10-Q 1 t79910_10q.htm FORM 10-Q



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q
 
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

For the quarterly period ended June 30, 2014

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

For the transition period from__________to___________

Commission file number 333-90052
NICOLET BANKSHARES, INC.
(Exact name of registrant as specified in its charter)
 
WISCONSIN
 (State or other jurisdiction of incorporation or organization)
47-0871001
 (I.R.S. Employer Identification No.)
 
111 North Washington Street
Green Bay, Wisconsin 54301
(920) 430-1400
(Address, including zip code, and telephone number, including area code, of
Registrant’s principal executive offices)

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate 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 o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer o      Accelerated filer o
Non-accelerated filer o (Do not check if a smaller reporting company) Smaller reporting company x

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

As of July 31, 2014 there were 4,114,846 shares of $0.01 par value common stock outstanding.
 
 
 

 


 Nicolet Bankshares, Inc.
 
TABLE OF CONTENTS

PART I
FINANCIAL INFORMATION
 
PAGE
 
 
Item 1.
 
Financial Statements:
   
   
 
Consolidated Balance Sheets
June 30, 2014 (unaudited) and December 31, 2013
 
 
3
 
   
 
Consolidated Statements of Income
Three Months and Six Months Ended June 30, 2014 and 2013 (unaudited)
 
 
4
 
         
   
Consolidated Statements of Comprehensive Income
Three Months and Six Months Ended June 30, 2014 and 2013 (unaudited)
 
 
5
 
   
Consolidated Statement of Changes in Stockholders’ Equity
Six Months Ended June 30, 2014 (unaudited)
 
Consolidated Statements of Cash Flows
Six Months Ended June 30, 2014 and 2013 (unaudited)
 
 
6
 
 
7
 
   
 
Notes to Unaudited Consolidated Financial Statements
 
8-26
 
 
 
Item 2.
 
Management’s Discussion and Analysis of Financial Condition
and Results of Operations
 
27-51
 
 
 
Item 3.
 
Quantitative and Qualitative Disclosures About Market Risk
 
52
 
 
 
Item 4.
 
Controls and Procedures
 
52
 
 
PART II
 
OTHER INFORMATION
   
 
 
Item 1.
 
Item 1A.
 
Legal Proceedings
 
Risk Factors
 
52
 
52
 
 
 
Item 2.
 
Unregistered Sales of Equity Securities and Use of Proceeds
 
52
 
 
 
Item 3.
 
Defaults Upon Senior Securities
 
52
 
 
 
Item 4.
 
Item 5.
 
Item 6.
 
Mine Safety Disclosures
 
Other Information
 
Exhibits
 
Signatures
 
52
 
52
 
53
 
53-57
 
 

2
 

 

 
PART I – FINANCIAL INFORMATION

Item 1. FINANCIAL STATEMENTS:
 
NICOLET BANKSHARES, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(In thousands, except share and per share data)

   
June 30, 2014
(Unaudited)
   
December 31, 2013
(Audited)
 
Assets
           
Cash and due from banks
  $ 21,235     $ 26,556  
Interest-earning deposits
    60,270       119,364  
Federal funds sold
    4,083       1,058  
Cash and cash equivalents
    85,588       146,978  
Certificates of deposit in other banks
    7,144       1,960  
Securities available for sale (“AFS”)
    143,655       127,515  
Other investments
    8,056       7,982  
Loans held for sale
    3,589       1,486  
Loans
    860,086       847,358  
Allowance for loan losses
    (9,642 )     (9,232 )
Loans, net
    850,444       838,126  
Premises and equipment, net
    28,617       29,845  
Bank owned life insurance
    26,980       23,796  
Accrued interest receivable and other assets
    19,699       21,115  
Total assets
  $ 1,173,772     $ 1,198,803  
 
Liabilities and Stockholders’ Equity
               
Liabilities:
               
