UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.
For the quarterly period ended March 31, 2016
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ___________ to ___________
Commission file number 001-37700
NICOLET BANKSHARES, INC.
(Exact name of registrant as specified in its charter)
WISCONSIN
(State or other jurisdiction of incorporation or organization)
47-0871001
(I.R.S. Employer Identification No.)
111 North Washington Street
Green Bay, Wisconsin 54301
(920) 430-1400
(Address, including zip code, and telephone number, including area code, of
Registrant’s principal executive offices)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Date File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
As of April 28, 2016 there were 4,254,126 shares of $0.01 par value common stock outstanding.
Nicolet Bankshares, Inc.
TABLE OF CONTENTS
Consolidated Balance Sheets
March 31, 2016 (unaudited) and December 31, 2015
Consolidated Statements of Income
Three Months Ended March 31, 2016 and 2015 (unaudited)
Consolidated Statements of Comprehensive Income
Consolidated Statement of Changes in Stockholders’ Equity
Three Months Ended March 31, 2016 (unaudited)
Consolidated Statements of Cash Flows
PART I – FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS:
NICOLET BANKSHARES, INC. AND SUBSIDIARIES
(In thousands, except share and per share data)
March 31, 2016
(Unaudited)
See accompanying notes to unaudited consolidated financial statements.
ITEM 1. Financial Statements Continued:
(In thousands, except share and per share data) (Unaudited)
(In thousands) (Unaudited)
Consolidated Statement of Stockholders’ Equity
Notes to Unaudited Consolidated Financial Statements
Note 1 – Basis of Presentation
General
In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments necessary to present fairly Nicolet Bankshares, Inc. (the “Company”) and its subsidiaries, consolidated balance sheets, statements of income, comprehensive income, changes in stockholders’ equity and cash flows for the periods presented, and all such adjustments are of a normal recurring nature. All material intercompany transactions and balances are eliminated. The results of operations for the interim periods are not necessarily indicative of the results to be expected for the entire year.
These interim consolidated financial statements have been prepared according to the rules and regulations of the Securities and Exchange Commission and, therefore, certain information and footnote disclosures normally presented in accordance with generally accepted accounting principles in the United States of America (“U.S. GAAP”) have been omitted or abbreviated. These consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements and footnotes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015.
Critical Accounting Policies and Estimates
Preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying disclosures. These estimates are based on management’s best knowledge of current events and actions the Company may undertake in the future. Estimates are used in accounting for, among other items, the allowance for loan losses, useful lives for depreciation and amortization, fair value of financial instruments, deferred tax assets, uncertain income tax positions and contingencies. Estimates that are particularly susceptible to significant change for the Company include the determination of the allowance for loan losses, the assessment of deferred tax assets and liabilities, and the valuation of loans acquired in the 2013 acquisitions; therefore, these are critical accounting policies. Factors that may cause sensitivity to the aforementioned estimates include but are not limited to: external market factors such as market interest rates and employment rates, changes to operating policies and procedures, changes in applicable banking regulations, and changes to deferred tax estimates. Actual results may ultimately differ from estimates, although management does not generally believe such differences would materially affect the consolidated financial statements in any individual reporting period presented.
There have been no material changes or developments with respect to the assumptions or methodologies that the Company uses when applying what management believes are critical accounting policies and developing critical accounting estimates as disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015.
Recent Accounting Developments Adopted
The Company has implemented all new accounting pronouncements that are in effect and that may impact its consolidated financial statements or results of operations.
Operating Segment
While the chief decision makers monitor the revenue streams of the various products and services, and evaluate costs, balance sheet positions and quality, all such products, services and activities are directly or indirectly related to the business of community banking, with no regular, formal or material segment delineations. Operations are managed and financial performance is evaluated on a company-wide basis, and accordingly, all the financial service operations are considered by management to be aggregated in one reportable operating segment.
Note 2 – Earnings per Common Share
Basic earnings per common share are calculated by dividing net income available to common shareholders by the weighted average number of common shares outstanding during the period. Diluted earnings per share is calculated by dividing net income available to common shareholders by the weighted average number of shares adjusted for the dilutive effect of common stock awards (outstanding stock options and unvested restricted stock), if any. Presented below are the calculations for basic and diluted earnings per common share.
Three Months Ended
March 31,
*Cumulative quarterly per share performance may not equal annual per share totals due to the effects of the amount and timing of capital increases. When computing earnings per share for an interim period, the denominator is based on the weighted-average shares outstanding during the interim period, and not on an annualized weighted-average basis. Accordingly, the sum of the quarters' earnings per share data will not necessarily equal the year to date earnings per share data.
There was no anti-dilutive effect of options outstanding at March 31, 2016. Options to purchase approximately 0.3 million shares were outstanding at March 31, 2015, but were excluded from the calculation of diluted earnings per common share as the effect would have been anti-dilutive.
Note 3 – Stock-based Compensation
A Black-Scholes model is utilized to estimate the fair value of stock options and the market price of the Company’s stock at the date of grant is used to estimate the value of restricted stock awards. The weighted average assumptions used in the model for valuing option grants were as follows:
Activity in the Company’s Stock Incentive Plans is summarized in the following tables:
*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.
Note 3 – Stock-based Compensation, continued
Options outstanding at March 31, 2016 are exercisable at option prices ranging from $16.00 to $33.50. There are 309,619 options outstanding in the range from $16.00 - $22.00 and 433,000 options outstanding in the range from $22.01 - $33.50. At March 31, 2016, the exercisable options have a weighted average remaining contractual life of approximately five years and a weighted average exercise price of $19.50.
Intrinsic value represents the amount by which the fair market value of the underlying stock exceeds the exercise price of the stock options. The total intrinsic value of options exercised in the first three months of 2016, and full year of 2015 was approximately $0.2 million, and $5.2 million, respectively.
*The terms of the restricted stock agreements permit the surrender of shares to the Company upon vesting in order to satisfy applicable tax withholding requirements at the minimum statutory withholding rate, and accordingly, 924 shares were surrendered during the three months ended March 31, 2016 and 7,715 shares were surrendered during the twelve months ended December 31, 2015.
The Company recognized approximately $412,000 and $290,000 of stock-based employee compensation expense during the three months ended March 31, 2016 and 2015, respectively, associated with its stock equity awards. As of March 31, 2016, there was approximately $3.7 million of unrecognized compensation cost related to equity award grants. The cost is expected to be recognized over the weighted average remaining vesting period of approximately three years.
Note 4- Securities Available for Sale
Amortized costs and fair values of securities available for sale are summarized as follows:
Gross
Unrealized
Gains
Losses
Note 4- Securities Available for Sale, continued
The following table represents gross unrealized losses and the related fair value of investment securities available for sale, aggregated by investment category and length of time individual securities have been in a continuous unrealized loss position, at March 31, 2016 and December 31, 2015.
Fair
Value
At March 31, 2016, the Company had $0.3 million of gross unrealized losses related to 82 securities. As of March 31, 2016, the Company does not consider securities with unrealized losses to be other-than-temporarily impaired. The unrealized losses in each category have occurred as a result of changes in interest rates, market spreads and market conditions subsequent to purchase. The Company has the ability and intent to hold its securities to maturity. There were no other-than-temporary impairments charged to earnings during the three-month periods ending March 31, 2016 or 2015.
The amortized cost and fair values of securities available for sale at March 31, 2016 by contractual maturity are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Fair values of securities are estimated based on financial models or prices paid for the same or similar securities. It is possible interest rates could change considerably, resulting in a material change in estimated fair value.
There were no sales of securities during the first three months of 2016 or 2015.
Note 5 – Loans, Allowance for Loan Losses, and Credit Quality
The loan composition as of March 31, 2016 and December 31, 2015 is summarized as follows.
% of
Total
Note 5 – Loans, Allowance for Loan Losses, and Credit Quality, continued
Practically all of the Company’s loans, commitments, financial letters of credit and standby letters of credit have been granted to customers in the Company’s market area. Although the Company has a diversified loan portfolio, the credit risk in the loan portfolio is largely influenced by general economic conditions and trends of the counties and markets in which the debtors operate, and the resulting impact on the operations of borrowers or on the value of underlying collateral, if any.
The allowance for loan and lease losses (“ALLL”) represents management’s estimate of probable and inherent credit losses in the Company’s loan portfolio at the balance sheet date. In general, estimating the amount of the ALLL is a function of a number of factors, including but not limited to changes in the loan portfolio, net charge-offs, trends in past due and impaired loans, and the level of potential problem loans, all of which may be susceptible to significant change. To the extent actual outcomes differ from management estimates, additional provisions for loan losses could be required that could adversely affect our earnings or financial position in future periods. Allocations to the ALLL may be made for specific loans but the entire ALLL is available for any loan that, in management’s judgment, should be charged-off or for which an actual loss is realized.
The allocation methodology used by the Company includes specific allocations for impaired loans evaluated individually for impairment based on collateral values and for the remaining loan portfolio collectively evaluated for impairment primarily based on historical loss rates and other qualitative factors. Loan charge-offs and recoveries are based on actual amounts charged-off or recovered by loan category. Management allocates the ALLL by pools of risk within each loan portfolio.
