10-Q 1 t1600234_10q.htm FORM 10-Q

 

 

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

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

 

For the quarterly period ended March 31, 2016

 

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

 

For the transition period from ___________ to ___________

 

Commission file number 001-37700

NICOLET BANKSHARES, INC.

(Exact name of registrant as specified in its charter)

 

WISCONSIN

(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)

 

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

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Date File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨

 

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

 

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

 

As of April 28, 2016 there were 4,254,126 shares of $0.01 par value common stock outstanding.

 

 

 

 

 

 

Nicolet Bankshares, Inc.

 

TABLE OF CONTENTS

 

PART I FINANCIAL INFORMATION PAGE
       
  Item 1. Financial Statements:  
       
   

Consolidated Balance Sheets

March 31, 2016 (unaudited) and December 31, 2015

3
       
   

Consolidated Statements of Income

Three Months Ended March 31, 2016 and 2015 (unaudited)

4
       
   

Consolidated Statements of Comprehensive Income

Three Months Ended March 31, 2016 and 2015 (unaudited)

5
       
   

Consolidated Statement of Changes in Stockholders’ Equity

Three Months Ended March 31, 2016 (unaudited)

6
       
   

Consolidated Statements of Cash Flows

Three Months Ended March 31, 2016 and 2015 (unaudited)

7
       
    Notes to Unaudited Consolidated Financial Statements 8-26
       
  Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 27-46
       
  Item 3. Quantitative and Qualitative Disclosures About Market Risk 47
       
  Item 4. Controls and Procedures 47
       
PART II OTHER INFORMATION  
       
  Item 1. Legal Proceedings 47
       
  Item 1A. Risk Factors 47
       
  Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 47
       
  Item 3. Defaults Upon Senior Securities 48
       
  Item 4. Mine Safety Disclosures 48
       
  Item 5. Other Information 48
       
  Item 6. Exhibits 49
       
    Signatures 49

 

 2 

 

 

PART I – FINANCIAL INFORMATION

 

Item 1. FINANCIAL STATEMENTS:

 

NICOLET BANKSHARES, INC. AND SUBSIDIARIES

Consolidated Balance Sheets

(In thousands, except share and per share data)

 

  

March 31, 2016

(Unaudited)

   December 31, 2015
(Audited)
 
Assets          
Cash and due from banks  $28,645   $11,947 
Interest-earning deposits   69,162    70,755 
Federal funds sold   376    917 
Cash and cash equivalents   98,183    83,619 
Certificates of deposit in other banks   4,163    3,416 
Securities available for sale (“AFS”)   174,470    172,596 
Other investments   8,174    8,135 
Loans held for sale   4,183    4,680 
Loans   888,708    877,061 
Allowance for loan losses   (10,530)   (10,307)
Loans, net   878,178    866,754 
Premises and equipment, net   30,124    29,613 
Bank owned life insurance (“BOLI”)   28,725    28,475 
Accrued interest receivable and other assets   17,835    17,151 
Total assets  $1,244,035   $1,214,439 
           
Liabilities and Stockholders’ Equity          
Liabilities:          
Demand  $221,807   $226,554 
Money market and NOW accounts   505,330    486,677 
Savings   145,403    136,733 
Time   208,932    206,453 
Total deposits   1,081,472    1,056,417 
Notes payable   15,344    15,412 
Junior subordinated debentures   12,577    12,527 
Subordinated notes   11,858    11,849 
Accrued interest payable and other liabilities   7,937    8,547 
Total liabilities   1,129,188    1,104,752 
           
Stockholders’ Equity:          
Preferred equity   12,200    12,200 
Common stock   42    42 
Additional paid-in capital   46,894    45,220 
Retained earnings   53,601    51,059 
Accumulated other comprehensive income (“AOCI”)   1,878    980 
Total Nicolet Bankshares, Inc. stockholders’ equity   114,615    109,501 
Noncontrolling interest   232    186 
Total stockholders’ equity and noncontrolling interest   114,847    109,687 
Total liabilities, noncontrolling interest and stockholders’ equity  $1,244,035   $1,214,439 
           
Preferred shares authorized (no par value)   10,000,000    10,000,000 
Preferred shares issued and outstanding   12,200    12,200 
Common shares authorized (par value $0.01 per share)   30,000,000    30,000,000 
Common shares outstanding   4,203,908    4,154,377 
Common shares issued   4,263,066    4,191,067 

 

See accompanying notes to unaudited consolidated financial statements.

 

 3 

 

 

ITEM 1. Financial Statements Continued:

 

NICOLET BANKSHARES, INC. AND SUBSIDIARIES

Consolidated Statements of Income

(In thousands, except share and per share data) (Unaudited)

 

   Three Months Ended
March 31,
 
   2016   2015 
Interest income:          
Loans, including loan fees  $11,570   $11,979 
Investment securities:          
Taxable   404    394 
Non-taxable   262    271 
Other interest income   193    100 
Total interest income   12,429    12,744 
Interest expense:          
Money market and NOW accounts   490    566 
Savings and time deposits   665    743 
Short-term borrowings   -    - 
Junior subordinated debentures   159    217 
Subordinated notes   226    51 
Notes payable   150    164 
Total interest expense   1,690    1,741 
Net interest income   10,739    11,003 
Provision for loan losses   450    450 
Net interest income after provision for loan losses   10,289    10,553 
Noninterest income:          
Service charges on deposit accounts   593    509 
Trust services fee income   1,162    1,204 
Mortgage income, net   571    874 
Brokerage fee income   310    170 
Bank owned life insurance   250    242 
Rent income   262    284 
Investment advisory fees   100    118 
Gain (loss) on sale of assets, net   (5)   211 
Other income   635    458 
Total noninterest income   3,878    4,070 
Noninterest expense:          
Salaries and employee benefits   5,348    5,691 
Occupancy, equipment and office   1,798    1,785 
Business development and marketing   578    485 
Data processing   1,156    831 
FDIC assessments   143    164 
Intangible amortization   249    275 
Other expense   746    571 
Total noninterest expense   10,018    9,802 
           
Income before income tax expense   4,149    4,821 
Income tax expense   1,449    1,708 
Net income   2,700    3,113 
Less: net income attributable to noncontrolling interest   46    33 
Net income attributable to Nicolet Bankshares, Inc.   2,654    3,080 
Less:  preferred stock dividends   112    61 
Net income available to common shareholders  $2,542   $3,019 
           
Basic earnings per common share  $0.61   $0.75 
Diluted earnings per common share  $0.57   $0.70 
Weighted average common shares outstanding:          
Basic   4,181,920    4,031,323 
Diluted   4,456,442    4,307,274 

 

See accompanying notes to unaudited consolidated financial statements.

 

 4 

 

 

ITEM 1. Financial Statements Continued:

 

NICOLET BANKSHARES, INC. AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income

(In thousands) (Unaudited)

 

   Three Months Ended
March 31,
 
   2016   2015 
Net income  $2,700   $3,113 
Other comprehensive income, net of tax:          
Unrealized gains on securities AFS:          
Net unrealized holding gains arising during the period   1,472    925 
Reclassification adjustment for net gains included in net income   -    - 
Net unrealized gains on securities before tax expense   1,472    925 
Income tax expense   (574)   (361)
Total other comprehensive income   898    564 
Comprehensive income  $3,598   $3,677 

 

See accompanying notes to unaudited consolidated financial statements.

 

 5 

 


ITEM 1. Financial Statements Continued:

 

NICOLET BANKSHARES, INC. AND SUBSIDIARIES

Consolidated Statement of Stockholders’ Equity

(In thousands) (Unaudited)

 

   Nicolet Bankshares, Inc. Stockholders’ Equity         
   Preferred
Equity
   Common
Stock
   Additional
Paid-In
Capital
   Retained
Earnings
   Accumulated
Other
Comprehensive
Income
   Noncontrolling
Interest
   Total 
Balance December 31, 2015  $12,200   $42   $45,220   $51,059   $980   $186   $109,687 
Comprehensive income:                                   
Net income   -    -    -    2,654    -    46    2,700 
Other comprehensive income   -    -    -    -    898    -    898 
Stock compensation expense   -    -    412    -    -    -    412 
Exercise of stock options, net   -    -    100    -    -    -    100 
Issuance of common stock   -    -    35    -    -    -    35 
Issuance of  common stock - acquisition   -    -    1,157    -    -    -    1,157 
Purchase and retirement of common stock   -    -    (30)   -    -    -    (30)
Preferred stock dividends   -    -    -    (112)   -    -    (112)
Balance, March 31, 2016  $12,200   $42   $46,894   $53,601   $1,878   $232   $114,847 

 

See accompanying notes to unaudited consolidated financial statements.

 

 6 

 

 

ITEM 1. Financial Statements Continued:

 

NICOLET BANKSHARES, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

(In thousands) (Unaudited)

 

   Three Months Ended March 31, 
   2016   2015 
Cash Flows From Operating Activities:          
Net income  $2,700   $3,113 
Adjustments to reconcile net income to net cash provided by operating activities:          
Depreciation, amortization, and accretion   498    1,078 
Provision for loan losses   450    450 
Provision for deferred taxes   (200)   (19)
Increase in cash surrender value of life insurance   (250)   (242)
Stock compensation expense   412    290 
(Gain) loss on sale of assets, net   5    (211)
Gain on sale of loans held for sale, net   (517)   (874)
Proceeds from sale of loans held for sale   29,128    48,703 
Origination of loans held for sale   (28,114)   (48,993)
Net change in:          
Accrued interest receivable and other assets   460    (723)
Accrued interest payable and other liabilities   (2,531)   (1,132)
Net cash provided by operating activities   2,041    1,440 
Cash Flows From Investing Activities:          
Net (increase) decrease in certificates of deposit in other banks   (747)   2,984 
Net (increase) decrease in loans   (11,114)   3,064 
Purchases of securities AFS   (4,908)   (11,097)
Proceeds from calls and maturities of securities AFS   5,382    6,585 
Purchase of other investments   (39)   (15)
Purchase of premises and equipment   (933)   (411)
Proceeds from sales of other real estate and other assets   27    1,191 
Net cash paid in business combination   (206)   - 
Net cash provided (used) by investing activities   (12,538)   2,301 
Cash Flows From Financing Activities:          
Net increase (decrease) in deposits   25,055    (19,125)
Repayments of notes payable   (68)   (66)
Proceeds from issuance of subordinated notes, net   -    7,880 
Purchase and retirement of common stock   (30)   (1,621)
Proceeds from issuance of common stock, net   135    388 
Cash dividends paid on preferred stock   (31)   (61)
Net cash provided (used) by financing activities   25,061    (12,605)
Net increase (decrease) in cash and cash equivalents   14,564    (8,864)
Cash and cash equivalents:          
Beginning  $83,619   $68,708 
Ending  $98,183   $59,844 
Supplemental Disclosures of Cash Flow Information:          
Cash paid for interest  $1,683   $1,766 
Cash paid for taxes   1,850    1,600 
Transfer of loans and bank premises to other real estate owned   33    576 
Acquisition: Fair value of assets acquired (including intangibles)   1,363     

 

See accompanying notes to unaudited consolidated financial statements.

