10-K 1 t81601_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, 2014
 
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, 2014, (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 $83.3 million based on the closing sale price of $24.55 per share as reported on the OTCQB on June 30, 2014.
 
As of February 28, 2015, 4,024,204 shares of common stock were outstanding.
 
 
 

 


Nicolet Bankshares, Inc.
 
TABLE OF CONTENTS
 
PART I
 
PAGE
       
 
Item 1.
Business
3-11
       
 
Item 1A.
Risk Factors
12-18
       
 
Item 1B.
Unresolved Staff Comments
18
       
 
Item 2.
Properties
19
       
 
Item 3.
Legal Proceedings
19
       
 
Item 4.
Mine Safety Disclosures
19
       
PART II
   
 
Item 5.
Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
20
       
 
Item 6.
Selected Financial Data
20-21
       
 
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operation
22-46
       
 
Item 7A.
Quantitative and Qualitative Disclosures about Market Risk
46
       
 
Item 8.
Financial Statements and Supplementary Data
47-96
       
 
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
97
       
 
Item 9A.
Controls and Procedures
97
       
 
Item 9B.
Other Information
97
       
PART III
     
       
 
Item 10.
Directors, Executive Officers and Corporate Governance
98-99
       
 
Item 11.
Executive Compensation
100-103
 
 
 
 
 
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
103-104
       
 
Item 13.
Certain Relationships and Related Transactions, and Director Independence
105
       
 
Item 14.
Principal Accountant Fees and Services
105
       
PART IV
     
       
 
Item 15.
Exhibits and Financial Statement Schedules
106
       
 
Signatures
 
107
 
2
 

 

 
Forward-Looking Statements
 
This Annual Report on Form 10-K contains forward-looking statements within the meaning of the federal securities law.  Statements in this report that are not strictly historical are forward-looking and based upon current expectations that may differ materially from actual results.  These forward-looking statements, identified by words such as “will”, “expect”, “believe” and “prospects”, involve risks and uncertainties that could cause actual results to differ materially from those anticipated by the statement made herein.  These risks and uncertainties include, but are not limited to, general economic trends and changes in interest rates, increased competition, regulatory or legislative developments affecting the financial industry generally or Nicolet Bankshares, Inc. specifically, 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 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”).
 
3
 

 

 
At December 31, 2014, Nicolet had total assets of $1.2 billion, loans of $883 million, deposits of $1.1 billion and total shareholders’ equity of $111 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, 2014, Nicolet earned net income of $9.9 million, and after $0.2 million of preferred stock dividends, net income available to common shareholders was $9.7 million or $2.25 per diluted common share.
 
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, brokerage and other investment management services for individuals and retirement plan services for 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 and lines of credit, owner-occupied commercial real estate (“owner-occupied CRE”), and agricultural (“AG”) production and real estate loans]; commercial real estate (“CRE”) loans [consisting of investment real estate loans (“CRE investment”) and construction and land development loans]; residential real estate loans (consisting of residential first lien mortgages, junior lien mortgages, 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, 2014, Nicolet’s loan portfolio mix was as follows:
           
 
Loan category
 
% of Total Loans
 
Commercial & industrial
    33 %
 
Owner-occupied CRE
    21 %
 
AG production
    1 %
 
AG real estate
    5 %
 
Total commercial loans
    60 %
 
CRE investment
    9 %
 
Construction & land development
    5 %
 
Total CRE loans
    14 %
 
Residential construction
    1 %
 
Residential first mortgages
    18 %
 
Residential junior mortgages
    6 %
 
Total residential real estate loans
    25 %
 
Other
    1 %
 
4
 

 

 
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.
 
Employees
 
At December 31, 2014, Nicolet had approximately 280 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, 2014 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, 2014, the Bank ranks in the top three of market share for Brown, Taylor and Clark counties and in the top five 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 earned on loans, as well as to deliver other aspects of banking competitively. Many of Nicolet’s competitors may enjoy competitive advantages, including greater financial resources, broader geographic presence, more accessible branches or more advanced technologic delivery of products or services, more favorable pricing alternatives and lower origination or operating costs.
 
We believe our competitive pricing, personalized service and community engagement enable us to effectively compete in our markets. Nicolet employs seasoned banking and wealth management professionals with experience in its market areas and who are active in their communities.  Nicolet’s emphasis on meeting customer needs in a relationship-focused manner, combined with local decision making on extensions of credit, distinguishes Nicolet from its competitors, particularly in the case of large financial institutions. Nicolet believes it further distinguishes itself by providing a range of products and services characteristic of a large financial institution while providing the personalized service, real conversation, and convenience characteristic of a local, community bank.
 
Supervision and Regulation
 
Set forth below is an explanation of the major pieces of legislation and regulation affecting the banking industry and how that legislation and regulation affects Nicolet’s 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.
 
5
 

 

 
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, as amended (the “Bank Holding Company Act”).  As a result, Nicolet is primarily subject to the supervision, examination, and reporting requirements of the Bank Holding Company Act and the regulations of the Board of Governors of the Federal Reserve System (the “Federal Reserve”).  As a bank holding company located in Wisconsin, the Wisconsin Department of Financial Institutions (the “WDFI”) also regulates and monitors all significant aspects of its operations.
 
Acquisitions of Banks.  The Bank Holding Company Act requires every bank holding company to obtain the prior approval of the Federal Reserve before:
 
 
acquiring direct or indirect ownership or control of any voting shares of any bank if, after the acquisition, the bank holding company will directly or indirectly own or control more than 5% of the bank’s voting shares;
 
acquiring all or substantially all of the assets of any bank; or
 
merging or consolidating with any other bank holding company.
 
Additionally, The Bank Holding Company Act provides that the Federal Reserve may not approve any of these transactions if it would result in or tend to create a monopoly, substantially lessen competition, or otherwise function as a restraint of trade, unless the anti-competitive effects of the proposed transaction are clearly outweighed by the public interest in meeting the convenience and needs of the community to be served.  The Federal Reserve is also required to consider the financial and managerial resources and future prospects of the bank holding companies and banks involved in the transaction and the convenience and needs of the community to be served.  The Federal Reserve’s consideration of financial resources generally focuses on capital adequacy, which is discussed below.
 
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 to engage in activities that are financial in nature or incidental or complementary to financial activities.  Those activities include, among other activities, certain insurance, advisory and security activities. 
 
Nicolet meets the qualification standards applicable to financial holding companies, and elected to become a financial holding company in 2008. In order to remain a financial holding company, Nicolet must continue to be considered well managed and well capitalized by the Federal Reserve, and Nicolet National Bank must continue to be considered well managed and well capitalized by the OCC and have at least a “satisfactory” rating under the Community Reinvestment Act.
 
Support of Subsidiary Institutions.   Under Federal Reserve policy and the Dodd-Frank 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.
 
6
 

 

 
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.
 
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 be 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.
 
7
 

 

 
The OCC also considers interest rate risk (arising when the interest rate sensitivity of the Bank’s assets does not match the sensitivity of its liabilities or its off-balance-sheet position) in the evaluation of the bank’s capital adequacy.  Banks with excessive interest rate risk exposure are required to hold additional amounts of capital against their exposure to losses resulting from that risk.  Through the risk-weighting of assets, the regulators also require banks to incorporate market risk components into their risk-based capital.  Under these market risk requirements, capital is allocated to support the amount of market risk related to a bank’s lending and trading activities.
 
The Bank’s capital categories are determined solely for the purpose of applying the “prompt corrective action” rules described below and they are not necessarily an accurate representation of its overall financial condition or prospects for other purposes. Failure to meet capital guidelines could subject a bank or bank holding company to a variety of enforcement remedies, including issuance of a capital directive, the termination of deposit insurance by the FDIC, a prohibition on accepting brokered deposits, and certain other restrictions on its business.  See “Prompt Corrective Action” below.
 
Prompt Corrective Action.  The Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”) establishes a system of prompt corrective action to resolve the problems of undercapitalized financial institutions.  Under this system, the federal banking regulators have established five capital categories:  well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized, in which all institutions are placed.  The federal banking agencies have also specified by regulation the relevant capital levels for each category.
 
A “well-capitalized” bank is one that is not required to meet and maintain a specific capital level for any capital measure, pursuant to any written agreement, order, capital directive, or prompt corrective action directive, and has a total risk-based capital ratio of at least 10%, a Tier 1 risk-based capital ratio of at least 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, 2014, 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 8, 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.
 
