10-Q 1 t1700244_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, 2017

 

¨ 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, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth 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)

 

Emerging Growth Company x

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨

 

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 25, 2017 there were 8,612,382 shares of $0.01 par value common stock outstanding.

 

 

 

 

 

 

Nicolet Bankshares, Inc.

 

TABLE OF CONTENTS

 

PAGE
     
PART I FINANCIAL INFORMATION  
     
  Item 1. Financial Statements:  
       
 

Consolidated Balance Sheets

March 31, 2017 (unaudited) and December 31, 2016

3
       
    Consolidated Statements of Income
Three Months Ended March 31, 2017 and 2016 (unaudited)
4
       
  Consolidated Statements of Comprehensive Income
Three Months Ended March 31, 2017 and 2016 (unaudited)
5
       
  Consolidated Statement of Changes in Stockholders’ Equity
Three Months Ended March 31, 2017 (unaudited)
6
       
    Consolidated Statements of Cash Flows
Three Months Ended March 31, 2017 and 2016 (unaudited)
7
       
  Notes to Unaudited Consolidated Financial Statements 8-29
       
  Item 2.

Management’s Discussion and Analysis of Financial Condition

and Results of Operations

30-49
       
  Item 3. Quantitative and Qualitative Disclosures About Market Risk 49
       
  Item 4. Controls and Procedures 49
       
PART II OTHER INFORMATION  
     
  Item 1. Legal Proceedings 50
       
  Item 1A. Risk Factors

50

   
  Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 50
       
  Item 3. Defaults Upon Senior Securities 50
       
  Item 4. Mine Safety Disclosures 50
       
  Item 5. Other Information 50
       
  Item 6. Exhibits 51
       
    Signatures 51

 

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, 2017
(Unaudited)
   December 31, 2016
(Audited)
 
Assets          
Cash and due from banks  $41,099   $68,056 
Interest-earning deposits   2,452    60,320 
Federal funds sold   728    727 
Cash and cash equivalents   44,279    129,103 
Certificates of deposit in other banks   3,235    3,984 
Securities available for sale (“AFS”)   404,358    365,287 
Other investments   11,670    17,499 
Loans held for sale   3,818    6,913 
Loans   1,618,279    1,568,907 
Allowance for loan losses   (12,189)   (11,820)
Loans, net   1,606,090    1,557,087 
Premises and equipment, net   44,275    45,862 
Bank owned life insurance (“BOLI”)   54,535    54,134 
Goodwill and other intangibles   86,776    87,938 
Accrued interest receivable and other assets   33,608    33,072 
Total assets  $2,292,644   $2,300,879 
           
Liabilities and Stockholders’ Equity          
Liabilities:          
Demand  $452,915   $482,300 
Money market and NOW accounts   942,042    964,509 
Savings   234,314    221,282 
Time   317,000    301,895 
Total deposits   1,946,271    1,969,986 
Short-term borrowings   6,000    - 
Notes payable   1,000    1,000 
Junior subordinated debentures   24,840    24,732 
Subordinated notes   11,894    11,885 
Accrued interest payable and other liabilities   17,126    16,911 
Total liabilities   2,007,131    2,024,514 
           
Stockholders’ Equity:          
Common stock   86    86 
Additional paid-in capital   210,817    209,700 
Retained earnings   75,096    68,888 
Accumulated other comprehensive loss   (977)   (2,727)
Total Nicolet Bankshares, Inc. stockholders’ equity   285,022    275,947 
Noncontrolling interest   491    418 
Total stockholders’ equity and noncontrolling interest   285,513    276,365 
Total liabilities, noncontrolling interest and stockholders’ equity  $2,292,644   $2,300,879 
Preferred shares authorized (no par value)   10,000,000    10,000,000 
Common shares authorized (par value $0.01 per share)   30,000,000    30,000,000 
Common shares outstanding   8,604,763    8,553,292 
Common shares issued   8,641,448    8,596,241 

 

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,
 
   2017   2016 
Interest income:          
Loans, including loan fees  $21,095   $11,570 
Investment securities:          
Taxable   1,069    404 
Non-taxable   565    262 
Other interest income   354    193 
Total interest income   23,083    12,429 
Interest expense:          
Money market and NOW accounts   596    490 
Savings and time deposits   591    665 
Short-term borrowings and notes payable   24    150 
Junior subordinated debentures   396    226 
Subordinated notes   159    159 
Total interest expense   1,766    1,690 
Net interest income   21,317    10,739 
Provision for loan losses   450    450 
Net interest income after provision for loan losses   20,867    10,289 
Noninterest income:          
Service charges on deposit accounts   1,008    593 
Mortgage income, net   842    571 
Trust services fee income   1,467    1,162 
Brokerage fee income   1,259    310 
Bank owned life insurance   401    250 
Rent income   272    262 
Investment advisory fees   156    100 
Loss on sale or write-down of assets, net   (6)   (5)
Other income   1,370    635 
Total noninterest income   6,769    3,878 
Noninterest expense:          
Personnel   9,933    5,348 
Occupancy, equipment and office   2,831    1,798 
Business development and marketing   929    578 
Data processing   1,983    1,156 
FDIC assessments   232    143 
Intangibles amortization   1,162    249 
Other expense   1,253    746 
Total noninterest expense   18,323    10,018 
Income before income tax expense   9,313    4,149 
Income tax expense   3,032    1,449 
Net income   6,281    2,700 
Less: Net income attributable to noncontrolling interest   73    46 
Net income attributable to Nicolet Bankshares, Inc.   6,208    2,654 
Less: Preferred stock dividends   -    112 
Net income available to common shareholders  $6,208   $2,542 
           
Basic earnings per common share  $0.72   $0.61 
Diluted earnings per common share  $0.69   $0.57 
Weighted average common shares outstanding:          
Basic   8,584,289    4,181,920 
Diluted   8,958,425    4,456,442 

 