The following tables present the balance and activity in the ALLL by portfolio segment and the recorded investment in loans by portfolio at or for the three months ended March 31, 2016:
(in
thousands)
ALLL:
Commercial
& industrial
Owner-
occupied
CRE
AG
production
AG real
estate
investment
Construction
& land
development
Residential
construction
first
mortgage
junior
Retail
& other
(in thousands)
firstmortgage
The following table presents the balance and activity in the ALLL by portfolio segment and the recorded investment in loans by portfolio at or for the three months ended March 31, 2015.
first mortgage
The following table presents nonaccrual loans by portfolio segment in total and then as a further breakdown by originated or acquired as of March 31, 2016 and December 31, 2015.
The following tables present total past due loans by portfolio segment as of March 31, 2016 and December 31, 2015:
Current
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.
9 Loss: Assets in this category are considered uncollectible. Pursuing any recovery or salvage value is impractical but does not preclude partial recovery in the future.
The following tables present total loans by loan grade as of March 31, 2016 and December 31, 2015:
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.
The following tables present impaired loans as of March 31, 2016 and December 31, 2015. As a further breakdown, impaired loans are also summarized by originated and acquired for the periods presented. Purchased Credit Impaired (“PCI”) loans acquired in the 2013 acquisitions were initially recorded at a fair value of $16.7 million on their respective acquisition dates, net of an initial $12.2 million non-accretable mark and a zero accretable mark. At March 31, 2016, $2.1 million of the $16.7 million remain in impaired loans and $0.6 million of acquired loans have subsequently become impaired, bringing acquired impaired loans to $2.7 million.
As a further breakdown, impaired loans as of March 31, 2016 are summarized by originated and acquired as follows:
*One owner-occupied CRE loan with a balance of $0.6 million had a specific reserve of $119,000. No other loans had a related allowance at March 31, 2016 and, therefore, the above disclosure was not expanded to include loans with and without a related allowance.
As a further breakdown, impaired loans as of December 31, 2015 are summarized by originated and acquired as follows:
Troubled Debt Restructurings
At March 31, 2016, there were eight loans classified as troubled debt restructurings totaling $575,000. These eight loans had a combined premodification balance of $758,000 and a combined outstanding balance of $575,000 at March 31, 2016. There were no other loans which were modified and classified as troubled debt restructurings at March 31, 2016. There were no loans classified as troubled debt restructurings during the previous twelve months that subsequently defaulted as of March 31, 2016.
Note 6 - Notes Payable
The Company had the following long-term notes payable:
At the completion of the construction of the Company’s headquarters building in 2005 and as part of a joint venture investment related to the building, the Company and the other joint venture partners guaranteed a joint venture note to finance certain costs of the building. This note is secured by the building, bears a fixed rate of 5.81% and requires monthly principal and interest payments until its maturity on June 1, 2016.
The Company’s FHLB advances are all fixed rate, require interest-only monthly payments, and have maturities through February 2018. The weighted average rates of FHLB advances were 0.83% at both March 31, 2016 and December 31, 2015. The FHLB advances are collateralized by a blanket lien on qualifying first mortgages, home equity loans, multi-family loans and certain farmland loans which totaled approximately $150.7 million and $154.3 million at March 31, 2016 and December 31, 2015, respectively.
The following table shows the maturity schedule of the notes payable as of March 31, 2016:
Note 7 - Junior Subordinated Debentures
The Company’s carrying value of junior subordinated debentures was $12.6 million at March 31, 2016 and $12.5 million at December 31, 2015. In July 2004 Nicolet Bankshares Statutory Trust I (the “Statutory Trust”), issued $6.0 million of guaranteed preferred beneficial interests (“trust preferred securities”) that qualify as Tier I capital under Federal Reserve Board guidelines. All of the common securities of the Statutory Trust are owned by the Company. The proceeds from the issuance of the common securities and the trust preferred securities were used by the Statutory Trust to purchase $6.2 million of junior subordinated debentures of the Company, which pay an 8% fixed rate. Interest on these debentures is current. The debentures may be redeemed in part or in full, on or after July 15, 2009 at par plus any accrued but unpaid interest. The maturity date of the debenture, if not redeemed, is July 15, 2034.
As part of the 2013 acquisition of Mid-Wisconsin Financial Services, Inc., the Company assumed $10.3 million of junior subordinated debentures related to $10.0 million of issued trust preferred securities. The trust preferred securities and the debentures mature on December 15, 2035 and have a floating rate of the three-month LIBOR plus 1.43% adjusted quarterly. Interest on these debentures is current. The debentures may be called at par in part or in full, on or after December 15, 2010 or within 120 days of certain events. At acquisition in April 2013 the debentures were recorded at a fair value of $5.8 million, with the discount being accreted to interest expense over the remaining life of the debentures. At March 31, 2016, the carrying value of these junior debentures was $6.3 million, and the $6.0 million carrying value of related trust preferred securities qualifies as Tier 1 capital.
Note 8 – Subordinated Notes
In 2015 the Company placed an aggregate of $12 million in subordinated Notes in private placements with certain accredited investors. All Notes were issued with 10-year maturities, have a fixed annual interest rate of 5% payable quarterly, are callable on or after the fifth anniversary of their respective issuances dates, and qualify for Tier 2 capital for regulatory purposes.
The $180,000 debt issuance costs associated with the $12 million Notes are being amortized on a straight line basis over the first five years, representing the no-call periods, as additional interest expense. As of March 31, 2016 and December 31, 2015, $142,000 and $151,000, respectively, of unamortized debt issuance costs remain and are reflected as a deduction to the carrying value of the outstanding Notes.
Note 9 - Fair Value Measurements
As provided for by accounting standards, the Company records and/or discloses financial instruments on a fair value basis. These financial assets and financial liabilities are measured at fair value in three levels, based on the markets in which the assets and liabilities are traded and the observability of the assumptions used to determine fair value. These levels are: Level 1 - quoted market prices in active markets for identical assets or liabilities that a company has the ability to access at the measurement date; Level 2 - inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly; Level 3 – significant unobservable inputs for the asset or liability, which are typically based on an entity’s own assumptions, as there is little, if any, related market activity. In instances where the fair value measurement is based on inputs from different levels, the level within which the entire fair value measurement will be categorized is based on the lowest level input that is significant to the fair value measurement in its entirety; this assessment of the significance of an input requires management judgment.
Disclosure of the fair value of financial instruments, whether recognized or not recognized in the balance sheet, is required for those instruments for which it is practicable to estimate that value, with the exception of certain financial instruments and all nonfinancial instruments as provided for by the accounting standards. For financial instruments recognized at fair value in the consolidated balance sheets, the fair value disclosure requirements also apply.
Fair value (i.e. the price that would be received in an orderly transaction that is not a forced liquidation or distressed sale at the measurement date), among other things, is based on exit price versus entry price, should include assumptions about risk such as nonperformance risk in liability fair values, and is a market-based measurement versus an entity-specific measurement.
Note 9 - Fair Value Measurements, continued
The following table presents the balances of assets and liabilities measured at fair value on a recurring basis for the periods presented. One security classified as Level 3 was purchased for $0.6 million during the first quarter of 2016. There were no other changes in Level 3 values to report during the first three months of 2016.
The following is a description of the valuation methodologies used by the Company for the Securities AFS noted in the tables of this footnote. Where quoted market prices on securities exchanges are available, the investment is classified as Level 1. Level 1 investments primarily include exchange-traded equity securities available for sale. If quoted market prices are not available, fair value is generally determined using prices obtained from independent pricing vendors who use pricing models (with typical inputs including benchmark yields, reported trades for similar securities, issuer spreads or relationship to other benchmark quoted securities), or discounted cash flows, and are classified as Level 2. Examples of these investments include mortgage-related securities and obligations of state, county and municipals. Finally, in certain cases where there is limited activity or less transparency around inputs to the estimated fair value, investments are classified within Level 3 of the hierarchy. Examples of these include auction rate securities available for sale (for which there has been no liquid market since 2008) and corporate debt securities, which include trust preferred security investments. At March 31, 2016 and December 31, 2015, it was determined that carrying value was the best approximation of fair value for these Level 3 securities, based primarily on receipt of par from refinances for the auction rate securities and the internal analysis on the corporate debt securities.
The following table presents the Company’s impaired loans and other real estate owned (“OREO”) measured at fair value on a nonrecurring basis for the periods presented.
The following is a description of the valuation methodologies used by the Company for the items noted in the table above, including the general classification of such instruments in the fair value hierarchy. For individually evaluated impaired loans, the amount of impairment is based upon the present value of expected future cash flows discounted at the loan’s effective interest rate, the estimated fair value of the underlying collateral for collateral-dependent loans, or the estimated liquidity of the note. For OREO, the fair value is based upon the estimated fair value of the underlying collateral adjusted for the expected costs to sell.
The carrying amounts and estimated fair values of the Company’s financial instruments at March 31, 2016 and December 31, 2015 are shown below.
Not all the financial instruments listed in the table above are subject to the disclosure provisions of Accounting Standards Codification (“ASC”) 820, as certain assets and liabilities result in their carrying value approximating fair value. These include cash and cash equivalents, other investments, bank owned life insurance, and nonmaturing deposits. For those financial instruments not previously disclosed the following is a description of the evaluation methodologies used.
Certificates of deposits in other banks:Fair values are estimated using discounted cash flow analysis based on current interest rates being offered by instruments with similar terms and represents a Level 2 measurement.