 

 7 

 

 

NICOLET BANKSHARES, INC. AND SUBSIDIARIES

 

Notes to Unaudited Consolidated Financial Statements

 

Note 1 – Basis of Presentation

 

General

 

In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments necessary to present fairly Nicolet Bankshares, Inc. (the “Company”) and its subsidiaries, consolidated balance sheets, statements of income, comprehensive income, changes in stockholders’ equity and cash flows for the periods presented, and all such adjustments are of a normal recurring nature. All material intercompany transactions and balances are eliminated. The results of operations for the interim periods are not necessarily indicative of the results to be expected for the entire year.

 

These interim consolidated financial statements have been prepared according to the rules and regulations of the Securities and Exchange Commission and, therefore, certain information and footnote disclosures normally presented in accordance with generally accepted accounting principles in the United States of America (“U.S. GAAP”) have been omitted or abbreviated. These consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements and footnotes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015.

 

Critical Accounting Policies and Estimates

 

Preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying disclosures. These estimates are based on management’s best knowledge of current events and actions the Company may undertake in the future. Estimates are used in accounting for, among other items, the allowance for loan losses, useful lives for depreciation and amortization, fair value of financial instruments, deferred tax assets, uncertain income tax positions and contingencies. Estimates that are particularly susceptible to significant change for the Company include the determination of the allowance for loan losses, the assessment of deferred tax assets and liabilities, and the valuation of loans acquired in the 2013 acquisitions; therefore, these are critical accounting policies. Factors that may cause sensitivity to the aforementioned estimates include but are not limited to: external market factors such as market interest rates and employment rates, changes to operating policies and procedures, changes in applicable banking regulations, and changes to deferred tax estimates. Actual results may ultimately differ from estimates, although management does not generally believe such differences would materially affect the consolidated financial statements in any individual reporting period presented.

 

There have been no material changes or developments with respect to the assumptions or methodologies that the Company uses when applying what management believes are critical accounting policies and developing critical accounting estimates as disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015.

 

Recent Accounting Developments Adopted


The Company has implemented all new accounting pronouncements that are in effect and that may impact its consolidated financial statements or results of operations.

 

Operating Segment

 

While the chief decision makers monitor the revenue streams of the various products and services, and evaluate costs, balance sheet positions and quality, all such products, services and activities are directly or indirectly related to the business of community banking, with no regular, formal or material segment delineations. Operations are managed and financial performance is evaluated on a company-wide basis, and accordingly, all the financial service operations are considered by management to be aggregated in one reportable operating segment.

 

 

 8 

 

 

Note 2 – Earnings per Common Share

 

Basic earnings per common share are calculated by dividing net income available to common shareholders by the weighted average number of common shares outstanding during the period. Diluted earnings per share is calculated by dividing net income available to common shareholders by the weighted average number of shares adjusted for the dilutive effect of common stock awards (outstanding stock options and unvested restricted stock), if any. Presented below are the calculations for basic and diluted earnings per common share.

 

  

Three Months Ended

March 31,

 
   2016   2015 
(In thousands except per share data)          
Net income, net of noncontrolling interest  $2,654   $3,080 
Less: preferred stock dividends   112    61 
Net income available to common shareholders  $2,542   $3,019 
Weighted average common shares outstanding   4,182    4,031 
Effect of dilutive stock instruments   274    276 
Diluted weighted average common shares outstanding   4,456    4,307 
Basic earnings per common share*  $0.61   $0.75 
Diluted earnings per common share*  $0.57   $0.70 

 

*Cumulative quarterly per share performance may not equal annual per share totals due to the effects of the amount and timing of capital increases. When computing earnings per share for an interim period, the denominator is based on the weighted-average shares outstanding during the interim period, and not on an annualized weighted-average basis. Accordingly, the sum of the quarters' earnings per share data will not necessarily equal the year to date earnings per share data.

 

There was no anti-dilutive effect of options outstanding at March 31, 2016. Options to purchase approximately 0.3 million shares were outstanding at March 31, 2015, but were excluded from the calculation of diluted earnings per common share as the effect would have been anti-dilutive.

 

Note 3 – Stock-based Compensation

 

A Black-Scholes model is utilized to estimate the fair value of stock options and the market price of the Company’s stock at the date of grant is used to estimate the value of restricted stock awards. The weighted average assumptions used in the model for valuing option grants were as follows:

 

   Three months ended   Year Ended 
   March 31, 2016   December 31, 2015 
Dividend yield   0%    0% 
Expected volatility   25%    25% 
Risk-free interest rate   1.67%    1.68% 
Expected average life   7 years    7 years 
Weighted average per share fair value of options  $9.82   $8.11 

 

Activity in the Company’s Stock Incentive Plans is summarized in the following tables:

 

Stock Options  Weighted-
Average Fair
Value of Options
Granted
   Option Shares
Outstanding
   Weighted-
Average
Exercise Price
   Exercisable
Shares
 
Balance – December 31, 2014        967,859   $19.30    630,121 
Granted  $8.11    162,000    26.66      
Exercise of stock options*        (381,505)   18.00      
Forfeited        (2,350)   19.61      
Balance – December 31, 2015        746,004    21.56    325,979 
Granted  $9.82    15,000    32.33      
Exercise of stock options*        (17,885)   21.84      
Forfeited        (500)   16.50      
Balance – March 31, 2016        742,619   $21.77    334,994 

 

*The terms of the stock option agreements permit having a number of shares of stock withheld, the fair market value of which as of the date of exercise is sufficient to satisfy the exercise price and/or tax withholding requirements.

 

 9 

 

 

Note 3 – Stock-based Compensation, continued

 

Options outstanding at March 31, 2016 are exercisable at option prices ranging from $16.00 to $33.50. There are 309,619 options outstanding in the range from $16.00 - $22.00 and 433,000 options outstanding in the range from $22.01 - $33.50. At March 31, 2016, the exercisable options have a weighted average remaining contractual life of approximately five years and a weighted average exercise price of $19.50.

 

Intrinsic value represents the amount by which the fair market value of the underlying stock exceeds the exercise price of the stock options. The total intrinsic value of options exercised in the first three months of 2016, and full year of 2015 was approximately $0.2 million, and $5.2 million, respectively.

 

Restricted Stock  Weighted-
Average Grant
Date Fair Value
   Restricted
Shares
Outstanding
 
Balance – December 31, 2014  $18.62    66,231 
Granted   -    - 
Vested*   19.26    (29,261)
Forfeited   16.50    (280)
Balance – December 31, 2015   18.70    36,690 
Granted   31.33    25,202 
Vested *   32.00    (2,734)
Forfeited   -    - 
Balance – March 31, 2016  $23.47    59,158 

 

*The terms of the restricted stock agreements permit the surrender of shares to the Company upon vesting in order to satisfy applicable tax withholding requirements at the minimum statutory withholding rate, and accordingly, 924 shares were surrendered during the three months ended March 31, 2016 and 7,715 shares were surrendered during the twelve months ended December 31, 2015.

 

The Company recognized approximately $412,000 and $290,000 of stock-based employee compensation expense during the three months ended March 31, 2016 and 2015, respectively, associated with its stock equity awards. As of March 31, 2016, there was approximately $3.7 million of unrecognized compensation cost related to equity award grants. The cost is expected to be recognized over the weighted average remaining vesting period of approximately three years.

 

Note 4- Securities Available for Sale

 

Amortized costs and fair values of securities available for sale are summarized as follows:

   March 31, 2016 
(in thousands)  Amortized Cost  

Gross

Unrealized

Gains

  

Gross

Unrealized

Losses

   Fair Value 
U.S. government sponsored enterprises  $287   $13   $-   $300 
State, county and municipals   104,393    883    95    105,181 
Mortgage-backed securities   61,817    714    166    62,365 
Corporate debt securities   1,700    -    -    1,700 
Equity securities   3,196    1,758    30    4,924 
   $171,393   $3,368   $291   $174,470 

 

   December 31, 2015 
(in thousands)  Amortized Cost   Gross
Unrealized
Gains
   Gross Unrealized
Losses
   Fair Values 
U.S. government sponsored enterprises  $287   $7   $-   $294 
State, county and municipals   104,768    497    244    105,021 
Mortgage-backed securities   61,600    418    554    61,464 
Corporate debt securities   1,140    -    -    1,140 
Equity securities   3,196    1,504    23    4,677 
   $170,991   $2,426   $821   $172,596 

 

 10 

 

 

Note 4- Securities Available for Sale, continued

 

The following table represents gross unrealized losses and the related fair value of investment securities available for sale, aggregated by investment category and length of time individual securities have been in a continuous unrealized loss position, at March 31, 2016 and December 31, 2015.

 

   March 31, 2016 
   Less than 12 months   12 months or more   Total 
(in thousands) 

Fair

Value

  

Unrealized

Losses

  

Fair

Value

  

Unrealized

Losses

  

Fair

Value

  

Unrealized

Losses

 
State, county and municipals  $16,471   $30   $9,457   $65   $25,928   $95 
Mortgage-backed securities   10,740    46    11,310    120    22,050    166 
Equity securities   609    30    -    -    609    30 
   $27,820   $106   $20,767   $185   $48,587   $291 
                               
   December 31, 2015 
   Less than 12 months   12 months or more   Total 
(in thousands)  Fair
Value
   Unrealized
Losses
   Fair
Value
   Unrealized
Losses
   Fair
Value
   Unrealized
Losses
 
State, county and municipals  $34,283   $112   $12,702   $132   $46,985   $244 
Mortgage-backed securities   22,228    167    13,750    387    35,978    554 
Equity securities   408    23    -    -    408    23 
   $56,919   $302   $26,452   $519   $83,371   $821 

 

At March 31, 2016, the Company had $0.3 million of gross unrealized losses related to 82 securities. As of March 31, 2016, the Company does not consider securities with unrealized losses to be other-than-temporarily impaired. The unrealized losses in each category have occurred as a result of changes in interest rates, market spreads and market conditions subsequent to purchase. The Company has the ability and intent to hold its securities to maturity. There were no other-than-temporary impairments charged to earnings during the three-month periods ending March 31, 2016 or 2015.

 

The amortized cost and fair values of securities available for sale at March 31, 2016 by contractual maturity are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Fair values of securities are estimated based on financial models or prices paid for the same or similar securities. It is possible interest rates could change considerably, resulting in a material change in estimated fair value.