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,
 
   2017   2016 
Net income  $6,281   $2,700 
Other comprehensive income, net of tax:          
Unrealized gains on securities AFS:          
Net unrealized holding gains arising during the period   2,870    1,472 
Income tax expense   (1,120)   (574)
Total other comprehensive income   1,750    898 
Comprehensive income  $8,031   $3,598 

 

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         
   Common
Stock
   Additional
Paid-In
Capital
   Retained
Earnings
   Accumulated
Other
Comprehensive
Loss
   Noncontrolling
Interest
   Total 
Balance December 31, 2016  $86   $209,700   $68,888   $(2,727)  $418   $276,365 
Comprehensive income:                              
Net income   -    -    6,208    -    73    6,281 
Other comprehensive income   -    -    -    1,750    -    1,750 
Stock compensation expense   -    384    -    -    -    384 
Exercise of stock options, net   -    760    -    -    -    760 
Issuance of common stock   -    52    -    -    -    52 
Purchase and retirement of common stock   -    (79)   -    -    -    (79)
Balance, March 31, 2017  $86   $210,817   $75,096   $(977)  $491   $285,513 

 

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, 
   2017   2016 
Cash Flows From Operating Activities:          
Net income  $6,281   $2,700 
Adjustments to reconcile net income to net cash provided by operating activities:          
Depreciation, amortization, and accretion   1,598    498 
Provision for loan losses   450    450 
Increase in cash surrender value of life insurance   (401)   (250)
Stock compensation expense   384    412 
Loss on sale or write-down of assets, net   6    5 
Gain on sale of loans held for sale, net   (553)   (517)
Proceeds from sale of loans held for sale   39,269    29,128 
Origination of loans held for sale   (38,857)   (28,114)
Net change in:          
Accrued interest receivable and other assets   (377)   260 
Accrued interest payable and other liabilities   (904)   (2,531)
Net cash provided by operating activities   6,896    2,041 
Cash Flows From Investing Activities:          
Net (increase) decrease in certificates of deposit in other banks   749    (747)
Purchases of securities AFS   (48,222)   (4,908)
Proceeds from calls and maturities of securities AFS   11,133    5,382 
Proceeds from sales of other investments   5,829    - 
Purchase of other investments   -    (39)
Net increase in loans   (44,795)   (11,114)
Net (increase) decrease in premises and equipment   344    (933)
Proceeds from sales of other real estate and other assets   224    27 
Net cash paid in business combination   -    (206)
Net cash used by investing activities   (74,738)   (12,538)
Cash Flows From Financing Activities:          
Net increase (decrease) in deposits   (23,715)   25,055 
Net increase in short-term borrowings   6,000    - 
Repayments of notes payable   -    (68)
Purchase and retirement of common stock   (79)   (30)
Proceeds from issuance of common stock, net   812    135 
Cash dividends paid on preferred stock   -    (31)
Net cash provided (used) by financing activities   (16,982)   25,061 
Net increase (decrease) in cash and cash equivalents   (84,824)   14,564 
Cash and cash equivalents:          
Beginning  $129,103   $83,619 
Ending  $44,279   $98,183 
Supplemental Disclosures of Cash Flow Information:          
Cash paid for interest  $1,938   $1,683 
Cash paid for taxes   -    1,850 
Transfer of loans and bank premises to other real estate owned   513    33 
Capitalized mortgage servicing rights   185    43 
Transfer of loans from held for sale to held for investment   3,236    - 
Acquisition: Fair value of assets acquired (including intangibles), net   -    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, 2016.

 

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 and 2016 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, 2016.

 

Recent Accounting Developments Adopted

 

In December 2016, the Financial Accounting Standards Board (“FASB”) issued updated guidance to Accounting Standards Update (“ASU”) 2016-19 Technical Corrections and Improvements intended to make changes to clarify the Accounting Standards Codification or correct unintended application of guidance that is not expected to have a significant effect on current accounting practice. The ASU is effective for annual periods, including interim periods within those annual periods, beginning after December 15, 2016. The impact of the new guidance did not have a material impact on the Company’s consolidated financial statements.

 

In March 2016, the FASB issued updated guidance to ASU 2016-09: Stock Compensation Improvements to Employee Share-Based Payment Activity intended to simplify and improve several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of such awards as either equity or liabilities and classification on the statement of cash flows. The updated guidance is effective for interim and annual reporting periods beginning after December 15, 2016. The consolidated financial statements include the impact of the new guidance. The Company adopted the pronouncement as required on January 1, 2017, prospectively, which included a reduction to income tax expense of $0.1 million in the three months ended March 31, 2017 for deductions attributable to exercised stock options and vesting of restricted stock.

 

8 

 

 

Note 1 – Basis of Presentation, continued

 

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 2016 consolidated financial statements have been reclassified to conform to the 2017 presentation.

 

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 “Baylake 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 “Bank”). The system integration was completed, and 21 branches of Baylake opened, on May 2, 2016, as branches of the Bank, expanding its presence into Door, Kewaunee, and Manitowoc Counties, Wisconsin. The Company closed one of its Brown County locations concurrently with the Baylake merger, and closed an additional six branches in the fourth quarter of 2016.

 

The purpose of the Baylake merger was for strategic reasons beneficial to the Company. The acquisition was 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 Baylake 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 as defined in the Baylake Merger Agreement), 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 estimated 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 may 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.

 

9 

 

 

Note 2 – Acquisitions, continued

 

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 

 

The following unaudited pro forma information presents the results of operations for three months ended March 31, 2016 as if the acquisition had occurred January 1, 2016. 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 the period presented, nor are they intended to represent or be indicative of future results of operations.

 

   Three Months Ended 
   March 31, 2016 
(in thousands, except per share data)     
Total revenues, net of interest expense  $26,603 
Net income   5,871 
Diluted earnings per share   0.63 

 

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.