Basel III
 
On July 2, 2013, the Federal Reserve and OCC approved a final rule to establish a new comprehensive regulatory capital framework for all US banking organizations, with an effective date of January 1, 2015.  The Regulatory Capital Framework (“Basel III”) implements several changes to the U.S. regulatory capital framework required by the Dodd-Frank Act. The new U.S. 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 U.S. 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 III final rule requires that all banking organizations maintain a “capital conservation buffer” consisting of CET1 in an amount equal to 2.5% of risk-weighted assets in order to avoid restrictions on their ability to make capital distributions and to pay certain discretionary bonus payments to executive officers.  In order to avoid those restrictions, the capital conservation buffer effectively increases the minimum CET1 capital, Tier 1 capital, and total capital ratios for U.S. banking organizations to 7.0%, 8.5%, and 10.5%, respectively. Banking organizations with capital levels that fall within the buffer will be required to limit dividends, share repurchases or redemptions (unless replaced within the same calendar quarter by capital instruments of equal or higher quality), and discretionary bonus payments.  The capital conservation buffer is phased in over a 5-year period beginning January 1, 2016.
 
8
 

 

 
 
Adequately Capitalized
Requirement, effective
January 1, 2015
Well-Capitalized
Requirement, effective
January 1,2015
Well-Capitalized
with Buffer, fully
phased in 2019
Leverage
4.0%
5.0%
5.0%
CET1
4.5%
6.5%
7.0%
Tier 1
6.0%
8.0%
8.5%
Total Capital
8.0%
10.0%
10.5%
 
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.  Nicolet intends to elect to opt-out to continue excluding Accumulated Other Comprehensive Income from its regulatory capital.
 
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.  Our preliminary calculations indicate we will meet or exceed the new requirements to continue to be classified as well-capitalized under Basel III as of January 1, 2015.
 
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.
 
At December 31, 2014 Nicolet National Bank’s commercial real estate lending levels are below the guidance levels noted above.
 
Enforcement Powers.  The Financial Institution Reform Recovery and Enforcement Act (“FIRREA”) expanded and increased civil and criminal penalties available for use by the federal regulatory agencies against depository institutions and certain “institution-affiliated parties.”  Institution-affiliated parties primarily include management, employees, and agents of a financial institution, as well as independent contractors and consultants such as attorneys and accountants and others who participate in the conduct of the financial institution’s affairs.  These practices can include the failure of an institution to timely file required reports or the filing of false or misleading information or the submission of inaccurate reports.  Civil penalties may be as high as $1,100,000 per day for such violations.  Criminal penalties for some financial institution crimes have been increased to 20 years.
 
9
 

 

 
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.
 
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.
 
10
 

 

 
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.
 
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.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.
 
11
 

 

 
ITEM 1A. RISK FACTORS
                    
An investment in our common stock involves risks.  If any of the following risks, or other risks which have not been identified or which we may believe are immaterial or unlikely, actually occur, our business, financial condition and results of operations could be harmed.  In such a case, the trading price of our common stock could decline, and you could lose all or part of your investment.  The risks discussed below also include forward-looking statements, and our actual results may differ substantially from those discussed in these forward-looking statements.
 
Risks Relating to Nicolet’s Business
 
Nicolet may not be able to sustain its historical rate of growth, or may encounter issues associated with its growth, either of which could adversely affect our financial condition, results of operations, and share price.
 
We have grown over the past several years and intend to continue to pursue a significant growth strategy for our business.  Our prospects must be considered in light of the risks, expenses and difficulties frequently encountered by companies in significant growth stages of development.  We may not be able to further expand our market presence in existing markets or to enter new markets successfully, nor can we guarantee that any such expansion would not adversely affect our results of operations.  Failure to manage growth effectively could have a material adverse effect on the business, future prospects, financial condition or results of our operations, and could adversely affect our ability to successfully implement business strategies.  Also, if such growth occurs more slowly than anticipated or declines, our operating results could be materially adversely affected.
 
Our ability to grow successfully will depend on a variety of factors including the continued availability of desirable business opportunities, the competitive responses from other financial institutions in our market areas and the ability to manage our growth.  While we believe we have the management resources and internal systems in place to manage future growth successfully, there can be no assurance that growth opportunities will be available or that any growth will be managed successfully. In addition, our recent growth may distort some of our historical financial ratios and statistics.
 
As part of our growth strategy, we regularly evaluate merger and acquisition opportunities and conduct due diligence activities related to possible transactions with other financial institutions and financial services companies. As a result, negotiations may take place and future mergers or acquisitions involving cash, debt, or equity securities may occur at any time. We seek merger or acquisition partners that are culturally similar, have experienced management, and possess either significant market presence or have potential for improved profitability through financial management, economies of scale, or expanded services.
 
Acquiring other banks, businesses, or branches involves potential adverse impact to our financial results and various other risks commonly associated with acquisitions, including, among other things, difficulty in estimating the value of the target company, payment of a premium over book and market values that may dilute our tangible book value and earnings per share in the short and long term, potential exposure to unknown or contingent liabilities of the target company, exposure to potential asset quality issues of the target company, potential volatility in reported income as goodwill impairment losses could occur irregularly and in varying amounts, difficulty and expense of integrating the operations and personnel of the target company, inability to realize the expected revenue increases, cost savings, increases in geographic or product presence, and / or other projected benefits,  potential disruption to our business, potential diversion of our management’s time and attention,  and the possible loss of key employees and customers of the target company.
 
As a community bank, Nicolet’s success depends upon local and regional economic conditions and has different lending risks than larger banks.
 
We provide services to our local communities.  Our ability to diversify economic risks is limited by our own local markets and economies.  We lend primarily to individuals and small- to medium-sized businesses, which may expose us to greater lending risks than those of banks lending to larger, better-capitalized businesses with longer operating histories.
 
We manage our credit exposure through careful monitoring of loan applicants and loan concentrations in particular industries, and through loan approval and review procedures.  We have established an evaluation process designed to determine the adequacy of our allowance for loan losses.  While this evaluation process uses historical and other objective information, the classification of loans and the establishment of loan losses is an estimate based on experience, judgment and expectations regarding borrowers and economic conditions, as well as regulator judgments.  We can make no assurance that our loan loss reserves will be sufficient to absorb future loan losses or prevent a material adverse effect on its business, profitability or financial condition.
 
12
 

 

 
The core industries in our market area are manufacturing, wholesaling, paper, packaging, food production and processing, agriculture, forest products, retail, service, and businesses supporting the general building industry.  The area has a broad range of diversified equipment manufacturing services related to these core industries and others.  The residential and commercial real estate markets throughout these areas depend primarily on the strength of these core industries.  A material decline in any of these sectors will affect the communities we serve and could negatively impact our financial results and have a negative impact on profitability.
 
If the communities in which we operate do not grow or if the prevailing economic conditions locally or nationally are less favorable than we have assumed, our ability to maintain our low volume of non-performing loans and other real estate owned and implement our business strategies may be adversely affected and our actual financial performance may be materially different from our projections.
 
Nicolet may experience increased delinquencies and credit losses, which could have a material adverse effect on our capital, financial condition, results of operations, and share price.
 
Our success depends to a significant extent upon the quality of our assets, particularly loans.  In originating loans, there is a substantial likelihood that we will experience credit losses.  The risk of loss will vary with, among other things, general economic conditions, the type of loan, the creditworthiness of the borrower over the term of the loan, and, in the case of a collateralized loan, the quality of the collateral for the loan.
 
Our loan customers may not repay their loans according to the terms of these loans, and the collateral securing the payment of these loans may be insufficient to assure repayment.  As a result, we may experience significant loan losses, which could have a material adverse effect on our operating results.  Management makes various assumptions and judgments about the collectability of our loan portfolio, including the creditworthiness of our borrowers and the value of the real estate and other assets serving as collateral for the repayment of many of our loans.  We maintain an allowance for loan losses in an attempt to cover any loan losses that may occur.  In determining the size of the allowance, we rely on an analysis of our loan portfolio based on historical loss experience, volume and types of loans, trends in classification, volume and trends in delinquencies and non-accruals, national and local economic conditions, and other pertinent information.
 
If management’s assumptions are wrong, our current allowance may not be sufficient to cover future loan losses, and we may need to make adjustments to allow for different economic conditions or adverse developments in our loan portfolio.  Material additions to our allowance would materially decrease net income.  We expect our allowance to continue to fluctuate; however, given current and future market conditions, we can make no assurance that our allowance will be adequate to cover future loan losses.
 
In addition, the market value of the real estate securing our loans as collateral continues to be adversely affected by the slow economy and unfavorable changes in economic conditions in our market areas and could be further adversely affected in the future.  As of December 31, 2014, approximately 40% of our loans were secured by commercial-based real estate and 25% of our loans receivable were secured by residential real estate.  Any sustained period of increased payment delinquencies, foreclosures, or losses caused by adverse market and economic conditions, including another downturn in the real estate market, in our markets could adversely affect the value of our assets, revenues, results of operations, and financial condition.
 
