10-Q 1 t1600692_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 September 30, 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   47-0871001
(State or other jurisdiction of incorporation or organization)   (I.R.S. Employer Identification No.)

 

111 North Washington Street

Green Bay, Wisconsin 54301

(920) 430-1400

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

 

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 ¨ (Do not check if a smaller reporting company) 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 October 31, 2016 there were 8,547,004 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
September 30, 2016 (unaudited) and December 31, 2015
3
       
    Consolidated Statements of Income
Three Months and Nine Months Ended September 30, 2016 and 2015 (unaudited)
4
       
    Consolidated Statements of Comprehensive Income
Three Months and Nine Months Ended September 30, 2016 and 2015 (unaudited)
5
       
    Consolidated Statement of Changes in Stockholders’ Equity
Nine Months Ended September 30, 2016 (unaudited)
6
       
    Consolidated Statements of Cash Flows
Nine Months Ended September 30, 2016 and 2015 (unaudited)
7
       
    Notes to Unaudited Consolidated Financial Statements 8-30
       
  Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 31-55
       
  Item 3. Quantitative and Qualitative Disclosures About Market Risk 55
       
  Item 4. Controls and Procedures 56
       
PART II OTHER INFORMATION  
     
  Item 1. Legal Proceedings 57
       
  Item 1A. Risk Factors 57
       
  Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 57
       
  Item 3. Defaults Upon Senior Securities 57
       
  Item 4. Mine Safety Disclosures 57
       
  Item 5. Other Information 57
       
  Item 6. Exhibits 58
       
    Signatures 58-62

 

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)

 

  

September 30, 2016

(Unaudited)

   December 31, 2015
(Audited)
 
Assets          
Cash and due from banks  $63,990   $11,947 
Interest-earning deposits   39,654    70,755 
Federal funds sold   727    917 
Cash and cash equivalents   104,371    83,619 
Certificates of deposit in other banks   5,177    3,416 
Securities available for sale (“AFS”)   366,316    172,596 
Other investments   18,297    8,135 
Loans held for sale   8,312    4,680 
Loans   1,554,124    877,061 
Allowance for loan losses   (11,481)   (10,307)
Loans, net   1,542,643    866,754 
Premises and equipment, net   47,038    29,613 
Bank owned life insurance (“BOLI”)   53,730    28,475 
Goodwill and other intangibles   89,100    3,793 
Accrued interest receivable and other assets   34,503    13,358 
Total assets  $2,269,487   $1,214,439 
           
Liabilities and Stockholders’ Equity          
Liabilities:          
Demand  $485,421   $226,554 
Money market and NOW accounts   902,427    486,677 
Savings   222,887    136,733 
Time   323,347    206,453 
Total deposits   1,934,082    1,056,417 
Notes payable   1,000    15,412 
Junior subordinated debentures   24,623    12,527 
Subordinated notes   11,876    11,849 
Accrued interest payable and other liabilities   21,275    8,547 
Total liabilities   1,992,856    1,104,752 
           
Stockholders’ Equity:          
Preferred equity   -    12,200 
Common stock   86    42 
Additional paid-in capital   211,073    45,220 
Retained earnings   62,801    51,059 
Accumulated other comprehensive income (“AOCI”)   2,309    980 
Total Nicolet Bankshares, Inc. stockholders’ equity   276,269    109,501 
Noncontrolling interest   362    186 
Total stockholders’ equity and noncontrolling interest   276,631    109,687 
Total liabilities, noncontrolling interest and stockholders’ equity  $2,269,487   $1,214,439 
Preferred shares authorized (no par value)   10,000,000    10,000,000 
Preferred shares issued and outstanding   -    12,200 
Common shares authorized (par value $0.01 per share)   30,000,000    30,000,000 
Common shares outstanding   8,582,425    4,154,377 
Common shares issued   8,632,240    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
September 30,
   Nine Months Ended
September 30,
 
   2016   2015   2016   2015 
Interest income:                    
Loans, including loan fees  $21,049   $11,159   $49,455   $33,921 
Investment securities:                    
Taxable   902    339    2,068    1,098 
Non-taxable   493    253    1,146    788 
Other interest income   351    108    906    327 
Total interest income   22,795    11,859    53,575    36,134 
Interest expense:                    
Money market and NOW accounts   631    569    1,726    1,693 
Savings and time deposits   719    732    2,102    2,225 
Short-term borrowings   -    2    5    2 
Notes payable   6    158    230    488 
Junior subordinated debentures   376    222    926    658 
Subordinated notes   159    159    477    335 
Total interest expense   1,891    1,842    5,466    5,401 
Net interest income   20,904    10,017    48,109    30,733 
Provision for loan losses   450    450    1,350    1,350 
Net interest income after provision for loan losses   20,454    9,567    46,759    29,383 
Noninterest income:                    
Service charges on deposit accounts   1,051    631    2,514    1,752 
Trust services fee income   1,373    1,196    4,000    3,636 
Mortgage income, net   2,010    811    3,713    2,670 
Brokerage fee income   992    170    2,090    509 
Bank owned life insurance   318    252    880    749 
Rent income   285    324    820    890 
Investment advisory fees   146    98    341    301 
Gain on sale or writedown of assets, net   453    91    548    1,042 
Other income   1,904    612    3,874    1,600 
Total noninterest income   8,532    4,185    18,780    13,149 
Noninterest expense:                    
Salaries and employee benefits   10,516    5,637    24,748    16,996 
Occupancy, equipment and office   3,018    1,745    7,324    5,263 
Business development and marketing   985    549    2,353    1,584 
Data processing   1,831    864    4,408    2,585 
FDIC assessments   247    142    629    469 
Intangibles amortization   1,172    248    2,295    783 
Other expense   1,250    664    4,799    1,695 
Total noninterest expense   19,019    9,849    46,556    29,375 
                     
Income before income tax expense   9,967    3,903    18,983    13,157 
Income tax expense   3,438    1,281    6,432    4,452 
Net income   6,529    2,622    12,551    8,705 
Less: net income attributable to noncontrolling interest   65    28    176    96 
Net income attributable to Nicolet Bankshares, Inc.   6,464    2,594    12,375    8,609 
Less: preferred stock dividends   247    60    633    182 
Net income available to common shareholders  $6,217   $2,534   $11,742   $8,427 
                     