 

10 

 

 

Note 3 – Earnings per Common Share, continued

 

   Three Months Ended
 March 31,
 
   2017   2016 
(In thousands except per share data)        
Net income, net of noncontrolling interest  $6,208   $2,654 
Less: preferred stock dividends   -    112 
Net income available to common shareholders  $6,208   $2,542 
Weighted average common shares outstanding   8,584    4,182 
Effect of dilutive stock instruments   374    274 
Diluted weighted average common shares outstanding   8,958    4,456 
Basic earnings per common share*  $0.72   $0.61 
Diluted earnings per common share*  $0.69   $0.57 

 

*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, 2017 and March 31, 2016.

 

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 for the year ended December 31, 2016. There were no options granted during the three months ended March 31, 2017.

 

   Year ended
December 31, 2016
 
Dividend yield   0%
Expected volatility   25%
Risk-free interest rate   1.52%
Expected average life   7 years 
Weighted average per share fair value of options  $11.04 

 

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, 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*        (84,723)   20.98      
Forfeited        (1,456)   21.71      
Balance – December 31, 2016        922,026    24.39    439,639 
Granted  $0.00    -    -      
Exercise of stock options*        (48,583)   18.31      
Forfeited        (400)   16.50      
Balance – March 31, 2017        873,043   $24.73    421,455 

 

*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, and accordingly 2,697 shares were surrendered during the three months ended March 31, 2017 and 10,244 shares were surrendered during the year ended December 31, 2016. These stock options were considered exercised and then surrendered and are included in the Exercise of stock option line.

 

11 

 

 

Note 4 – Stock-based Compensation, continued

 

Options outstanding at March 31, 2017 are exercisable at option prices ranging from $9.19 to $38.10. There are 263,400 options outstanding in the range from $9.19 - $20.00, 247,165 options outstanding in the range of $20.01 - $25.00, 157,724 options outstanding in the range of $25.01 - $30.00, and 204,754 options outstanding in the range from $30.01 - $38.10. At March 31, 2017, the exercisable options have a weighted average remaining contractual life of approximately five years and a weighted average exercise price of $20.63.

 

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 2017, and full year of 2016 was approximately $1.2 million, and $1.3 million, respectively.

 

Restricted Stock  Weighted-
Average Grant
Date Fair Value
   Restricted
Shares
Outstanding
 
Balance – December 31, 2015  $18.70    36,690 
Granted   33.68    31,466 
Vested*   23.58    (25,207)
Forfeited   -    - 
Balance – December 31, 2016   26.80    42,949 
Granted   -    - 
Vested *   31.45    (6,134)
Forfeited   16.50    (130)
Balance – March 31, 2017  $24.30    36,685 

 

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, 1,639 shares were surrendered during the three months ended March 31, 2017 and 7,851 shares were surrendered during the year ended December 31, 2016.

 

The Company recognized approximately $384,000 and $412,000 of stock-based employee compensation expense during the three months ended March 31, 2017 and 2016, respectively, associated with its stock equity awards. As of March 31, 2017, there was approximately $4.1 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:

 

   March 31, 2017 
(in thousands)  Amortized Cost   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
   Fair Value 
U.S. government agency securities  $28,065   $14   $109   $27,970 
State, county and municipals   187,182    263    2,888    184,557 
Mortgage-backed securities   154,908    258    1,788    153,378 
Corporate debt securities   33,174    203    57    33,320 
Equity securities   2,631    2,502    -    5,133 
   $405,960   $3,240   $4,842   $404,358 

 

   December 31, 2016 
(in thousands)  Amortized Cost   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
   Fair Values 
U.S. government agency securities  $1,981   $-   $18   $1,963 
State, county and municipals   191,721    160    4,638    187,243 
Mortgage-backed securities   161,309    242    2,422    159,129 
Corporate debt securities   12,117    52    -    12,169 
Equity securities   2,631    2,152    -    4,783 
   $369,759   $2,606   $7,078   $365,287 

 

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 March 31, 2017 and December 31, 2016.

 

   March 31, 2017 
   Less than 12 months   12 months or more   Total 
(in thousands)  Fair Value   Unrealized
Losses
   Fair Value   Unrealized
Losses
   Fair Value   Unrealized
Losses
 
U.S. government agency securities  $17,731   $109   $-   $-   $17,731   $109 
State, county and municipals   137,200    2,883    892    5    138,092    2,888 
Mortgage-backed securities   127,408    1,697    3,555    91    130,963    1,788 
Corporate debt securities   12,123    57    -    -    12,123    57 
   $294,462   $4,746   $4,447   $96   $298,909   $4,842 

 

   December 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
 
U.S. government agency securities  $1,963   $18   $-   $-   $1,963   $18 
State, county and municipals   167,457    4,629    1,300    9    168,757    4,638 
Mortgage-backed securities   134,770    2,311    3,653    111    138,423    2,422 
   $304,190   $6,958   $4,953   $120   $309,143   $7,078 

 

At March 31, 2017, the Company had $4.8 million of gross unrealized losses related to 499 securities. As of March 31, 2017, 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 three-month periods ending March 31, 2017 or 2016.

 

The amortized cost and fair values of securities available for sale at March 31, 2017 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, 2017 
(in thousands)  Amortized Cost   Fair Value 
Due in less than one year  $14,086   $14,088 
Due in one year through five years   92,851    92,808 
Due after five years through ten years   132,282    129,623 
Due after ten years   9,202    9,328 
    248,421    245,847 
Mortgage-backed securities   154,908    153,378 
Equity securities   2,631    5,133 
Securities available for sale  $405,960   $404,358 

 

There were no sales of securities during the first three months of 2017 or 2016.

 

13 

 

 

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

 

The loan composition as of March 31, 2017 and December 31, 2016 is summarized as follows.