 

   March 31, 2016 
(in thousands)  Amortized Cost   Fair Value 
Due in less than one year  $6,029   $6,037 
Due in one year through five years   76,212    76,493 
Due after five years through ten years   21,929    22,409 
Due after ten years   2,210    2,242 
    106,380    107,181 
Mortgage-backed securities   61,817    62,365 
Equity securities   3,196    4,924 
Securities available for sale  $171,393   $174,470 

 

There were no sales of securities during the first three months of 2016 or 2015.

 

 11 

 

 

Note 5 – Loans, Allowance for Loan Losses, and Credit Quality

 

The loan composition as of March 31, 2016 and December 31, 2015 is summarized as follows.

 

   Total 
   March 31, 2016   December 31, 2015 
(in thousands)  Amount  

% of

Total

   Amount   % of
Total
 
Commercial & industrial  $305,994    34.4%  $294,419    33.6%
Owner-occupied commercial real estate (“CRE”)   181,851    20.5    185,285    21.1 
Agricultural (“AG”) production   13,735    1.5    15,018    1.7 
AG real estate   40,826    4.6    43,272    4.9 
CRE investment   81,727    9.2    78,711    9.0 
Construction & land development   38,815    4.4    36,775    4.2 
Residential construction   11,552    1.3    10,443    1.2 
Residential first mortgage   157,248    17.7    154,658    17.6 
Residential junior mortgage   50,427    5.7    51,967    5.9 
Retail & other   6,533    0.7    6,513    0.8 
Loans   888,708    100.0%   877,061    100.0%
Less allowance for loan losses   10,530         10,307      
Loans, net  $878,178        $866,754      
Allowance for loan losses to loans   1.18%        1.18%     

 

   Originated 
   March 31, 2016   December 31, 2015 
(in thousands)  Amount  

% of

Total

   Amount   % of
Total
 
Commercial & industrial  $295,482    39.0%  $284,023    38.4%
Owner-occupied CRE   152,114    20.1    153,563    20.7 
AG production   5,620    0.8    6,849    0.9 
AG real estate   25,684    3.4    25,464    3.4 
CRE investment   62,168    8.2    58,949    8.0 
Construction & land development   29,500    3.9    27,231    3.7 
Residential construction   11,552    1.5    10,443    1.4 
Residential first mortgage   125,866    16.6    122,373    16.5 
Residential junior mortgage   43,473    5.7    44,889    6.1 
Retail & other   6,395    0.8    6,351    0.9 
Loans   757,854    100.0%  $740,135    100.0%
Less allowance for loan losses   8,847         8,714      
Loans, net  $749,007        $731,421      
Allowance for loan losses to loans   1.17%        1.18%     

 

   Acquired 
   March 31, 2016   December 31, 2015 
(in thousands)  Amount  

% of

Total

   Amount   % of
Total
 
Commercial & industrial  $10,512    8.0%  $10,396    7.6%
Owner-occupied CRE   29,737    22.7    31,722    23.2 
AG production   8,115    6.2    8,169    6.0 
AG real estate   15,142    11.6    17,808    13.0 
CRE investment   19,559    15.0    19,762    14.4 
Construction & land development   9,315    7.1    9,544    7.0 
Residential construction   -    -    -    - 
Residential first mortgage   31,382    24.0    32,285    23.5 
Residential junior mortgage   6,954    5.3    7,078    5.2 
Retail & other   138    0.1    162    0.1 
Loans  $130,854    100.0%  $136,926    100.0%
Less allowance for loan losses   1,683         1,593      
Loans, net  $129,171        $135,333      
Allowance for loan losses to loans   1.29%        1.16%     

 

 12 

 

 

Note 5 – Loans, Allowance for Loan Losses, and Credit Quality, continued

 

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

 

The allowance for loan and lease losses (“ALLL”) represents management’s estimate of probable and inherent credit losses in the Company’s loan portfolio at the balance sheet date. In general, estimating the amount of the ALLL is a function of a number of factors, including but not limited to changes in the loan portfolio, net charge-offs, trends in past due and impaired loans, and the level of potential problem loans, all of which may be susceptible to significant change. To the extent actual outcomes differ from management estimates, additional provisions for loan losses could be required that could adversely affect our earnings or financial position in future periods. Allocations to the ALLL may be made for specific loans but the entire ALLL is available for any loan that, in management’s judgment, should be charged-off or for which an actual loss is realized.

 

The allocation methodology used by the Company includes specific allocations for impaired loans evaluated individually for impairment based on collateral values and for the remaining loan portfolio collectively evaluated for impairment primarily based on historical loss rates and other qualitative factors. Loan charge-offs and recoveries are based on actual amounts charged-off or recovered by loan category. Management allocates the ALLL by pools of risk within each loan portfolio.

 

The following tables present the balance and activity in the ALLL by portfolio segment and the recorded investment in loans by portfolio at or for the three months ended March 31, 2016:

 

   TOTAL – Three Months Ended March 31, 2016 

(in

thousands)

ALLL:

 

Commercial

& industrial

  

Owner-

occupied

CRE

  

AG

production

  

AG real

estate

  

CRE

investment

  

Construction

& land

development

  

Residential

construction

  

Residential

first

mortgage

  

Residential

junior

mortgage

  

Retail

& other

   Total 
Beginning balance  $3,721   $1,933   $85   $380   $785   $1,446   $147   $1,240   $496   $74   $10,307 
Provision   15    181    (12)   14    82    149    5    18    (21)   19    450 
Charge-offs   (224)   -    -    -    -    -    -    -    -    (16)   (240)
Recoveries   -    1    -    -    4    -    -    2    5    1    13 
Net charge-offs   (224)   1    -    -    4    -    -    2    5    (15)   (227)
Ending balance  $3,512   $2,115   $73   $394   $871   $1,595   $152   $1,260   $480   $78   $10,530 
As percent of ALLL   33.4%   20.1%   0.7%   3.7%   8.3%   15.1%   1.4%   12.0%   4.6%   0.7%   100%
                                                        
ALLL:                                                       
Individually evaluated  $-   $119   $-   $-   $-   $-   $-   $-   $-   $-   $119 
Collectively evaluated   3,512    1,996    73    394    871    1,595    152    1,260    480    78    10,411 
Ending balance  $3,512   $2,115   $73   $394   $871   $1,595   $152   $1,260   $480   $78   $10,530 
                                                        
Loans:                                                       
Individually evaluated  $1,009   $1,245   $39   $242   $846   $270   $-   $396   $139   $-   $4,186 
Collectively evaluated   304,985    180,606    13,696    40,584    80,881    38,545    11,552    156,852    50,288    6,533    884,522 
Total loans  $305,994   $181,851   $13,735   $40,826   $81,727   $38,815   $11,552   $157,248   $50,427   $6,533   $888,708 
                                                        
Less ALLL  $3,512   $2,115   $73   $394   $871   $1,595   $152   $1,260   $480   $78   $10,530 
Net loans  $302,482   $179,736   $13,662   $40,432   $80,856   $37,220   $11,400   $155,988   $49,947   $6,455   $878,178 

 

 13 

 

 

Note 5 – Loans, Allowance for Loan Losses, and Credit Quality, continued

 

   Originated – Three Months Ended March 31, 2016 

(in thousands)

ALLL:

 

Commercial

& industrial

  

Owner-

occupied

CRE

  

AG

production

  

AG real

estate

  

CRE

investment

  

Construction

& land

development

  

Residential

construction

  

Residential

first

mortgage

  

Residential

junior

mortgage

  

Retail

& other

   Total 
Beginning balance  $3,135   $1,567   $71   $299   $646   $1,381   $147   $987   $418   $63   $8,714 
Provision   (41)   170    (10)   11    66    141    5    17    (17)   20    362 
Charge-offs   (224)   -    -    -    -    -    -    -    -    (16)   (240)
Recoveries   -    1    -    -    4    -    -    1    5    -    11 
Net charge-offs   (224)   1    -    -    4    -    -    1    5    (16)   (229)
Ending balance  $2,870   $1,738   $61   $310   $716   $1,522   $152   $1,005   $406   $67   $8,847 
As percent of ALLL   32.4%   19.6%   0.7%   3.5%   8.1%   17.2%   1.7%   11.4%   4.6%   0.8%   100%
                                                        
ALLL:                                                       
Individually evaluated  $-   $119   $-   $-   $-   $-   $-   $-   $-   $-   $119 
Collectively evaluated   2,870    1,619    61    310    716    1,522    152    1,005    406    67    8,728 
Ending balance  $2,870   $1,738   $61   $310   $716   $1,522   $152   $1,005   $406   $67   $8,847 
                                                        
Loans:                                                       
Individually evaluated  $870   $623   $-   $-   $-   $-   $-   $-   $-   $-   $1,493 
Collectively evaluated   294,612    151,491    5,620    25,684    62,168    29,500    11,552    125,866    43,473    6,395    756,361 
Total loans  $295,482   $152,114   $5,620   $25,684   $62,168   $29,500   $11,552   $125,866   $43,473   $6,395   $757,854 
                                                        
Less ALLL  $2,870   $1,738   $61   $310   $716   $1,522   $152   $1,005   $406   $67   $8,847 
Net loans  $292,612   $150,376   $5,559   $25,374   $61,452   $27,978   $11,400   $124,861   $43,067   $6,328   $749,007 

 

   Acquired – Three Months Ended March 31, 2016 

(in

thousands)

ALLL:

 

Commercial

& industrial

  

Owner-

occupied

CRE

  

AG

production

  

AG real

estate

  

CRE

investment

  

Construction

& land

development

  

Residential

construction

  

Residential

first
mortgage

  

Residential

junior

mortgage

  

Retail

& other

   Total 
Beginning balance  $586   $366   $14   $81   $139   $65   $-   $253   $78   $11   $1,593 
Provision   56    11    (2)   3    16    8    -    1    (4)   (1)   88 
Charge-offs   -    -    -    -    -    -    -    -    -    -    - 
Recoveries   -    -    -    -    -    -    -    1    -    1    2 
Net charge-offs   -    -    -    -    -    -    -    1    -    1    2 
Ending balance  $642   $377   $12   $84   $155   $73   $-   $255   $74   $11   $1,683 
As percent of ALLL   38.1%   22.4%   0.7%   5.0%   9.2%   4.3%   -%   15.2%   4.4%   0.7%   100%
                                                        
Loans:                                                       
Individually evaluated  $139   $622   $39   $242   $846   $270   $-   $396   $139   $-   $2,693 
Collectively evaluated   10,373    29,115    8,076    14,900    18,713    9,045    -    30,986    6,815    138    128,161 
Total loans  $10,512   $29,737   $8,115   $15,142   $19,559   $9,315   $-   $31,382   $6,954   $138   $130,854 
                                                        
Less ALLL  $642   $377   $12   $84   $155   $73   $-   $255   $74   $11   $1,683 
Net loans  $9,870   $29,360   $8,103   $15,058   $19,404   $9,242   $-   $31,127   $6,880   $127   $129,171 

 

 14 

 

 

Note 5 – Loans, Allowance for Loan Losses, and Credit Quality, continued

 

The following table presents the balance and activity in the ALLL by portfolio segment and the recorded investment in loans by portfolio at or for the three months ended March 31, 2015.