Other investments: The carrying amount of Federal Reserve Bank, Bankers Bank, Farmer Mac, and FHLB stock is a reasonably accepted fair value estimate given their restricted nature. Fair value is the redeemable (carrying) value based on the redemption provisions of the instruments which is considered a Level 2 measurement. The carrying amount of the remaining other investments (particularly common stocks of companies or other banks that are not publicly traded) approximates their fair value, determined primarily by analysis of company financial statements and recent capital issuances of the respective companies or banks, if any, and represents a Level 3 measurement.
Loans held for sale: The fair value estimation process for the loans held for sale portfolio is segregated by loan type. The estimated fair value was based on what secondary markets are currently offering for portfolios with similar characteristics and represents a Level 2 measurement.
Loans, net: For variable-rate loans that reprice frequently and with no significant change in credit risk or other optionality, fair values are based on carrying values. Fair values for all other loans are estimated by discounting contractual cash flows using estimated market discount rates, which reflect the credit and interest rate risk inherent in the loan. Collateral-dependent impaired loans are included in loans, net. The fair value of loans is considered to be a Level 3 measurement due to internally developed discounted cash flow measurements.
Deposits: The fair value of deposits with no stated maturity (such as demand deposits, savings, interest and non-interest checking, and money market accounts) is, by definition, equal to the amount payable on demand at the reporting date. Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered in the market place on certificates of similar remaining maturities. Use of internal discounted cash flows provides a Level 3 fair value measurement.
Notes payable: The fair value of the Federal Home Loan Bank advances is obtained from the Federal Home Loan Bank which uses a discounted cash flow analysis based on current market rates of similar maturity debt securities and represents a Level 2 measurement. The fair values of remaining notes payable are estimated using discounted cash flow analysis based on current interest rates being offered by instruments with similar terms and credit quality which represents a Level 2 measurement.
Junior subordinated debentures and subordinated notes: The fair values of these debt instruments utilize a discounted cash flow analysis based on an estimate of current interest rates being offered by instruments with similar terms and credit quality. Since the market for these instruments is limited, the internal evaluation represents a Level 3 measurement.
Off-balance-sheet instruments: The estimated fair value of letters of credit at March 31, 2016 and December 31, 2015 was insignificant. Loan commitments on which the committed interest rate is less than the current market rate are also insignificant at March 31, 2016 and December 31, 2015.
Limitations: Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of a particular financial instrument. Fair value estimates may not be realizable in an immediate settlement of the instrument. In some instances, there are no quoted market prices for the Company’s various financial instruments, in which case fair values may be based on estimates using present value or other valuation techniques, or based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of the financial instruments, or other factors. Those techniques are significantly affected by the assumptions used, including the discount rate and estimate of future cash flows. Subsequent changes in assumptions could significantly affect the estimates.
Note 10 – Acquisition
During the first quarter of 2016, Nicolet agreed, in a private transaction, to hire a select group of financial advisors and purchase their respective books of business, as well as their operating platform, to enhance the leadership and future growth of the Company’s wealth management business. A portion of this transaction was completed and recorded in the first quarter of 2016; accordingly, the Company paid total consideration of $1.4 million in a mix of cash and stock, recorded $0.4 million of goodwill, $0.8 million of customer list intangibles (included in other assets), and fixed assets of $0.2 million. The transaction will impact the income statement primarily within brokerage income, personnel expense, and intangibles amortization. The remainder of the transaction took place and was recorded in April 2016.
Note 11 – Pending Merger Transaction
On September 8, 2015 Nicolet announced the signing of a definitive merger agreement (“Merger Agreement”) with Baylake Corp. (“Baylake”) (NASDAQ:BYLK) under which Baylake will merge with and into Nicolet to create the third largest publicly traded community bank headquartered in Wisconsin by deposit market share. Based upon the financial results as of March 31, 2016, the combined company would have total assets of approximately $2.3 billion, deposits of $1.9 billion and loans of $1.6 billion. Since the merger transaction is expected to close on April 29, 2016, the Company is not able to make the disclosures required by purchase accounting standards as management has not yet completed the initial accounting for this business combination.
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION
Nicolet Bankshares, Inc. is a bank holding company headquartered in Green Bay, Wisconsin, providing a diversified range of traditional banking and wealth management services to individuals and businesses in its market area through the 21 branch offices of its banking subsidiary, Nicolet National Bank, in northeastern and central Wisconsin and Menominee, Michigan.
Overview
At March 31, 2016, Nicolet Bankshares, Inc. and its subsidiaries (“Nicolet” or the “Company”) had total assets of $1.2 billion, loans of $889 million, deposits of $1.1 billion and total stockholders’ equity of $115 million. Nicolet’s profitability is significantly dependent upon net interest income (interest income earned on loans and other interest-earning assets such as investments, net of interest expense on deposits and other borrowed funds), and noninterest income sources (including but not limited to service charges on deposits, trust and brokerage fees, mortgage income from sales of residential mortgages into the secondary market, and other fees or revenue from financial services provided to customers or ancillary to loans and deposits), offset by the level of the provision for loan losses, noninterest expenses (largely employee compensation and overhead expenses tied to processing and operating the Bank’s business), and income taxes. Business volumes and pricing drive revenue potential and tend to be influenced by overall economic factors, including market interest rates, business spending, consumer confidence, economic growth and competitive conditions within the marketplace. For the quarter ended March 31, 2016, Nicolet earned net income of $2.7 million, and after $112,000 of preferred stock dividends, net income available to common shareholders was $2.5 million or $0.57 per diluted common share.
Consistent with Nicolet’s stated interest in strategic growth, Nicolet remains focused on the consummation and integration of its previously announced acquisitions. Nicolet and Baylake Corp. (“Baylake”) announced and signed a definitive merger agreement in September 2015, under which Baylake will merge with and into Nicolet to create the third largest publicly traded bank headquartered in Wisconsin by deposit market share. The transaction is a stock-for-stock merger (with cash in lieu of fractional shares) at a fixed exchange ratio of 0.4517 shares of Nicolet common stock for each share of Baylake common stock outstanding, has received all regulatory and shareholder approvals, and is on target for an April 29, 2016 consummation. The merger is expected to drive growth and efficiency through increased scale, leverage the strengths of each bank across the combined customer base, enhance profitability, and add liquidity and shareholder value. Based upon the financial position as of March 31, 2016, the combined company would have total assets of $2.3 billion, deposits of $1.9 billion and loans of $1.6 billion, and an expanded geography operating out of 42 bank branches. Appropriately, other than direct merger and integration costs being expensed as incurred, the Baylake transaction is not included in Nicolet’s financial position or financial results as of March 31, 2016. Additionally, during the first quarter of 2016, Nicolet agreed, in a private transaction, to hire a select group of financial advisors and purchase their respective books of business, as well as their operating platform, to enhance the leadership and future growth of the Company’s wealth management business. A portion of this transaction was completed and recorded in the first quarter of 2016; the remainder of the transaction took place and was recorded in April 2016.
Forward-Looking Statements
Statements made in this document and in any documents that are incorporated by reference which are not purely historical are forward-looking statements, as defined in the Private Securities Litigation Reform Act of 1995, including any statements regarding descriptions of management’s plans, objectives, or goals for future operations, products or services, and forecasts of its revenues, earnings, or other measures of performance. Forward-looking statements are based on current management expectations and, by their nature, are subject to risks and uncertainties. These statements generally may be identified by the use of words such as “believe,” “expect,” “anticipate,” “plan,” “estimate,” “should,” “will,” “intend,” or similar expressions. Shareholders should note that many factors, some of which are discussed elsewhere in this document, could affect the future financial results of Nicolet and could cause those results to differ materially from those expressed in forward-looking statements contained in this document. These factors, many of which are beyond Nicolet’s control, include, but are not necessarily limited to the following:
These factors should be considered in evaluating the forward-looking statements, and you should not place undue reliance on such statements. Nicolet specifically disclaims any obligation to update factors or to publicly announce the results of revisions to any of the forward-looking statements or comments included herein to reflect future events or developments.
Critical Accounting Policies
The consolidated financial statements of Nicolet are prepared in conformity with U.S. GAAP and follow general practices within the industry in which it operates. This preparation requires management to make estimates, assumptions and judgments that affect the amounts reported in the consolidated financial statements and accompanying notes. These estimates, assumptions and judgments are based on information available as of the date of the consolidated financial statements; accordingly, as this information changes, actual results could differ from the estimates, assumptions and judgments reflected in the consolidated financial statements. Certain policies inherently have a greater reliance on the use of estimates, assumptions and judgments and, as such, have a greater possibility of producing results that could be materially different than originally reported. Estimates that are particularly susceptible to significant change include the valuation of loans acquired in business combinations, as well as the determination of the allowance for loan losses and income taxes and, therefore, are critical accounting policies.
Valuation of Loans Acquired in Business Combinations
Acquisitions accounted for under FASB Accounting Standards Codification (“ASC”) Topic 805, Business Combinations, require the use of the acquisition method of accounting. Assets acquired and liabilities assumed in a business combination are recorded at estimated fair value on their purchase date. In particular, the valuation of acquired loans involves significant estimates, assumptions and judgment based on information available as of the acquisition date. Substantially all loans acquired in the transaction are evaluated either individually or in pools of loans with similar characteristics; and since the estimated fair value of acquired loans includes a credit consideration, no carryover of any previously recorded allowance for loan losses is recorded at acquisition. A number of factors are considered in determining the estimated fair value of purchased loans including, among other things, the remaining life of the acquired loans, estimated prepayments, estimated loss ratios, estimated value of the underlying collateral, estimated holding periods, contractual interest rates compared to market interest rates, and net present value of cash flows expected to be received.