Basic earnings per common share  $0.72   $0.64   $1.76   $2.11 
Diluted earnings per common share  $0.69   $0.58   $1.67   $1.93 
Weighted average common shares outstanding:                    
Basic   8,607,719    3,961,004    6,689,367    3,999,641 
Diluted   8,969,735    4,397,906    7,024,169    4,358,082 

 

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
September 30,
   Nine Months Ended
September 30,
 
   2016   2015   2016   2015 
Net income  $6,529   $2,622   $12,551   $8,705 
Other comprehensive income, net of tax:                    
Unrealized gains (losses) on securities AFS:                    
Net unrealized holding gains (losses) arising during the period   (984)   1,143    2,257    1,058 
Reclassification adjustment for net gains included in net income   (37)   -    (77)   (630)
Income tax benefit (expense)   397    (446)   (851)   (167)
Total other comprehensive income (loss)   (624)   697    1,329    261 
Comprehensive income  $5,905   $3,319   $13,880   $8,966 

 

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   -    -    -    12,375    -    176    12,551 
Other comprehensive income   -    -    -    -    1,329    -    1,329 
Stock compensation expense   -    -    1,123    -    -    -    1,123 
Exercise of stock options, net   -    -    1,502    -    -    -    1,502 
Issuance of common stock   -    1    100    -    -    -    101 
Issuance of common stock in acquisitions, net of capitalized issuance costs of $260   -    44    164,991    -    -    -    165,035 
Purchase and retirement of common stock   -    (1)   (3,045)   -    -    -    (3,046)
Equity awards assumed in acquisition   -    -    1,182    -    -    -    1,182 
Redemption of preferred stock   (12,200)   -    -    -    -    -    (12,200)
Preferred stock dividends   -    -    -    (633)   -    -    (633)
Balance, September 30, 2016  $-   $86   $211,073   $62,801   $2,309   $362   $276,631 

 

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)

 

   Nine Months Ended September 30, 
   2016   2015 
Cash Flows From Operating Activities, net of effects of business combinations:          
Net income  $12,551   $8,705 
Adjustments to reconcile net income to net cash provided by operating activities:          
Depreciation, amortization, and accretion   4,227    3,083 
Provision for loan losses   1,350    1,350 
Increase in cash surrender value of life insurance   (880)   (749)
Stock compensation expense   1,123    907 
Gain on sale or writedown of assets, net   (548)   (1,042)
Gain on sale of loans held for sale, net   (3,713)   (2,670)
Income from branch sale   -    (123)
Proceeds from sale of loans held for sale   179,967    149,509 
Origination of loans held for sale   (179,581)   (142,759)
Net change in:          
Accrued interest receivable and other assets   1,182    (244)
Accrued interest payable and other liabilities   (3,888)   2,330 
Net cash provided by operating activities   11,790    18,297 
Cash Flows From Investing Activities, net of effects of business combinations:          
Net decrease in certificates of deposit in other banks   239    6,226 
Net decrease (increase) in loans   15,582    (14,388)
Purchases of securities AFS   (57,510)   (34,238)
Proceeds from sales of securities AFS   30,319    13,883 
Proceeds from calls and maturities of securities AFS   22,962    17,643 
Purchase of other investments   (3,745)   (61)
Net increase in premises and equipment   (3,802)   (478)
Proceeds from sales of other real estate and other assets   1,661    2,470 
Net cash used in branch sale   -    (19,865)
Purchase of BOLI   (20,000)   - 
Proceeds from redemption of BOLI   21,549    - 
Net cash received in business combination   66,517    - 
Net cash provided (used) by investing activities   73,772    (28,808)
Cash Flows From Financing Activities, net of effects of business combinations:          
Net increase (decrease) in deposits   55,332    (13,728)
Net decrease in short-term borrowings   (49,087)   - 
Repayments of notes payable   (56,519)   (5,695)
           
Proceeds from issuance of subordinated notes, net   -    11,820 
Redemption of preferred stock   (12,200)   (12,200)
Purchase and retirement of common stock   (3,046)   (4,278)
Capitalized issuance costs, net   (260)   - 
Proceeds from issuance of common stock   101    122 
Proceeds from exercise of common stock options, net   1,502    610 
Cash dividends paid on preferred stock   (633)   (213)
Net cash used by financing activities   (64,810)   (23,562)
Net increase (decrease) in cash and cash equivalents   20,752    (34,073)
Cash and cash equivalents:          
Beginning  $83,619   $68,708 
Ending  $104,371   $34,635 
Supplemental Disclosures of Cash Flow Information:          
Cash paid for interest  $5,787   $5,458 
Cash paid for taxes   7,150    2,430 
Transfer of loans and bank premises to other real estate owned   33    870 
Acquisitions          
Fair value of assets acquired   1,035,517     
Fair value of liabilities assumed   936,621     
Net assets acquired   98,896     

 

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 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.

 

Reclassifications

 

Certain amounts in the 2015 consolidated financial statements have been reclassified to conform to the 2016 presentation.

 

8 

 

 

Note 2 – Acquisitions

 

On April 29, 2016, the Company consummated its merger with Baylake Corp. (“Baylake”), pursuant to the Agreement and Plan of Merger by and between the Company and Baylake dated September 8, 2015, (the “Merger Agreement”), whereby Baylake was merged with and into the Company, and Baylake Bank, Baylake’s wholly owned commercial bank subsidiary serving northeastern Wisconsin, was merged with and into Nicolet National Bank. The system integration was completed, and 21 branches of Baylake opened, on May 2, 2016, as Nicolet National Bank branches, expanding its presence into Door, Kewaunee, and Manitowoc Counties, Wisconsin. Concurrently, Nicolet closed one of its Brown County locations, bringing the Bank’s footprint to 42 branches as of September 30, 2016.

 

The purpose of the merger was for strategic reasons beneficial to the Company. The acquisition is consistent with its plan 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.