 

   TOTAL – Three Months Ended March 31, 2015 

(in

thousands)

ALLL:

 

Commercial

& industrial

  

Owner-

occupied

CRE

  

AG

production

  

AG real

estate

  

CRE

investment

  

Construction

& land

development

  

Residential

construction

  

Residential

first mortgage

  

Residential

junior

mortgage

  

Retail

& other

   Total 
Beginning balance  $3,191   $1,230   $53   $226   $511   $2,685   $140   $866   $337   $49   $9,288 
Provision   207    171    (17)   6    23    23    24    (16)   22    7    450 
Charge-offs   (14)   (154)   -    -    -    -    -    (32)   -    (12)   (212)
Recoveries   -    1    -    -    5    -    -    -    -    5    11 
Net charge-offs   (14)   (153)   -    -    5    -    -    (32)   -    (7)   (201)
Ending balance  $3,384   $1,248   $36   $232   $539   $2,708   $164   $818   $359   $49   $9,537 
As percent of ALLL   35.5%   13.1%   0.4%   2.4%   5.7%   28.4%   1.7%   8.6%   3.8%   0.4%   100%
                                                        
ALLL:                                                       
Individually evaluated  $382   $-   $-   $-   $-   $320   $-   $-   $-   $-   $702 
Collectively evaluated   3,002    1,248    36    232    539    2,388    164    818    359    49    8,835 
Ending balance  $3,384   $1,248   $36   $232   $539   $2,708   $164   $818   $359   $49   $9,537 
                                                        
Loans:                                                       
Individually evaluated  $488   $994   $39   $402   $1,108   $4,028   $-   $801   $151   $-   $8,011 
Collectively evaluated   291,730    178,200    14,189    40,739    79,960    40,490    13,118    154,385    53,301    5,683    871,795 
Total loans  $292,218   $179,194   $14,228   $41,141   $81,068   $44,518   $13,118   $155,186   $53,452   $5,683   $879,806 
                                                        
Less ALLL  $3,384   $1,248   $36   $232   $539   $2,708   $164   $818   $359   $49   $9,537 
Net loans  $288,834   $177,946   $14,192   $40,909   $80,529   $41,810   $12,954   $154,368   $53,093   $5,634   $870,269 

 

   Originated – Three Months Ended March 31, 2015 

(in thousands)

ALLL:

 

Commercial

& industrial

  

Owner-

occupied

CRE

  

AG

production

  

AG real

estate

  

CRE

investment

  

Construction

& land

development

  

Residential

construction

  

Residential

first

mortgage

  

Residential

junior

mortgage

  

Retail

& other

   Total 
Beginning balance  $3,191   $1,230   $53   $226   $511   $2,685   $140   $866   $337   $49   $9,288 
Provision   207    171    (17)   6    23    23    24    (16)   22    7    450 
Charge-offs   (14)   (154)   -    -    -    -    -    (32)   -    (12)   (212)
Recoveries   -    1    -    -    5    -    -    -    -    5    11 
Net charge-offs   (14)   (153)   -    -    5    -    -    (32)   -    (7)   (201)
Ending balance  $3,384   $1,248   $36   $232   $539   $2,708   $164   $818   $359   $49   $9,537 
As percent of ALLL   35.5%   13.1%   0.4%   2.4%   5.7%   28.4%   1.7%   8.6%   3.8%   0.4%   100%
                                                        
ALLL:                                                       
Individually evaluated  $382   $-   $-   $-   $-   $320   $-   $-   $-   $-   $702 
Collectively evaluated   3,002    1,248    36    232    539    2,388    164    818    359    49    8,835 
Ending balance  $3,384   $1,248   $36   $232   $539   $2,708   $164   $818   $359   $49   $9,537 
                                                        
Loans:                                                       
Individually evaluated  $485   $-   $-   $-   $-   $3,715   $-   $-   $-   $-   $4,200 
Collectively evaluated   272,758    137,430    4,128    19,897    54,808    30,771    13,118    116,388    45,286    5,285    699,869 
Total loans  $273,243   $137,430   $4,128   $19,897   $54,808   $34,486   $13,118   $116,388   $45,286   $5,285   $704,069 
                                                        
Less ALLL  $3,384   $1,248   $36   $232   $539   $2,708   $164   $818   $359   $49   $9,537 
Net loans  $269,859   $136,182   $4,092   $19,665   $54,269   $31,778   $12,954   $115,570   $44,927   $5,236   $694,532 

 

 15 

 

 

Note 5 – Loans, Allowance for Loan Losses, and Credit Quality, continued

 

   Acquired – Three Months Ended March 31, 2015 
(in thousands)
ALLL:
  Commercial
& industrial
   Owner-
occupied
CRE
   AG
production
   AG real
estate
   CRE
investment
   Construction
& land
development
   Residential
construction
   Residential
first
mortgage
   Residential
junior
mortgage
   Retail &
other
   Total 
Provision  $-   $-   $-   $-   $-   $-   $-   $-   $-   $-   $- 
Charge-offs   -    -    -    -    -    -    -    -    -    -    - 
Recoveries   -    -    -    -    -    -    -    -    -    -    - 
Loans:                                                       
Individually evaluated  $3   $994   $39   $402   $1,108   $313   $-   $801   $151   $-   $3,811 
Collectively evaluated   18,972    40,770    10,061    20,842    25,152    9,719    -    37,997    8,015    398    171,926 
Total loans  $18,975   $41,764   $10,100   $21,244   $26,260   $10,032   $-   $38,798   $8,166   $398   $175,737 

  

The following table presents nonaccrual loans by portfolio segment in total and then as a further breakdown by originated or acquired as of March 31, 2016 and December 31, 2015.

 

   Total Nonaccrual Loans 
(in thousands)  March 31, 2016   % to Total   December 31, 2015   % to Total 
Commercial & industrial  $1,044    23.6%  $204    5.8%
Owner-occupied CRE   1,293    29.3    951    26.9 
AG production   12    0.3    13    0.4 
AG real estate   219    5.0    230    6.5 
CRE investment   593    13.4    1,040    29.4 
Construction & land development   270    6.1    280    7.9 
Residential construction   -    -    -    - 
Residential first mortgage   838    19.0    674    19.1 
Residential junior mortgage   149    3.3    141    4.0 
Retail & other   -    -    -    - 
Nonaccrual loans - Total  $4,418    100.0%  $3,533    100.0%

 

   Originated 
(in thousands)  March 31, 2016   % to Total   December 31, 2015   % to Total 
Commercial & industrial  $890    45.7%  $49    8.4%
Owner-occupied CRE   671    34.5    -    - 
AG production   12    0.6    13    2.2 
AG real estate   -    -    -    - 
CRE investment   -    -    387    66.7 
Construction & land development   -    -    -    - 
Residential construction   -    -    -    - 
Residential first mortgage   363    18.7    132    22.7 
Residential junior mortgage   10    0.5    -    - 
Retail & other   -    -    -    - 
Nonaccrual loans - Originated  $1,946    100.0%  $581    100.0%

 

   Acquired 
(in thousands)  March 31, 2016   % to Total   December 31, 2015   % to Total 
Commercial & industrial  $154    6.2%  $155    5.3%
Owner-occupied CRE   622    25.2    951    32.1 
AG production   -    -    -    - 
AG real estate   219    8.9    230    7.8 
CRE investment   593    24.0    653    22.1 
Construction & land development   270    10.9    280    9.5 
Residential construction   -    -    -    - 
Residential first mortgage   475    19.2    542    18.4 
Residential junior mortgage   139    5.6    141    4.8 
Retail & other   -    -    -    - 
Nonaccrual loans – Acquired  $2,472    100.0%  $2,952    100.0%

 

 16 

 

 

Note 5 – Loans, Allowance for Loan Losses, and Credit Quality, continued

 

The following tables present total past due loans by portfolio segment as of March 31, 2016 and December 31, 2015:

 

   March 31, 2016 
(in thousands)  30-89 Days
Past Due
(accruing)
   90 Days &
Over or non-
accrual
  

 

Current

  

 

Total

 
Commercial & industrial  $-   $1,044   $304,950   $305,994 
Owner-occupied CRE   -    1,293    180,558    181,851 
AG production   -    12    13,723    13,735 
AG real estate   112    219    40,495    40,826 
CRE investment   -    593    81,134    81,727 
Construction & land development   -    270    38,545    38,815 
Residential construction   -    -    11,552    11,552 
Residential first mortgage   444    838    155,966    157,248 
Residential junior mortgage   -    149    50,278    50,427 
Retail & other   10    -    6,523    6,533 
Total loans  $566   $4,418   $883,724   $888,708 
As a percent of total loans   0.1%   0.5%   99.4%   100.0%

 

   December 31, 2015 
(in thousands)  30-89 Days Past
Due (accruing)
   90 Days &
Over or
nonaccrual
   Current   Total 
Commercial & industrial  $50   $204   $294,165   $294,419 
Owner-occupied CRE   -    951    184,334    185,285 
AG production   16    13    14,989    15,018 
AG real estate   -    230    43,042    43,272 
CRE investment   -    1,040    77,671    78,711 
Construction & land development   -    280    36,495    36,775 
Residential construction   -    -    10,443    10,443 
Residential first mortgage   150    674    153,834    154,658 
Residential junior mortgage   10    141    51,816    51,967 
Retail & other   12    -    6,501    6,513 
Total loans  $238   $3,533   $873,290   $877,061 
As a percent of total loans   0.1%   0.4%   99.5%   100.0%

 

A description of the loan risk categories used by the Company follows:

 

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

 

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

 

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

 

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

 

8 Doubtful: Assets with this rating exhibit all the weaknesses as one rated Substandard with the added characteristic that such weaknesses make collection or liquidation in full highly questionable.

 

 17 

 

 

Note 5 – Loans, Allowance for Loan Losses, and Credit Quality, continued

 

9 Loss: Assets in this category are considered uncollectible. Pursuing any recovery or salvage value is impractical but does not preclude partial recovery in the future.