 

   Total 
   March 31, 2017   December 31, 2016 
(in thousands)  Amount   % of
Total
   Amount   % of
Total
 
Commercial & industrial  $468,265    29.0%  $428,270    27.3%
Owner-occupied commercial real estate (“CRE”)   368,607    22.8    360,227    23.0 
Agricultural (“AG”) production   35,037    2.2    34,767    2.2 
AG real estate   48,499    3.0    45,234    2.9 
CRE investment   191,274    11.8    195,879    12.5 
Construction & land development   75,964    4.7    74,988    4.8 
Residential construction   18,390    1.1    23,392    1.5 
Residential first mortgage   304,479    18.8    300,304    19.1 
Residential junior mortgage   92,880    5.7    91,331    5.8 
Retail & other   14,884    0.9    14,515    0.9 
Loans  $1,618,279    100.0%  $1,568,907    100.0%
Less allowance for loan losses   12,189         11,820      
Loans, net  $1,606,090        $1,557,087      
Allowance for loan losses to loans   0.75%        0.75%     
                     

   Originated 
   March 31, 2017   December 31, 2016 
(in thousands)  Amount   % of
Total
   Amount   % of
Total
 
Commercial & industrial  $374,881    38.0%  $330,073    36.6%
Owner-occupied CRE   197,110    20.0    182,776    20.3 
AG production   9,183    0.9    9,192    1.0 
AG real estate   22,408    2.3    18,858    2.1 
CRE investment   77,548    7.9    72,930    8.1 
Construction & land development   47,633    4.8    44,147    4.9 
Residential construction   17,373    1.8    20,768    2.3 
Residential first mortgage   176,006    17.9    164,949    18.3 
Residential junior mortgage   51,975    5.3    48,199    5.3 
Retail & other   10,938    1.1    10,095    1.1 
Loans  $985,055    100.0%  $901,987    100.0%
Less allowance for loan losses   9,861         9,449      
Loans, net  $975,194        $892,538      
Allowance for loan losses to loans   1.00%        1.05%     
                     

   Acquired 
   March 31, 2017   December 31, 2016 
(in thousands)  Amount   % of
Total
   Amount   % of
Total
 
Commercial & industrial  $93,384    14.7%  $98,197    14.7%
Owner-occupied CRE   171,497    27.1    177,451    26.6 
AG production   25,854    4.1    25,575    3.8 
AG real estate   26,091    4.1    26,376    4.0 
CRE investment   113,726    18.0    122,949    18.4 
Construction & land development   28,331    4.5    30,841    4.6 
Residential construction   1,017    0.2    2,624    0.4 
Residential first mortgage   128,473    20.3    135,355    20.3 
Residential junior mortgage   40,905    6.4    43,132    6.5 
Retail & other   3,946    0.6    4,420    0.7 
Loans  $633,224    100.0%  $666,920    100.0%
Less allowance for loan losses   2,328         2,371      
Loans, net  $630,896        $664,549      
Allowance for loan losses to loans   0.37%        0.36%     

 

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 three months ended March 31, 2017:

 

   TOTAL – Three Months Ended March 31, 2017 
(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  $3,919   $2,867   $150   $285   $1,124   $774   $304   $1,784   $461   $152   $11,820 
Provision   531    (45)   (2)   10    16    16    (169)   52    2    39    450 
Charge-offs   (75)   -    -    -    -    (13)   -    -    -    (23)   (111)
Recoveries   11    13    -    -    -    -    -    3    1    2    30 
Net charge-offs   (64)   13    -    -    -    (13)   -    3    1    (21)   (81)
Ending balance  $4,386   $2,835   $148   $295   $1,140   $777   $135   $1,839   $464   $170   $12,189 
As percent of ALLL   35.9%   23.3%   1.2%   2.4%   9.4%   6.4%   1.1%   15.1%   3.8%   1.4%   100.0%
                                                        
ALLL:                                                       
Individually evaluated  $-   $-   $-   $-   $-   $-   $-   $-   $-   $-   $- 
Collectively evaluated   4,386    2,835    148    295    1,140    777    135    1,839    464    170    12,189 
Ending balance  $4,386   $2,835   $148   $295   $1,140   $777   $135   $1,839   $464   $170   $12,189 
                                                        
Loans:                                                       
Individually evaluated  $335   $2,445   $39   $229   $6,957   $449   $97   $1,886   $293   $-   $12,730 
Collectively evaluated   467,930    366,162    34,998    48,270    184,317    75,515    18,293    302,593    92,587    14,884    1,605,549 
Total loans  $468,265   $368,607   $35,037   $48,499   $191,274   $75,964   $18,390   $304,479   $92,880   $14,884   $1,618,279 
                                                        
Less ALLL  $4,386   $2,835   $148   $295   $1,140   $777   $135   $1,839   $464   $170   $12,189 
Net loans  $463,879   $365,772   $34,889   $48,204   $190,134   $75,187   $18,255   $302,640   $92,416   $14,714   $1,606,090 

 

15 

 

 

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

 

   Originated – Three Months Ended March 31, 2017 
(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  $3,150   $2,263   $122   $222   $893   $656   $266   $1,372   $373   $132   $9,449 
Provision   517    (7)   1    5    24    6    (160)   66    4    38    494 
Charge-offs   (75)   -    -    -    -    -    -    -    -    (23)   (98)
Recoveries   -    12    -    -    -    -    -    1    1    2    16 
Net charge-offs   (75)   12    -    -    -    -    -    1    1    (21)   (82)
Ending balance  $3,592   $2,268   $123   $227   $917   $662   $106   $1,439   $378   $149   $9,861 
As percent of ALLL   36.4%   23.0%   1.3%   2.3%   9.3%   6.7%   1.1%   14.6%   3.8%   1.5%   100.0%
                                                        
ALLL:                                                       
Individually evaluated  $-   $-   $-   $-   $-   $-   $-   $-   $-   $-   $- 
Collectively evaluated   3,592    2,268    123    227    917    662    106    1,439    378    149    9,861 
Ending balance  $3,592   $2,268   $123   $227   $917   $662   $106   $1,439   $378   $149   $9,861 
                                                        