 

Pursuant to the terms of the Merger Agreement, Baylake shareholders received 0.4517 shares of the Company’s common stock for each outstanding share of Baylake common stock (except for Baylake shares pre-owned by the Company at the time of the merger), and cash in lieu of any fractional share. Pre-existing Baylake equity awards (restricted stock units and stock options) immediately vested upon consummation of the merger. The Company issued 0.4517 shares of its common stock for each vesting Baylake restricted stock unit, and Nicolet assumed, after appropriate adjustment by the 0.4517 exchange ratio, all pre-existing Baylake stock options. As a result, the Company issued 4,344,243 shares of the Company’s common stock, for common stock consideration of $163.3 million (based on $37.58 per share, the volume weighted average closing price of the Company’s common stock over the preceding 20 trading day period, and recorded an additional $1.2 million consideration for the assumed stock options. Approximately $0.3 million in direct stock issuance costs for the merger were incurred and charged against additional paid in capital, bringing the total purchase price to $164.2 million.

 

The Company accounted for the transaction under the acquisition method of accounting, and thus, the financial position and results of operations of Baylake prior to the consummation date were not included in the accompanying consolidated financial statements. The accounting required assets purchased and liabilities assumed to be recorded at their respective fair values at the date of acquisition. The Company determined the fair value of core deposit intangibles, securities, premises and equipment, loans, OREO, BOLI and other assets, deposits, debt and deferred taxes with the assistance of third party valuations, appraisals, and third party advisors. The estimated fair values will be subject to refinement as additional information relative to the closing date fair values becomes available through the measurement period of approximately one year from consummation.

 

The fair value of the assets acquired and liabilities assumed on April 29, 2016 was as follows:

 

(in millions)  As recorded by
Baylake Corp
   Fair Value
Adjustments
   As Recorded
by Nicolet
 
Cash, cash equivalents and securities available for sale  $262   $1   $263 
Loans   710    (19)   691 
Other real estate owned   3    (2)   1 
Core deposit intangible   1    16    17 
Fixed assets and other assets   71    (8)   63 
Total assets acquired  $1,047   $(12)  $1,035 
                
Deposits  $822   $-   $822 
Junior subordinated debentures, borrowings and other liabilities   116    (1)   115 
Total liabilities acquired  $938   $(1)  $937 
                
Excess of assets acquired over liabilities acquired  $109   $(11)  $98 
Less: purchase price             164 
Goodwill            $66 

 

9 

 

 

Note 2 – Acquisitions, continued

 

The following unaudited pro forma information presents the results of operations for three months and nine months ended September 30, 2016 and 2015, as if the acquisition had occurred January 1 of each period. The Company expects to achieve further operating cost savings and other business synergies as a result of the acquisition which are not reflected in the pro forma amounts. These unaudited pro forma results are presented for illustrative purposes and are not intended to represent or be indicative of the actual results of operations of the combined company that would have been achieved had the acquisition occurred at the beginning of each period presented, nor are they intended to represent or be indicative of future results of operations.

 

   Three Months Ended   Nine Months Ended 
   September 30,
2016
   September 30,
2015
   September 30,
2016
   September 30,
2015
 
(in thousands, except per share data)                
Total revenues, net of interest expense  $29,436   $25,433   $82,870   $78,118 
Net income   6,827    5,237    17,042    16,637 
Diluted earnings per share   0.74    0.57    1.85    1.86 

 

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. The transaction was effected in phases and completed April 1, 2016. The Company paid $4.9 million total initial consideration, including $0.8 million cash, $2.6 million of Nicolet common stock, and recorded a $1.5 million earn-out liability payable to one principal in the future (which may require adjustment based on change in initial business purchased over a period, but not contingent upon the principal’s employment). The Company initially recorded $0.4 million of goodwill, $0.2 million of fixed assets, and $4.3 million of customer relationship intangibles (a portion amortizing straight-line over 10 years and a portion over 15 years). The transaction will impact the income statement primarily within brokerage income, personnel expense, and intangibles amortization.

 

Note 3 – 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
September 30,
   Nine Months Ended
September 30,
 
   2016   2015   2016   2015 
(In thousands except per share data)                
Net income, net of noncontrolling interest  $6,464   $2,594   $12,375   $8,609 
Less: preferred stock dividends   247    60    633    182 
Net income available to common shareholders  $6,217   $2,534   $11,742   $8,427 
Weighted average common shares outstanding   8,608    3,961    6,689    4,000 
Effect of dilutive stock instruments   362    437    335    358 
Diluted weighted average common shares outstanding   8,970    4,398    7,024    4,358 
Basic earnings per common share*  $0.72   $0.64   $1.76   $2.11 
Diluted earnings per common share*  $0.69   $0.58   $1.67   $1.93 

 

*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.

 

No shares were outstanding at September 30, 2016 which were excluded from the calculation of diluted earnings per common share as anti-dilutive. Options to purchase approximately 0.2 million shares were outstanding at September 30, 2015, but were excluded from the calculation of diluted earnings per common share as the effect would have been anti-dilutive.

 

10 

 

 

Note 4 – 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:

 

   Nine months ended
September 30, 2016
       Year ended
December 31, 2015
 
Dividend yield   0%   0%
Expected volatility   25%   25%
Risk-free interest rate   1.52%   1.68%
Expected average life   7 years    7 years 
Weighted average per share fair value of options  $11.04   $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  $11.04    170,500    36.86      
Options assumed in acquisition        91,701    21.03      
Exercise of stock options*        (72,783)   20.90      
Forfeited        (1,456)   21.71      
Balance – September 30, 2016        933,966   $24.35    407,779 

 

*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.

 

Options outstanding at September 30, 2016 are exercisable at option prices ranging from $9.19 to $38.10. There are 304,393 options outstanding in the range from $9.19 - $20.00, 260,489 in the range from $20.01 - $25.00, 162,211 in the range from $25.01 - $30.00, and 206,873 options outstanding in the range from $30.01 - $38.10. At September 30, 2016, the exercisable options have a weighted average remaining contractual life of approximately 5 years and a weighted average exercise price of $19.60.

 

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 nine months of 2016, and full year of 2015 was approximately $1.1 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 *   20.01    (12,077)
Forfeited   -    - 
Balance – September 30, 2016  $24.77    49,815 

 

*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 3,653 shares were surrendered during the nine months ended September 30, 2016 and 7,715 shares were surrendered during the twelve months ended December 31, 2015.