 

The following tables present total loans by loan grade as of March 31, 2016 and December 31, 2015:

 

   March 31, 2016 
(in thousands)  Grades 1- 4   Grade 5   Grade 6   Grade 7   Grade 8   Grade 9   Total 
Commercial & industrial  $289,750   $9,643   $2,198   $4,403   $-   $-   $305,994 
Owner-occupied CRE   175,513    2,707    246    3,385    -    -    181,851 
AG production   12,478    717    -    540    -    -    13,735 
AG real estate   39,596    370    -    860    -    -    40,826 
CRE investment   77,714    2,230    -    1,783    -    -    81,727 
Construction & land development   34,367    3,841    -    607    -    -    38,815 
Residential construction   10,945    607    -    -    -    -    11,552 
Residential first mortgage   154,362    783    449    1,654    -    -    157,248 
Residential junior mortgage   50,095    162    -    170    -    -    50,427 
Retail & other   6,533    -    -    -    -    -    6,533 
Total loans  $851,353   $21,060   $2,893   $13,402   $-   $-   $888,708 
Percent of total   95.8%   2.4%   0.3%   1.5%   -    -    100%

 

   December 31, 2015 
(in thousands)  Grades 1- 4   Grade 5   Grade 6   Grade 7   Grade 8   Grade 9   Total 
Commercial & industrial  $278,118   $9,267   $2,490   $4,544   $-   $-   $294,419 
Owner-occupied CRE   176,371    5,072    253    3,589    -    -    185,285 
AG production   13,238    1,765    -    15    -    -    15,018 
AG real estate   39,958    2,600    -    714    -    -    43,272 
CRE investment   74,778    2,020    -    1,913    -    -    78,711 
Construction & land development   31,897    4,598    -    280    -    -    36,775 
Residential construction   9,792    651    -    -    -    -    10,443 
Residential first mortgage   151,835    860    457    1,506    -    -    154,658 
Residential junior mortgage   51,736    68    -    163    -    -    51,967 
Retail & other   6,513    -    -    -    -    -    6,513 
Total loans  $834,236   $26,901   $3,200   $12,724   $-   $-   $877,061 
Percent of total   95.0%   3.1%   0.4%   1.5%   -    -    100%

 

Management considers a loan to be impaired when it is probable the Company will be unable to collect all contractual principal and interest payments due in accordance with the terms of the loan agreement. For determining the adequacy of the ALLL, management defines impaired loans as nonaccrual credit relationships over $250,000, plus additional loans with impairment risk characteristics. At the time an individual loan goes into nonaccrual status, however, management evaluates the loan for impairment and possible charge-off regardless of loan size.

 

In determining the appropriateness of the ALLL, management includes allocations for specifically identified impaired loans and loss factor allocations for all remaining loans, with a component primarily based on historical loss rates and another component primarily based on other qualitative factors. Impaired loans are individually assessed and are measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate or, as a practical expedient, at the loan’s observable market price or the fair value of the collateral if the loan is collateral dependent.

 

Loans that are determined not to be impaired are collectively evaluated for impairment, stratified by type and allocated loss ranges based on the Company’s actual historical loss ratios for each strata, and adjustments are also provided for certain current environmental and qualitative factors. An internal loan review function rates loans using a grading system based on nine different categories. Loans with grades of seven or higher (“classified loans”) represent loans with a greater risk of loss and may be assigned allocations for loss based on specific review of the weaknesses observed in the individual credits if classified as impaired. Classified loans are constantly monitored by the loan review function to ensure early identification of any deterioration.

 

 18 

 

 

Note 5 – Loans, Allowance for Loan Losses, and Credit Quality, continued

 

The following tables present impaired loans as of March 31, 2016 and December 31, 2015. As a further breakdown, impaired loans are also summarized by originated and acquired for the periods presented. Purchased Credit Impaired (“PCI”) loans acquired in the 2013 acquisitions were initially recorded at a fair value of $16.7 million on their respective acquisition dates, net of an initial $12.2 million non-accretable mark and a zero accretable mark. At March 31, 2016, $2.1 million of the $16.7 million remain in impaired loans and $0.6 million of acquired loans have subsequently become impaired, bringing acquired impaired loans to $2.7 million.

 

   Total Impaired Loans – March 31, 2016 
(in thousands)  Recorded
Investment
   Unpaid
Principal
Balance
   Related
Allowance
   Average
Recorded
Investment
   Interest Income
Recognized
 
Commercial & industrial  $1,009   $1,009   $-   $1,011   $14 
Owner-occupied CRE*   1,245    1,955    119    1,390    52 
AG production   39    50    -    39    1 
AG real estate   242    336    -    247    12 
CRE investment   846    2,648    -    880    36 
Construction & land development   270    812    -    275    5 
Residential construction   -    -    -    -    - 
Residential first mortgage   396    1,034    -    408    18 
Residential junior mortgage   139    462    -    139    7 
Retail & Other   -    11    -    -    - 
Total  $4,186   $8,317   $119   $4,389   $145 

 

As a further breakdown, impaired loans as of March 31, 2016 are summarized by originated and acquired as follows:

 

   Originated – March 31, 2016 
(in thousands)  Recorded
Investment
   Unpaid
Principal
Balance
   Related
Allowance
   Average
Recorded
Investment
   Interest Income
Recognized
 
Commercial & industrial  $870   $870   $-   $870   $11 
Owner-occupied CRE*   623    623    119    623    6 
AG production   -    -    -    -    - 
AG real estate   -    -    -    -    - 
CRE investment   -    -    -    -    - 
Construction & land development   -    -    -    -    - 
Residential construction   -    -    -    -    - 
Residential first mortgage   -    -    -    -    - 
Residential junior mortgage   -    -    -    -    - 
Retail & Other   -    -    -    -    - 
Total  $1,493   $1,493   $119   $1,493   $17 

 

   Acquired – March 31, 2016 
(in thousands)  Recorded
Investment
   Unpaid
Principal
Balance
   Related
Allowance
   Average
Recorded
Investment
   Interest Income
Recognized
 
Commercial & industrial  $139   $139   $-   $141   $3 
Owner-occupied CRE   622    1,332    -    767    46 
AG production   39    50    -    39    1 
AG real estate   242    336    -    247    12 
CRE investment   846    2,648    -    880    36 
Construction & land development   270    812    -    275    5 
Residential construction   -    -    -    -    - 
Residential first mortgage   396    1,034    -    408    18 
Residential junior mortgage   139    462    -    139    7 
Retail & Other   -    11    -    -    - 
Total  $2,693   $6,824   $-   $2,896   $128 

 

*One owner-occupied CRE loan with a balance of $0.6 million had a specific reserve of $119,000. No other loans had a related allowance at March 31, 2016 and, therefore, the above disclosure was not expanded to include loans with and without a related allowance.

 

 19 

 

 

Note 5 – Loans, Allowance for Loan Losses, and Credit Quality, continued

 

   Total Impaired Loans – December 31, 2015 
(in thousands)  Recorded
Investment
   Unpaid Principal
Balance
   Related
Allowance
   Average
Recorded
Investment
   Interest Income
Recognized
 
Commercial & industrial  $142   $142   $-   $144   $10 
Owner-occupied CRE   950    1,688    -    1,111    135 
AG production   39    53    -    38    4 
AG real estate   252    348    -    260    27 
CRE investment   1,301    3,109    -    1,432    175 
Construction & land development   280    822    -    301    18 
Residential construction   -    -    -    -    - 
Residential first mortgage   460    1,150    -    515    79 
Residential junior mortgage   142    471    -    147    26 
Retail & Other   -    12    -    -    1 
Total  $3,566   $7,795   $-   $3,948   $475 

 

As a further breakdown, impaired loans as of December 31, 2015 are summarized by originated and acquired as follows:

 

   Originated – December 31, 2015 
(in thousands)  Recorded
Investment
   Unpaid Principal
Balance
   Related
Allowance
   Average
Recorded
Investment
   Interest Income
Recognized
 
Commercial & industrial  $-   $-   $-   $-   $- 
Owner-occupied CRE   -    -    -    -    - 
AG production   -    -    -    -    - 
AG real estate   -    -    -    -    - 
CRE investment   387    387    -    387    29 
Construction & land development   -    -    -    -    - 
Residential construction   -    -    -    -    - 
Residential first mortgage   -    -    -    -    - 
Residential junior mortgage   -    -    -    -    - 
Retail & Other   -    -    -    -    - 
Total  $387   $387   $-   $387   $29 

 

   Acquired – December 31, 2015 
(in thousands)  Recorded
Investment
   Unpaid Principal
Balance
   Related
Allowance
   Average
Recorded
Investment
   Interest Income
Recognized
 
Commercial & industrial  $142   $142   $-   $144   $10 
Owner-occupied CRE   950    1,688    -    1,111    135 
AG production   39    53    -    38    4 
AG real estate   252    348    -    260    27 
CRE investment   914    2,722    -    1,045    146 
Construction & land development   280    822    -    301    18 
Residential construction   -    -    -    -    - 
Residential first mortgage   460    1,150    -    515    79 
Residential junior mortgage   142    471    -    147    26 
Retail & other   -    12    -    -    1 
Total  $3,179   $7,408   $-   $3,561   $446 

 

 20 

 

 

Note 5 – Loans, Allowance for Loan Losses, and Credit Quality, continued

 

Troubled Debt Restructurings

 

At March 31, 2016, there were eight loans classified as troubled debt restructurings totaling $575,000. These eight loans had a combined premodification balance of $758,000 and a combined outstanding balance of $575,000 at March 31, 2016. There were no other loans which were modified and classified as troubled debt restructurings at March 31, 2016. There were no loans classified as troubled debt restructurings during the previous twelve months that subsequently defaulted as of March 31, 2016.


Note 6 - Notes Payable

 

The Company had the following long-term notes payable:

 

(in thousands)  March 31, 2016   December 31, 2015 
Joint venture note  $9,344   $9,412 
Federal Home Loan Bank (“FHLB”) advances   6,000    6,000 
Notes payable  $15,344   $15,412 

 

At the completion of the construction of the Company’s headquarters building in 2005 and as part of a joint venture investment related to the building, the Company and the other joint venture partners guaranteed a joint venture note to finance certain costs of the building. This note is secured by the building, bears a fixed rate of 5.81% and requires monthly principal and interest payments until its maturity on June 1, 2016.

 

The Company’s FHLB advances are all fixed rate, require interest-only monthly payments, and have maturities through February 2018. The weighted average rates of FHLB advances were 0.83% at both March 31, 2016 and December 31, 2015. The FHLB advances are collateralized by a blanket lien on qualifying first mortgages, home equity loans, multi-family loans and certain farmland loans which totaled approximately $150.7 million and $154.3 million at March 31, 2016 and December 31, 2015, respectively.