Loans:                                                       
Individually evaluated  $-   $-   $-   $-   $-   $-   $-   $-   $-   $-   $- 
Collectively evaluated   374,881    197,110    9,183    22,408    77,548    47,633    17,373    176,006    51,975    10,938    985,055 
Total loans  $374,881   $197,110   $9,183   $22,408   $77,548   $47,633   $17,373   $176,006   $51,975   $10,938   $985,055 
                                                        
Less ALLL  $3,592   $2,268   $123   $227   $917   $662   $106   $1,439   $378   $149   $9,861 
Net loans  $371,289   $194,842   $9,060   $22,181   $76,631   $46,971   $17,267   $174,567   $51,597   $10,789   $975,194 

  

   Acquired – Three Months Ended March 31, 2017 
(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  $769   $604   $28   $63   $231   $118   $38   $412   $88   $20   $2,371 
Provision   14    (38)   (3)   5    (8)   10    (9)   (14)   (2)   1    (44)
Charge-offs   -    -    -    -    -    (13)   -    -    -    -    (13)
Recoveries   11    1    -    -    -    -    -    2    -    -    14 
Net charge-offs   11    1    -    -    -    (13)   -    2    -    -    1 
Ending balance  $794   $567   $25   $68   $223   $115   $29   $400   $86   $21   $2,328 
As percent of ALLL   34.1%   24.4%   1.1%   2.9%   9.6%   4.9%   1.2%   17.2%   3.7%   0.9%   100.0%
                                                        
Loans:                                                       
Individually evaluated  $335   $2,445   $39   $229   $6,957   $449   $97   $1,886   $293   $-   $12,730 
Collectively evaluated   93,049    169,052    25,815    25,862    106,769    27,882    920    126,587    40,612    3,946    620,494 
Total loans  $93,384   $171,497   $25,854   $26,091   $113,726   $28,331   $1,017   $128,473   $40,905   $3,946   $633,224 
                                                        
Less ALLL  $794   $567   $25   $68   $223   $115   $29   $400   $86   $21   $2,328 
Net loans  $92,590   $170,930   $25,829   $26,023   $113,503   $28,216   $988   $128,073   $40,819   $3,925   $630,896 

 

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 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%   100.0%
                                                        
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 

 

   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%   100.0%
                                                        
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 

 

17 

 

 

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

 

   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%   100.0%
                                                        
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 

 

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 March 31, 2017 and December 31, 2016.

 

   Total Nonaccrual Loans 
(in thousands)  March 31, 2017   % to Total   December 31, 2016   % to Total 
Commercial & industrial  $352    2.6%  $358    1.8%
Owner-occupied CRE   2,612    19.0    2,894    14.3 
AG production   4    -    9    0.1 
AG real estate   197    1.4    208    1.0 
CRE investment   6,662    48.6    12,317    60.6 
Construction & land development   924    6.7    1,193    5.9 
Residential construction   97    0.7    260    1.3 
Residential first mortgage   2,666    19.4    2,990    14.7 
Residential junior mortgage   219    1.6    56    0.3 
Retail & other   2    -    -    - 
Nonaccrual loans – Total  $13,735    100.0%  $20,285    100.0%

 

   Originated 
(in thousands)  March 31, 2017   % to Total   December 31, 2016   % to Total 
Commercial & industrial  $3    1.2%  $4    1.6%
Owner-occupied CRE   41    16.9    42    16.3 
AG production   4    1.7    7    2.7 
AG real estate   -    -    -    - 
CRE investment   -    -    -    - 
Construction & land development   -    -    -    - 
Residential construction   -    -    -    - 
Residential first mortgage   194    80.2    204    79.4 
Residential junior mortgage   -    -    -    - 
Retail & other   -    -    -    - 
Nonaccrual loans – Originated  $242    100.0%  $257    100.0%

 

   Acquired 
(in thousands)  March 31, 2017   % to Total   December 31, 2016   % to Total 
Commercial & industrial  $349    2.6%  $354    1.8%
Owner-occupied CRE   2,571    19.1    2,852    14.2 
AG production   -    -    2    0.1 
AG real estate   197    1.5    208    1.0 
CRE investment   6,662    49.4    12,317    61.4 
Construction & land development   924    6.8    1,193    6.0 
Residential construction   97    0.7    260    1.3 
Residential first mortgage   2,472    18.3    2,786    13.9 
Residential junior mortgage   219    1.6    56    0.3 
Retail & other   2    -    -    - 
Nonaccrual loans – Acquired  $13,493    100.0%  $20,028    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 March 31, 2017 and December 31, 2016:

   March 31, 2017 
(in thousands)  30-89 Days
Past Due
(accruing)
   90 Days &
Over or
nonaccrual
   Current   Total 
Commercial & industrial  $80   $352   $467,833   $468,265 
Owner-occupied CRE   484    2,612    365,511    368,607 
AG production   -    4    35,033    35,037 
AG real estate   -    197    48,302    48,499 
CRE investment   -    6,662    184,612    191,274 
Construction & land development   -    924    75,040    75,964 
Residential construction   -    97    18,293    18,390 
Residential first mortgage   155    2,666    301,658    304,479 
Residential junior mortgage   263    219    92,398    92,880 
Retail & other   2    2    14,880    14,884 
Total loans  $984   $13,735   $1,603,560   $1,618,279 
As a percent of total loans   0.1%   0.8%   99.1%   100.0%

 

   December 31, 2016 
(in thousands) 

30-89 Days
Past Due
(accruing)