 

11 

 

 

Note 4 – Stock-based Compensation, continued

 

The Company recognized approximately $1.1 million and $0.9 million of stock-based employee compensation expense during the nine months ended September 30, 2016 and 2015, respectively, associated with its stock equity awards. As of September 30, 2016, there was approximately $4.7 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 5 – Securities Available for Sale

 

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

 

   September 30, 2016 
(in thousands)  Amortized Cost  

Gross

Unrealized

Gains

   Gross
Unrealized
Losses
   Fair Value 
U.S. government sponsored enterprises  $1,985   $9   $-   $1,994 
State, county and municipals   186,025    1,567    100    187,492 
Mortgage-backed securities   161,448    1,602    124    162,926 
Corporate debt securities   10,442    248    -    10,690 
Equity securities   2,631    583    -    3,214 
   $362,531   $4,009   $224   $366,316 

 

   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 

 

12 

 

 

Note 5 – 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 September 30, 2016 and December 31, 2015.

 

   September 30, 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  $42,144   $94   $1,306   $6   $43,450   $100 
Mortgage-backed securities   16,761    79    3,290    45    20,051    124 
   $58,905   $173   $4,596   $51   $63,501   $224 

 

   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 September 30, 2016 the Company had $0.2 million of gross unrealized losses related to 152 securities. As of September 30, 2016, the Company does not consider securities with unrealized losses to be other-than-temporarily impaired as 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 nine-month periods ending September 30, 2016 or September 30, 2015.

 

The amortized cost and fair values of securities available for sale at September 30, 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.

 

   September 30, 2016 
(in thousands)  Amortized Cost   Fair Value 
Due in less than one year  $10,673   $10,675 
Due in one year through five years   80,933    81,499 
Due after five years through ten years   98,176    99,029 
Due after ten years   8,670    8,973 
    198,452    200,176 
Mortgage-backed securities   161,448    162,926 
Equity securities   2,631    3,214 
Securities available for sale  $362,531   $366,316 

 

Proceeds from sales of securities available for sale during the first nine months of 2016 and 2015 were approximately $30.3 million and $13.9 million, respectively. Gross gains of approximately $0.1 million and $0.6 million were realized during the first nine months of 2016 and 2015, respectively. Gross losses of approximately $13,000 were realized on sales of securities during the first nine months of 2016. No losses were realized on sales of securities during the first nine months of 2015.

 

13 

 

 

Note 6 – Loans, Allowance for Loan Losses, and Credit Quality

 

The loan composition as of September 30, 2016 and December 31, 2015 is summarized as follows.

 

   Total 
   September 30, 2016   December 31, 2015 
(in thousands)  Amount  

% of

Total

   Amount   % of
Total
 
Commercial & industrial  $423,790    27.3%  $294,419    33.6%
Owner-occupied commercial real estate (“CRE”)   362,554    23.3    185,285    21.1 
Agricultural (“AG”) production   34,077    2.2    15,018    1.7 
AG real estate   45,671    2.9    43,272    4.9 
CRE investment   197,884    12.7    78,711    9.0 
Construction & land development   68,161    4.4    36,775    4.2 
Residential construction   27,331    1.8    10,443    1.2 
Residential first mortgage   284,653    18.3    154,658    17.6 
Residential junior mortgage   95,901    6.2    51,967    5.9 
Retail & other   14,102    0.9    6,513    0.8 
Loans   1,554,124    100.0%   877,061    100.0%
Less allowance for loan losses   11,481         10,307      
Loans, net  $1,542,643        $866,754      
Allowance for loan losses to loans   0.74%        1.18%     

 

   Originated 
   September 30, 2016   December 31, 2015 
(in thousands)  Amount  

% of

Total

   Amount   % of
Total
 
Commercial & industrial  $321,522    37.7%  $284,023    38.4%
Owner-occupied CRE   181,107    21.3    153,563    20.7 
AG production   8,857    1.0    6,849    0.9 
AG real estate   18,222    2.1    25,464    3.4 
CRE investment   72,182    8.5    58,949    8.0 
Construction & land development   34,916    4.1    27,231    3.7 
Residential construction   20,964    2.5    10,443    1.4 
Residential first mortgage   138,103    16.2    122,373    16.5 
Residential junior mortgage   47,346    5.5    44,889    6.1 
Retail & other   9,179    1.1    6,351    0.9 
Loans   852,398    100.0%   740,135    100.0%
Less allowance for loan losses   8,988         8,714      
Loans, net  $843,410        $731,421      
Allowance for loan losses to loans   1.05%        1.18%     

 

   Acquired 
   September 30, 2016   December 31, 2015 
(in thousands)  Amount  

% of

Total

   Amount   % of
Total
 
Commercial & industrial  $102,268    14.6%  $10,396    7.6%
Owner-occupied CRE   181,447    25.9    31,722    23.2 
AG production   25,220    3.6    8,169    6.0 
AG real estate   27,449    3.9    17,808    13.0 
CRE investment   125,702    17.9    19,762    14.4 
Construction & land development   33,245    4.7    9,544    7.0 
Residential construction   6,367    0.9    -    - 
Residential first mortgage   146,550    20.9    32,285    23.5 
Residential junior mortgage   48,555    6.9    7,078    5.2 
Retail & other   4,923    0.7    162    0.1 
Loans   701,726    100.0%   136,926    100.0%
Less allowance for loan losses   2,493         1,593      
Loans, net  $699,233        $135,333      
Allowance for loan losses to loans   0.36%        1.16%     

 

14 

 

 

Note 6 – 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 nine months ended September 30, 2016:

 

   TOTAL – Nine Months Ended September 30, 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   745    710    40    (77)   23    (586)   176    188    42    89    1,350 
Charge-offs   (279)   (61)   -    -    -    -    -    -    (53)   (39)   (432)
Recoveries   17    3    -    -    221    -    -    5    7    3    256 
Net charge-offs   (262)   (58)   -    -    221    -    -    5    (46)   (36)   (176)
Ending balance  $4,204   $2,585   $125   $303   $1,029   $860   $323   $1,433   $492   $127   $11,481 
As percent of ALLL   36.6%   22.5%   1.1%   2.6%   9.0%   7.5%   2.8%   12.5%   4.3%   1.1%   100.0%
                                                        
