG, noninterest income was $13.8 million for 2013, up $3.1 million or 28.6% over 2012.  Analytically year-over-year, an approximate 40% increase could be expected in certain line items due to the size and timing of the acquisitions, as Nicolet grew about 60% with the 2013 acquisitions which were included for approximately 8 of 12 months in 2013.
 
20
 

 

 
Service fees on deposit accounts for 2013 were $1.8 million, up $0.6 million or 54.7% over 2012, largely due to inclusion of the 2013 acquisitions which added deposit balances, locations and ATMs, but even more importantly more than doubled the number of deposit accounts, increasing the opportunity for deposit-based charges and fees.  Most notably, overdraft and non-sufficient funds (“NSF”) fees combined accounted for the majority of the increase, up $0.4 million over 2012, while the remaining $0.2 million increase was due to higher service-charges and other fees combined on both business and household accounts.
 
Mortgage income represents net gains received from the sale of residential real estate loans service-released into the secondary market and to a small degree, some related income. Residential refinancing activity and new purchase activity remained steady for the first half of 2013, despite mortgage rates being higher than a year ago and trending upward; however, such activity slowed considerably in the second half of 2013.  Secondary mortgage production was $133 million for 2013, down 30% from 2012’s production of $189 million.  As a result, mortgage income was $2.3 million for 2013, down $0.8 million or 24.4%, compared to $3.1 million for 2012. The change between the years was not significantly impacted by the acquisitions.
 
Trust service fees were $4.0 million for 2013, up $1.1 million or 35.4% over 2012.  In addition to the larger base of customers acquired and trust assets added from Mid-Wisconsin, there was market improvement over last year on assets under management, on which trust fees are based.  Similarly, brokerage fees were $0.5 million, up $0.2 million or 47.7% over 2012, mainly from increased legacy business, market improvements, and to a lesser degree from the 2013 acquisitions.
 
BOLI income was $0.8 million, up $0.1 million or 16.2% over 2012, while the average BOLI investment was $22.0 million, up 24% over 2012.  New BOLI investment of $3.8 million was procured in the first quarter of 2012, and $4.3 million of slightly lower-earning BOLI was acquired in the April 2013 Mid-Wisconsin transaction.  Other income was $1.3 million for 2013, up $0.6 million over 2012, with $0.4 million of the increase due to higher debit card fees (aided in part by the additional accounts from the acquisitions but also from greater activity related to a popular checking product design), and the remainder largely from other ancillary fees tied to deposit-related products, such as safe deposit fees, check cashing and wire fee income.
 
Nicolet recognized $1.7 million net gain on sale, disposal and write down of assets in 2013, compared to $0.4 million in 2012.  The activity in 2013 consisted predominantly of $0.5 million of net gains on AFS securities sales (mainly selling a large portion of the acquired investment portfolio in second quarter to prepay higher costing debt assumed in the Mid-Wisconsin merger at a net loss, but more than offset by selling a portion of an equity holding in the second half for a net gain) and $1.3 million net gains on sales of Other Real Estate Owned (“OREO”) (as properties were generally resolved at better than expected terms), offset by a $0.1 million write down to the carrying value of one OREO property.  Comparably, the net gain in 2012 consisted mainly of $0.4 million net gains on sales of AFS securities.
 
Noninterest Expense
 
Table 5: Noninterest Expense
(dollars in thousands)
   
Years ended December 31,
   
2013 Compared to 2012
 
   
2013
   
2012
   
$ Change
   
% Change
 
Salaries and employee benefits
  $ 19,615     $ 13,146     $ 6,469       49.2 %
Occupancy, equipment and office
    6,407       4,415       1,992       45.1  
Business development and marketing
    2,348       1,649       699       42.4  
Data processing
    2,477       1,689       788       46.7  
FDIC assessments
    700       566       134       23.7  
Core deposit intangible amortization
    1,111       639       472       73.9  
Other expense
    3,773       1,958       1,815       92.7  
Total noninterest expense
  $ 36,431     $ 24,062     $ 12,369       51.4 %
 
Comparison of 2013 versus 2012
 
Total noninterest expense was $36.4 million for 2013, an increase of $12.4 million or 51.4%, over 2012, predominantly due to the larger operating base and timing of the 2013 acquisitions.  Additionally, 2013 included approximately $1.9 million of non-recurring, direct merger and integration costs, of which approximately $1 million was in salaries and employee benefits and $0.9 million was in other expense.  Analytically year-over-year, an approximate 40% increase could be expected in certain line items due to the size and timing of the acquisitions, as Nicolet grew about 60% with the 2013 acquisitions which were included for approximately 8 of 12 months in 2013.
 