   90 Days &
Over or
nonaccrual
   Current   Total 
Commercial & industrial  $22   $358   $427,890   $428,270 
Owner-occupied CRE   268    2,894    357,065    360,227 
AG production   -    9    34,758    34,767 
AG real estate   -    208    45,026    45,234 
CRE investment   -    12,317    183,562    195,879 
Construction & land development   -    1,193    73,795    74,988 
Residential construction   -    260    23,132    23,392 
Residential first mortgage   486    2,990    296,828    300,304 
Residential junior mortgage   200    56    91,075    91,331 
Retail & other   15    -    14,500    14,515 
Total loans  $991   $20,285   $1,547,631   $1,568,907 
As a percent of total loans   0.1%   1.3%   98.6%   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 March 31, 2017 and December 31, 2016:

 

   March 31, 2017 
(in thousands)  Grades 1- 4   Grade 5   Grade 6   Grade 7   Grade 8   Grade 9   Total 
Commercial & industrial  $434,714   $20,929   $3,434   $9,188   $-   $-   $468,265 
Owner-occupied CRE   348,900    14,758    186    4,763    -    -    368,607 
AG production   29,529    4,968    66    474    -    -    35,037 
AG real estate   42,052    5,695    -    752    -    -    48,499 
CRE investment   175,108    7,895    -    8,271    -    -    191,274 
Construction & land development   70,749    3,914    -    1,301    -    -    75,964 
Residential construction   16,542    1,751    -    97    -    -    18,390 
Residential first mortgage   299,773    1,194    190    3,322    -    -    304,479 
Residential junior mortgage   92,537    -    -    343    -    -    92,880 
Retail & other   14,882    -    -    2    -    -    14,884 
Total loans  $1,524,786   $61,104   $3,876   $28,513   $-   $-   $1,618,279 
Percent of total   94.2%   3.8%   0.2%   1.8%   -    -    100.0%

 

   December 31, 2016 
(in thousands)  Grades 1- 4   Grade 5   Grade 6   Grade 7   Grade 8   Grade 9   Total 
Commercial & industrial  $401,954   $16,633   $2,133   $7,550   $-   $-   $428,270 
Owner-occupied CRE   340,846    14,758    193    4,430    -    -    360,227 
AG production   31,026    3,191    70    480    -    -    34,767 
AG real estate   41,747    2,727    -    760    -    -    45,234 
CRE investment   173,652    8,137    -    14,090    -    -    195,879 
Construction & land development   69,097    4,318    -    1,573    -    -    74,988 
Residential construction   22,030    1,102    -    260    -    -    23,392 
Residential first mortgage   295,109    1,348    192    3,655    -    -    300,304 
Residential junior mortgage   91,123    -    114    94    -    -    91,331 
Retail & other   14,515    -    -    -    -    -    14,515 
Total loans  $1,481,099   $52,214   $2,702   $32,892   $-   $-   $1,568,907 
Percent of total   94.4%   3.3%   0.2%   2.1%   -    -    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 March 31, 2017 and December 31, 2016.

 

   Total Impaired Loans – March 31, 2017 
(in thousands)  Recorded
Investment
   Unpaid
Principal
Balance
   Related
Allowance
   Average
Recorded
Investment
   Interest Income
Recognized
 
Commercial & industrial  $335   $600   $-   $338   $6 
Owner-occupied CRE   2,445    4,349    -    2,499    62 
AG production   39    98    -    39    1 
AG real estate   229    320    -    234    12 
CRE investment   6,957    12,315    -    7,087    159 
Construction & land development   449    1,877    -    571    28 
Residential construction   97    1,000    -    108    13 
Residential first mortgage   1,886    3,204    -    1,907    35 
Residential junior mortgage   293    617    -    296    3 
Retail & Other   -    31    -    -    - 
Total  $12,730   $24,411   $-   $13,079   $319 

 

There were no originated impaired loans as of March 31, 2017. All loans in the table above were acquired loans.

 

   Total Impaired Loans – December 31, 2016 
(in thousands)  Recorded
Investment
   Unpaid
Principal
Balance
   Related
Allowance
   Average
Recorded
Investment
   Interest Income
Recognized
 
Commercial & industrial  $338   $720   $-   $348   $34 
Owner-occupied CRE   2,588    4,661    -    2,700    271 
AG production   41    163    -    48    6 
AG real estate   240    332    -    245    26 
CRE investment   12,552    19,695    -    12,982    1,051 
Construction & land development   694    2,122    -    752    112 
Residential construction   261    1,348    -    287    82 
Residential first mortgage   2,204    3,706    -    2,312    190 
Residential junior mortgage   299    639    -    209    17 
Retail & Other   -    36    -    -    - 
Total  $19,217   $33,422   $-   $19,883   $1,789 

 

There were no originated impaired loans as of December 31, 2016. All loans in the table above were acquired loans.

 

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 $13.9 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 $26.1 million non-accretable mark and a zero accretable mark. At March 31, 2017, $12.3 million of the $37.5 million remain in impaired loans and $0.4 million of acquired loans have subsequently become impaired, bringing acquired impaired loans to $12.7 million.

 

Non-accretable discount on purchase credit impaired (“PCI”) loans:  Three
months
ended
   Year ended 
(in thousands)  March 31,
2017
   December 31,
2016
 
Balance at beginning of period  $14,327   $4,229 
Acquired balance   -    13,923 
Reclassifications from (to) non-accretable   -    - 
Accretion to loan interest income   (2,160)   (3,458)
Disposals of loans   (242)   (367)
Balance at end of period  $11,925   $14,327 

 

22 

 

 

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

 

Troubled Debt Restructurings

 

At March 31, 2017, there were four loans classified as troubled debt restructurings totaling $796,000. These four loans had a combined pre-modification balance of $1,280,000 and a combined outstanding balance of $796,000 at March 31, 2017. There were no other loans which were modified and classified as troubled debt restructurings at March 31, 2017. There were no loans classified as troubled debt restructurings during the previous twelve months that subsequently defaulted as of March 31, 2017. As of March 31, 2017 there were no commitments to lend additional funds to debtors whose terms have been modified in troubled debt restructurings.