ALLL:                                                       
Individually evaluated  $96   $-   $-   $-   $-   $-   $-   $-   $-   $-   $96 
Collectively evaluated   4,108    2,585    125    303    1,029    860    323    1,433    492    127    11,385 
Ending balance  $4,204   $2,585   $125   $303   $1,029   $860   $323   $1,433   $492   $127   $11,481 
                                                        
Loans:                                                       
Individually evaluated  $662   $2,666   $53   $240   $13,466   $722   $287   $2,303   $181   $-   $20,580 
Collectively evaluated   423,128    359,888    34,024    45,431    184,418    67,439    27,044    282,350    95,720    14,102    1,533,544 
Total loans  $423,790   $362,554   $34,077   $45,671   $197,884   $68,161   $27,331   $284,653   $95,901   $14,102   $1,554,124 
                                                        
Less ALLL  $4,204   $2,585   $125   $303   $1,029   $860   $323   $1,433   $492   $127   $11,481 
Net loans  $419,586   $359,969   $33,952   $45,368   $196,855   $67,301   $27,008   $283,220   $95,409   $13,975   $1,542,643 

 

15 

 

 

Note 6 – Loans, Allowance for Loan Losses, and Credit Quality, continued

 

   Originated – Nine Months Ended September 30, 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   426    408    29    (73)   (70)   (633)   130    85    16    80    398 
Charge-offs   (262)   (3)   -    -    -    -    -    -    (53)   (38)   (356)
Recoveries   -    3    -    -    221    -    -    -    6    2    232 
Net charge-offs   (262)   -    -    -    221    -    -    -    (47)   (36)   (124)
Ending balance  $3,299   $1,975   $100   $226   $797   $748   $277   $1,072   $387   $107   $8,988 
As percent of ALLL   36.7%   22.0%   1.1%   2.5%   8.9%   8.3%   3.1%   11.9%   4.3%   1.2%   100.0%
                                                        
ALLL:                                                       
Individually evaluated  $96   $-   $-   $-   $-   $-   $-   $-   $-   $-   $96 
Collectively evaluated   3,203    1,975    100    226    797    748    277    1,072    387    107    8,892 
Ending balance  $3,299   $1,975   $100   $226   $797   $748   $277   $1,072   $387   $107   $8,988 
                                                        
Loans:                                                       
Individually evaluated  $319   $-   $-   $-   $-   $-   $-   $-   $-   $-   $319 
Collectively evaluated   321,203    181,107    8,857    18,222    72,182    34,916    20,964    138,103    47,346    9,179    852,079 
Total loans  $321,522   $181,107   $8,857   $18,222   $72,182   $34,916   $20,964   $138,103   $47,346   $9,179   $852,398 
                                                        
Less ALLL  $3,299   $1,975   $100   $226   $797   $748   $277   $1,072   $387   $107   $8,988 
Net loans  $318,223   $179,132   $8,757   $17,996   $71,385   $34,168   $20,687   $137,031   $46,959   $9,072   $843,410 

 

   Acquired – Nine Months Ended September 30, 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   319    302    11    (4)   93    47    46    103    26    9    952 
Charge-offs   (17)   (58)   -    -    -    -    -    -    -    (1)   (76)
Recoveries   17    -    -    -    -    -    -    5    1    1    24 
Net charge-offs   -    (58)   -    -    -    -    -    5    1    -    (52)
Ending balance  $905   $610   $25   $77   $232   $112   $46   $361   $105   $20   $2,493 
As percent of ALLL   36.3%   24.5%   1.0%   3.1%   9.3%   4.5%   1.8%   14.5%   4.2%   0.8%   100.0%
                                                        
Loans:                                                       
Individually evaluated  $343   $2,666   $53   $240   $13,466   $722   $287   $2,303   $181   $-   $20,261 
Collectively evaluated   101,925    178,781    25,167    27,209    112,236    32,523    6,080    144,247    48,374    4,923    681,465 
Total loans  $102,268   $181,447   $25,220   $27,449   $125,702   $33,245   $6,367   $146,550   $48,555   $4,923   $701,726 
                                                        
Less ALLL  $905   $610   $25   $77   $232   $112   $46   $361   $105   $20   $2,493 
Net loans  $101,363   $180,837   $25,195   $27,372   $125,470   $33,133   $6,321   $146,189   $48,450   $4,903   $699,233 

 

16 

 

 

Note 6 – 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 nine months ended September 30, 2015.

 

   TOTAL – Nine Months Ended September 30, 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   781    682    31    76    227    (975)   (34)   291    244    27    1,350 
Charge-offs   (305)   (219)   -    -    -    -    -    (60)   (104)   (29)   (717)
Recoveries   37    3    -    -    13    -    -    18    1    12    84 
Net charge-offs   (268)   (216)   -    -    13    -    -    (42)   (103)   (17)   (633)
Ending balance  $3,704   $1,696   $84   $302   $751   $1,710   $106   $1,115   $478   $59   $10,005 
As percent of ALLL   37.0%   17.0%   0.8%   3.0%   7.5%   17.1%   1.1%   11.1%   4.8%   0.6%   100%
                                                        
ALLL:                                                       
Individually evaluated  $-   $-   $-   $-   $-   $-   $-   $-   $-   $-   $- 
Collectively evaluated   3,704    1,696    84    302    751    1,710    106    1,115    478    59    10,005 
Ending balance  $3,704   $1,696   $84   $302   $751   $1,710   $106   $1,115   $478   $59   $10,005 
                                                        
Loans:                                                       
Individually evaluated  $147   $1,224   $39   $392   $982   $686   $-   $627   $144   $-   $4,241 
Collectively evaluated   304,711    178,345    15,670    39,323    82,296    38,801    8,106    152,935    54,026    5,994    880,207 
Total loans  $304,858   $179,569   $15,709   $39,715   $83,278   $39,487   $8,106   $153,562   $54,170   $5,994   $884,448 
                                                        
Less ALLL  $3,704   $1,696   $84   $302   $751   $1,710   $106   $1,115   $478   $59   $10,005 
Net loans  $301,154   $177,873   $15,625   $39,413   $82,527   $37,777   $8,000   $152,447   $53,692   $5,935   $874,443 