Demand
  $ 190,464     $ 171,321  
Money market and NOW accounts
    451,791       492,499  
Savings
    112,232       97,601  
Time
    256,634       273,413  
Total deposits
    1,011,121       1,034,834  
Short-term borrowings
    3,399       7,116  
Notes payable
    27,299       32,422  
Junior subordinated debentures
    12,228       12,128  
Accrued interest payable and other liabilities
    11,588       7,424  
Total liabilities
    1,065,635       1,093,924  
                 
Stockholders’ Equity:
               
Preferred equity
    24,400       24,400  
Common stock
    41       42  
Additional paid-in capital
    47,746       49,616  
Retained earnings
    34,784       30,138  
Accumulated other comprehensive income (“AOCI”)
    1,096       666  
Total Nicolet Bankshares, Inc. stockholders’ equity
    108,067       104,862  
Noncontrolling interest
    70       17  
Total stockholders’ equity and noncontrolling interest
    108,137       104,879  
Total liabilities, noncontrolling interest and stockholders’ equity
  $ 1,173,772     $ 1,198,803  
Preferred shares authorized (no par value)
    10,000,000       10,000,000  
Preferred shares issued
    24,400       24,400  
Common shares authorized (par value $0.01 per share)
    30,000,000       30,000,000  
Common shares outstanding
    4,147,226       4,241,044  
Common shares issued
    4,196,670       4,303,407  
 
See accompanying notes to unaudited consolidated financial statements.
 
3
 

 


 
ITEM 1. Financial Statements Continued:

NICOLET BANKSHARES, INC. AND SUBSIDIARIES
Consolidated Statements of Income
(In thousands, except share and per share data) (Unaudited)
 
   
Three Months Ended
June 30,
   
Six Months Ended
June 30,
 
   
2014
   
2013
   
2014
   
2013
 
Interest income:
                       
Loans, including loan fees
  $ 11,616     $ 9,828     $ 22,623     $ 16,609  
Investment securities:
                               
Taxable
    415       278       833       405  
Non-taxable
    170       187       343       360  
Other interest income
    128       65       263       145  
Total interest income
    12,329       10,358       24,062       17,519  
Interest expense:
                               
Money market and NOW accounts
    572       463       1,165       977  
Savings and time deposits
    793       562       1,481       1,049  
Short term borrowings
    4       6       7       7  
Junior subordinated debentures
    218       165       435       289  
Notes payable
    246       344       498       627  
Total interest expense
    1,833       1,540       3,586       2,949  
 Net interest income
    10,496       8,818       20,476       14,570  
Provision for loan losses
    675       975       1,350       1,950  
 Net interest income after provision for loan losses
    9,821       7,843       19,126       12,620  
Noninterest income:
                               
Service charges on deposit accounts
    544       470       1,038       754  
Trust services fee income
    1,119       1,074       2,224       1,876  
Mortgage income
    431       714       646       1,586  
Brokerage fee income
    166       115       326       217  
Bank owned life insurance
    220       212       434       381  
Rent income
    288       274       588       524  
Investment advisory fees
    102       76       212       162  
Gain (loss) on sale or writedown of assets, net
    (442 )     45       308       49  
Bargain purchase gain
    -       10,435       -       10,435  
Other
    452       351       864       538  
 Total noninterest income
    2,880       13,766       6,640       16,522  
Noninterest expense:
                               
Salaries and employee benefits
    5,384       5,555       10,679       9,114  
Occupancy, equipment and office
    1,737       1,466       3,635       2,570  
Business development and marketing
    537       473       1,072       898  
Data processing
    775       572       1,529       995  
 FDIC assessments
    203       130       387       240  
Core deposit intangible amortization
    315       286       650       434  
Other
    533       1,104       1,120       1,675  
Total noninterest expense
    9,484       9,586       19,072       15,926  
                                 
Income before income tax expense
    3,217       12,023       6,694       13,216  
Income tax expense
    641       547       1,873       966  
Net income
    2,576       11,476       4,821       12,250  
Less: net income attributable to noncontrolling interest
    22       19       53       38  
Net income attributable to Nicolet Bankshares, Inc.
    2,554       11,457       4,768       12,212  
Less: preferred stock dividends
    61       305       122       610  
Net income available to common shareholders
  $ 2,493     $ 11,152     $ 4,646     $ 11,602  
                                 
Basic earnings per common share
  $ 0.59     $ 2.79     $ 1.10     $ 3.12  
Diluted earnings per common share
  $ 0.58     $ 2.78     $ 1.08     $ 3.11  
Weighted average common shares outstanding:
                               
Basic
    4,212,174       3,999,732       4,227,446       3,717,627  
Diluted
    4,332,016       4,008,426       4,312,005       3,728,599  

See accompanying notes to unaudited consolidated financial statements.
 