 

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). 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 quarterly assessment indicated no impairment charge on goodwill, core deposit intangible or customer list intangible was required for 2016 or the first three months of 2017.

 

Goodwill: Goodwill was $66.7 million at March 31, 2017 and December 31, 2016. 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 core deposit intangibles and to customer list intangibles. See Note 2 for additional information on the 2016 acquisitions.

 

(in thousands)  At or for the three
months ended
March 31, 2017
   At or for the year
ended
December 31, 2016
 
Core deposit intangibles:          
Gross carrying amount  $25,345   $25,345 
Accumulated amortization   (9,310)   (8,244)
Net book value  $16,035   $17,101 
Additions during the period  $-   $17,259 
Amortization during the period  $1,066   $3,189 
           
Other intangibles:          
Gross carrying amount  $4,363   $4,363 
Accumulated amortization   (365)   (269)
Net book value  $3,998   $4,094 
Additions during the period  $-   $4,363 
Amortization during the period  $96   $269 

 

Mortgage servicing rights: 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. Activity in the mortgage servicing rights asset for 2016 and the three months ended March 31, 2017 was as follows:

 

23 

 

 

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

 

   Three Months Ended   Year Ended 
(in thousands)  March 31, 2017   December 31, 2016 
Mortgage servicing rights (MSR) asset:          
Balance at beginning of year    $ 1,922   $193 
Additions during the period*   185    1,908 
Amortization during the period   (83)   (179)
Valuation allowance at end of period   -    - 
Net book value at end of period  $2,024   $1,922 
*Purchased MSR asset included in period  $-   $885 
           
Fair value of MSR asset at end of period  $2,401   $2,013 
Residential mortgage loans serviced for others  $304,888   $295,353 
Net book value of MSR asset to loans serviced for others   0.66%   0.65%

 

The Company periodically evaluates its mortgage servicing rights asset for impairment. At each reporting date, impairment is assessed based on an 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). No valuation or impairment charge was recorded for the 2016 or 2017 periods.

 

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 March 31, 2017. 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,               
2017 (remaining nine months)  $2,739   $289   $252 
2018   3,254    385    336 
2019   2,762    385    336 
2020   2,156    385    400 
2021   1,763    385    204 
Thereafter   3,361    2,169    496 
Total  $16,035   $3,998   $2,024 

 

Note 8 - Notes Payable

 

The Company had the following long-term notes payable:

 

(in thousands)  March 31, 2017   December 31, 2016 
Federal Home Loan Bank (“FHLB”) advances  $1,000   $1,000 
Notes payable  $1,000   $1,000 

 

The Company’s FHLB advance is at a fixed rate, requires interest-only monthly payments, and has a maturity of February 2018. The weighted average rates of FHLB advances were 1.17% at both March 31, 2017 and December 31, 2016. 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 $284.7 million and $283.8 million at March 31, 2017 and December 31, 2016, respectively.

 

The following table shows the maturity schedule of the notes payable as of March 31, 2017:

 

Maturing in  (in thousands) 
2017  $- 
2018   1,000 
   $1,000 

 

24 

 

 

Note 8 - Notes Payable, continued

 

The Company has a $10 million line of credit with a third party bank bearing a variable rate of interest based on one-month LIBOR plus a margin, but subject to a floor rate, with quarterly payments of interest only. At March 31, 2017, the available line was $10 million, the rate was one-month LIBOR plus 2.25% with a 3.25% floor. The outstanding balance was zero at March 31, 2017 and December 31, 2016, and the line was not used in 2017 or 2016.

 

Note 9 - Junior Subordinated Debentures

 

At March 31, 2017 and December 31, 2016, the Company’s carrying value of junior subordinated debentures was $24.8 million and $24.7 million, respectively. At March 31, 2017 and December 31, 2016, $23.8 million and $23.7 million, respectively, of trust preferred securities qualify as Tier 1 capital.

 

In July 2004, Nicolet Bankshares Statutory Trust I (the “Nicolet Trust”) issued $6.0 million of guaranteed preferred beneficial interests (“trust preferred securities”) in the Company’s junior subordinated deferrable interest debentures that qualify as Tier 1 capital under Federal Reserve Board guidelines. All of the common securities of the Nicolet Trust are owned by the Company. The proceeds from the common securities and trust preferred securities were used by the Nicolet Trust to purchase $6.2 million of junior subordinated debentures (the “debentures”) of the Company. The trust preferred securities and debentures pay an 8% fixed rate. The proceeds received by the Company from the sale of the debentures were used for general purposes, primarily to provide capital to the Bank. The Company has the right to redeem the debentures, in whole or in part, on or after July 15, 2009. If the debentures are redeemed prior to maturity, the redemption price will be the principal amount and any accrued but unpaid interest. The maturity date of the debentures, if not redeemed, is July 15, 2034. Interest on the debentures is current.

 

In April 2013, as part of the Mid-Wisconsin Financial Services, Inc. (“Mid-Wisconsin”) acquisition, the Company assumed $10.3 million of junior subordinated debentures issued in December 2005 by Mid-Wisconsin, related to $10.0 million of trust preferred securities issued by a statutory trust, whose common securities were wholly owned by Mid-Wisconsin. These trust preferred securities and 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 interest rates were 2.56% and 2.39% as of March 31, 2017 and December 31, 2016, respectively. The debentures may be called at par plus any accrued but unpaid interest, in part or in full, on or after December 15, 2010. At acquisition the debentures were recorded at an initial fair market value of $5.8 million, with the initial $4.5 million discount being accreted to interest expense over the remaining life of the debentures. At March 31, 2017, the carrying value of these junior debentures was $6.6 million.