Nicolet is subject to extensive regulation that could limit or restrict our activities, which could have a material adverse effect on our results of operations or share price.
 
We operate in a highly regulated industry and are subject to examination, supervision, and comprehensive regulation by various regulatory agencies.  Our compliance with these regulations, including compliance with regulatory commitments, is costly and restricts certain of our activities, including the declaration and payment of cash dividends to stockholders, mergers and acquisitions, investments, loans and interest rates charged, interest rates paid on deposits, and locations of offices.  We are also subject to capitalization guidelines established by our regulators, which require us to maintain adequate capital to support our growth and operations.
 
13
 

 

 
The laws and regulations applicable to the banking industry have recently changed and may continue to change, and we cannot predict the effects of these changes on our business and profitability.  Some or all of the changes, including the new rulemaking authority granted to the newly-created CFPB, may result in greater reporting requirements, assessment fees, operational restrictions, capital requirements, and other regulatory burdens for us, and many of our competitors that are not banks or bank holding companies may remain free from such limitations.  This could affect our ability to attract and maintain depositors, to offer competitive products and services, and to expand our business.  Because government regulation greatly affects the business and financial results of all commercial banks and bank holding companies, the cost of compliance could adversely affect our ability to operate profitably.
 
Congress may consider additional proposals to substantially change the financial institution regulatory system and to expand or contract the powers of banking institutions and bank holding companies.  Such legislation may change existing banking statutes and regulations, as well as the current operating environment significantly.  If enacted, such legislation could increase or decrease the cost of doing business, limit or expand our permissible activities, or affect the competitive balance among banks, savings associations, credit unions, and other financial institutions.  We cannot predict whether new legislation will be enacted and, if enacted, the effect that it, or any regulations, would have on our business, financial condition, or results of operations.
 
Nicolet’s profitability is sensitive to changes in the interest rate environment.
 
As a financial institution, our earnings significantly depend on net interest income, which is the difference between the interest income that we earn on interest-earning assets, such as investment securities and loans, and the interest expense that we pay on interest-bearing liabilities, such as deposits and borrowings.  Therefore, any change in general market interest rates, including changes in federal fiscal and monetary policies, affects us more than non-financial institutions and can have a significant effect on our net interest income and total income.  Our assets and liabilities may react differently to changes in overall market rates or conditions because there may be mismatches between the repricing or maturity characteristics of the assets and liabilities.  As a result, an increase or decrease in market interest rates could have material adverse effects on our net interest margin and results of operations.
 
In addition, we cannot predict whether interest rates will continue to remain at present levels, or the timing of any anticipated changes.  Changes in interest rates may cause significant changes, up or down, in our net interest income.  Depending on our portfolio of loans and investments, our results of operations may be adversely affected by changes in interest rates.  If there is a substantial increase in interest rates, our investment portfolio is at risk of experiencing price declines that may negatively impact our total capital position through changes in other comprehensive income.  In addition, any significant increase in prevailing interest rates could adversely affect our mortgage banking business because higher interest rates could cause customers to request fewer refinancings and purchase money mortgage originations.
 
We rely on other companies to provide key components of our business infrastructure.
 
Third party vendors provide key components of our business infrastructure such as internet connections, network access and core application processing. While we have selected these third party vendors carefully, we do not control their actions. Any problems caused by these third parties, including as a result of their not providing us their services for any reason or their performing their services poorly, could adversely affect our ability to deliver products and services to our customers and otherwise to conduct our business. Replacing these third party vendors could also entail significant delay and expense.
 
Negative publicity could damage our reputation.
 
Reputation risk, or the risk to our earnings and capital from negative public opinion, is inherent in our business. Negative public opinion could adversely affect our ability to keep and attract customers and expose us to adverse legal and regulatory consequences. Negative public opinion could result from our actual or alleged conduct in any number of activities, including lending or foreclosure practices, corporate governance, regulatory compliance, mergers and acquisitions, and disclosure, sharing or inadequate protection of customer information, and from actions taken by government regulators and community organizations in response to that conduct.
 
14
 

 

 
Competition in the banking industry is intense and Nicolet faces strong competition from larger, more established competitors.
 
The banking business is highly competitive, and we experience strong competition from many other financial institutions.  We compete with commercial banks, credit unions, savings and loan associations, mortgage banking firms, consumer finance companies, securities brokerage firms, insurance companies, money market funds, and other financial institutions that operate in our primary market areas and elsewhere.
 
We compete with these institutions both in attracting deposits and in making loans.  In addition, we have to attract our customer base from other existing financial institutions and from new residents.  Many of our competitors are well-established, much larger financial institutions.  While we believe we can and do successfully compete with these other financial institutions in its markets, we may face a competitive disadvantage as compared to large national or regional banks as a result of our smaller size and lack of geographic diversification.
 
Although we compete by concentrating our marketing efforts in our primary market area with local advertisements, personal contacts, and greater flexibility in working with local customers, we can give no assurance that this strategy will be successful.
 
Nicolet continually encounters technological change and we may have fewer resources than our competition to continue to invest in technological improvements; as well, Nicolet’s information systems may experience an interruption or breach in security.
 
The banking and financial services industry is undergoing rapid technological changes, with frequent introductions of new technology-driven products and services.  In addition to better serving customers, the effective use of technology increases efficiency and enables financial institutions to reduce costs.  Our future success will depend, in part, upon our ability to address the needs of our customers by using technology to provide products and services that enhance customer convenience, as well as create additional efficiencies in operations.  Many of our competitors have greater resources to invest in technological improvements, and we may not be able to effectively implement new technology-driving products and services, which could reduce our ability to effectively compete.
 
In addition, we rely heavily on communications and information systems to conduct our business. Any failure, interruption or breach in security of these systems could result in failures or disruptions in customer relationship management, general ledger, deposit, loan functionality and the effective operation of other systems. While we have policies and procedures designed to prevent or limit the effect of a failure, interruption or security breach of our information systems, there can be no assurance that any such failures, interruptions or security breaches will not occur or, if they do occur, that they will be adequately addressed. The occurrence of any failures, interruptions or security breaches of our information systems could damage our reputation, result in a loss of customer business, subject us to additional regulatory scrutiny, or expose us to civil litigation and possible financial liability, any of which could have a material adverse effect on our financial condition and results of operations.
 
Risks Related to Ownership of Nicolet’s Common Stock
 
Our stock price can be volatile.
 
Stock price volatility may make it more difficult for you to sell your common stock when you want and at prices you find attractive. Our stock price can fluctuate widely in response to a variety of factors including, among other things:
 
     actual or anticipated variations in quarterly results of operations or financial condition;
 
     operating results and stock price performance of other companies that investors deem comparable to us;
 
     news reports relating to trends, concerns, and other issues in the financial services industry;
 
     perceptions in the marketplace regarding us and / or our competitors;
 
     new technology used or services offered by competitors;
 
     significant acquisitions or business combinations, strategic partnerships, joint ventures, or capital commitments by or involving us or our competitors;
 
     failure to integrate acquisitions or realize anticipated benefits from acquisitions;
 
     changes in government regulations;
 
     geopolitical conditions such as acts or threats of terrorism or military conflicts;
 
     our own participation in the market through our buyback program; and
 
     recommendations by securities analysts.
 
15
 

 

 
General market fluctuations, industry factors, and general economic and political conditions and events, such as economic slowdowns or recessions, interest rate changes, or credit loss trends, could also cause our stock price to decrease regardless of our operating results.
 
The trading volume of Nicolet’s common stock is less than that of other larger companies.
 
The trading volume of our common stock is less than that of other larger banks.  For the public trading market for our common stock to have the desired characteristics of depth, liquidity and orderliness requires the presence in the marketplace of willing buyers and sellers of our common stock at any given time.  This presence depends on the individual decisions of investors and general economic and market conditions over which we have no control.
 
Given the lower trading volume of our common stock, significant sales of our common stock, or the expectation of these sales, could cause our stock price to fall more than would otherwise be expected.  Conversely, significant purchases of our common stock, or the absence of willing sellers, could cause our stock price to be greater than would otherwise be expected in a liquid trading market. Such pricing may make it more difficult for us to sell equity or equity-related securities in the future at a time and price that we deem appropriate.  Finally we may, through a board-approved stock purchase program, be a buyer of our own common stock from time to time; as such, our own activity through the open market purchases can influence actual and/or perceived trading volume and pricing expectations.
 
Nicolet has not historically paid dividends to our common shareholders and cannot guarantee that we will pay dividends to such shareholders in the future.
 