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Salaries and employee benefits expense increased by $6.5 million or 49.2%, of which approximately $1 million of the increase was due to direct merger costs, such as stay bonuses and severance costs.  Total personnel costs were largely impacted by the larger workforce (including commensurate increases in payroll taxes, health insurance and employer 401k match), merit increases between the years, higher cash and equity-based incentive compensation between the years given Nicolet’s stronger 2013 performance, and higher overtime related to the acquisitions.   There were 258 average full-time equivalent (“FTE”) employees for 2013, up 63% over 158 average FTE employees for 2012.
 
Occupancy, equipment and office expense increased $2.0 million or 45.1%, most notably impacted by the 2013 acquisitions, including certain infrastructure and set-up costs needed to integrate the new office locations, data and telecommunications, signage, postage and functional procedures onto a consistent platform or process.
 
Business development and marketing expense was up $0.7 million or 42.4% over 2012, given the greater focus on outreach especially in the newly acquired markets through promotional items, higher donations and mileage, as well as increased sales efforts through sales seminars and events.
 
Data processing expense was up $0.8 million or 46.7% over 2012, due to conversions for the 2013 acquisitions, higher processing costs related to the increased number of loan, deposit and wealth management accounts, and more ATM machines, as well as costs to provide technology functionality for the increased workforce.
 
The core deposit intangible (“CDI”) amortization increased $0.5 million or 73.9%, fully attributable to the CDI recorded in the Mid-Wisconsin transaction.  Since the amortization method is accelerated in earlier years, it resulted in higher initial expense for the partial 2013 year.
 
Other operating expenses were $1.8 million higher than 2012, of which approximately $0.9 million was due to direct merger costs, mostly consultant, professional and legal in nature to effect the mergers, assist with fair value accounting and support conversions.  Without these direct merger costs, other expense in 2013 was up $0.9 million or 47% over 2012, with the largest variance being the $0.7 million increase in foreclosure and OREO expenses, given the higher amount of OREO acquired and carried.
 
Income Taxes
 
Income tax expense was $3.8 million for 2013 and $1.5 million for 2012. The effective tax rates were 19.2% for 2013 and 33.1% for 2012.  Significantly impacting the effective tax rate for 2013 was the tax free nature of the Mid-Wisconsin merger, whereby tax expense was not directly charged on the $9.5 million BPG.  The $2.4 million BPG from the Bank of Wausau acquisition was taxable.  In addition to the 2013 impact of the tax free BPG, these tax rates are also influenced by the amount of income before tax and the mix of tax-exempt income each year, and to a smaller degree by the non-deductibility of certain merger-related costs. The 2013 acquisition also impacted deferred taxes significantly, increasing the net deferred tax asset of $2.4 million at the end of 2012 to a net deferred tax asset of $6.1 million at the end of 2013. The basic principles for accounting for income taxes require that deferred income taxes be analyzed to determine if a valuation allowance is required. A valuation allowance is required if it is more likely than not that some portion of the deferred tax asset will not be realized. At December 31, 2013 and 2012, no valuation allowance was determined to be necessary.
 
BALANCE SHEET ANALYSIS
 
Loans
 
Nicolet services a diverse customer base throughout Northern Wisconsin and in Menominee, Michigan including the following industries: manufacturing, wholesaling, agriculture, retail, service, and businesses supporting the general building industry. It continues to concentrate its efforts in originating loans in its local markets and assisting its current loan customers. It actively utilizes government loan programs such as those provided by the U.S. Small Business Administration to help customers weather current economic conditions and position their businesses for the future.
 
Nicolet’s primary lending function is to make commercial loans, consisting of commercial and industrial business loans and owner-occupied commercial real estate loans and agricultural production and real estate loans; commercial real estate (“CRE”) loans, consisting of commercial investment real estate loans and construction and land development loans; residential real estate loans, including residential first mortgages, residential junior mortgages (such as home equity loans and lines), and to a lesser degree residential construction loans; and retail and other loans.
 
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Total gross loans were $847 million at December 31, 2013, an increase of $294 million, or 53%, compared to total gross loans of $553 million at December 31, 2012. Loans acquired in 2013 totaled $284 million at the time of acquisition.  Excluding the acquired loans, loans grew organically 2% over year end 2012, mostly in commercial and industrial, owner-occupied CRE and residential first mortgages.   The overall mix of loans acquired was similar to Nicolet’s legacy portfolio with the most notable variances being the increased concentrations of owner-occupied CRE, agricultural real estate and production, and residential first mortgages.
 