 

The following table shows the maturity schedule of the notes payable as of March 31, 2016:

 

Maturing in   (in thousands) 
2016  $14,344 
2017   - 
2018   1,000 
   $15,344 

 

 21 

 

 

Note 7 - Junior Subordinated Debentures

 

The Company’s carrying value of junior subordinated debentures was $12.6 million at March 31, 2016 and $12.5 million at December 31, 2015. In July 2004 Nicolet Bankshares Statutory Trust I (the “Statutory Trust”), issued $6.0 million of guaranteed preferred beneficial interests (“trust preferred securities”) that qualify as Tier I capital under Federal Reserve Board guidelines. All of the common securities of the Statutory Trust are owned by the Company. The proceeds from the issuance of the common securities and the trust preferred securities were used by the Statutory Trust to purchase $6.2 million of junior subordinated debentures of the Company, which pay an 8% fixed rate. Interest on these debentures is current. The debentures may be redeemed in part or in full, on or after July 15, 2009 at par plus any accrued but unpaid interest. The maturity date of the debenture, if not redeemed, is July 15, 2034.

 

As part of the 2013 acquisition of Mid-Wisconsin Financial Services, Inc., the Company assumed $10.3 million of junior subordinated debentures related to $10.0 million of issued trust preferred securities. The trust preferred securities and the debentures mature on December 15, 2035 and have a floating rate of the three-month LIBOR plus 1.43% adjusted quarterly. Interest on these debentures is current. The debentures may be called at par in part or in full, on or after December 15, 2010 or within 120 days of certain events. At acquisition in April 2013 the debentures were recorded at a fair value of $5.8 million, with the discount being accreted to interest expense over the remaining life of the debentures. At March 31, 2016, the carrying value of these junior debentures was $6.3 million, and the $6.0 million carrying value of related trust preferred securities qualifies as Tier 1 capital.

 

Note 8 – Subordinated Notes

 

In 2015 the Company placed an aggregate of $12 million in subordinated Notes in private placements with certain accredited investors. All Notes were issued with 10-year maturities, have a fixed annual interest rate of 5% payable quarterly, are callable on or after the fifth anniversary of their respective issuances dates, and qualify for Tier 2 capital for regulatory purposes.

 

The $180,000 debt issuance costs associated with the $12 million Notes are being amortized on a straight line basis over the first five years, representing the no-call periods, as additional interest expense. As of March 31, 2016 and December 31, 2015, $142,000 and $151,000, respectively, of unamortized debt issuance costs remain and are reflected as a deduction to the carrying value of the outstanding Notes.

 

Note 9 - Fair Value Measurements

 

As provided for by accounting standards, the Company records and/or discloses financial instruments on a fair value basis. These financial assets and financial liabilities are measured at fair value in three levels, based on the markets in which the assets and liabilities are traded and the observability of the assumptions used to determine fair value. These levels are: Level 1 - quoted market prices in active markets for identical assets or liabilities that a company has the ability to access at the measurement date; Level 2 - inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly; Level 3 – significant unobservable inputs for the asset or liability, which are typically based on an entity’s own assumptions, as there is little, if any, related market activity. In instances where the fair value measurement is based on inputs from different levels, the level within which the entire fair value measurement will be categorized is based on the lowest level input that is significant to the fair value measurement in its entirety; this assessment of the significance of an input requires management judgment.

 

Disclosure of the fair value of financial instruments, whether recognized or not recognized in the balance sheet, is required for those instruments for which it is practicable to estimate that value, with the exception of certain financial instruments and all nonfinancial instruments as provided for by the accounting standards. For financial instruments recognized at fair value in the consolidated balance sheets, the fair value disclosure requirements also apply.

 

Fair value (i.e. the price that would be received in an orderly transaction that is not a forced liquidation or distressed sale at the measurement date), among other things, is based on exit price versus entry price, should include assumptions about risk such as nonperformance risk in liability fair values, and is a market-based measurement versus an entity-specific measurement.

 

 22 

 

 

Note 9 - Fair Value Measurements, continued

 

The following table presents the balances of assets and liabilities measured at fair value on a recurring basis for the periods presented. One security classified as Level 3 was purchased for $0.6 million during the first quarter of 2016. There were no other changes in Level 3 values to report during the first three months of 2016.

 

       Fair Value Measurements Using 
Measured at Fair Value on a Recurring Basis:  Total   Level 1   Level 2   Level 3 
(in thousands)                
U.S. government sponsored enterprises  $300   $-   $300   $- 
State, county and municipals   105,181    -    104,655    526 
Mortgage-backed securities   62,365    -    62,365    - 
Corporate debt securities   1,700    -    -    1,700 
Equity securities   4,924    4,924    -    - 
Securities AFS, March 31, 2016  $174,470   $4,924   $167,320   $2,226 
                     
(in thousands)                    
U.S. government sponsored enterprises  $294   $-   $294   $- 
State, county and municipals   105,021    -    104,495    526 
Mortgage-backed securities   61,464    -    61,464    - 
Corporate debt securities   1,140    -    -    1,140 
Equity securities   4,677    4,677    -    - 
Securities AFS, December 31, 2015  $172,596   $4,677   $166,253   $1,666 

 

The following is a description of the valuation methodologies used by the Company for the Securities AFS noted in the tables of this footnote. Where quoted market prices on securities exchanges are available, the investment is classified as Level 1. Level 1 investments primarily include exchange-traded equity securities available for sale. If quoted market prices are not available, fair value is generally determined using prices obtained from independent pricing vendors who use pricing models (with typical inputs including benchmark yields, reported trades for similar securities, issuer spreads or relationship to other benchmark quoted securities), or discounted cash flows, and are classified as Level 2. Examples of these investments include mortgage-related securities and obligations of state, county and municipals. Finally, in certain cases where there is limited activity or less transparency around inputs to the estimated fair value, investments are classified within Level 3 of the hierarchy. Examples of these include auction rate securities available for sale (for which there has been no liquid market since 2008) and corporate debt securities, which include trust preferred security investments. At March 31, 2016 and December 31, 2015, it was determined that carrying value was the best approximation of fair value for these Level 3 securities, based primarily on receipt of par from refinances for the auction rate securities and the internal analysis on the corporate debt securities.

 

The following table presents the Company’s impaired loans and other real estate owned (“OREO”) measured at fair value on a nonrecurring basis for the periods presented.

 

Measured at Fair Value on a Nonrecurring Basis
       Fair Value Measurements Using 
(in thousands)  Total   Level 1   Level 2   Level 3 
March 31, 2016:                
Impaired loans  $4,067   $-   $-   $4,067 
OREO   376    -    -    376 
December 31, 2015:                    
Impaired loans  $3,566   $-   $-   $3,566 
OREO   367    -    -    367 

 

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Note 9 - Fair Value Measurements, continued

 

The following is a description of the valuation methodologies used by the Company for the items noted in the table above, including the general classification of such instruments in the fair value hierarchy. For individually evaluated impaired loans, the amount of impairment is based upon the present value of expected future cash flows discounted at the loan’s effective interest rate, the estimated fair value of the underlying collateral for collateral-dependent loans, or the estimated liquidity of the note. For OREO, the fair value is based upon the estimated fair value of the underlying collateral adjusted for the expected costs to sell.

 

The carrying amounts and estimated fair values of the Company’s financial instruments at March 31, 2016 and December 31, 2015 are shown below.

 

March 31, 2016                    
(in thousands)  Carrying
Amount
   Estimated
Fair Value
   Level 1   Level 2   Level 3 
Financial assets:                         
Cash and cash equivalents  $98,183   $98,183   $98,183   $-   $- 
Certificates of deposit in other banks   4,163    4,173    -    4,173    - 
Securities AFS   174,470    174,470    4,924    167,320    2,226 
Other investments   8,174    8,174    -    6,033    2,141 
Loans held for sale   4,183    4,255    -    4,255    - 
Loans, net   878,178    876,210    -    -    876,210 
BOLI   28,725    28,725    28,725    -    - 
                          
Financial liabilities:                         
Deposits  $1,081,472   $1,083,694   $-   $-   $1,083,694 
Notes payable   15,344    15,357    -    15,357    - 
Junior subordinated debentures   12,577    11,948    -    -    11,948 
Subordinated notes   11,858    11,423    -    -    11,423 

 

December 31, 2015                    
(in thousands)  Carrying
Amount
   Estimated
Fair Value
   Level 1   Level 2   Level 3 
Financial assets:                         
Cash and cash equivalents  $83,619   $83,619   $83,619   $-   $- 
Certificates of deposit in other banks   3,416    3,416    -    3,416    - 
Securities AFS   172,596    172,596    4,677    166,253    1,666 
Other investments   8,135    8,135    -    5,995    2,140 
Loans held for sale   4,680    4,755    -    4,755    - 
Loans, net   866,754    865,027    -    -    865,027 
BOLI   28,475    28,475    28,475    -    - 
                          
Financial liabilities:                         
Deposits  $1,056,417   $1,057,614   $-   $-   $1,057,614 
Notes payable   15,412    18,354    -    18,354    - 
Junior subordinated debentures   12,527    11,900    -    -    11,900 
Subordinated notes   11,849    11,414    -    -    11,414 

 

Not all the financial instruments listed in the table above are subject to the disclosure provisions of Accounting Standards Codification (“ASC”) 820, as certain assets and liabilities result in their carrying value approximating fair value. These include cash and cash equivalents, other investments, bank owned life insurance, and nonmaturing deposits. For those financial instruments not previously disclosed the following is a description of the evaluation methodologies used.

 

Certificates of deposits in other banks: Fair values are estimated using discounted cash flow analysis based on current interest rates being offered by instruments with similar terms and represents a Level 2 measurement.

 

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Note 9 - Fair Value Measurements, continued

 

Other investments: The carrying amount of Federal Reserve Bank, Bankers Bank, Farmer Mac, and FHLB stock is a reasonably accepted fair value estimate given their restricted nature. Fair value is the redeemable (carrying) value based on the redemption provisions of the instruments which is considered a Level 2 measurement. The carrying amount of the remaining other investments (particularly common stocks of companies or other banks that are not publicly traded) approximates their fair value, determined primarily by analysis of company financial statements and recent capital issuances of the respective companies or banks, if any, and represents a Level 3 measurement.

 

Loans held for sale: The fair value estimation process for the loans held for sale portfolio is segregated by loan type. The estimated fair value was based on what secondary markets are currently offering for portfolios with similar characteristics and represents a Level 2 measurement.

 

Loans, net: For variable-rate loans that reprice frequently and with no significant change in credit risk or other optionality, fair values are based on carrying values. Fair values for all other loans are estimated by discounting contractual cash flows using estimated market discount rates, which reflect the credit and interest rate risk inherent in the loan. Collateral-dependent impaired loans are included in loans, net. The fair value of loans is considered to be a Level 3 measurement due to internally developed discounted cash flow measurements.

 

Deposits: The fair value of deposits with no stated maturity (such as demand deposits, savings, interest and non-interest checking, and money market accounts) is, by definition, equal to the amount payable on demand at the reporting date. Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered in the market place on certificates of similar remaining maturities. Use of internal discounted cash flows provides a Level 3 fair value measurement.