The holders of our common stock, receive dividends if and when declared by the Nicolet board of directors out of legally available funds.  Nicolet’s board of directors has not declared a dividend on the common stock since our inception in 2000 and does not expect to do so in the foreseeable future.  Any future determination relating to dividend policy will be made at the discretion of Nicolet’s board of directors and will depend on a number of factors, including the company’s future earnings, capital requirements, financial condition, future prospects, regulatory restrictions and other factors that the board of directors may deem relevant.
 
Our principal business operations are conducted through Nicolet National Bank.  Cash available to pay dividends to our shareholders is derived primarily, if not entirely, from dividends paid by Nicolet National Bank.  The ability of Nicolet National Bank to pay dividends to us, as well as our ability to pay dividends to our shareholders, is subject to and limited by certain legal and regulatory restrictions.  Further, any lenders making loans to us may impose financial covenants that may be more restrictive than regulatory requirements with respect to the payment of dividends by us.  There can be no assurance of whether or when we may pay dividends in the future.
 
Nicolet may need to raise additional capital in the future, including through proposed increased minimum capital thresholds established by our regulators as part of their implementation of Basel III, but that capital may not be available when it is needed or may be dilutive to our shareholders.
 
We are required by federal and state regulatory authorities to maintain adequate capital levels to support our operations.  New regulations implementing the Basel III capital standards require financial institutions to maintain higher capital ratios and place a greater emphasis on common equity as a component of Tier 1 capital.  In order to support our operations and comply with regulatory standards, we may need to raise capital in the future.  Our ability to raise additional capital will depend on conditions in the capital markets at that time, which are outside our control, and on our financial performance.  Accordingly, we cannot assure you of our ability to raise additional capital, if needed, on favorable terms.  The capital and credit markets have experienced significant volatility in recent years.  In some cases, the markets have produced downward pressure on stock prices and credit availability for certain issuers without regard to those issuers’ underlying financial strength.  If current levels of volatility worsen, our ability to raise additional capital may be disrupted.  If we cannot raise additional capital when needed, our results of operations and financial condition may be adversely affected, and our banking regulators may subject us to regulatory enforcement action, including receivership.  In addition, the issuance of additional shares of our equity securities will dilute the economic ownership interest of our common and preferred shareholders.
 
16
 

 

 
Nicolet’s directors and executive officers own a significant portion of our common stock and can influence stockholder decisions.
 
Our directors and executive officers, as a group, beneficially owned approximately 24% of our fully diluted issued and outstanding common stock as of December 31, 2014.  As a result of their ownership, our directors and executive officers have the ability, if they voted their shares in concert, to influence the outcome of all matters submitted to our shareholders for approval, including the election of directors.
 
Holders of Nicolet’s subordinated debentures have rights that are senior to those of its common stockholders.
 
We have supported our continued growth by issuing trust preferred securities and accompanying junior subordinated debentures.  As of December 31, 2014, we had outstanding trust preferred securities and associated junior subordinated debentures with an aggregate par principal amount of approximately $16.5 million.
 
We have unconditionally guaranteed the payment of principal and interest on our trust preferred securities.  Also, the junior debentures issued to the special purpose trusts that relate to those trust preferred securities are senior to our common stock.  As a result, we must make payments on the junior subordinated debentures before we can pay any
 
dividends on our common stock, and in the event of our bankruptcy, dissolution or liquidation, holders of our junior subordinated debentures must be satisfied before any distributions can be made on our common stock.  We do have the right to defer distributions on our junior subordinated debentures (and related trust preferred securities) for up to five years, but during that time would not be able to pay dividends on our common or preferred stock.
 
Holders of Nicolet’s SBLF Preferred Stock have rights that are senior to those of its common stock, and contractual restrictions relative to Nicolet’s SBLF Preferred Stock may limit or prevent Nicolet from paying dividends on and repurchasing its common stock.
 
We have supported our capital operations by issuing preferred stock to the Treasury pursuant to the SBLF program.
 
The SBLF Preferred Stock issued to and currently held by the Treasury has dividend rights that are senior to those of our common stock; therefore, we must pay dividends on the SBLF Preferred Stock before we can pay any dividends to holders of our common stock. In the event of our bankruptcy, dissolution, or liquidation, the holders of the SBLF Preferred Stock must be satisfied before we can make any distributions to holders of our common stock.  In addition, under the terms of the SBLF Preferred Stock and the securities purchase agreement between Nicolet and the Treasury in connection with the SBLF transaction, we are generally unable to pay dividends on or repurchase our common stock where such payment or repurchase would result in a reduction of our Tier 1 capital from the level on September 1, 2011, the date on which the SBLF Preferred Stock was issued, by more than 10%.
 
Holders of Nicolet’s SBLF Preferred Stock have limited voting rights.
 
Other than under certain limited circumstances, holders of our SBLF Preferred Stock have no voting rights except with respect to matters that would involve certain fundamental changes to the terms of the SBLF Preferred Stock or as required by law.  These matters include the authorization of stock senior to the SBLF Preferred Stock, amendments that adversely affect the rights of the holders of the SBLF Preferred Stock, and certain business combination transactions.  These rights could make it more difficult to consummate a transaction that our common shareholders wish to approve.
 
Because Nicolet is a regulated bank holding company, your ability to obtain “control” or to act in concert with others to obtain control over Nicolet without the prior consent of the Federal Reserve or other applicable bank regulatory authorities is limited and may subject you to regulatory oversight.
 
Nicolet is a bank holding company and, as such, is subject to significant regulation of its business and operations.  In addition, under the provisions of the Bank Holding Company Act and the Change in Bank Control Act, certain regulatory provisions may become applicable to individuals or groups who are deemed by the regulatory authorities to “control” Nicolet or our subsidiary bank.  The Federal Reserve and other bank regulatory authorities have very broad interpretive discretion in this regard and it is possible that the Federal Reserve or some other bank regulatory authority may, whether through a merger or through subsequent acquisition of Nicolet’s shares, deem one or more of Nicolet’s shareholders to control or to be acting in concert for purposes of gaining or exerting control over Nicolet.  Such a determination may require a shareholder or group of shareholders, among other things, to make voluminous regulatory filings under the Change in Bank Control Act, including disclosure to the regulatory authorities of significant amounts of confidential personal or corporate financial information.  In addition, certain groups or entities may also be required to either register as a bank holding company under the Bank Holding Company Act, becoming themselves subject to regulation by the Federal Reserve under that Act and the rules and regulations promulgated thereunder, which may include requirements to materially limit other operations or divest other business concerns, or to divest immediately their investments in Nicolet.
 
17
 

 

 
In addition, these limitations on the acquisition of our stock may generally serve to reduce the potential acquirers of our stock or to reduce the volume of our stock that any potential acquirer may be able to acquire.  These restrictions may serve to generally limit the liquidity of our stock and, consequently, may adversely affect its value.
 
Nicolet’s securities are not FDIC insured.
 
Our securities are not savings or deposit accounts or other obligations of Nicolet National Bank, and are not insured by the Deposit Insurance Fund, or any other agency or private entity and are subject to investment risk, including the possible loss of some or all of the value of your investment.
 
ITEM 1B.  
UNRESOLVED STAFF COMMENTS
 
None.
 
18
 

 


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
Owned
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.
 
19
 

 

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, 2015, Nicolet had approximately 660 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, 2014
  $ 25.00     $ 23.10     $ 25.00  
September 30, 2014
    24.74       22.35       23.20  
June 30, 2014
    27.25       19.05       24.55  
March 31, 2014
    19.44       16.51       19.44  
                         
    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       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.  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 “Business—Regulation of Nicolet National Bank – Payment of Dividends” and in Note 17, “Regulatory Capital Requirements and Restrictions on Dividends,” in the Notes to Consolidated Financial Statements under Item 8.

Under two actions in 2014, Nicolet’s board of directors approved a resolution authorizing a stock repurchase program whereby Nicolet may utilize up to $12 million to purchase up to 625,000 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.  Through December 31, 2014, $5.6 million was used to repurchase and cancel 257,291 shares at a weighted average price of $21.95 per share including commissions.
 
ITEM 6. 
SELECTED FINANCIAL DATA
 
The selected consolidated financial data presented as of December 31, 2014 and 2013 and for each of the years in the two-year period ended December 31, 2014 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, 2012, 2011 and 2010 is derived from audited consolidated financial statements that are not required to be included in this report.