In determining the Day 1 Fair Values of acquired loans, management calculates a non-accretable difference (the credit mark component of the acquired loans) and an accretable difference (the market rate or yield component of the acquired loans). The non-accretable difference is the difference between the undiscounted contractually required payments and the undiscounted cash flows expected to be collected in accordance with management’s determination of the Day 1 Fair Values. Subsequent decreases to the expected cash flows will generally result in a provision for loan losses. Subsequent increases in cash flows will result in a reversal of the provision for loan losses to the extent of prior charges and then an adjustment to the accretable and non-accretable differences, which would have a positive impact on interest income.
The accretable yield on acquired loans is the difference between the expected cash flows and the initial investment in the acquired loans. The accretable yield is recognized into earnings using the effective yield method over the term of the loans. Management separately monitors the acquired loan portfolio and periodically reviews loans contained within this portfolio against the factors and assumptions used in determining the Day 1 Fair Values.
Allowance for Loan Losses (“ALLL”)
The ALLL is a reserve for estimated credit losses on individually evaluated loans determined to be impaired as well as estimated credit losses inherent in the loan portfolio. Actual credit losses, net of recoveries, are deducted from the ALLL. Loans are charged off when management believes that the collectability of the principal is unlikely. Subsequent recoveries, if any, are credited to the ALLL. A provision for loan losses, which is a charge against earnings, is recorded to bring the ALLL to a level that, in management’s judgment, is adequate to absorb probable losses in the loan portfolio. Management’s evaluation process used to determine the appropriateness of the ALLL is subject to the use of estimates, assumptions, and judgment. The evaluation process involves gathering and interpreting many qualitative and quantitative factors which could affect probable credit losses. Because interpretation and analysis involves judgment, current economic or business conditions can change, and future events are inherently difficult to predict, the anticipated amount of estimated loan losses and therefore the appropriateness of the ALLL could change significantly.
The allocation methodology applied by Nicolet is designed to assess the appropriateness of the ALLL and includes allocations for specifically identified impaired loans and loss factor allocations for all remaining loans, with a component primarily based on historical loss rates and a component primarily based on other qualitative factors. The methodology includes evaluation and consideration of several factors, such as, but not limited to, management’s ongoing review and grading of loans, facts and issues related to specific loans, historical loan loss and delinquency experience, trends in past due and nonaccrual loans, existing risk characteristics of specific loans or loan pools, the fair value of underlying collateral, current economic conditions and other qualitative and quantitative factors which could affect potential credit losses. While management uses the best information available to make its evaluation, future adjustments to the allowance may be necessary if there are significant changes in economic conditions or circumstances underlying the collectability of loans. Because each of the criteria used is subject to change, the allocation of the ALLL is made for analytical purposes and is not necessarily indicative of the trend of future loan losses in any particular loan category. The total allowance is available to absorb losses from any segment of the loan portfolio. Management believes the ALLL is appropriate at March 31, 2016. The allowance analysis is reviewed by the board of directors on a quarterly basis in compliance with regulatory requirements. In addition, various regulatory agencies periodically review the ALLL. These agencies may require Nicolet to make additions to the ALLL based on their judgments of collectability based on information available to them at the time of their examination.
Income Taxes
The assessment of income tax assets and liabilities involves the use of estimates, assumptions, interpretation, and judgment concerning certain accounting pronouncements and federal and state tax codes. There can be no assurance that future events, such as court decisions or positions of federal and state taxing authorities, will not differ from management’s current assessment, the impact of which could be significant to the consolidated results of operations and reported earnings.
Nicolet files a consolidated federal income tax return and a combined state income tax return (both of which include Nicolet and its wholly owned subsidiaries). Accordingly, amounts equal to tax benefits of those companies having taxable federal losses or credits are reimbursed by the companies that incur federal tax liabilities. Amounts provided for income tax expense are based on income reported for financial statement purposes and do not necessarily represent amounts currently payable under tax laws. Deferred income tax assets and liabilities are computed quarterly for differences between the financial statement and tax bases of assets and liabilities that will result in taxable or deductible amounts in the future based on enacted tax law rates applicable to the periods in which the differences are expected to affect taxable income. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through provision for income tax expense. Valuation allowances are established when it is more likely than not that a portion of the full amount of the deferred tax asset will not be realized. In assessing the ability to realize deferred tax assets, management considers the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies. Nicolet may also recognize a liability for unrecognized tax benefits from uncertain tax positions. Unrecognized tax benefits represent the differences between a tax position taken or expected to be taken in a tax return and the benefit recognized and measured in the financial statements. Penalties related to unrecognized tax benefits are classified as income tax expense.
Management’s Discussion and Analysis
The following discussion is Nicolet management’s analysis of the consolidated financial condition as of March 31, 2016 and December 31, 2015 and results of operations for the three-month periods ended March 31, 2016 and 2015. It should be read in conjunction with Nicolet’s audited consolidated financial statements as of December 31, 2015 and 2014, and for the three years ended December 31, 2015, included in Nicolet’s Annual Report on Form 10-K for the year ended December 31, 2015.
Certain actions in 2015 will have an impact on balance sheet changes between March 31, 2015, and March 31, 2016. The most notable are Nicolet’s sale of two outlying branches in August 2015 (at that time reducing deposits by $34 million, loans by $13 million, fixed assets by $1 million and cash by $20 million), issuance of $12 million of 5% fixed-rate, 10-year subordinated debt in the first half of 2015, redemption of $12.2 million or half of its then outstanding preferred stock in September 2015 at par, and its $4.2 million repurchase of common stock (146,404 shares) in the first 8 months of 2015.
Performance Summary
Nicolet reported net income of $2.7 million for the three months ended March 31, 2016, compared to $3.1 million for the first three months of 2015. After $112,000 of preferred stock dividends, net income available to common shareholders was $2.5 million, or $0.57 per diluted common share for the first quarter of 2016. Comparatively, after $61,000 of preferred stock dividends, net income available to common shareholders was $3.0 million, or $0.70 per diluted common share for the first quarter of 2015. Beginning March 1, 2016, the annual dividend rate on preferred stock moved from 1% to 9% in accordance with the contractual terms. In advance of such increase, Nicolet redeemed half of its then outstanding preferred stock in September 2015. The changes in rate and preferred stock outstanding affected the preferred stock dividends between the first quarter periods.
Net Interest Income
Nicolet’s earnings are substantially dependent on net interest income. Net interest income is the primary source of Nicolet’s revenue and is the difference between interest income earned on interest earning assets, such as loans and investments, and interest expense on interest-bearing liabilities, such as deposits and other borrowings. Net interest income is directly impacted by the sensitivity of the balance sheet to changes in interest rates and by the amount and composition of earning assets and interest-bearing liabilities, including characteristics such as the fixed or variable nature of the financial instruments, contractual maturities, and repricing frequencies.
Net interest income in the consolidated statements of income (which excludes any taxable equivalent adjustment) was $10.7 million in the first three months of 2016, 2% lower than $11.0 million in the first three months of 2015. Taxable equivalent adjustments (adjustments to bring tax-exempt interest to a level that would yield the same after-tax income had that been subject to a 34% tax rate) were $0.3 million for the first three months of 2016 and 2015, resulting in taxable equivalent net interest income of $11.0 million and $11.3 million, respectively.
Taxable equivalent net interest income is a non-GAAP measure, but is a preferred industry measurement of net interest income (and its use in calculating a net interest margin) as it enhances the comparability of net interest income arising from taxable and tax-exempt sources.
Tables 1 through 3 present information to facilitate the review and discussion of selected average balance sheet items, taxable equivalent net interest income, interest rate spread and net interest margin.
Table 1: Quarterly Net Interest Income Analysis
Table 2: Quarterly Volume/Rate Variance
Comparison of the three months ended March 31, 2016 versus the three months ended March 31, 2015 follows:
Table 3: Interest Rate Spread, Margin and Average Balance Mix
Taxable-equivalent net interest income was $11.0 million and $11.3 million for the first three months of 2016 and 2015, respectively, down $0.3 million or 2%, driven mostly by lower interest income from earning assets, though offset partly by lower interest expense on funding. Taxable equivalent interest income on earning assets decreased $0.3 million or 2% between the three-month periods, with $0.1 million more interest from non-loan earning assets due to volume and rate, but $0.4 million less interest income from loans, nearly all from rate. Interest expense declined nearly $0.1 million, led by $0.2 million lower interest on interest-bearing deposits, nearly all from rate (benefiting from deposit product pricing changes implemented in December 2015), but partially offset by $0.1 million of higher interest expense on wholesale funds, nearly all from volume (impacted by the timing of subordinated debt procured during the first half of 2015).
The taxable-equivalent net interest margin was 3.87% for the first three months of 2016, down 23 bps versus the first three months of 2015. The interest rate spread fell 24 bps between the first quarter periods, with an unfavorable decline in the earning asset yield (down 27 bps to 4.47% for first quarter 2016), offset partly by an improvement in the cost of funds (down 3 bps to 0.77% for first quarter 2016). The contribution from net free funds increased by 1 bps, mostly due to higher average non-interest bearing deposit balances. In general, there has been and will be underlying downward margin pressure as assets mature in this prolonged low-rate environment, with current reinvestment rates still substantially lower than previous rates and less opportunity to offset such with similar changes in the already low cost of funds. After nearly 10 years, the Federal Reserve raised short-term interest rates by 25 bps to 50 bps, which through March 31, 2016, had no significant impact on the middle to long-end of the yield curve, and coupled with competitive factors did not have a significant impact on new loan pricing or the loan portfolio yield, but improved the yield on interest-bearing cash. Additionally, while both 2016 and 2015 periods are experiencing favorable income from discount accretion on acquired loans, particularly where such loans pay or resolve at better than their carrying values, such favorable interest flow can be sporadic and continues to diminish over time.