4
 

 

 
ITEM 1. Financial Statements Continued:

NICOLET BANKSHARES, INC. AND SUBSIDIARIES
Consolidated Statements of Comprehensive Income
(In thousands) (Unaudited)
                                 
   
Three Months Ended
June 30,
   
Six Months Ended
June 30,
 
   
2014
   
2013
   
2014
   
2013
 
Net income
  $ 2,576     $ 11,476     $ 4,821     $ 12,250  
Other comprehensive income (loss), net of tax:
                               
Securities available for sale:
                               
Net unrealized holding gains (losses) arising during the period
    446       (1,645     1,045       (1,130 )
Less: reclassification adjustment for net (gains) losses realized in net income
    -       239       (341     239  
Net unrealized gains (losses) on securities before tax expense
    446       (1,406     704       (891 )
Income tax (expense) benefit
    (173 )     549       (274     348  
Total other comprehensive income (loss)
    273       (857     430       (543 )
Comprehensive income
  $ 2,849     $ 10,619     $ 5,251     $ 11,707  

See accompanying notes to unaudited consolidated financial statements.
 
5
 

 

 
ITEM 1. Financial Statements Continued:

NICOLET BANKSHARES, INC. AND SUBSIDIARIES
Consolidated Statement of Stockholders’ Equity
(In thousands) (Unaudited)
 
   
Nicolet Bankshares, Inc. Stockholders’ Equity
             
                                           
   
Preferred
Equity
   
Common
Stock
   
Additional
Paid-In Capital
   
Retained
Earnings
   
Accumulated Other Comprehensive Income
   
 
 
Noncontrolling
Interest
   
 
 
 
Total
 
Balance December 31, 2013
  $ 24,400     $ 42     $ 49,616     $ 30,138     $ 666     $ 17     $ 104,879  
Comprehensive income:
                                                       
Net income
    -       -       -       4,768       -       53       4,821  
Other comprehensive income
    -       -       -       -       430       -       430  
Stock compensation expense
    -       -       306       -       -       -       306  
Exercise of stock options
    -       -       298       -       -       -       298  
Issuance of common stock
    -       -       29       -       -       -       29  
Purchase and retirement of common stock
    -       (1 )     (2,503 )     -       -       -       (2,504 )
Preferred stock dividends
    -       -       -       (122 )     -       -       (122 )
Balance, June 30, 2014
  $ 24,400     $ 41     $ 47,746     $ 34,784     $ 1,096     $ 70     $ 108,137  

See accompanying notes to unaudited consolidated financial statements.
 
6
 

 


ITEM 1. Financial Statements Continued:
 
NICOLET BANKSHARES, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(In thousands) (Unaudited)
 
   
Six Months Ended June 30,
 
   
2014
   
2013
 
Cash Flows From Operating Activities:
 
 
   
 
 
Net income
  $ 4,821     $ 12,250  
Adjustments to reconcile net income to net cash provided by operating activities:
               
Depreciation, amortization, and accretion
    1,796       1,985  
Provision for loan losses
    1,350       1,950  
Increase in cash surrender value of life insurance
    (434 )     (381 )
Stock compensation expense
    306       342  
Gain on sale or writedown of assets, net
    (308 )     (49 )
Gain on sale of loans held for sale, net
    (646 )     (1,586 )
Proceeds from sale of loans held for sale
    31,322       95,965  
Origination of loans held for sale
    (32,779 )     (90,198 )
Bargain purchase gain
    -       (10,435 )
Net change in:
               