20
 

 

 
                                         
EARNINGS SUMMARY AND SELECTED FINANCIAL DATA
 
(In thousands, except per share data)
 
At and for the year ended December 31,
 
   
2014
   
2013
   
2012
   
2011
   
2010
 
Results of operations:
     
Interest income
  $ 48,949     $ 43,196     $ 28,795     $ 29,830     $ 31,420  
Interest expense
    7,067       6,292       6,530       8,383       11,291  
Net interest income
    41,882       36,904       22,265       21,447       20,129  
Provision for loan losses
    2,700       6,200       4,325       6,600       8,500  
Net interest income after provision for loan losses
    39,182       30,704       17,940       14,847       11,629  
Other income
    14,185       25,736       10,744       8,444       8,968  
Other expense
    38,709       36,431       24,062       21,443       19,316  
Income before income taxes
    14,658       20,009       4,622       1,848       1,281  
Income tax expense
    4,607       3,837       1,529       318       136  
Net income
    10,051       16,172       3,093       1,530       1,145  
Net income attributable to noncontrolling interest
    102       31       57       40       35  
Net income attributable to Nicolet Bankshares, Inc.
    9,949       16,141       3,036       1,490       1,110  
Preferred stock dividends and discount accretion
    244       976       1,220       1,461       985  
Net income available to common equity
  $ 9,705     $ 15,165     $ 1,816     $ 29     $ 125  
Earnings per common share:
                                       
Basic
  $ 2.33     $ 3.81     $ 0.53     $ 0.01     $ 0.04  
Diluted
    2.25       3.80       0.53       0.01       0.04  
Weighted average common shares outstanding:
                                       
Basic
    4,165       3,977       3,440       3,469       3,452  
Diluted
    4,311       3,988       3,442       3,488       3,481  
Year-End Balances:
                                       
Loans
  $ 883,341     $ 847,358     $ 552,601     $ 472,489     $ 513,761  
Allowance for loan losses
    9,288       9,232       7,120       5,899       8,635  
Investment securities available for sale, at fair value
    168,475       127,515       55,901       56,759       52,388  
Total assets
    1,215,285       1,198,803       745,255       678,249       674,754  
Deposits
    1,059,903       1,034,834       616,093       551,536       558,464  
Other debt
    21,175       39,538       39,190       39,506       39,972  
Junior subordinated debentures
    12,328       12,128       6,186       6,186       6,186  
Common equity
    86,608       80,462       52,933       51,623       50,417  
Stockholders’ equity
    111,008       104,862       77,333       76,023       65,620  
Book value per common share
    21.34       18.97       15.45       14.83       14.57  
Average Balances:
                                       
Loans
  $ 859,256     $ 753,284     $ 521,209     $ 503,362     $ 499,193  
Interest-earning assets
    1,084,408       913,104       614,252       582,486       603,182  
Total assets
    1,191,348       997,372       674,222       642,353       653,710  
Deposits
    1,028,336       830,884       545,896       522,297       530,682  
Interest-bearing liabilities
    892,872       756,606       511,572       500,895       524,461  
Common equity
    84,033       70,737       52,135       50,968       51,661  
Stockholders’ equity
    108,433       95,137       76,535       69,284       66,923  
Financial Ratios:
                                       
Return on average assets
    0.84 %     1.62 %     0.45 %     0.23 %     0.17 %
Return on average equity
    9.18 %     16.97 %     3.97 %     2.15 %     1.66 %
Return on average common equity
    11.55 %     21.44 %     3.48 %     0.06 %     0.24 %
Average equity to average assets
    9.10 %     9.54 %     11.35 %     10.79 %     10.22 %
Net interest margin
    3.89 %     4.06 %     3.67 %     3.75 %     3.39 %
Stockholders’ equity to assets
    9.13 %     8.75 %     10.38 %     11.21 %     9.73 %
Net loan charge-offs to average loans
    0.31 %     0.54 %     0.60 %     1.85 %     1.22 %
Nonperforming loans to total loans
    0.61 %     1.21 %     1.27 %     2.01 %     2.10 %
Nonperforming assets to total assets
    0.61 %     1.02 %     0.97 %     1.49 %     1.81 %
 
21
 

 

 
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 2014 results compared to 2013.  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.

2014 was a year for continued execution on growth and performance.  At December 31, 2014, total assets were $1.2 billion, up only 1% over year end 2013, but with an improved asset mix.  Since year end 2013, loans grew 4% to $883 million (predominantly in commercial and industrial loans and lines of credit) and securities available for sale grew 32% to $168 million, both funded mainly by higher deposits, which grew 2% to $1.06 billion, and continued deployment of cash.  Asset quality was strong with net charge offs to average loans of 0.31% for 2014 and nonperforming assets to assets of 0.61% at December 31, 2014, reflecting successful integration of loans acquired in its 2013 acquisitions and the ongoing strength of the core loan portfolio and credit practices. Return on average assets of 0.84% and return on average common equity of 11.55% indicates solid performance traction in 2014.  As part of its capital management, Nicolet began and has been executing on a common stock repurchase program in 2014. For 2015, Nicolet remains focused on organic loan growth, comprehensive balance sheet management and revenue maximization in its markets, and continues to evaluate acquisition opportunities for strategic growth.

Evaluation of financial performance between 2014 and 2013 will be impacted in general from the timing of Nicolet’s 2013 acquisition of two distressed financial institutions – the predominantly stock-for-stock merger with Mid-Wisconsin consummated in April 2013 and the smaller FDIC-assisted acquisition of Bank of Wausau 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.  Since the results of operations of both entities prior to consummation are appropriately not included in the accompanying consolidated financial statements, income statement results and average balances for 2013 include partial year contributions from the 2013 acquisitions versus a full year in 2014.  Notably, 2013 includes approximately 8 months of Mid-Wisconsin operations and 5 months of Bank of Wausau operations, which analytically could reasonably explain roughly 20% increases in certain average balances and income statement lines between 2014 and 2013; and as well, the 2013 acquisitions recorded $11.9 million of non-recurring bargain purchase gains and $1.9 million of direct pre-tax merger expenses, which net after tax contributed $9.7 million to 2013’s $16.1 million net income.
 
22
 

 

 
Performance Summary
 
Net income attributable to Nicolet was $9.9 million for 2014, and after $0.2 million of preferred stock dividends, net income available to common shareholders was $9.7 million, or $2.25 per diluted common share.  Comparatively, 2013 net income was $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 for 2013.  As noted above, the 2013 acquisitions impacted 2013 net income most directly from inclusion of non-recurring bargain purchase gains and direct merger expenses, which after tax accounted for $9.7 million of the $16.1 million net income in 2013.  Beginning in the fourth quarter of 2013 Nicolet qualified for a 1% annual dividend rate on its preferred stock issued to the Treasury related to its participation in the SBLF, compared to the previous 5% annual rate paid by Nicolet.   A full year of the 1% rate in 2014 resulted in a $0.7 million reduction in preferred stock dividends between 2014 and 2013, with 2013 only reflecting the lower rate for one quarter.
 
 
Net interest income was $41.9 million for 2014, an increase of $5.0 million or 13% compared to 2013.   The improvement was primarily volume related, with average interest-earning assets up $171 million or 19%, but at a lower interest rate spread between 2014 and 2013, driven mainly by lower loan yields and a higher mix of low-earning interest-bearing cash balances, though partly offset by a lower cost of funds.  On a tax-equivalent basis, the 2014 net interest margin was 3.89%, down 17 basis points (“bps”) from 4.06% in 2013 while the cost of interest-bearing liabilities was 0.79%, 4 bps lower than 2013.   The average yield on earning assets was 4.54%, 21 bps lower than in 2013, resulting in a 17 bps decline in the interest rate spread.
 
 
Loans were $883 million at December 31, 2014, up $36 million or 4% over December 31, 2013. The strongest growth came in commercial and industrial loans which increased $36 million and grew to 33% of the loan portfolio at December 31, 2014 versus 30% a year ago.  Since year-end 2013, acquired loans declined $43 million or 19% to $182 million at December 31, 2014 through amortization, refinances, and payoffs.  Average loans were $859 million in 2014 yielding 5.32%, compared to $753 million in 2013 yielding 5.40%, an increase of 14% in average balances.
 
 
Total deposits were $1.1 billion at December 31, 2014, an increase of $25 million or 2% over December 31, 2013.  Between 2014 and 2013, average deposits were up $197 million or 24%, with average total deposits of $1.0 billion for 2014 and $831 million for 2013.  Interest-bearing deposits cost 0.63% for both 2014 and 2013.
 
 
Asset quality measures remained strong.  Nonperforming assets were 0.61% of assets at December 31, 2014 compared to 1.02% of assets at year end 2013, a result of dedicated work on asset resolution.  For 2014, the provision for loan losses was $2.7 million, exceeding net charge offs of $2.6 million.  For 2013, the provision for loan losses was $6.2 million, exceeding net charge offs of $4.1 million.  The allowance for loan losses (“ALLL”) was $9.3 million or 1.05% of loans at December 31, 2014, compared to an ALLL of $9.2 million representing 1.09% of loans at December 31, 2013.
 