The earning asset yield was influenced largely by the mix of underlying earning assets, particularly carrying a lower proportion of higher rate loans and a higher proportion of low-earning cash. Loans, investments and other interest earning assets (mostly low-earning cash) represented 79%, 14% and 7% of average earning assets, respectively, for the first three months of 2016, and 81%, 15%, and 4%, respectively, for the comparable 2015 quarter. Loans yielded 5.19% and 5.41%, respectively, for the first three months of 2016 and 2015, while non-loan earning assets yielded 1.84% and 1.95%, respectively, for the first quarter periods. The 22 bps decrease in loan yield between the three-month periods was largely due to $0.3 million lower aggregate discount accretion between periods, as well as continued pricing pressure on new and renewing loans. A higher proportion of low-earning cash was the main reason for the 11 bps decrease in the non-loan yield between the three-month periods.
Nicolet’s cost of funds decreased 3 bps to 0.77% for the first three months of 2016 compared to a year ago. The average cost of interest-bearing deposits (which represent over 95% of average interest-bearing liabilities for both periods), was 0.55% for the first three months of 2016, down 8 bps from the first three months of 2015. Between the first quarter periods, the decline in the cost of savings, interest-bearing demand and MMAs was primarily the result of deposit product pricing changes implemented in December 2015, while the increase in the rate on time deposits (both CDs/IRAs and brokered deposits) was primarily due to lower costing time deposits maturing and not being renewed. Average other interest-bearing liabilities (comprised of short- and long-term borrowings) cost 88 bps more between the three-month periods as 5% fixed rate subordinated debt was added to the funding mix in the first half of 2015, replacing lower costing advances.
Average interest-earning assets were $1.1 billion for the first three months of 2016 and 2015, declining by $28 million or 3%. The change in average interest-earning assets was the result of a $4 million (0.4%) decrease in total loans (to $885 million for the first quarter of 2016) and a $32 million increase in average non-loan earning assets (to $242 million for the first quarter of 2016, with interest-bearing cash accountable for $31 million of the increase).
Average interest-bearing liabilities were essentially unchanged at $880 million for the first three months of 2016 and 2015, with the mix unchanged at 95% interest-bearing deposits and 5% from other funds for both periods. Average interest-bearing deposits were unchanged at $840 million for the first quarter of 2016, with more transaction deposits replacing time deposits, while average other interest-bearing liabilities increased $1 million to $40 million for the first quarter of 2016, with subordinated debt replacing maturing FHLB advances.
Provision for Loan Losses
The provision for loan losses for the three months ended March 31, 2016 and 2015 was $0.4 million, exceeding net charge-offs of $0.2 million in each three-month period. Asset quality trends remained strong with continued resolutions of problem loans. The ALLL was $10.5 million (1.18% of loans) at March 31, 2016, compared to $10.3 million (1.18% of loans) at December 31, 2015 and $9.5 million (1.08% of loans) at March 31, 2015.
The provision for loan losses is predominantly a function of Nicolet’s methodology and judgment as to qualitative and quantitative factors used to determine the adequacy of the ALLL. The adequacy of the ALLL is affected by changes in the size and character of the loan portfolio, changes in levels of impaired and other nonperforming loans, historical losses and delinquencies in each portfolio segment, the risk inherent in specific loans, concentrations of loans to specific borrowers or industries, existing and future economic conditions, the fair value of underlying collateral, and other factors which could affect potential credit losses. For additional information regarding asset quality and the ALLL, see “Balance Sheet Analysis — Loans,” “— Allowance for Loan and Lease Losses,” and “— Impaired Loans and Nonperforming Assets.
Noninterest Income
Table 4: Noninterest Income
Noninterest income was $3.9 million for the first three months of 2016 (including a slight net loss on sales of assets), compared to $4.1 million for the first three months of 2015 (including $0.2 million of net gain on sale of assets). Removing these net gains (losses), noninterest income was essentially unchanged at $3.9 million for both first quarter periods.
The 2016 activity in net gain (loss) on sale of assets consisted of a small net loss between the sale of OREO and disposal of fixed assets, while the 2015 activity consisted of a $0.2 million net gain on sales of OREO.
Service charges on deposit accounts were $0.6 million for the first three months of 2016, up $0.1 million or 16.5% over the first three months of 2015, resulting from higher commercial analysis charges and increased non-sufficient funds and overdraft activity.
Trust service fees remained fairly consistent at $1.2 million for the first three months of 2016 and 2015. Brokerage fees were $0.3 million, up 82.4% over the first three months of 2015, attributable to new business acquired in the 2016 acquisition of financial advisory personnel and their books of business.
Mortgage income represents predominantly net gains received from the sale of residential real estate loans service-released into the secondary market and, to a small degree, some related income. The first quarter of 2015 saw a significantly more robust mortgage market and strong production compared to the first quarter of 2016. As a result, net mortgage income was down $0.3 million or 34.7% between the comparable first quarter periods.
BOLI, rent income and investment advisory fees combined were unchanged at $0.6 million for the first three months of 2016 and 2015. Other noninterest income was $0.6 million, up $0.2 million or 38.6% over the first quarter of 2015, mostly attributable to ancillary fees tied to deposit-related products, especially debit card interchange, credit card interchange and wire fee income.
Noninterest Expense
Table 5: Noninterest Expense
Total noninterest expense was $10.0 million for the first three months of 2016 (including approximately $0.4 million attributable to non-recurring, merger-based expenses such as legal and conversion processing costs related to the in-process mergers). The $0.2 million, or 2.2%, increase over the first three months of 2015was modest; however, excluding the 2016 merger-based costs, noninterest expense was down $0.2 million or 2%, exhibiting general expense control. Data processing, business development, occupancy and other expenses were up while all other expense categories were down compared to the same period in 2015.
Salaries and employee benefits expense was $5.3 million for the first three months of 2016, down $0.3 million or 6.0% compared to the first three months of 2015, largely a result of the salary base remaining flat (with lower average full-time equivalent employees, partly offsetting usual merit increases between the years), and a slower pace of incentives and stock compensation combined between the first quarter periods. Average full time equivalent employees for the first three months of 2016 were 281, down 2% from 286 for the comparable 2015 period.
Occupancy, equipment and office expense remained relatively flat at $1.8 million for the first three months of 2016 compared to 2015, primarily the result of lower occupancy costs and depreciation expense offset by more expense related to software and small office equipment expenses largely in preparation for the merger.
Business development and marketing expense increased $0.1 million, or 19.2%, between the comparable three-month periods, largely due to additional marketing, promotions and donations for the first quarter of 2016.
Data processing expenses, which are primarily volume-based, rose $0.3 million or 39% between the first quarter periods, which includes $0.2 million of merger-related processing expenses. The increase is otherwise in line with the increase in number of accounts and increased services, such as plastics processing. Intangible amortization declined as the core deposit intangible has aged under an accelerated amortization schedule. Other noninterest expense increased $0.2 million between the first quarter periods, attributable mostly to 2016 carrying merger-based expenses such as legal and consulting fees.
For the three-month periods ending March 31, 2016 and 2015, income tax expense was $1.4 million and $1.7 million, respectively. U.S. GAAP requires that deferred income taxes be analyzed to determine if a valuation allowance is required. A valuation allowance is required if it is more likely than not that some portion of the deferred tax asset will not be realized. No valuation allowance was determined to be necessary as of March 31, 2016 or December 31, 2015.
BALANCE SHEET ANALYSIS
Loans
Nicolet services a diverse customer base throughout Northeast and Central Wisconsin and in Menominee, Michigan including the following industries: manufacturing, agriculture, wholesaling, retail, service, and businesses supporting the general building industry. It continues to concentrate its efforts in originating loans in its local markets and assisting its current loan customers. It actively utilizes government loan programs such as those provided by the U.S. Small Business Administration to help customers’ weather current economic conditions and position their businesses for the future.
Nicolet’s primary lending function is to make 1) commercial loans, consisting of commercial, industrial and business loans and lines of credit, owner-occupied commercial real estate (“CRE”) loans and agricultural (“AG”) production loans; 2) CRE loans, consisting of CRE investment loans, AG real estate, and construction and land development loans; 3) residential real estate loans, including residential first mortgages, residential junior mortgages (such as home equity loans and lines), and to a lesser degree residential construction loans; and 4) retail and other loans . Using the four broad groups the mix of loans at March 31, 2016 was 56% commercial, 18% CRE loans, 25% residential real estate, and 1% retail and other loans.
Total loans were $889 million at March 31, 2016 compared to $877 million at December 31, 2015 an increase of $12 million or 1.4%. Compared to March 31, 2015, loans grew $9 million or 1%. On average, loans were $885 million and $889 million for the first three months of 2016 and 2015, respectively, down 0.4%.