Table 6: Loan Composition
As of December 31,
(dollars in thousands)
                                                     
   
2013
 
2012
 
2011
 
2010
 
2009
 
   
Amount
 
% of
Total
 
Amount
 
% of
Total
 
Amount
 
% of
Total
 
Amount
 
% of
Total
 
Amount
 
% of
Total
 
Commercial & industrial
 
$
253,674
 
29.9
%
$
197,301
 
35.7
%
$
153,810
 
32.6
%
$
170,898
 
33.3
%
$
146,041
 
30.0
%
Owner-occupied CRE
   
187,476
 
22.1
   
106,888
 
19.3
   
110,094
 
23.3
   
120,943
 
23.5
   
139,353
 
28.6
 
Ag production
   
14,256
 
1.7
   
215
 
0.1
   
201
 
0.0
   
21
 
0.0
   
80
 
0.0
 
Ag real estate
   
37,057
 
4.4
   
11,354
 
2.1
   
1,085
 
0.2
   
2,179
 
0.5
   
3,268
 
0.7
 
CRE investment
   
90,295
 
10.7
   
76,618
 
13.9
   
66,577
 
14.1
   
63,839
 
12.4
   
37,908
 
7.8
 
Construction & land development
   
42,881
 
5.1
   
21,791
 
3.9
   
24,774
 
5.2
   
31,464
 
6.1
   
40,619
 
8.3
 
Residential construction
   
12,535
 
1.5
   
7,957
 
1.4
   
9,363
 
2.0
   
8,893
 
1.7
   
12,940
 
2.7
 
Residential first mortgage
   
154,403
 
18.2
   
85,588
 
15.5
   
56,392
 
11.9
   
56,533
 
11.0
   
47,352
 
9.7
 
Residential junior mortgage
   
49,363
 
5.8
   
39,352
 
7.1
   
42,699
 
9.0
   
46,621
 
9.1
   
47,020
 
9.7
 
Retail & other
   
5,418
 
0.6
   
5,537
 
1.0
   
7,494
 
1.7
   
12,370
 
2.4
   
11,990
 
2.5
 
Total loans
 
$
847,358
 
100.0
%
$
552,601
 
100.0
%
$
472,489
 
100.0
%
$
513,761
 
100.0
%
$
486,571
 
100.0
%
 
On a broad commercial loan (i.e. commercial, agricultural, CRE and construction loans combined) versus retail loan (i.e. residential real estate and other retail loans) mix basis, year end 2013 was 73.9% commercial-based and 26.1% retail-based at December 31, 2013 versus 74.9% and 25.1%, respectively, for year end 2012.  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 increased $56 million since year end 2012 with about half of this increase resulting from acquisitions.  Commercial and industrial loans continue to be the largest segment of Nicolet’s portfolio but fell to 29.9% of the total portfolio at year end 2013 since the percentage of these loans in the acquired portfolio was significantly less at only 12% of total acquired loans, at acquisition.
 
Owner-occupied CRE loans grew to 22.1% of loans at year end 2013 and primarily consist 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. The total increase of $81 million between year ends was predominately from acquired balances.
 
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.  The $40 million increase in these portfolios was entirely driven by acquired balances, as agriculture is more prevalent in our newly acquired markets, offering a new growth area for Nicolet.  These portfolios remain predominately under the management of the originating officers who continue with Nicolet.  In total, the portfolio increased from 2.2% of total loans at December 31, 2012 to 6.1% of total loans at December 31, 2013.
 
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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.  These loans increased $53 million at the time of the 2013 acquisitions and subsequently declined $39 million as borrowers repaid, refinanced elsewhere, or foreclosed, for a net decrease of $14 million between year end periods.  At December 31, 2013 CRE investment loans represented 10.7% of loans compared to 13.9% a year ago.
 
Loans in the construction and land development portfolio represent 5.1% of total loans at year end 2013 and such 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.  Lending in this area has declined steadily both in total dollars and as a percentage of the portfolio over the prior four years, until the increase in 2013 of $21 million which was nearly all from acquired balances.
 