 

As part of the 2016 acquisition of Baylake, the Company assumed $16.6 million of junior subordinated debentures related to $16.1 million of issued trust preferred securities. The trust preferred securities and the debentures mature on September 30, 2036 and have a floating rate of three-month LIBOR plus 1.35% adjusted quarterly. Interest on these debentures is current. The interest rates were 2.50% and 2.35% as of March 31, 2017 and December 31, 2016, respectively. The debentures may be redeemed on any interest payment date at par in part or in full, on or after June 30, 2011. At acquisition in April 2016 the debentures were recorded at fair value of $11.8 million, with the discount being accreted to interest expense over the remaining life of the debentures. At March 31, 2017, the carrying value of these junior debentures was $12.1 million.

 

The debentures represent the sole asset of the respective statutory trusts. The statutory trusts are not included in the consolidated financial statements. The net effect of all the documents entered into with respect to the trust preferred securities is that the Company, through payment on its debentures, is liable for the distributions and other payments required on the trust preferred securities.

 

Note 10 – 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. At March 31, 2017, the carrying value of these subordinated Notes was $11.9 million.

 

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, 2017 and December 31, 2016, $106,000 and $115,000, respectively, of unamortized debt issuance costs remain and are reflected as a deduction to the carrying value of the outstanding debt.

 

25 

 

 

Note 11 - 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.

 

The following table presents the balances of assets and liabilities measured at fair value on a recurring basis for the periods presented. Two securities classified as Level 3 had a change in fair value during the first quarter of 2017. There were no other changes in Level 3 values to report during the first three months of 2017.

 

       Fair Value Measurements Using 
Measured at Fair Value on a Recurring Basis:  Total   Level 1   Level 2   Level 3 
(in thousands)                    
U.S. government agency securities  $27,970   $-   $27,970   $- 
State, county and municipals   184,557    -    184,031    526 
Mortgage-backed securities   153,378    -    153,378    - 
Corporate debt securities   33,320    -    24,773    8,547 
Equity securities   5,133    5,133    -    - 
Securities AFS, March 31, 2017  $404,358   $5,133   $390,152   $9,073 
                     
(in thousands)                    
U.S. government agency securities  $1,963   $-   $1,963   $- 
State, county and municipals   187,243    -    186,717    526 
Mortgage-backed securities   159,129    -    159,076    53 
Corporate debt securities   12,169    -    3,640    8,529 
Equity securities   4,783    4,783    -    - 
Securities AFS, December 31, 2016  $365,287   $4,783   $351,396   $9,108 

 

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 corporate debt securities, which include trust preferred security investments. At March 31, 2017 and December 31, 2016, 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.

 

26 

 

 

Note 11 - Fair Value Measurements, continued

 

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, 2017:                    
Impaired loans  $12,730   $-   $-   $12,730 
OREO   2,298    -    -    2,298 
December 31, 2016:                    
Impaired loans  $19,217   $-   $-   $19,217 
OREO   2,059    -    -    2,059 

 

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, 2017 and December 31, 2016 are shown below.

 

March 31, 2017
(in thousands)  Carrying
Amount
   Estimated
Fair Value
   Level 1   Level 2   Level 3 
Financial assets:                         
Cash and cash equivalents  $44,279   $44,279   $44,279   $-   $- 
Certificates of deposit in other banks   3,235    3,228    -    3,228    - 
Securities AFS   404,358    404,358    5,133    390,152    9,073 
Other investments   11,670    11,670    -    9,950    1,720 
Loans held for sale   3,818    3,880    -    3,880    - 
Loans, net   1,606,090    1,624,157    -    -    1,624,157 
BOLI   54,535    54,535    54,535    -    - 
MSR asset   2,024    2,401    -    -    2,401 
                          
Financial liabilities:                         
Deposits  $1,946,271   $1,945,906   $-   $-   $1,945,906 
Short-term borrowings   6,000    6,000    6,000    -    - 
Notes payable   1,000    1,001    -    1,001    - 
Junior subordinated debentures   24,840    24,201    -    -    24,201 
Subordinated notes   11,894    11,399    -    -    11,399 

 

December 31, 2016
(in thousands)  Carrying
Amount
   Estimated
Fair Value
   Level 1   Level 2   Level 3 
Financial assets:                         
Cash and cash equivalents  $129,103   $129,103   $129,103   $-   $- 
Certificates of deposit in other banks   3,984    3,992    -    3,992    - 
Securities AFS   365,287    365,287    4,783    351,396    9,108 
Other investments   17,499    17,499    -    15,779    1,720 
Loans held for sale   6,913    6,968    -    6,968    - 
Loans, net   1,557,087    1,568,676    -    -    1,568,676 
BOLI   54,134    54,134    54,134    -    - 
MSR asset   1,922    2,013    -    -    2,013 
                          
Financial liabilities:                         
Deposits  $1,969,986   $1,969,973   $-   $-   $1,969,973 
Notes payable   1,000    1,002    -    1,002    - 
Junior subordinated debentures   24,732    24,095    -    -    24,095 
Subordinated notes   11,885    11,459    -    -    11,459 

 

27 

 

 

Note 11 - Fair Value Measurements, continued

 

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, short-term borrowings, 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.

 

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.

 

MSR asset: To estimate the fair value of the MSR asset, the underlying serviced loan pools are stratified by interest rate tranche and term of the loan, and a valuation model is used to calculate the present value of expected future cash flows for each stratum. When the carrying value of the MSR asset related to a stratum exceeds its fair value, the stratum is recorded at fair value, generally through a valuation allowance. The valuation model incorporates assumptions that market participants would use in estimating future net servicing income, such as costs to service, a discount rate, ancillary income, default rates and losses, and prepayment speeds. Although some of these assumptions are based on observable market data, other assumptions are based on unobservable estimates of what market participants would use to measure fair value. As a result, the fair value measurement of mortgage servicing rights is considered a Level 3 measurement and represents an income approach to fair value.

 

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, 2017 and December 31, 2016 was insignificant. Loan commitments on which the committed interest rate is less than the current market rate are also insignificant at March 31, 2017 and December 31, 2016.

 

28 

 

  

Note 11 - Fair Value Measurements, continued

 

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 a