 

Notes payable: The fair value of the Federal Home Loan Bank advances is obtained from the Federal Home Loan Bank which uses a discounted cash flow analysis based on current market rates of similar maturity debt securities and represents a Level 2 measurement. The fair values of remaining notes payable are estimated using discounted cash flow analysis based on current interest rates being offered by instruments with similar terms and credit quality which represents a Level 2 measurement.

 

Junior subordinated debentures and subordinated notes: The fair values of these debt instruments utilize a discounted cash flow analysis based on an estimate of current interest rates being offered by instruments with similar terms and credit quality. Since the market for these instruments is limited, the internal evaluation represents a Level 3 measurement.

 

Off-balance-sheet instruments: The estimated fair value of letters of credit at March 31, 2016 and December 31, 2015 was insignificant. Loan commitments on which the committed interest rate is less than the current market rate are also insignificant at March 31, 2016 and December 31, 2015.

 

Limitations: Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of a particular financial instrument. Fair value estimates may not be realizable in an immediate settlement of the instrument. In some instances, there are no quoted market prices for the Company’s various financial instruments, in which case fair values may be based on estimates using present value or other valuation techniques, or based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of the financial instruments, or other factors. Those techniques are significantly affected by the assumptions used, including the discount rate and estimate of future cash flows. Subsequent changes in assumptions could significantly affect the estimates.

 

Note 10 – Acquisition

 

During the first quarter of 2016, Nicolet agreed, in a private transaction, to hire a select group of financial advisors and purchase their respective books of business, as well as their operating platform, to enhance the leadership and future growth of the Company’s wealth management business. A portion of this transaction was completed and recorded in the first quarter of 2016; accordingly, the Company paid total consideration of $1.4 million in a mix of cash and stock, recorded $0.4 million of goodwill, $0.8 million of customer list intangibles (included in other assets), and fixed assets of $0.2 million. The transaction will impact the income statement primarily within brokerage income, personnel expense, and intangibles amortization. The remainder of the transaction took place and was recorded in April 2016.

 

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Note 11 – Pending Merger Transaction

 

On September 8, 2015 Nicolet announced the signing of a definitive merger agreement (“Merger Agreement”) with Baylake Corp. (“Baylake”) (NASDAQ:BYLK) under which Baylake will merge with and into Nicolet to create the third largest publicly traded community bank headquartered in Wisconsin by deposit market share. Based upon the financial results as of March 31, 2016, the combined company would have total assets of approximately $2.3 billion, deposits of $1.9 billion and loans of $1.6 billion. Since the merger transaction is expected to close on April 29, 2016, the Company is not able to make the disclosures required by purchase accounting standards as management has not yet completed the initial accounting for this business combination.

 

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION

 

Nicolet Bankshares, Inc. is a bank holding company headquartered in Green Bay, Wisconsin, providing a diversified range of traditional banking and wealth management services to individuals and businesses in its market area through the 21 branch offices of its banking subsidiary, Nicolet National Bank, in northeastern and central Wisconsin and Menominee, Michigan.

 

Overview

 

At March 31, 2016, Nicolet Bankshares, Inc. and its subsidiaries (“Nicolet” or the “Company”) had total assets of $1.2 billion, loans of $889 million, deposits of $1.1 billion and total stockholders’ equity of $115 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, mortgage income from sales of residential mortgages into the secondary market, and other fees or revenue from financial services provided to customers or ancillary to loans and deposits), 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. 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. For the quarter ended March 31, 2016, Nicolet earned net income of $2.7 million, and after $112,000 of preferred stock dividends, net income available to common shareholders was $2.5 million or $0.57 per diluted common share.

 

Consistent with Nicolet’s stated interest in strategic growth, Nicolet remains focused on the consummation and integration of its previously announced acquisitions. Nicolet and Baylake Corp. (“Baylake”) announced and signed a definitive merger agreement in September 2015, under which Baylake will merge with and into Nicolet to create the third largest publicly traded bank headquartered in Wisconsin by deposit market share. The transaction is a stock-for-stock merger (with cash in lieu of fractional shares) at a fixed exchange ratio of 0.4517 shares of Nicolet common stock for each share of Baylake common stock outstanding, has received all regulatory and shareholder approvals, and is on target for an April 29, 2016 consummation. The merger is expected to drive growth and efficiency through increased scale, leverage the strengths of each bank across the combined customer base, enhance profitability, and add liquidity and shareholder value. Based upon the financial position as of March 31, 2016, the combined company would have total assets of $2.3 billion, deposits of $1.9 billion and loans of $1.6 billion, and an expanded geography operating out of 42 bank branches. Appropriately, other than direct merger and integration costs being expensed as incurred, the Baylake transaction is not included in Nicolet’s financial position or financial results as of March 31, 2016. Additionally, during the first quarter of 2016, Nicolet agreed, in a private transaction, to hire a select group of financial advisors and purchase their respective books of business, as well as their operating platform, to enhance the leadership and future growth of the Company’s wealth management business. A portion of this transaction was completed and recorded in the first quarter of 2016; the remainder of the transaction took place and was recorded in April 2016.

 

Forward-Looking Statements

 

Statements made in this document and in any documents that are incorporated by reference which are not purely historical are forward-looking statements, as defined in the Private Securities Litigation Reform Act of 1995, including any statements regarding descriptions of management’s plans, objectives, or goals for future operations, products or services, and forecasts of its revenues, earnings, or other measures of performance. Forward-looking statements are based on current management expectations and, by their nature, are subject to risks and uncertainties. These statements generally may be identified by the use of words such as “believe,” “expect,” “anticipate,” “plan,” “estimate,” “should,” “will,” “intend,” or similar expressions. Shareholders should note that many factors, some of which are discussed elsewhere in this document, could affect the future financial results of Nicolet and could cause those results to differ materially from those expressed in forward-looking statements contained in this document. These factors, many of which are beyond Nicolet’s control, include, but are not necessarily limited to the following:

 

·operating, legal and regulatory risks, including the effects of the Dodd-Frank Wall Street Reform and Consumer Protection Act and regulations promulgated thereunder, as well as the rules by the Federal bank regulatory agencies to implement the Basel III capital accord;
·economic, political and competitive forces affecting Nicolet’s banking and wealth management businesses;
·changes in interest rates, monetary policy and general economic conditions, which may impact Nicolet’s net interest income;

 

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·potential difficulties in integrating the operations of Nicolet with those of acquired entities, if any;
·compliance or operational risks related to new products, services, ventures, or lines of business, if any, that Nicolet may pursue or implement; and
·the risk that Nicolet’s analyses of these risks and forces could be incorrect and/or that the strategies developed to address them could be unsuccessful.

 

These factors should be considered in evaluating the forward-looking statements, and you should not place undue reliance on such statements. Nicolet specifically disclaims any obligation to update factors or to publicly announce the results of revisions to any of the forward-looking statements or comments included herein to reflect future events or developments.

 

Critical Accounting Policies

 

The consolidated financial statements of Nicolet are prepared in conformity with U.S. GAAP and follow general practices within the industry in which it operates. This preparation requires management to make estimates, assumptions and judgments that affect the amounts reported in the consolidated financial statements and accompanying notes. These estimates, assumptions and judgments are based on information available as of the date of the consolidated financial statements; accordingly, as this information changes, actual results could differ from the estimates, assumptions and judgments reflected in the consolidated financial statements. Certain policies inherently have a greater reliance on the use of estimates, assumptions and judgments and, as such, have a greater possibility of producing results that could be materially different than originally reported. Estimates that are particularly susceptible to significant change include the valuation of loans acquired in business combinations, as well as the determination of the allowance for loan losses and income taxes and, therefore, are critical accounting policies.

 

Valuation of Loans Acquired in Business Combinations

 

Acquisitions accounted for under FASB Accounting Standards Codification (“ASC”) Topic 805, Business Combinations, require the use of the acquisition method of accounting. Assets acquired and liabilities assumed in a business combination are recorded at estimated fair value on their purchase date. In particular, the valuation of acquired loans involves significant estimates, assumptions and judgment based on information available as of the acquisition date. Substantially all loans acquired in the transaction are evaluated either individually or in pools of loans with similar characteristics; and since the estimated fair value of acquired loans includes a credit consideration, no carryover of any previously recorded allowance for loan losses is recorded at acquisition. A number of factors are considered in determining the estimated fair value of purchased loans including, among other things, the remaining life of the acquired loans, estimated prepayments, estimated loss ratios, estimated value of the underlying collateral, estimated holding periods, contractual interest rates compared to market interest rates, and net present value of cash flows expected to be received.

 

In determining the Day 1 Fair Values of acquired loans, management calculates a non-accretable difference (the credit mark component of the acquired loans) and an accretable difference (the market rate or yield component of the acquired loans). The non-accretable difference is the difference between the undiscounted contractually required payments and the undiscounted cash flows expected to be collected in accordance with management’s determination of the Day 1 Fair Values. Subsequent decreases to the expected cash flows will generally result in a provision for loan losses. Subsequent increases in cash flows will result in a reversal of the provision for loan losses to the extent of prior charges and then an adjustment to the accretable and non-accretable differences, which would have a positive impact on interest income.

 

The accretable yield on acquired loans is the difference between the expected cash flows and the initial investment in the acquired loans. The accretable yield is recognized into earnings using the effective yield method over the term of the loans. Management separately monitors the acquired loan portfolio and periodically reviews loans contained within this portfolio against the factors and assumptions used in determining the Day 1 Fair Values.

 

Allowance for Loan Losses (“ALLL”)

 

The ALLL is a reserve for estimated credit losses on individually evaluated loans determined to be impaired as well as estimated credit losses inherent in the loan portfolio. Actual credit losses, net of recoveries, are deducted from the ALLL. Loans are charged off when management believes that the collectability of the principal is unlikely. Subsequent recoveries, if any, are credited to the ALLL. A provision for loan losses, which is a charge against earnings, is recorded to bring the ALLL to a level that, in management’s judgment, is adequate to absorb probable losses in the loan portfolio. Management’s evaluation process used to determine the appropriateness of the ALLL is subject to the use of estimates, assumptions, and judgment. The evaluation process involves gathering and interpreting many qualitative and quantitative factors which could affect probable credit losses. Because interpretation and analysis involves judgment, current economic or business conditions can change, and future events are inherently difficult to predict, the anticipated amount of estimated loan losses and therefore the appropriateness of the ALLL could change significantly.