 
Noninterest income was $14.2 million for 2014 (including $0.5 million of net gain on sale or writedown of assets), compared to $25.7 million for 2013 (including $13.6 million of combined net gain on sale or writedown of assets and bargain purchase gains (“BPG”)). Removing these net gains, noninterest income was up $1.5 million or 12%, with increases in all line items, except mortgage income, largely due to increased business from Nicolet’s expanded size, timing of the 2013 acquisitions and improved market performance.
 
 
Noninterest expense was $38.7 million for 2014, up $2.3 million or 6% over 2013; however, excluding $1.9 million of non-recurring merger-based expenses (of which $1 million was in personnel and $0.9 million was in other expense) incurred in 2013, expenses were up 12%.  The increase in almost all line items was predominantly due to the larger operating base from the 2013 acquisitions being included for a full year in 2014, net of cost efficiency efforts made during 2014.  Most notably, salaries and employee benefits were up 9% (or up 15% over 2013 excluding the $1 million merger-based expense), while average full-time equivalent employees grew only 10% between the years.  All other non-personnel expenses combined were up 3% (or 8% over 2013 excluding the $0.9 million merger-based expense) and accounted for $0.4 million of the total variance between years.
 
23
 

 

 
Net Interest Income
 
Net interest income in the consolidated statements of income (which excludes any taxable equivalent adjustments) was $41.9 million in 2014, up 13% compared to $36.9 million in 2013. 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 $795,000 for 2014 and $608,000 for 2013, resulting in taxable equivalent net interest income of $42.7 million for 2014 and $37.5 million for 2013.

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.
 
24
 

 

 
Table 1: Average Balance Sheet and Net Interest Income Analysis — Taxable-Equivalent Basis
(dollars in thousands)
                                                                         
   
Years Ended December 31,
 
   
2014
   
2013
   
2012
 
   
Average
Balance
   
Interest
   
Average
Rate
   
Average
Balance
   
Interest
   
Average
Rate
   
Average
Balance
   
Interest
   
Average
Rate
 
ASSETS
                                                     
Earning assets
                                                     
Loans
  $ 859,256     $ 46,206       5.32 %   $ 753,284     $ 41,119       5.40 %   $ 521,209     $ 27,280       5.17 %
Investment securities
                                                                       
Taxable
    83,692       1,606       1.92 %     76,016       1,107       1.46 %     21,963       625       2.85 %
Tax-exempt
    55,678       1,463       2.63 %     31,989       1,234       3.86 %     26,396       1,247       4.73 %
Other interest-earning assets
    85,782       469       0.55 %     51,815       344       0.66 %     44,684       233       0.52 %
Total interest-earning assets
    1,084,408     $ 49,744       4.54 %     913,104     $ 43,804       4.75 %     614,252     $ 29,385       4.73 %
Cash and due from banks
    39,954                       22,178                       15,628                  
Other assets
    66,986                       62,090                       44,342                  
Total assets
  $ 1,191,348                     $ 997,372                     $ 674,222                  
LIABILITIES AND STOCKHOLDERS’ EQUITY
                                                                       
Interest-bearing liabilities
                                                                       
Savings
  $ 110,969     $ 274       0.25 %   $ 79,164     $ 216       0.27 %   $ 33,046     $ 151       0.46 %
Interest-bearing demand
    207,121       1,541       0.74 %     154,991       1,251       0.81 %     90,666       888       0.98 %
MMA
    265,693       711       0.27 %     222,299       780       0.35 %     167,196       780       0.47 %
Core time deposits
    226,112       2,348       1.04 %     195,226       1,776       0.91 %     133,814       2,373       1.77 %
Brokered deposits
    38,319       468       1.22 %     41,029       370       0.90 %     40,203       511       1.27 %
Total interest-bearing deposits
    848,214       5,342       0.63 %     692,709       4,393       0.63 %     464,925       4,703       1.01 %
Other interest-bearing liabilities
    44,658       1,725       3.81 %     63,897       1,899       2.93 %     46,647       1,827       3.85 %
Total interest-bearing liabilities
    892,872       7,067       0.79 %     756,606       6,292       0.83 %     511,572       6,530       1.27 %
Noninterest-bearing demand
    180,122                       138,175                       80,971                  
Other liabilities
    9,921                       7,454                       5,144                  
Total equity
    108,433                       95,137                       76,535                  
Total liabilities and stockholders’ equity
  $ 1,191,348                     $ 997,372                     $ 674,222                  
Net interest income and rate spread
          $ 42,677       3.75 %           $ 37,512       3.92 %           $ 22,855       3.46 %
Net interest margin
                    3.89 %                     4.06 %                     3.67 %
 

 
(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 $291,000 in 2014, $453,000 in 2013 and $128,000 in 2012.
 
25
 

 

 
Table 2: Volume/Rate Variance — Taxable-Equivalent Basis
(dollars in thousands)
                                                 
   
2014 Compared to 2013
Increase (decrease)
Due to Changes in
   
2013 Compared to 2012
Increase (decrease)
Due to Changes in
 
   
Volume
   
Rate*
   
Net(1)
   
Volume
   
Rate*
   
Net(1)
 
Earning assets
                                   
Loans (2)
  $ 5,681     $ (594 )   $ 5,087     $ 12,532     $ 1,307     $ 13,839  
Investment securities
                                               
Taxable
    153       346       499       760       (278 )     482  
Tax-exempt (2)
    710       (481 )     229       238       (251 )     (13 )
Other interest-earning assets
    120       5       125       89       22       111  
Total interest-earning assets
  $ 6,664     $ (724 )   $ 5,940     $ 13,619     $ 800     $ 14,419  
                                                 
Interest-bearing liabilities
                                               
Savings deposits
  $ 80     $ (22 )   $ 58     $ 145     $ (80 )   $ 65  
Interest-bearing demand
    394       (104 )     290       541       (178 )     363  
MMA
    136       (205 )     (69 )     220       (220 )     -  
Core time deposits
    303       269       572       831       (1,428 )     (597 )
Brokered deposits
    (26 )     124       98       10       (151 )     (141 )
Total interest-bearing deposits
    887       62       949       1,747       (2,057 )     (310 )
Other interest-bearing liabilities
    (140 )     (34 )     (174 )     433       (361 )     72  
Total interest-bearing liabilities
    747       28       775       2,180       (2,418 )     (238 )
Net interest income
  $ 5,917     $ (752 )   $ 5,165     $ 11,439     $ 3,218     $ 14,657  
 

 
*
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,  
    2014     2013     2012  
         
% of
               
% of
               
% of
       
   
Average
   
Earning
         
Average
   
Earning
         
Average
   
Earning
       
   
Balance
   
Assets
   
Yield/Rate
   
Balance
   
Assets
   
Yield/Rate
   
Balance
   
Assets
   
Yield/Rate
 
Total loans
  $ 859,256       79.2 %     5.32 %   $ 753,284       82.5 %     5.40 %   $ 521,209       84.9 %     5.17 %
Securities and other earning assets
    225,152       20.8 %     1.57 %     159,820       17.5 %     1.68 %     93,043       15.1 %     2.26 %
Total interest-earning assets
  $ 1,084,408       100 %     4.54 %   $ 913,104       100.0 %     4.75 %   $ 614,252       100.0 %     4.73 %
                                                                         
Interest-bearing liabilities
  $ 892,872       82.3 %     0.79 %   $ 756,606       82.9 %     0.83 %   $ 511,572       83.3 %     1.27 %
Noninterest-bearing funds, net
    191,536       17.7 %             156,498       17.1 %             102,680       16.7 %        
Total funds sources
  $ 1,084,408       100.0 %     0.65 %   $ 913,104       100.0 %     0.69 %   $ 614,252       100.0 %     1.06 %
Interest rate spread
                    3.75 %                     3.92 %                     3.46 %
Contribution from net free funds
                    0.14 %                     0.14 %                     0.21 %
Net interest margin
                    3.89 %                     4.06 %                     3.67 %
 
26
 

 

 
Comparison of 2014 versus 2013
 
Taxable-equivalent net interest income was $42.7 million for 2014, up $5.2 million or 14%, compared to 2013.  The increase in taxable-equivalent net interest income was predominantly volume related, given the timing of the 2013 acquisitions.  Taxable equivalent interest income increased $5.9 million (or 14%) between 2013 and 2014 driven mainly by loans (including $5.7 million from higher loan volumes offset by $0.6 million from lower loan yields).  Interest expense increased by $0.8 million (or 12%) between the two periods mainly due to time deposits (including $0.3 million more expense from volume and $0.3 million more from rate) and an increase in interest-bearing demand deposits ($0.4 million more expense from volume offset by $0.1 million less expense from rate).