 

   Originated – Nine Months Ended September 30, 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   160    260    15    4    79    (1,045)   (34)   41    149    17    (354)
Charge-offs   (305)   (157)   -    -    -    -    -    (60)   (91)   (29)   (642)
Recoveries   37    3    -    -    13    -    -    15    -    12    80 
Net charge-offs   (268)   (154)   -    -    13    -    -    (45)   (91)   (17)   (562)
Ending balance  $3,083   $1,336   $68   $230   $603   $1,640   $106   $862   $395   $49   $8,372 
As percent of ALLL   36.8%   16.0%   0.8%   2.7%   7.2%   19.6%   1.3%   10.3%   4.7%   0.6%   100%
                                                        
ALLL:                                                       
Individually evaluated  $-   $-   $-   $-   $-   $-   $-   $-   $-   $-   $- 
Collectively evaluated   3,083    1,336    68    230    603    1,640    106    862    395    49    8,372 
Ending balance  $3,083   $1,336   $68   $230   $603   $1,640   $106   $862   $395   $49   $8,372 
                                                        
Loans:                                                       
Individually evaluated  $-   $-   $-   $-   $-   $-   $-   $-   $-   $-   $- 
Collectively evaluated   294,160    146,155    7,334    21,541    59,894    28,314    8,106    119,503    47,096    5,752    737,855 
Total loans  $294,160   $146,155   $7,334   $21,541   $59,894   $28,314   $8,106   $119,503   $47,096   $5,752   $737,855 
                                                        
Less ALLL  $3,083   $1,336   $68   $230   $603   $1,640   $106   $862   $395   $49   $8,372 
Net loans  $291,077   $144,819   $7,266   $21,311   $59,291   $26,674   $8,000   $118,641   $46,701   $5,703   $729,483 

 

17 

 

 

Note 6 – Loans, Allowance for Loan Losses, and Credit Quality, continued

 

   Acquired – Nine Months Ended September 30, 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  $-   $-   $-   $-   $-   $-   $-   $-   $-   $-   $- 
Provision   621    422    16    72    148    70    -    250    95    10    1,704 
Charge-offs   -    (62)   -    -    -    -    -    -    (13)   -    (75)
Recoveries   -    -    -    -    -    -    -    3    1    -    4 
Net charge-offs   -    (62)   -    -    -    -    -    3    (12)   -    (71)
Ending balance  $621   $360   $16   $72   $148   $70   $-   $253   $83   $10   $1,633 
As percent of ALLL   38.0%   22.0%   1.0%   4.4%   9.1%   4.3%   -%   15.5%   5.1%   0.6%   100%
                                                        
Loans:                                                       
Individually evaluated  $147   $1,224   $39   $392   $982   $686   $-   $627   $144   $-   $4,241 
Collectively evaluated   10,551    32,190    8,336    17,782    22,402    10,487    -    33,432    6,930    242    142,352 
Total loans  $10,698   $33,414   $8,375   $18,174   $23,384   $11,173   $-   $34,059   $7,074   $242   $146,593 
                                                        
Less ALLL  $621   $360   $16   $72   $148   $70   $-   $253   $83   $10   $1,633 
Net loans  $10,077   $33,054   $8,359   $18,102   $23,236   $11,103   $-   $33,806   $6,991   $232   $144,960 

 

18 

 

 

Note 6 – Loans, Allowance for Loan Losses, and Credit Quality, continued

 

The following table presents nonaccrual loans by portfolio segment in total and then as a further breakdown by originated or acquired as of September 30, 2016 and December 31, 2015.

 

   Total Nonaccrual Loans 
(in thousands)  September 30,
2016
   % to Total   December 31, 2015   % to Total 
Commercial & industrial  $680    3.2%  $204    5.8%
Owner-occupied CRE   2,986    13.9    951    26.9 
AG production   23    0.1    13    0.4 
AG real estate   208    1.0    230    6.5 
CRE investment   13,216    61.4    1,040    29.4 
Construction & land development   1,220    5.7    280    7.9 
Residential construction   287    1.3    -    - 
Residential first mortgage   2,656    12.4    674    19.1 
Residential junior mortgage   212    1.0    141    4.0 
Retail & other   -    -    -    - 
Nonaccrual loans - Total  $21,488    100.0%  $3,533    100.0%

 

   Originated 
(in thousands)  September 30,
2016
   % to Total   December 31, 2015   % to Total 
Commercial & industrial  $324    47.3%  $49    8.4%
Owner-occupied CRE   44    6.4    -    - 
AG production   8    1.2    13    2.2 
AG real estate   -    -    -    - 
CRE investment   -    -    387    66.7 
Construction & land development   -    -    -    - 
Residential construction   -    -    -    - 
Residential first mortgage   309    45.1    132    22.7 
Residential junior mortgage   -    -    -    - 
Retail & other   -    -    -    - 
Nonaccrual loans - Originated  $685    100.0%  $581    100.0%

 

   Acquired 
(in thousands)  September 30,
2016
   % to Total   December 31, 2015   % to Total 
Commercial & industrial  $356    1.7%  $155    5.3%
Owner-occupied CRE   2,942    14.1    951    32.1 
AG production   15    0.1    -    - 
AG real estate   208    1.0    230    7.8 
CRE investment   13,216    63.5    653    22.1 
Construction & land development   1,220    5.9    280    9.5 
Residential construction   287    1.4    -    - 
Residential first mortgage   2,347    11.3    542    18.4 
Residential junior mortgage   212    1.0    141    4.8 
Retail & other   -    -    -    - 
Nonaccrual loans – Acquired  $20,803    100.0%  $2,952    100.0%

 

19 

 

 

Note 6 – Loans, Allowance for Loan Losses, and Credit Quality, continued

 

The following tables present total past due loans by portfolio segment as of September 30, 2016 and December 31, 2015:

 

   September 30, 2016 
(in thousands)  30-89 Days
Past Due
(accruing)
   90 Days &
Over or non-
accrual
   Current   Total 
Commercial & industrial  $78   $680   $423,032   $423,790 
Owner-occupied CRE   -    2,986    359,568    362,554 
AG production   -    23    34,054    34,077 
AG real estate   71    208    45,392    45,671 
CRE investment   -    13,216    184,668    197,884 
Construction & land development   -    1,220    66,941    68,161 
Residential construction   -    287    27,044    27,331 
Residential first mortgage   211    2,656    281,786    284,653 
Residential junior mortgage   44    212    95,645    95,901 
Retail & other   -    -    14,102    14,102 
Total loans  $404   $21,488   $1,532,232   $1,554,124 
As a percent of total loans   0.1%   1.3%   98.6%   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.