On a combined basis, Nicolet’s residential real estate loans represent 25.5% of total loans at year end 2013. Residential first mortgage loans include conventional first-lien home mortgages.  Residential junior mortgage real estate loans consist of home equity lines and term loans secured by junior mortgage liens.  Across the industry, home equities involve loans that are often in second or junior lien positions, but Nicolet has secured many of these types of loans in a first lien position, further mitigating the portfolio risks.  Nicolet has not experienced significant losses in its residential real estate loans; however, residential real estate, 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 further, 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 without retaining the servicing rights.  In 2013, the total portfolio of residential mortgage loans increased $79 million with $70 million coming from acquired balances at acquisition. Nicolet’s mortgage loans have historically had low net charge off rates and held mortgages typically are of high quality.  While mortgage loans normally hold terms of 30 years, Nicolet’s portfolio mortgages have an average contractual life of less than 15 years.
 
Loans in the retail and other classification represent less than 1% of the total loan portfolio, and include predominantly short-term and other personal installment loans not secured by real estate. Credit risk is primarily controlled by reviewing the creditworthiness of the borrowers, monitoring payment histories, and taking appropriate collateral and/or guaranty positions. The loan balances in this portfolio remained relatively unchanged between year end 2013 and 2012 and the portfolio has declined as a percent of total loans.
 
Factors that are important to managing overall credit quality are sound loan underwriting and administration, systematic monitoring of existing loans and commitments, effective loan review on an ongoing basis, early problem loan identification and remedial action to minimize losses, an adequate ALLL, and sound nonaccrual and charge-off policies. An active credit risk management process is used for commercial loans to further ensure that sound and consistent credit decisions are made. The credit management process is regularly reviewed and the process has been modified over the past several years to further strengthen the controls.
 
The loan portfolio is widely diversified by types of borrowers, industry groups, and market areas. Significant loan concentrations are considered to exist for a financial institution when there are amounts loaned to multiple numbers of borrowers engaged in similar activities that would cause them to be similarly impacted by economic or other conditions. At December 31, 2013, no significant industry concentrations existed in Nicolet’s portfolio in excess of 25% of total loans. Nicolet has also developed guidelines to manage its exposure to various types of concentration risks.
 
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The following table presents the maturity distribution of the loan portfolio at December 31, 2013:
 
Table 7: Loan Maturity Distribution
(dollars in thousands)
                         
   
Loan Maturity
 
   
One Year
or Less
   
Over One
Year
to Five Years
   
Over
Five Years
   
Totals
 
Commercial & industrial
  $ 129,703     $ 121,387     $ 2,584     $ 253,674  
Owner-occupied CRE
    44,870       118,674       23,932       187,476  
Ag production
    4,806       9,450             14,256  
Ag real estate
    16,580       16,421       4,056       37,057  
CRE investment
    22,537       59,738       8,020       90,295  
Construction & land development
    17,658       20,248       4,975       42,881  
Residential construction
    12,535                   12,535  
Residential first mortgage
    19,049       36,403       98,951       154,403  
Residential junior mortgage
    3,635       27,549       18,179       49,363  
Retail & other
    2,493       2,849       76       5,418  
Total loans
  $ 273,866     $ 412,719     $ 160,773     $ 847,358  
Percent by maturity distribution
    32 %     49 %     19 %     100 %
Fixed rate
  $ 126,658     $ 293,497     $ 81,554     $ 501,709  
Floating rate
    147,208       119,222       79,219       345,649  
    Total
  $ 273,866     $ 412,719     $ 160,773     $ 847,358  
 
Allowance for Loan and Lease Losses
 
In addition to the discussion that follows, accounting policies behind loans and the allowance for loan losses are described in Note 1, “Nature of Business and Significant Accounting Policies,” and additional disclosures are included in Note 4, “Loans and Allowance for Loan Losses,” in the Notes to Consolidated Financial Statements, under Part II, Item 8.
 
Credit risks within the loan portfolio are inherently different for each loan type as described under “Balance Sheet Analysis-Loans.” Credit risk is controlled and monitored through the use of lending standards, a thorough review of potential borrowers, and on-going review of loan payment performance. Active asset quality administration, including early problem loan identification and timely resolution of problems, aids in the management of credit risk and minimization of loan losses.
 