 

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The allocation methodology applied by Nicolet is designed to assess the appropriateness of the ALLL and includes allocations for specifically identified impaired loans and loss factor allocations for all remaining loans, with a component primarily based on historical loss rates and a component primarily based on other qualitative factors. The methodology includes evaluation and consideration of several factors, such as, but not limited to, management’s ongoing review and grading of loans, facts and issues related to specific loans, historical loan loss and delinquency experience, trends in past due and nonaccrual loans, existing risk characteristics of specific loans or loan pools, the fair value of underlying collateral, current economic conditions and other qualitative and quantitative factors which could affect potential credit losses. While management uses the best information available to make its evaluation, future adjustments to the allowance may be necessary if there are significant changes in economic conditions or circumstances underlying the collectability of loans. Because each of the criteria used is subject to change, the allocation of the ALLL is made for analytical purposes and is not necessarily indicative of the trend of future loan losses in any particular loan category. The total allowance is available to absorb losses from any segment of the loan portfolio. Management believes the ALLL is appropriate at March 31, 2016. The allowance analysis is reviewed by the board of directors on a quarterly basis in compliance with regulatory requirements. In addition, various regulatory agencies periodically review the ALLL. These agencies may require Nicolet to make additions to the ALLL based on their judgments of collectability based on information available to them at the time of their examination.

 

Income Taxes

 

The assessment of income tax assets and liabilities involves the use of estimates, assumptions, interpretation, and judgment concerning certain accounting pronouncements and federal and state tax codes. There can be no assurance that future events, such as court decisions or positions of federal and state taxing authorities, will not differ from management’s current assessment, the impact of which could be significant to the consolidated results of operations and reported earnings.

 

Nicolet files a consolidated federal income tax return and a combined state income tax return (both of which include Nicolet and its wholly owned subsidiaries). Accordingly, amounts equal to tax benefits of those companies having taxable federal losses or credits are reimbursed by the companies that incur federal tax liabilities. Amounts provided for income tax expense are based on income reported for financial statement purposes and do not necessarily represent amounts currently payable under tax laws. Deferred income tax assets and liabilities are computed quarterly for differences between the financial statement and tax bases of assets and liabilities that will result in taxable or deductible amounts in the future based on enacted tax law rates applicable to the periods in which the differences are expected to affect taxable income. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through provision for income tax expense. Valuation allowances are established when it is more likely than not that a portion of the full amount of the deferred tax asset will not be realized. In assessing the ability to realize deferred tax assets, management considers the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies. Nicolet may also recognize a liability for unrecognized tax benefits from uncertain tax positions. Unrecognized tax benefits represent the differences between a tax position taken or expected to be taken in a tax return and the benefit recognized and measured in the financial statements. Penalties related to unrecognized tax benefits are classified as income tax expense.

 

Management’s Discussion and Analysis

 

The following discussion is Nicolet management’s analysis of the consolidated financial condition as of March 31, 2016 and December 31, 2015 and results of operations for the three-month periods ended March 31, 2016 and 2015. It should be read in conjunction with Nicolet’s audited consolidated financial statements as of December 31, 2015 and 2014, and for the three years ended December 31, 2015, included in Nicolet’s Annual Report on Form 10-K for the year ended December 31, 2015.

 

Certain actions in 2015 will have an impact on balance sheet changes between March 31, 2015, and March 31, 2016. The most notable are Nicolet’s sale of two outlying branches in August 2015 (at that time reducing deposits by $34 million, loans by $13 million, fixed assets by $1 million and cash by $20 million), issuance of $12 million of 5% fixed-rate, 10-year subordinated debt in the first half of 2015, redemption of $12.2 million or half of its then outstanding preferred stock in September 2015 at par, and its $4.2 million repurchase of common stock (146,404 shares) in the first 8 months of 2015.

 

Performance Summary

 

Nicolet reported net income of $2.7 million for the three months ended March 31, 2016, compared to $3.1 million for the first three months of 2015. After $112,000 of preferred stock dividends, net income available to common shareholders was $2.5 million, or $0.57 per diluted common share for the first quarter of 2016. Comparatively, after $61,000 of preferred stock dividends, net income available to common shareholders was $3.0 million, or $0.70 per diluted common share for the first quarter of 2015. Beginning March 1, 2016, the annual dividend rate on preferred stock moved from 1% to 9% in accordance with the contractual terms. In advance of such increase, Nicolet redeemed half of its then outstanding preferred stock in September 2015. The changes in rate and preferred stock outstanding affected the preferred stock dividends between the first quarter periods.

 

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·Net interest income was $10.7 million for the first three months of 2016, a decrease of $0.3 million or 2% from the first three months of 2015. The decrease was primarily the result of rate variances. On a tax-equivalent basis, the net interest margin for the first three months of 2016 was 3.87%, down 23 basis points (“bps”) from 4.10% for the comparable 2015 period. Between the comparable three-month periods, the earning asset yield declined 27 bps to 4.47%, while the cost of interest bearing liabilities fell 3 bps to 0.77%, resulting in a 24 bps decrease in the interest rate spread between the comparable three-month periods.

 

·Loans were $889 million at March 31, 2016, up $12 million or 1% over from $877 million at December 31, 2015. Loans grew $9 million or 1% over $880 million at March 31, 2015; however, excluding the impact of the August 2015 branch sale noted earlier, loans grew 2% year-over-year. Between the comparative three-month periods, average loans were $885 million, down slightly (less than 0.5%, and in part impacted by the August 2015 branch sale), yielding 5.19%, compared to $889 million for first quarter 2015 yielding 5.41%. The 22 bps decline in loan yield was due to continued downward pressure on rates of new and renewing loans in the prolonged low rate environment and $0.3 million lower aggregate discount accretion on acquired loans between the first quarter periods (mostly related to $0.7 million recovered discounts on one favorably resolved acquired loans in first quarter 2016 versus $0.9 million combined discounts recovered on two resolved acquired loans in first quarter 2015).

 

·Total deposits were $1.08 billion at March 31, 2016, up $25 million or 2% from $1.06 billion at December 31, 2015 (with a customary pattern of deposit decline historically following year ends through the first three months of the year counteracted this year by activity across a dozen larger customers). Deposits grew $41 million or 4% over $1.04 billion at March 31, 2015; and, excluding the impact of the August 2015 branch sale noted earlier, deposits grew 7% year-over-year. Between the comparative three-month periods, average total deposits were up $26 million or 2%, fully attributable to noninterest-bearing demand deposits, with interest-bearing deposits costing 0.55%, down 8 bps from 0.63% for the same period in 2015, benefiting from deposit product rate changes implemented in December 2015.

 

·Asset quality measures remained steady and strong at March 31, 2016. Nonperforming assets were $4.8 million at March 31, 2016, compared to $3.9 million at year end 2015 and $6.8 million a year ago. Nonperforming assets represented 0.39%, 0.32% and 0.56% of total assets at March 31, 2016, December 31, 2015, and March 31, 2015, respectively. The allowance for loan losses was $10.5 million or 1.18% of loans at March 31, 2016, compared to $10.3 million or 1.18%, respectively at year end 2015, and $9.5 million or 1.08%, respectively at March 31, 2015. The provision for loan losses was $0.4 million with net charge-offs of $0.2 million for the first three months of 2016, versus provision of $0.4 million with $0.2 million of net charge-offs for the comparable 2015 period.

 

·Noninterest income was $3.9 million for the first three months of 2016 (including slight net losses on sales of assets) compared to $4.1 million for the first three months of 2015 (which included $0.2 million net gains on sales of assets). Removing the net gains (losses), noninterest income was unchanged at $3.9 million for both first quarter periods. The most notable increases over prior year were brokerage fee income, service charges and debit card interchange income (within other income), which offset lower net mortgage income, resulting from a less robust mortgage market and lower production in the first quarter of 2016 compared to the first quarter of 2015.

 

·Noninterest expense for the first three months of 2016 was $10.0 million (including approximately $0.4 million attributable to non-recurring merger-based expenses such as legal and conversion processing costs related to the in-process mergers). The increase between the first quarter periods was modest (up $0.2 million or 2%); however, excluding the 2016 merger-based costs, noninterest expense was down $0.2 million or 2%, exhibiting general expense control. Most notably, salaries and employee benefits of $5.3 million for the first quarter of 2016, were down $0.3 million or 6% from first quarter 2015, largely a result of the salary base remaining flat (with lower average full-time equivalent employees, partly offsetting usual merit increases between the years), and a slower pace of incentives and stock compensation combined between the first quarter periods.

 

Net Interest Income

 

Nicolet’s earnings are substantially dependent on net interest income. Net interest income is the primary source of Nicolet’s revenue and is the difference between interest income earned on interest earning assets, such as loans and investments, 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 and composition of earning assets and interest-bearing liabilities, including characteristics such as the fixed or variable nature of the financial instruments, contractual maturities, and repricing frequencies.

 

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Net interest income in the consolidated statements of income (which excludes any taxable equivalent adjustment) was $10.7 million in the first three months of 2016, 2% lower than $11.0 million in the first three months of 2015. 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 $0.3 million for the first three months of 2016 and 2015, resulting in taxable equivalent net interest income of $11.0 million and $11.3 million, respectively.


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.

 

Tables 1 through 3 present information to facilitate the review and discussion of selected average balance sheet items, taxable equivalent net interest income, interest rate spread and net interest margin.

 

Table 1: Quarterly Net Interest Income Analysis

   For the Three Months Ended March 31, 
   2016   2015 
(in thousands)  Average
Balance
   Interest   Average
Rate
   Average
Balance
   Interest   Average
Rate
 
ASSETS                              
Earning assets                              
Loans, including loan fees (1)(2)  $885,037   $11,592    5.19%  $888,892   $12,009    5.41%
Investment securities                              
Taxable   77,596    404    2.09%   78,529    394    2.01%
Tax-exempt (2)   87,538    518    2.37%   86,682    529    2.44%
Other interest-earning assets   77,000    193    1.00%   44,831    100    0.89%
Total interest-earning assets   1,127,171   $12,707    4.47%   1,098,934   $13,032    4.74%
Cash and due from banks   31,763              30,401           
Other assets   67,431              70,729           
Total assets  $1,226,365             $1,200,064           
LIABILITIES AND STOCKHOLDERS’ EQUITY                              
Interest-bearing liabilities                              
Savings  $141,962   $51    0.14%  $121,954   $73    0.24%
Interest-bearing demand   230,996    407    0.71%   203,203    405    0.81%
MMA   259,163    83    0.13%   275,810    161    0.24%
Core CDs and IRAs   180,411    513    1.14%   209,180    567    1.10%
Brokered deposits   27,883    101    1.47%   30,584    103    1.37%
Total interest-bearing deposits   840,415    1,155    0.55%   840,731    1,309    0.63%
Other interest-bearing liabilities   39,814    535    5.33%   38,883    432    4.45%
Total interest-bearing liabilities   880,229    1,690    0.77%   879,614    1,741    0.80%
Noninterest-bearing demand   224,834              198,985           
Other liabilities   8,595              8,912           
Total equity   112,707              112,553           
Total liabilities and stockholders’ equity  $1,226,365             $1,200,064