 

20 

 

 

Note 6 – 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 September 30, 2016 and December 31, 2015:

 

   September 30, 2016 
(in thousands)  Grades 1- 4   Grade 5   Grade 6   Grade 7   Grade 8   Grade 9   Total 
Commercial & industrial  $393,666   $20,566   $4,612   $4,946   $-   $-   $423,790 
Owner-occupied CRE   344,257    13,057    586    4,654    -    -    362,554 
AG production   31,649    1,861    73    494    -    -    34,077 
AG real estate   43,968    947    -    756    -    -    45,671 
CRE investment   174,264    8,153    1,096    14,371    -    -    197,884 
Construction & land development   62,217    4,516    -    1,428    -    -    68,161 
Residential construction   26,049    819    -    463    -    -    27,331 
Residential first mortgage   279,705    1,466    194    3,288    -    -    284,653 
Residential junior mortgage   95,557    -    91    253    -    -    95,901 
Retail & other   14,102    -    -    -    -    -    14,102 
Total loans  $1,465,434   $51,385   $6,652   $30,653   $-   $-   $1,554,124 
Percent of total   94.3%   3.3%   0.4%   2.0%   -    -    100.0%

 

   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%   -    -    100.0%

 

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.

 

21 

 

 

Note 6 – Loans, Allowance for Loan Losses, and Credit Quality, continued

 

The following tables present impaired loans as of September 30, 2016 and December 31, 2015. As a further breakdown, impaired loans are also summarized by originated and acquired for the periods presented. In April 2016, the Baylake merger added purchased credit impaired loans at a fair value of $20.8 million, net of an initial $12.9 million non-accretable mark. Including these credit impaired loans acquired in the Baylake merger, total purchased credit impaired loans acquired in aggregate were initially recorded at a fair value of $37.5 million on their respective acquisition dates, net of an initial $25.1 million non-accretable mark and a zero accretable mark. At September 30, 2016, $20.0 million of the $37.5 million remain in impaired loans and $0.3 million of acquired loans have subsequently become impaired, bringing acquired impaired loans to $20.3 million.

 

   Total Impaired Loans – September 30, 2016 
(in thousands)  Recorded
Investment
   Unpaid Principal
Balance
   Related Allowance   Average Recorded
Investment
   Interest Income
Recognized
 
Commercial & industrial*  $662   $1,089   $96   $815   $82 
Owner-occupied CRE   2,666    4,772    -    2,742    252 
AG production   53    180    -    61    9 
AG real estate   240    333    -    246    25 
CRE investment   13,466    21,093    -    13,634    891 
Construction & land development   722    2,150    -    781    95 
Residential construction   287    1,374    -    300    64 
Residential first mortgage   2,303    3,860    -    2,364    178 
Residential junior mortgage   181    617    -    186    37 
Retail & Other   -    42    -    -    5 
Total  $20,580   $35,510   $96   $21,129   $1,638 

 

As a further breakdown, impaired loans as of September 30, 2016 are summarized by originated and acquired as follows:

 

   Originated – September 30, 2016 
(in thousands)  Recorded
Investment
   Unpaid Principal
Balance
   Related Allowance   Average Recorded
Investment
   Interest Income
Recognized
 
Commercial & industrial*  $319   $319   $96   $464   $19 
Owner-occupied CRE   -    -    -    -    - 
AG production   -    -    -    -    - 
AG real estate   -    -    -    -    - 
CRE investment   -    -    -    -    - 
Construction & land development   -    -    -    -    - 
Residential construction   -    -    -    -    - 
Residential first mortgage   -    -    -    -    - 
Residential junior mortgage   -    -    -    -    - 
Retail & Other   -    -    -    -    - 
Total  $319   $319   $96   $464   $19 

 

   Acquired – September 30, 2016 
(in thousands)  Recorded
Investment
   Unpaid Principal
Balance
   Related Allowance   Average Recorded
Investment
   Interest Income
Recognized
 
Commercial & industrial*  $343   $770   $-   $351   $63 
Owner-occupied CRE   2,666    4,772    -    2,742    252 
AG production   53    180    -    61    9 
AG real estate   240    333    -    246    25 
CRE investment   13,466    21,093    -    13,634    891 
Construction & land development   722    2,150    -    781    95 
Residential construction   287    1,374    -    300    64 
Residential first mortgage   2,303    3,860    -    2,364    178 
Residential junior mortgage   181    617    -    186    37 
Retail & other   -    42    -    -    5 
Total  $20,261   $35,191   $-   $20,665   $1,619 

 

*One commercial & industrial loan with a balance of $0.3 million had a specific reserve of $96,000. No other loans had a related allowance at September 30, 2016 and, therefore, the above disclosure was not expanded to include loans with and without a related allowance.

 

22 

 

 

Note 6 – 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 

 

23 

 

 

Note 6 – Loans, Allowance for Loan Losses, and Credit Quality, continued

 

Troubled Debt Restructurings

 

At September 30, 2016, there were four loans classified as troubled debt restructurings totaling $340,000. These four loans had a combined premodification balance of $468,000. There were no other loans which were modified and classified as troubled debt restructurings at September 30, 2016. There were no loans classified as troubled debt restructurings during the previous twelve months that subsequently defaulted as of September 30, 2016. Loans which were considered troubled debt restructurings by Baylake prior to the acquisition are not required to be classified as troubled debt restructurings in the Company’s consolidated financial statements unless and until such loans would subsequently meet criteria to be classified as such, since acquired loans were recorded at their estimated fair values at the time of the acquisition.