The ALLL is established through a provision for loan losses charged to expense to appropriately provide for potential credit losses in the existing loan portfolio. Loans are charged against the ALLL when management believes that the collection of principal is unlikely. The level of the ALLL represents management’s estimate of an amount of reserves that provides for estimated probable credit losses in the loan portfolio at the balance sheet date. To assess the ALLL, an allocation methodology is applied by Nicolet which focuses on evaluation of qualitative and environmental factors, including but not limited to: (i) evaluation of facts and issues related to specific loans; (ii) management’s ongoing review and grading of the loan portfolio; (iii) consideration of historical loan loss and delinquency experience on each portfolio segment; (iv) trends in past due and nonperforming loans; (v) the risk characteristics of the various loan segments; (vi) changes in the size and character of the loan portfolio; (vii) concentrations of loans to specific borrowers or industries; (viii) existing and forecasted economic conditions; (ix) the fair value of underlying collateral; and (x) other qualitative and quantitative factors which could affect potential credit losses. Nicolet’s methodology reflects guidance by regulatory agencies to all financial institutions.
 
Nicolet’s management allocates the ALLL by pools of risk within each loan portfolio segment. The allocation methodology consists of the following components. First, a specific reserve for the estimated shortfall is established for all loans determined to be impaired. The specific reserve in the ALLL is equal to the aggregate collateral or discounted cash flow shortfall calculated from the impairment analyses. Loans measured for impairment include nonaccrual loans, non-performing troubled debt-restructurings (“restructured loans”), or other loans determined to be impaired by management. Second, Nicolet’s management allocates ALLL with historical loss rates by loan segment. The loss factors applied in the methodology are periodically re-evaluated and adjusted to reflect changes in historical loss levels on an annual basis. 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.
 
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Management performs ongoing intensive analyses of its loan portfolio to allow for early identification of customers experiencing financial difficulties, maintains prudent underwriting standards, understands the economy in its markets, and considers the trend of deterioration in loan quality in establishing the level of the ALLL.
 
Consolidated net income and stockholders’ equity could be affected if Nicolet’s management’s estimate of the ALLL necessary to cover expected losses is subsequently materially different, requiring a change in the level of provision for loan losses to be recorded. While management uses currently available information to recognize losses on loans, future adjustments to the ALLL may be necessary based on newly received appraisals, updated commercial customer financial statements, rapidly deteriorating customer cash flow, and changes in economic conditions that affect Nicolet’s customers. As an integral part of their examination process, federal regulatory agencies also review the ALLL. Such agencies may require additions to the ALLL or may require that certain loan balances be charged-off or downgraded into criticized loan categories when their credit evaluations differ from those of management based on their judgments about information available to them at the time of their examination.
 
At December 31, 2013, the ALLL was $9.2 million compared to $7.1 million at December 31, 2012.  The increase was a result of a 2013 provision of $6.2 million offset by 2013 net charge offs of $4.1 million, largely influenced by two significant credit relationships described under “Provision for Loan Losses.” Comparatively, the 2012 provision for loan losses was $4.3 million and 2012 net charge offs were $3.1 million.  For the acquired loan portfolio, $2.2 million was provided to cover $2.2 million of net charge offs in the acquired loan portfolio, of which a $1.8 million charge off was related to the grain credit previously noted.   Net charge offs as a percent of average loans were 0.54% in 2013 compared to 0.60% in 2012.   Loans charged off are subject to continuous review, and specific efforts are taken to achieve maximum recovery of principal, accrued interest, and related expenses.  The level of the provision for loan losses is directly correlated to the assessment of the adequacy of the allowance, including, but not limited to, consideration of the amount of net charge-offs, loan growth, levels of nonperforming loans, and trends in the risk profile of the loan portfolio.
 
The ratio of the ALLL as a percentage of period-end loans was 1.09% compared to 1.29% at December 31, 2012, with the decrease attributable to the 2013 acquisitions.  Since acquired loans are recorded at their estimated fair value at the acquisition dates, no ALLL was initially recorded at acquisition while $284 million was added to loans at acquisition.  At December 31, 2013 $9.2 million of the ALLL was reserved against originated loans (representing 1.48% of originated loans) and zero was reserved against acquired loans.
 
The largest portion of the ALLL allocated at year end 2013 and 2012 was $5.0 million and $2.6 million, respectively, allocated to construction and land development loans representing 53.8% and 36.2% of the ALLL at year end 2013 and 2012, respectively.  This allocation nearly doubled, consistent with the outstanding loans nearly doubling to $43 million at December 31, 2013.  While a portion of the increase was related to acquired loans which currently do not require a reserve, the inherent risks within the portfolio and past experience of realized losses warrant the additional allocation.  The remaining allocated ALLL balances were consistent with changes in the outstanding originated loan balances at December 31, 2013.
 
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Table 8: Loan Loss Experience
For the Years Ended December 31,
(dollars in thousands)