Table 6: Period End Loan Composition
Broadly, commercial-based loans (i.e. commercial, AG, CRE and construction loans combined) versus retail-based loans (i.e. residential real estate and other retail loans) were unchanged at approximately 75% commercial-based and 25% retail-based at March 31, 2016 and December 31, 2015. Commercial-based loans are considered to have more inherent risk of default than retail-based loans, in part because of the broader list of factors that could impact a commercial borrower negatively as well as the commercial balance per borrower is typically larger than that for retail-based loans, implying higher potential losses on an individual customer basis.
Commercial and industrial loans consist primarily of commercial loans to small businesses within a diverse range of industries and, to a lesser degree, to municipalities. The credit risk related to commercial and industrial loans is largely influenced by general economic conditions and the resulting impact on a borrower’s operations, or on the value of underlying collateral, if any. Commercial and industrial loans increased $12 million since year end 2015. Commercial and industrial loans continue to be the largest segment of Nicolet’s portfolio and increased to 34.4% of the total portfolio at March 31, 2016, up from 33.6% at December 31, 2015.
Owner-occupied CRE loans declined to 20.5% of loans at March 31, 2016 from 21.1% at December 31, 2015 and primarily consist of loans within a diverse range of industries secured by business real estate that is occupied by borrowers (i.e. who operate their businesses out of the underlying collateral) and who may also have commercial and industrial loans. The credit risk related to owner-occupied CRE loans is largely influenced by general economic conditions and the resulting impact on a borrower’s operations, or on the value of underlying collateral.
Agricultural production and agricultural real estate loans consist of loans secured by farmland and related farming operations. The credit risk related to agricultural loans is largely influenced by the prices farmers can get for their production and/or the underlying value of the farmland. In total, agricultural loans decreased $4 million since year end 2015, representing 6.1% of total loans at March 31, 2016, versus 6.6% at December 31, 2015.
The CRE investment loan classification primarily includes commercial-based mortgage loans that are secured by non-owner occupied, nonfarm/nonresidential real estate properties, and multi-family residential properties. Lending in this segment has been focused on loans that are secured by commercial income-producing properties as opposed to speculative real estate development. The balance of these loans increased $3.0 million since year end 2015, increasing as a percent of loans from 9.0% to 9.2% at March 31, 2016.
Loans in the construction and land development portfolio represent 4.4% of total loans at March 31, 2016 and such loans provide financing for the development of commercial income properties, multi-family residential development, and land designated for future development. Nicolet controls the credit risk on these types of loans by making loans in familiar markets, reviewing the merits of individual projects, controlling loan structure, and monitoring the progress of projects through the analysis of construction advances. Credit risk is managed by employing sound underwriting guidelines, lending primarily to borrowers in local markets, periodically evaluating the underlying collateral, and formally reviewing the borrower’s financial soundness and relationships on an ongoing basis. Lending on originated loans in this category has remained steady as a percent of loans. Since December 31, 2015, balances have increased only $2.0 million and have increased slightly as a percent of loans.
On a combined basis, Nicolet’s residential real estate loans represent 24.7% of total loans at both March 31, 2016 and year-end 2015, while balances were up $2.1 million or 1.0% over December 31, 2015. Residential first mortgage loans include conventional first-lien home mortgages. Residential junior mortgage real estate loans consist mainly of home equity lines and term loans secured by junior mortgage liens. Across the industry, home equities generally involve loans that are in second or junior lien positions, but Nicolet has secured many such loans in a first lien position, further mitigating the portfolio risks. Nicolet has not experienced significant losses in its residential real estate loans; however, if market values in the residential real estate markets decline, particularly in Nicolet’s market area, rising loan-to-value ratios could cause an increase in the provision for loan losses. As part of its management of originating residential mortgage loans, the vast majority of Nicolet’s long-term, fixed-rate residential real estate mortgage loans are sold in the secondary market without retaining the servicing rights. Mortgage loans retained in the portfolio are typically of high quality and have historically had low net charge-off rates.
Loans in the retail and other classification represent less than 1% of the total loan portfolio, and include predominantly short-term and other personal installment loans not secured by real estate. Credit risk is primarily controlled by reviewing the creditworthiness of the borrowers, monitoring payment histories, and taking appropriate collateral and/or guaranty positions. The loan balances in this portfolio remained relatively unchanged from December 31, 2015 to March 31, 2016.
Factors that are important to managing overall credit quality are sound loan underwriting and administration, systematic monitoring of existing loans and commitments, effective loan review on an ongoing basis, early problem loan identification and remedial action to minimize losses, an adequate ALLL, and sound nonaccrual and charge-off policies. An active credit risk management process is used for commercial loans to further ensure that sound and consistent credit decisions are made. The credit management process is regularly reviewed and the process has been modified over the past several years to further strengthen the controls.
The loan portfolio is widely diversified by types of borrowers, industry groups, and market areas. Significant loan concentrations are considered to exist for a financial institution when there are amounts loaned to multiple numbers of borrowers engaged in similar activities that would cause them to be similarly impacted by economic or other conditions. At March 31, 2016, no significant industry concentrations existed in Nicolet’s portfolio in excess of 25% of total loans. Nicolet has also developed guidelines to manage its exposure to various types of concentration risks.
Allowance for Loan and Lease Losses
In addition to the discussion that follows, see also Note 1, “Basis of Presentation,” and Note 5, “Loans, Allowance for Loan Losses and Credit Quality,” in the notes to the unaudited consolidated financial statements and the “Critical Accounting Policies” within management’s discussion and analysis.
Credit risks within the loan portfolio are inherently different for each loan type as described under “Balance Sheet Analysis-Loans.” Credit risk is controlled and monitored through the use of lending standards, a thorough review of potential borrowers, and on-going review of loan payment performance. Active asset quality administration, including early problem loan identification and timely resolution of problems, aids in the management of credit risk and minimization of loan losses.
The ALLL is established through a provision for loan losses charged to expense to appropriately provide for potential credit losses in the existing loan portfolio. Loans are charged off against the ALLL when management believes that the collection of principal is unlikely. The level of the ALLL represents management’s estimate of an amount of reserves that provides for estimated probable credit losses in the loan portfolio at the balance sheet date. To assess the ALLL, an allocation methodology is applied by Nicolet which focuses on evaluation of qualitative and environmental factors, including but not limited to: (i) evaluation of facts and issues related to specific loans; (ii) management’s ongoing review and grading of the loan portfolio; (iii) consideration of historical loan loss and delinquency experience on each portfolio segment; (iv) trends in past due and nonperforming loans; (v) the risk characteristics of the various loan segments; (vi) changes in the size and character of the loan portfolio; (vii) concentrations of loans to specific borrowers or industries; (viii) existing and forecasted economic conditions; (ix) the fair value of underlying collateral; and (x) other qualitative and quantitative factors which could affect potential credit losses. Nicolet’s methodology reflects guidance by regulatory agencies to all financial institutions.
Management allocates the ALLL by pools of risk within each loan portfolio segment. The allocation methodology consists of the following components. First, a specific reserve for the estimated shortfall is established for all loans determined to be impaired. The specific reserve in the ALLL is equal to the aggregate collateral or discounted cash flow shortfall calculated from the impairment analyses. Loans measured for impairment include nonaccrual loans, non-performing troubled debt-restructurings (“restructured loans”), or other loans determined to be impaired by management. Second, Nicolet’s management allocates ALLL with historical loss rates by loan segment. The loss factors applied in the methodology are periodically re-evaluated and adjusted to reflect changes in historical loss levels on an annual basis. The look-back period on which the average historical loss rates are determined is a rolling 20-quarter (5 year) average. Lastly, management allocates ALLL to the remaining loan portfolio using the qualitative factors mentioned above. Consideration is given to those current qualitative or environmental factors that are likely to cause estimated credit losses as of the evaluation date to differ from the historical loss experience of each loan segment.
Management performs ongoing intensive analyses of its loan portfolio to allow for early identification of customers experiencing financial difficulties, maintains prudent underwriting standards, understands the economy in its markets, and considers the trend of deterioration in loan quality in establishing the level of the ALLL.
Consolidated net income and stockholders’ equity could be affected if management’s estimate of the ALLL necessary to cover expected losses is subsequently materially different, requiring a change in the level of provision for loan losses to be recorded. While management uses currently available information to recognize losses on loans, future adjustments to the ALLL may be necessary based on newly received appraisals, updated commercial customer financial statements, rapidly deteriorating customer cash flow, and changes in economic conditions that affect Nicolet’s customers. As an integral part of their examination process, federal regulatory agencies also review the ALLL. Such agencies may require additions to the ALLL or may require that certain loan balances be charged-off or downgraded into criticized loan categories when their credit evaluations differ from those of management based on their judgments about information available to them at the time of their examination.
At March 31, 2016, the ALLL was $10.5 million compared to $10.3 million at December 31, 2015. The three-month increase was a result of a 2016 provision of $0.4 million offset by 2016 net charge-offs of $0.2 million. Comparatively, the provision for loan losses in the first three months of 2015 was $0.4 million and net charge-offs were $0.2 million. Annualized net charge-offs as a percent of average loans were 0.10% in the first three months of 2016 compared to 0.09% for the first three months of 2015 and 0.09% for the entire 2015 year. Loans charged off are subject to continuous review, and specific efforts are taken to achieve maximum recovery of principal, accrued interest, and related expenses. The level of the provision for loan losses is directly correlated to the assessment of the adequacy of the allowance, including, but not limited to, consideration of the amount of net charge-offs, loan growth, levels of nonperforming loans, and trends in the risk profile of the loan portfolio.