 

Note 7 – Goodwill and Intangible Assets and Mortgage Servicing Rights

 

The excess of the purchase price in an acquisition over the fair value of net assets acquired consists primarily of goodwill, core deposit intangibles and other identifiable intangibles (primarily related to customer relationships acquired). Goodwill is not amortized but is instead subject to impairment tests on at least an annual basis. Core deposit intangibles, which arise from value ascribed to the deposit base of a bank acquired, have estimated finite lives and are amortized on an accelerated basis to expense over a 10-year period. The other intangibles, which represent value ascribed to financial advisor books of business purchased in 2016 in a private transaction, have estimated finite lives and are amortized on a straight-line basis to expense over their weighted average life (of approximately 12 years for 2016).

 

Management periodically reviews the carrying value of its long-lived and intangible assets to determine if any impairment has occurred, in which case an impairment charge would be recorded as an expense in the period of impairment, or whether changes in circumstances have occurred that would require a revision to the remaining useful life which would impact expense prospectively. In making such determination, management evaluates whether there are any adverse qualitative factors indicating that an impairment may exist, as well as the performance, on an undiscounted basis, of the underlying operations or assets which give rise to the intangible. The Company’s annual assessments indicated no impairment charge on goodwill or core deposit intangible was required for 2015 or the first nine months of 2016.

 

Goodwill: Goodwill was $66.7 million at September 30, 2016 and $0.8 million at December 31, 2015. There were additions to the carrying amount of goodwill in 2016 of $0.4 million related to the acquisition of financial advisor business and of approximately $65.5 million related to the Baylake merger. See Note 2 for additional information on the 2016 acquisitions.

 

Other intangible assets: Other intangible assets, consisting of core deposit intangibles and other intangibles (related to the customer relationships acquired in connection with the 2016 acquisition of financial advisor business), are amortized over their estimated finite lives. Due to the 2016 acquisitions, there was an addition to the gross carrying amount of core deposit intangibles of $17.3 million and of other intangibles of $4.4 million. Amortization on core deposit intangibles was $1.1 million and $2.1 million for the three and nine months ended September 30, 2016, respectively, and $0.3 million and $1.0 million for the three and nine months ended September 30, 2015, respectively. Amortization on other intangible assets was $0.2 million for both the three and nine months ended September 30, 2016 and zero in 2015. See Note 2 for additional information on the 2016 acquisitions.

 

(in thousands)  September 30, 2016   December 31, 2015 
Core deposit intangibles:          
Gross carrying amount  $25,345   $8,086 
Accumulated amortization   (7,178)   (5,055)
Net book value  $18,167   $3,031 
Additions during the period  $17,259   $- 
           
Other intangibles:          
Gross carrying amount  $4,363   $- 
Accumulated amortization   (173)   - 
Net book value  $4,190   $- 
Additions during the period  $4,363   $- 

 

24 

 

 

Note 7 – Goodwill and Intangible Assets and Mortgage Servicing Rights, continued

 

Mortgage servicing rights: The Company may sell originated residential mortgage loans into the secondary market. If the Company retains the right to service these loans sold, a mortgage servicing right is capitalized upon sale (recorded in mortgage income, net, in the consolidated income statements), which represents the then-current estimated fair value of future net cash flows expected to be realized for performing the servicing activities. Mortgage servicing rights, when purchased (as in the case of the 2016 Baylake merger), are initially recorded at their then-estimated fair value. As the Company has not elected to subsequently measure any class of servicing assets under the fair value measurement method, the Company follows the amortization method. Mortgage servicing rights are amortized in proportion to and over the period of estimated net servicing income, and assessed for impairment at each reporting date, with the amortization recorded in mortgage income, net, in the consolidated income statements. Mortgage servicing rights are carried at the lower of the initial capitalized amount, net of accumulated amortization, or estimated fair value, and are included in other assets in the consolidated balance sheets.

 

(in thousands)  September 30, 2016   December 31, 2015 
Mortgage servicing rights (MSR) asset:          
MSR asset at beginning of year  $193   $- 
Additions during the period*   1,377    201 
Amortization during the period   (105)   (8)
Valuation allowance at end of period   -    - 
Net book value at end of period  $1,465   $193 
*Purchased MSR asset included in period  $885    - 
           
Fair value of MSR asset at end of period  $1,760   $249 
Residential mortgage loans serviced for others  $263,146   $34,940 

 

The Company periodically evaluates its mortgage servicing rights asset for impairment. At each reporting date, impairment is assessed based on estimated fair value using estimated prepayment speeds of the underlying mortgage loans serviced and stratifications based on the risk characteristics of the underlying loans serviced (predominantly loan type and note interest rate). A valuation allowance is established through a charge to earnings (which would be included in mortgage income, net, in the consolidated income statements) to the extent the amortized cost of the mortgage servicing rights exceeds the estimated fair value by stratification. If it is later determined that all or a portion of the temporary impairment no longer exists for a stratification, the valuation is reduced through a recovery to earnings, though not beyond the net amortized cost carried. An other-than-temporary impairment (i.e. recoverability is considered remote when considering interest rates and loan payoff activity) is recognized as a write-down of the MSR asset and the related valuation allowance (to the extent a valuation allowance is available) and then against earnings. A direct write-down permanently reduces the carrying value of the MSR asset and valuation allowance, precluding subsequent recoveries.

 

The following table shows the estimated future amortization expense for amortizing intangible assets. The projections are based on existing asset balances, the current interest rate environment and prepayment speeds as of the September 30, 2016. The actual amortization expense the Company recognizes in any given period may be significantly different depending upon acquisition or sale activities, changes in interest rates, prepayment speeds, market conditions, regulatory requirements and events or circumstances that indicate the carrying amount of an asset may not be recoverable.

 

(in thousands)  Core deposit
intangibles
   Other intangibles   MSR asset 
Year ending December 31,               
2016 (remaining three months)  $1,066   $96   $124 
2017   3,805    385    248 
2018   3,254    385    248 
2019   2,762    385    248 
2020   2,156    385    181 
Thereafter   5,124    2,554    416 
Total  $18,167   $4,190   $1,465 

 

25 

 

 

Note 8- Notes Payable

 

The Company had the following long-term notes payable:

 

(in thousands)  September 30, 2016   December 31, 2015 
Joint venture note  $-   $9,412 
Federal Home Loan Bank (“FHLB”) advances   1,000    6,000 
Notes payable  $1,000   $15,412 

 

At the completion of the construct