The taxable-equivalent net interest margin was 3.89% for 2014, down 17 bps from 2013, with improvement in the cost of funds at 0.79% (down 4 bps), more than offset by a lower earning asset yield of 4.54% (down 21 bps) and no change 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 both 2014 and 2013 such pressure was partially mitigated by the favorable income from acquired loans.

The earning asset yield was comprised mainly of loans, representing only 79% of average earning assets and yielding 5.32% for 2014, compared to 83% and 5.40%, respectively, for 2013.  The 8 bps decline in loan yield between the years was largely due to two acquired loans fully resolved at approximately $1 million above their carrying values during the third quarter of 2013.   The 21 bps decline in earning asset yield was also impacted by a higher mix of non-loan earning assets, which earn much less than loans.  All other interest earning assets combined represented 21% of average earning assets and yielded 1.57% versus 18% and 1.68%, respectively, for 2013.  A higher proportion of low-earning cash was the main reason for the 11 bps decline in the non-loan yield between the years.

Nicolet’s cost of funds continued its favorable decline during the low-rate environment, at 0.79% for 2014, 4 bps lower than 2013. The average cost of interest-bearing deposits (which represent over 90% of average interest-bearing liabilities for both years), was 0.63% for both years, with favorable rate variances in all deposit categories excluding time and brokered deposits.  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 decreased while their cost increased to 1.22% (versus 0.90% in 2013) as a portion of the lower rate balances matured and were not replaced.   Similarly other interest-bearing liabilities balances decreased while their cost increased to 3.81% (from 2.93% in 2013) mainly from lower rate advances that were paid back and not renewed.

Average interest-earning assets were $1.1 billion for 2014, $171 million or 19% higher than 2013, led by a $106 million increase in average loans (up 14% to $859 million and representing 79% of interest earning assets) and a $31 million increase in average investments (up 29% to $139 million and representing 13% of earning assets), both partially influenced by the size and timing of the acquisitions in 2013.

Average interest-bearing liabilities were $893 million, up $136 million or 18% over 2013, led by a $156 million increase in interest-bearing deposits (up 22% to $848 million representing 95% of interest-bearing liabilities) and a $19 million decrease in average other interest-bearing liabilities (to $45 million), both partially influenced by the size and timing of the acquisitions in 2013 and the use of stable deposits to pay down other wholesale funding.

Provision for Loan Losses

The provision for loan losses in 2014 was $2.7 million, compared to $6.2 million in 2013. The lower provision in 2014 was due to steady improvement during 2014 in levels of loans in nonperforming, delinquent, and classified status.  Net charge offs were $2.6 million in 2014 and $4.1 million in 2013 (which includes the $1.8 million charge off related to the grain credit noted above).  Asset quality trends remained strong.  At December 31, 2014, the ALLL was $9.3 million or 1.05% of loans compared to $9.2 million or 1.09% of loans at December 31, 2013.  With continued improvements in asset quality trends, the decrease in the ALLL as a percent of loans was the result of an increasing originated loan balance.  No ALLL has been recorded on acquired loans since acquisition or at December 31, 2014, since the remaining pool discounts exceed the required amount calculated based on the actual charge off experience in the acquired loan portfolio.
 
27
 

 

 
Nonperforming loans were $5.4 million (or 0.61% of total loans) at December 31, 2014 compared to $10.3 million (or 1.21% of total loans) at December 31, 2013.  The reduction in nonperforming loans was the result of a continued commitment to work distressed assets to resolution, particularly acquired nonaccrual loans.  Of the $16.7 million nonaccrual loans initially acquired in the 2013 acquisitions, $4.3 million remain included in the $5.4 million of nonaccruals at December 31, 2014, compared to $9.5 million 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,
   
2014 Compared to 2013
 
   
2014
   
2013
   
$ Change
   
% Change
 
                         
Service charges on deposit accounts
  $ 2,128     $ 1,793     $ 335       18.7 %
Trust services fee income
    4,569       4,028       541       13.4  
Mortgage income
    1,926       2,336       (410 )     (17.6 )
Brokerage fee income
    631       477       154       32.3  
Bank owned life insurance (“BOLI”)
    933       825       108       13.1  
Rent income
    1,239       1,036       203       19.6  
Investment advisory fees
    440       348       92       26.4  
Gain on sale or writedown of assets, net
    539       1,669       (1,130 )     (67.7 )
Bargain purchase gains (“BPG”)
    -       11,915       (11,915 )     N/M  
Other income
    1,780       1,309       471       36.0  
Total noninterest income
  $ 14,185     $ 25,736     $ (11,551 )     (44.9 )%
Noninterest income without BPG
  $ 14,185     $ 13,821     $ 364       2.6 %
Noninterest income without BPG and net gains
  $ 13,646     $ 12,152     $ 1,494       12.3 %
 
*N/M means not meaningful

Comparison of 2014 versus 2013

Noninterest income was $14.2 million for 2014 (including $0.5 million of net gain on sale or writedown of assets), compared to $25.7 million for 2013 (including $13.6 million of combined net gain on sale or writedown of assets and BPG). Removing these net gains, noninterest income was up $1.5 million or 12.3%, with increases in all line items, except mortgage income, largely due to increased business from Nicolet’s expanded size, timing of the 2013 acquisitions and improved market performance.

BPG is calculated as the net difference in the fair value of the net assets acquired less the consideration paid, which resulted in a non-taxable BPG of $9.5 million for Mid-Wisconsin and a taxable BPG of $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.

Service charges on deposit accounts for 2014 were $2.1 million, up $0.3 million or 18.7% over 2013, given the higher number of accounts and increased deposit activity.  Most notably, personal non-sufficient funds fees were up $0.2 million over 2013, while the remaining $0.1 million increase was due to higher service-charges and other fees.

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 vary with movements in mortgage rates, changes in mortgage regulation, and the impact of economic conditions on consumers. Secondary mortgage production was $92 million for 2014, down 30.8% from 2013’s production of $133 million. Mortgage income was $1.9 million for 2014, down $0.4 million or 17.6%, compared to $2.3 million for 2013, as a result of lower production offset partly by better sales pricing.
 
28
 

 


Trust service fees were $4.6 million for 2014, up $0.5 million or 13.4% over 2013. In addition to a full year of income on 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 $0.6 million, up $0.2 million or 32.3% over 2013, mainly from increased legacy business, market improvements, and to a lesser degree from a full year of the 2013 acquisitions.

BOLI income was $0.9 million, up $0.1 million or 13.1% over 2013, as a result of the $4.3 million BOLI acquired with Mid-Wisconsin and $2.8 million new BOLI purchased in June 2014 in this lower rate environment, bringing the average BOLI investment to $25.7 million, up 16.7% over 2013. Rent income, investment advisory fees and other income combined were $3.5 million for 2014, up $0.8 million or 28.4% over 2013, with the majority of the increase due to ancillary fees tied to deposit-related products, most particularly debit card interchange fees (up $0.3 million aided in part by a full year of activity from the 2013 acquisitions but also greater volume related to a popular checking product design), check orders, check cashing and wire fee income.

Nicolet recognized $0.5 million net gain on sale or writedown of assets in 2014, compared to $1.7 million in 2013. The 2014 activity consisted of a $0.3 million gain on sale of equity securities and $0.8 million net gains on sales of other real estate owned (“OREO”), and a $0.6 million writedown in the second quarter on a bank premise which was subsequently sold prior to year end.  The 2013 activity consisted of $0.5 million net gains on sales of AFS securities, $1.3 million net gains on OREO sales and $0.1 million writedown on OREO properties.

Noninterest Expense

Table 5: Noninterest Expense
(dollars in thousands)
                                 
   
Years ended December 31,
   
2014 Compared to 2013
 
   
2014
   
2013
   
$ Change
   
% Change
 
Salaries and employee benefits
  $ 21,472     $ 19,615     $ 1,857       9.5 %
Occupancy, equipment and office
    7,086       6,407       679       10.6  
Business development and marketing
    2,267       2,348       (81 )     (3.4 )
Data processing
    3,178       2,477       701       28.3  
FDIC assessments
    715       700       15       2.1  
Core deposit intangible amortization
    1,209       1,111       98       8.8  
Other expense
    2,782       3,773       (991 )     (26.3 )
Total noninterest expense
  $ 38,709     $ 36,431     $ 2,278       6.3 %

Comparison of 2014 versus 2013

Total noninterest expense was $38.7 million for 2014, an increase of $2.3 million or 6.3%, over 2013; however, excluding $1.9 million of non-recurring merger-based expenses (of which $1 million was in personnel and $0.9 million was in other expense) incurred in 2013, expenses were up 12.1%.  The increase in almost all line items was predominantly due to the larger operating base from the 2013 acquisitions being included for a full year in 2014, net of cost efficiency efforts made during 2014.