The ratio of the ALLL as a percentage of period-end loans was 1.18% at March 31, 2016 compared to 1.18% at December 31, 2015 and 1.08% at March 31, 2015. The ALLL to loans ratio is impacted by the accounting treatment of the 2013 acquisitions, which combined at their acquisition dates added no ALLL to the numerator and $284 million of loans into the denominator. Acquired loans were $131 million and $137 million at March 31, 2016 and December 31, 2015, respectively. The related allowance for acquired loans was $1.7 million and $1.6 million at March 31, 2016 and December 31, 2015, respectively. Growth in the ALLL to loans ratio is mostly a result of the provision for loan losses exceeding net charge-offs.
The largest portions of the ALLL were allocated to commercial & industrial loans and owner-occupied CRE loans combined, representing 53.5% and 55.0% of the ALLL at March 31, 2016 and December 31, 2015, respectively. The slight reduction in the allocation to these categories since December 31, 2015 was the result of minor changes to allowance allocations in conjunction with changes in loss histories.
Table 7: Loan Loss Experience
The allocation of the ALLL is based on Nicolet’s estimate of loss exposure by category of loans and is shown in Table 8 for March 31, 2016 and December 31, 2015.
Table 8: Allocation of the Allowance for Loan Losses
Impaired Loans and Nonperforming Assets
As part of its overall credit risk management process, Nicolet’s management has been committed to an aggressive problem loan identification philosophy. This philosophy has been implemented through the ongoing monitoring and review of all pools of risk in the loan portfolio to ensure that problem loans are identified early and the risk of loss is minimized.
Nonperforming loans are considered one indicator of potential future loan losses. Nonperforming loans are defined as nonaccrual loans, including those defined as impaired under current accounting standards, and loans 90 days or more past due but still accruing interest. Loans are generally placed on nonaccrual status when contractually past due 90 days or more as to interest or principal payments. Additionally, whenever management becomes aware of facts or circumstances that may adversely impact the collectability of principal or interest on loans, it is management’s practice to place such loans on nonaccrual status immediately. Nonaccrual loans were $4.4 million (consisting of $1.9 million originated loans and $2.5 million acquired loans) at March 31, 2016 compared to $3.5 million at December 31, 2015 (consisting of $0.6 million originated loans and $2.9 million acquired loans). Of the $16.7 million nonaccrual loans initially acquired in the 2013 acquisitions, $2.5 million remain which are included in the $4.4 million of nonaccruals at March 31, 2016. Nonperforming assets (which include nonperforming loans and other real estate owned “OREO”) were $4.8 million at March 31, 2016 compared to $3.9 million at December 31, 2015. OREO remained unchanged from $0.4 million at year end 2015. OREO at March 31, 2016 and December 31, 2015, included land which was moved from active to inactive status and written down to a fair value of $315,000. Nonperforming assets as a percent of total assets were 0.39% at March 31, 2016 compared to 0.32% at December 31, 2015.
The level of potential problem loans is another predominant factor in determining the relative level of risk in the loan portfolio and in determining the adequacy of the ALLL. Potential problem loans are generally defined by management to include loans rated as Substandard by management but that are in performing status; however, there are circumstances present which might adversely affect the ability of the borrower to comply with present repayment terms. The decision of management to include performing loans in potential problem loans does not necessarily mean that Nicolet expects losses to occur, but that management recognizes a higher degree of risk associated with these loans. The loans that have been reported as potential problem loans are predominantly commercial-based loans covering a diverse range of businesses and real estate property types. Potential problem loans were $9.0 million (1.0% of loans) and $9.2 million (1.0% of loans) at March 31, 2016 and December 31, 2015, respectively. Potential problem loans require a heightened management review of the pace at which a credit may deteriorate, the duration of asset quality stress, and uncertainty around the magnitude and scope of economic stress that may be felt by Nicolet’s customers and on underlying real estate values.
Table 9: Nonperforming Assets
Table 10: Investment Securities Portfolio
At March 31, 2016 the total carrying value of investment securities was $174 million, up from $173 million at December 31, 2015, and represented 14.0% and 14.2% of total assets at March 31, 2016 and December 31, 2015, respectively. At March 31, 2016, the securities portfolio did not contain securities of any single issuer that were payable from and secured by the same source of revenue or taxing authority where the aggregate carrying value of such securities exceeded 10% of stockholders’ equity.
In addition to securities available for sale, Nicolet had other investments of $8 million at March 31, 2016 and December 31, 2015, consisting of capital stock in the Federal Reserve and the FHLB (required as members of the Federal Reserve Bank System and the Federal Home Loan Bank System, respectively), and the Federal Agricultural Mortgage Corporation, as well as equity investments in other privately-traded companies. The FHLB and Federal Reserve investments are “restricted” in that they can only be sold back to the respective institutions or another member institution at par, and are thus not liquid, have no ready market or quoted market value, and are carried at cost. The remaining investments have no quoted market prices, and are carried at cost less other than temporary impairment (“OTTI”) charges, if any. Nicolet’s management evaluates all these other investments periodically for impairment, considering financial condition and other available relevant information. There were no OTTI charges recorded in 2015 or year to date 2016.
Table 11: Investment Securities Portfolio Maturity Distribution
Deposits
Deposits represent Nicolet’s largest source of funds. Nicolet competes with other bank and nonbank institutions for deposits, as well as with a growing number of non-deposit investment alternatives available to depositors, such as mutual funds, money market funds, annuities, and other brokerage investment products. Challenges to deposit growth include price changes on deposit products given movements in the rate environment and other competitive pricing pressures, and customer preferences regarding higher-costing deposit products or non-deposit investment alternatives. Included in total deposits in Table 12 are brokered deposits of $26 million at March 31, 2016 and December 31, 2015.
Table 12: Deposits
Total deposits were $1.08 billion at March 31, 2016, up $25 million or 2% since December 31, 2015. On average for the first three months of 2016, total deposits were $1.07 billion, up $26 million from the comparable 2015 period. On average, the mix of deposits changed between the comparable first quarter periods, with 2016 carrying more savings and demand accounts (i.e. noninterest-bearing) and less time, money market, and NOW accounts.
Table 13: Average Deposits
Table 14: Maturity Distribution of Certificates of Deposit of $100,000 or More
Other Funding Sources
Other funding sources, which include short-term and long-term borrowings (notes payable, junior subordinated debentures, and subordinated notes), were $40 million at March 31, 2016 and December 31, 2015. Short-term borrowings consist mainly of customer repurchase agreements maturing in less than three months or federal funds purchased. There were no short-term borrowings outstanding at March 31, 2016 or December 31, 2015. Long-term borrowings include a joint venture note and FHLB advances, totaling $15 million at March 31, 2016 and December 31, 2015. Junior subordinated debentures are another long-term funding source totaling $12.6 million and $12.5 million at March 31, 2016 and December 31, 2015, respectively. Junior subordinated debentures of $6.2 million were issued in July 2004 in connection with the issuance of $6.0 million of trust preferred securities. Acquired junior subordinated debentures of $10.3 million issued in connection with $10.0 million of trust preferred securities were assumed in the 2013 Mid-Wisconsin merger and initially recorded at the fair market value of $5.8 million, with the discount being accreted to interest expense over the remaining life of the debentures. Subordinated notes provide additional funding and are classified as Tier 2 capital. Total subordinated notes of $12 million were issued in 2015. Further information regarding these notes payable, junior subordinated debentures, and subordinated notes is located in “Note 6 – Notes Payable,” “Note 7 – Junior Subordinated Debentures,” and “Note 8 – Subordinated Notes” in the notes to the unaudited consolidated financial statements.
Additional funding sources consist of a $10 million available and unused line of credit at the holding company, $143 million of available and unused federal funds purchased lines, and available total borrowing capacity at the FHLB of $65 million of which $6 million was used at March 31, 2016.
Off-Balance Sheet Obligations
As of March 31, 2016 and December 31, 2015, Nicolet had the following commitments that did not appear on its balance sheet:
Table 15: Commitments
Liquidity Management
Liquidity management refers to the ability to ensure that cash is available in a timely and cost-effective manner to meet cash flow requirements of depositors and borrowers and to meet other commitments as they fall due, including the ability to pay dividends to shareholders, service debt, invest in subsidiaries, repurchase common stock, and satisfy other operating requirements.
Funds are available from a number of basic banking activity sources including but not limited to the core deposit base, the repayment and maturity of loans, investment securities calls, maturities, and sales, and funds obtained through brokered deposits. All investment securities are classified as available for sale and are reported at fair value on the consolidated balance sheet. Approximately $24 million of the $174 million investment securities portfolio on hand at March 31, 2016 was pledged to secure public deposits, short-term borrowings, repurchase agreements, and for other purposes as required by law. Other funding sources available include short-term borrowings, federal funds purchased, and long-term borrowings.
Cash and cash equivalents at March 31, 2016 and December 31, 2015 were approximately $98 million and $84 million, respectively. The increased cash and cash equivalents since year-end 2015 was predominantly due to strong growth in customer deposits, somewhat counter to Nicolet’s historical deposit behaviors for a first quarter period, followed by deployment of that cash partly into loans, while cash provided by investment maturities, calls or paydowns funded investment purchases. Nicolet’s liquidity resources were sufficient as of March 31, 2016 to fund loans and to meet other cash needs as necessary.