Salaries and employee benefits expense was $21.5 million for 2014, up $1.9 million or 9.5% over 2013 (or up 14.8% over 2013 excluding the $1 million merger-based expense, such as stay bonuses and severance costs), while average full-time equivalent employees (“FTE” employees) grew 10.1% between the years (284 for 2014 versus 258 for 2013).  Total personal costs were largely impacted by a full year of the larger workforce (including commensurate increases in payroll taxes and employer 401k match), rising health insurance costs, and merit increases between the years.

Occupancy, equipment and office expense increased $0.7 million or 10.6%, most notably impacted by a full year of the 2013 acquisitions, including certain infrastructure integration costs which carried over into 2014, but offset by efficiencies and lower one time signage, postage, and functional costs associated with the acquisitions.
 
29
 

 

 
Business development and marketing expense was flat (down $0.1 million) compared to 2013, with increases from the full year of activity offset by a reduction in higher initial costs incurred in the newly acquired markets.

Data processing expenses, which are primarily volume-based, were up $0.7 million or 28.3% over 2013, in line with the increase in number of accounts processed and full integration of systems.

FDIC assessments were flat (up approximately $15,000) compared to 2013, with the increase in assets (on which assessments are based) offset by a more favorable rate charged in 2014.  The core deposit intangible (“CDI”) amortization increased $0.1 million or 8.8%, attributable mainly to a full year of the CDI recorded in the Mid-Wisconsin transaction.

Other expenses were $1.0 million lower than 2013.   Approximately $0.9 million of 2013 expense was attributable 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 2014 decreased modestly from 2013 (down $0.1 million or 2.4%).   Most notable in other expense was a $0.5 million debit card fraud loss from a merchant’s breach in fourth quarter 2014, offset by $0.4 million lower OREO and foreclosure costs (given lower OREO volume) and $0.1 million lower other miscellaneous expenses between the years.

Income Taxes

Income tax expense was $4.6 million for 2014 and $3.8 million for 2013. The effective tax rates were 31.4% for 2014 and 19.2% for 2013.  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.  Tax expense for 2014 includes a $0.5 million tax benefit recorded to the deferred tax asset in the second quarter due to the increased ability to utilize net operating losses under the Internal Revenue Code section 382 following the one-year evaluation period related to the acquisition.  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 net deferred tax asset was $5.8 million at December 31, 2014 compared to $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, 2014 and 2013, 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, paper, packaging, food production and processing, agriculture, forest products, retail, service, and businesses supporting the general building industry. It continues to concentrate its efforts in originating loans in its local markets and assisting its current loan customers. It actively utilizes government loan programs such as those provided by the U.S. Small Business Administration to help customers weather current economic conditions and position their businesses for the future.

Nicolet’s primary lending function is to make commercial loans, consisting of commercial and industrial business loans and lines of credit and owner-occupied CRE loans and AG production and real estate loans; 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.

Total gross loans were $883 million at December 31, 2014, an increase of $36 million, or 4%, compared to total gross loans of $847 million at December 31, 2013. Loans acquired in 2013 totaled $284 million at the time of acquisition and had an outstanding balance of $182 million and $224 million at December 31, 2014 and 2013, respectively given amortization, refinances, and payoffs.  Loan growth in 2014 had to absorb this $42 million reduction in acquired loans resulting in organic growth of $78 million or 9% between December 31, 2014 and 2013.  The 2014 growth was predominately in commercial and industrial loans.   The overall mix of loans remained relatively stable with modest reductions in commercial real estate offset primarily by increases in commercial & industrial, agriculture, and first mortgage loans.
 
30
 

 

 
Table 6: Loan Composition
As of December 31,
(dollars in thousands)
                                                             
   
2014
   
2013
   
2012
   
2011
   
2010
 
   
Amount
 
% of
Total
   
Amount
 
% of
Total
   
Amount
 
% of
Total
   
Amount
 
% of
Total
   
Amount
 
% of
Total
 
Commercial & industrial
 
$
289,379
 
32.7
%
 
$
253,674
 
29.9
%
 
$
197,301
 
35.7
%
 
$
153,810
 
32.6
%
 
$
170,898
 
33.3
%
Owner-occupied CRE
   
182,574
 
20.7
     
187,476
 
22.1
     
106,888
 
19.3
     
110,094
 
23.3
     
120,943
 
23.5
 
AG production
   
14,617
 
1.6
     
14,256
 
1.7
     
215
 
0.1
     
201
 
0.0
     
21
 
0.0
 
AG real estate
   
42,754
 
4.8
     
37,057
 
4.4
     
11,354
 
2.1
     
1,085
 
0.2
     
2,179
 
0.5
 
CRE investment
   
81,873
 
9.3
     
90,295
 
10.7
     
76,618
 
13.9
     
66,577
 
14.1
     
63,839
 
12.4
 
Construction & land development
   
44,114
 
5.0
     
42,881
 
5.1
     
21,791
 
3.9
     
24,774
 
5.2
     
31,464
 
6.1
 
Residential construction
   
11,333
 
1.3
     
12,535
 
1.5
     
7,957
 
1.4
     
9,363
 
2.0
     
8,893
 
1.7
 
Residential first mortgage
   
158,683
 
18.0
     
154,403
 
18.2
     
85,588
 
15.5
     
56,392
 
11.9
     
56,533
 
11.0
 
Residential junior mortgage
   
52,104
 
5.9
     
49,363
 
5.8
     
39,352
 
7.1
     
42,699
 
9.0
     
46,621
 
9.1
 
Retail & other
   
5,910
 
0.7
     
5,418
 
0.6
     
5,537
 
1.0
     
7,494
 
1.7
     
12,370
 
2.4
 
Total loans
 
$
883,341
 
100.0
%
 
$
847,358
 
100.0
%
 
$
552,601
 
100.0
%
 
$
472,489
 
100.0
%
 
$
513,761
 
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 2014 was 74.1% commercial-based and 25.9% retail-based at December 31, 2014 versus 73.9% and 26.1%, respectively, for year-end 2013.  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 $36 million since year end 2013. Commercial and industrial loans continue to be the largest segment of Nicolet’s portfolio and increased to 32.7% of the portfolio at year end 2014 compared to 29.9% of the total portfolio at year end 2013.  This continues to be a strong growth area for Nicolet.

Owner-occupied CRE loans fell to 20.7% of loans at year end 2014 compared to 22.1% of loans at year end 2013.  This category primarily consists of loans within a diverse range of industries secured by business real estate that is occupied by borrowers who operate their businesses out of the underlying collateral and who may also have commercial and industrial loans. The credit risk related to owner-occupied CRE loans is largely influenced by general economic conditions and the resulting impact on a borrower’s operations, or on the value of underlying collateral. The total decrease of $5 million between year ends was predominately from a $17 million decrease in acquired balances offset by a $12 million increase in originated loans.

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 $6 million increase in these portfolios between year ends was driven by a $9 million increase in originated balances offset by a $3 million reduction in acquired balances.  Agriculture is more prevalent in our acquired markets, offering a growth area for Nicolet.  In total, these loans increased minimally to 6.4% from 6.1% of total loans at December 31, 2014 and 2013, respectively.

The CRE investment loan classification primarily includes commercial-based mortgage loans that are secured by non-owner occupied, nonfarm/nonresidential real estate properties, and multi-family residential properties.  Lending in this segment has been focused on loans that are secured by commercial income-producing properties as opposed to speculative real estate development.  From December 31, 2013 to December 31, 2014, these loans decreased $8 million.  At December 31, 2014 CRE investment loans represented 9.3% of loans compared to 10.7% a year ago.

Loans in the construction and land development portfolio represent 5.0% of total loans at year end 2014 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 remained steady both in total dollars and as a percentage of the portfolio compared between year ends.
 
31
 

 

 
On a combined basis, Nicolet’s residential real estate loans represent 25.2% of total loans at year end 2014 compared to 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, 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.  Nicolet’s mortgage loans have historically had low net charge off rates and held mortgages typically are of high quality.

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 2014 and 2013 and the portfolio has remained stable 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, 2014, 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.

Table 7: Loan Maturity Distribution

The following table presents the maturity distribution of the loan portfolio at December 31, 2014:
(dollars in thousands)
                                 
   
Loan Maturity
 
   
One Year
or Less
   
Over One
Year
to Five Years
   
Over
Five Years
   
Totals
 
Commercial & industrial
  $ 135,307     $ 146,330     $ 7,742     $ 289,379  
Owner-occupied CRE
    34,226       127,699       20,649       182,574  
AG production
    5,620       8,997       -       14,617  
AG real estate
    11,908       27,817       3,029