Interest Rate Sensitivity Management
A reasonable balance between interest rate risk, credit risk, liquidity risk and maintenance of yield, is highly important to Nicolet’s business success and profitability. As an ongoing part of its financial strategy and risk management, Nicolet attempts to understand and manage the impact of fluctuations in market interest rates on its net interest income. The consolidated balance sheet consists mainly of interest-earning assets (loans, investments and cash) which are primarily funded by interest-bearing liabilities (deposits and other borrowings). Such financial instruments have varying levels of sensitivity to changes in market rates of interest. Market rates are highly sensitive to many factors beyond our control, including but not limited to general economic conditions and policies of governmental and regulatory authorities. Our operating income and net income depends, to a substantial extent, on “rate spread” (i.e., the difference between the income earned on loans, investments and other earning assets and the interest expense paid to obtain deposits and other funding liabilities).
Asset-liability management policies establish guidelines for acceptable limits on the sensitivity to changes in interest rates on earnings and market value of assets and liabilities. Such policies are set and monitored by management and the board of directors’ Asset and Liability Committee.
To understand and manage the impact of fluctuations in market interest rates on net interest income, Nicolet measures its overall interest rate sensitivity through a net interest income analysis, which calculates the change in net interest income in the event of hypothetical changes in interest rates under different scenarios versus a baseline scenario. Such scenarios can involve static balance sheets, balance sheets with projected growth, parallel (or non-parallel) yield curve slope changes, immediate or gradual changes in market interest rates, and one-year or longer time horizons. The simulation modeling uses assumptions involving market spreads, prepayments of rate-sensitive instruments, renewal rates on maturing or new loans, deposit retention rates, and other assumptions.
Nicolet assessed the impact on net interest income in the event of a gradual +/-100 bps and +/-200 bps decrease in market rates (parallel to the change in prime rate) over a one-year time horizon to a static (flat) balance sheet. The interest rate scenarios are used for analytical purposes only and do not necessarily represent management’s view of future market interest rate movements. Based on this analysis on financial data at March 31, 2016, the projected changes in net interest income over a one-year time horizon, versus the baseline, was -1.4%, -0.5%, 0.0% and 0.1% for the -200, -100, +100 and +200 bps scenarios, respectively; such results are within Nicolet’s guidelines of not greater than -10% for +/- 100 bps and not greater than -15% for +/- 200 bps.
Actual results may differ from these simulated results due to timing, magnitude and frequency of interest rate changes, as well as changes in market conditions and their impact on customer behavior and management strategies.
Capital
Management regularly reviews the adequacy of its capital to ensure that sufficient capital is available for current and future needs and is in compliance with regulatory guidelines and actively reviews capital strategies in light of perceived business risks associated with current and prospective earning levels, liquidity, asset quality, economic conditions in the markets served, and level of returns available to shareholders. Management intends to maintain an optimal capital and leverage mix for growth and for shareholder return.
At March 31, 2016, Nicolet’s capital structure includes $12.2 million (or 11% of total capital) of preferred stock and $102.4 million (or 89%) of common stock equity. Beginning in the fourth quarter of 2013, given growth in qualifying small business loans, Nicolet qualified for a 1% annual dividend rate on its preferred stock issued to the Treasury related to its participation in the SBLF, compared to the previous 5% annual rate paid by Nicolet. This 1% rate adjusted to 9% effective March 1, 2016 according to the terms of the Securities Purchase Agreement.
Nicolet’s common equity to total assets at March 31, 2016 of 8.23% increased from 8.01% at December 31, 2015 and continues to reflect capacity to capitalize on opportunities. Further, Nicolet’s investors have demonstrated a strong commitment to capital, providing common capital when needed, with the two most recent examples being a December 2008 private placement raising $9.5 million in common capital as we entered the economic crisis and the April 2013 private placement raising $2.9 million in common capital alongside the predominately stock-for-stock Mid-Wisconsin merger which added $9.7 million in common capital. Additionally, in the first quarter of 2016, Nicolet issued $1.2 million of common stock in connection with the private acquisition of financial advisory business, which is further described in “Note 10 – Acquisition,” in the notes to the unaudited consolidated financial statements. Book value per common share increased 4% to $24.36 at March 31, 2016 from $23.42 at year end 2015 aided by retained earnings and the common stock issued with the acquisition noted above. During early 2014, a common stock repurchase program was approved which authorized, with subsequent modifications, the use of up to $18 million to repurchase up to 800,000 shares of outstanding common stock. Through December 31, 2015, $9.8 million was used to repurchase and cancel 403,695 total shares at a weighted average price per share of $24.27 including commissions. Given the pending merger with Baylake, Nicolet suspended its repurchase program and no shares were repurchased since September 8, 2015.
As shown in Table 16, Nicolet’s regulatory capital ratios remain well above minimum regulatory ratios. At March 31, 2016, Nicolet’s Total, Tier 1, Common Equity Tier 1 (“CET1”) risk-based ratios and its leverage ratio were 14.9%, 12.6%, 10.0% and 9.9%, respectively, compared to the minimum requirements of 8.0%, 6.0%, 4.5% and 4.0%, respectively. Also, at March 31, 2016, Nicolet National Bank’s Total, Tier 1, CET1 and leverage ratios were 13.2%, 12.1%, 12.1% and 9.5%, respectively, and qualify the Bank as well-capitalized under the prompt-corrective action framework with hurdles of 10%, 8%, 6.5% and 5%, respectively. This strong base of capital has allowed Nicolet to be opportunistic in the current environment and in strategic growth.
A source of income and funds for Nicolet as the parent company of Nicolet National Bank are dividends from the Bank. Dividends declared by the Bank that exceed the retained net income for the most current year plus retained net income for the preceding two years must be approved by federal regulatory agencies. At March 31, 2016, the Bank could pay dividends of approximately $4.9 million without seeking regulatory approval. During 2015 and 2014, the Bank paid $11 million and $9 million of dividends, respectively, to the parent company, and paid no dividends during the first quarter of 2016.
A summary of Nicolet’s and Nicolet National Bank’s regulatory capital amounts and ratios as of March 31, 2016 and December 31, 2015 are presented in the following table.
Table 16: Capital
In July 2013, the Federal Reserve Board and the OCC issued final rules implementing the Basel III regulatory capital framework and related Dodd-Frank Act changes. The final rules took effect for Nicolet and the Bank on January 1, 2015, subject to a transition period for certain parts of the rules. The rules permitted certain banking organizations to retain, through a one-time election, the existing treatment for accumulated other comprehensive income. Nicolet and the Bank made the election in 2015 to retain the existing treatment for accumulated other comprehensive income.
The tables above calculate and present regulatory capital based upon the capital ratio requirements under Basel III that became effective on January 1, 2015. Beginning in 2016, an additional capital conservation buffer will be added to the minimum requirements for capital adequacy purposes, subject to a three year phase-in period. The capital conservation buffer will be fully phased-in on January 1, 2019 at 2.5 percent. A banking organization with a conservation buffer of less than 2.5 percent (or the required phase-in amount in years prior to 2019) will be subject to limitations on capital distributions, including dividend payments and certain discretionary bonus payments to executive officers. At the present time, the ratios for the Company and Bank are sufficient to meet the fully phased-in conservation buffer.
Future Accounting Pronouncements
In March 2016, the Financial Accounting Standards Board (“FASB”) issued updated guidance to Accounting Standards Update 2015-09 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, with early adoption permitted. The Company is currently assessing the impact of the new guidance on its consolidated financial statements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
See section “Interest Rate Sensitivity Management” of Management Discussion & Analysis under Part 1, Item 2.
ITEM 4. CONTROLS AND PROCEDURES
As of the end of the period covered by this report, management, under the supervision, and with the participation, of our Chief Executive Officer and President and Chief Financial Officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as such term in Rule 13a-15(e) and 15d-15(e) under the Exchange Act pursuant to Exchange Act Rule 13a-15. Based upon, and as of the date of such evaluation, the Chief Executive Officer and President and the Chief Financial Officer concluded that our disclosure controls and procedures were effective.
There have been no changes in the Company’s internal controls or, to the Company’s knowledge, in other factors during the quarter covered by this report that have materially affected, or are reasonably likely to materially affect, the Company’s internal controls over financial reporting. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
PART II – OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
We and our subsidiaries may be involved from time to time in various routine legal proceedings incidental to our respective businesses. Neither we nor any of our subsidiaries are currently engaged in any legal proceedings that are expected to have a material adverse effect on our results of operations or financial position.
ITEM 1A. RISK FACTORS
There have been no material changes in the risk factors previously disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
During the first quarter of 2016, Nicolet hired a group of financial advisors and purchased their book of business. The consideration Nicolet paid for this business included cash plus the issuance of 19,650 shares of Nicolet common stock, which were issued in a private placement exempt from registration under Section 4(a)(2) of the Securities Act of 1933, as amended.
Commencing on February 24, 2016, Nicolet’s common stock is traded on the Nasdaq Capital Market under the symbol NCBS. Following are Nicolet’s monthly common stock purchases during the first quarter of 2016.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
ITEM 5. OTHER INFORMATION
ITEM 6. EXHIBITS
The following exhibits are filed herewith:
*Indicates information that is furnished and not filed or a part of a registration statement or prospectus for purposes of sections 11 or 12 of the Securities Act of 1933, is deemed not filed for purposes of section 18 of the Securities Exchange Act of 1934, and otherwise is not subject to liability under these sections.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.