Accrued interest receivable and other assets
    270       366  
Accrued interest payable and other liabilities
    (1,136 )     1,354  
Net cash provided by operating activities
    4,562       11,563  
Cash Flows From Investing Activities:
               
Net increase in certificates of deposit in other banks
    (5,184 )     -  
Net increase in loans
    (13,800 )     (19,689 )
Purchases of securities AFS
    (23,107 )     (8,711 )
Proceeds from sales of securities AFS
    4,021       43,945  
Proceeds from calls and maturities of securities AFS
    8,276       8,089  
Purchase of other investments
    (74 )     (8 )
Purchase of premises and equipment
    (778 )     (1,246 )
Proceeds from sales of premises and equipment
    7       -  
Proceeds from sales of other real estate and other assets
    2,159       993  
Purchase of bank owned life insurance
    (2,750 )     -  
Net cash received in business combination
    -       13,898  
Net cash provided (used) by investing activities
    (31,230 )     37,271  
Cash Flows From Financing Activities:
               
Net decrease in deposits
    (23,583 )     (54,152 )
Net change in short-term borrowings
    (3,717 )     3,091  
Repayments of notes payable
    (5,123 )     (45,809 )
Purchase and retirement of common stock
    (2,504 )     (63 )
Stock issuance costs
    -       (401 )
Proceeds from issuance of common stock, net
    29       3,107  
Proceeds from exercise of common stock options
    298       206  
Noncontrolling interest in joint venture
    -       (60 )
Cash dividends paid on preferred stock
    (122 )     (610 )
Net cash used by financing activities
    (34,722 )     (94,691 )
Net decrease in cash and cash equivalents
    (61,390 )     (45,857 )
Cash and cash equivalents:
               
Beginning
  $ 146,978     $ 82,003  
Ending
  $ 85,588     $ 36,146  
Supplemental Disclosures of Cash Flow Information:
               
Cash paid for interest
  $ 3,761     $ 2,241  
Cash paid for taxes
    2,060       1,018  
Transfer of loans and bank premises to other real estate owned
    1,061       2,116  
Acquisitions:
               
Fair value of assets acquired
    -       435,692  
Fair value of liabilities assumed
    -       415,067  
Net assets acquired
    -       20,625  
                 
See accompanying notes to unaudited consolidated financial statements.
 
7
 

 


NICOLET BANKSHARES, INC. AND SUBSIDIARIES

Notes to Unaudited Consolidated Financial Statements

Note 1 – Basis of Presentation

General

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

These interim consolidated financial statements have been prepared according to the rules and regulations of the Securities and Exchange Commission and, therefore, certain information and footnote disclosures normally presented in accordance with generally accepted accounting principles in the United States of America (“U.S. GAAP”) have been omitted or abbreviated. These consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements and footnotes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013.

Critical Accounting Policies and Estimates

Preparation of 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 within the first twelve months after acquisition as allowed by purchase accounting guidelines. 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, 2013.

Recent Accounting Developments Adopted

The Company has implemented all new accounting pronouncements that are in effect and that may impact its consolidated financial statements and does not believe that there are any other new accounting pronouncements that have been issued that might have a material impact on its financial position or results of operations.

Note 2 – Acquisitions

Bank of Wausau: On August 9, 2013, Nicolet National Bank entered into an agreement with the Federal Deposit Insurance Corporation (“FDIC”), purchasing selected Bank of Wausau assets and assuming all of its deposits, in a transaction that was effective immediately. The financial position and results of operations of Bank of Wausau prior to its acquisition date were not included in the accompanying consolidated financial statements. The FDIC-assisted transaction carried no loss-share provisions. With the addition of Bank of Wausau’s one branch, Nicolet National Bank operates two branches in Wausau, WI. As of the acquisition date, the transaction added approximately $47 million in assets at fair value, including mostly cash as well as $9.4 million of investments and $12.5 million in loans, of which $1.4 million were classified as Purchase Credit Impaired (“PCI”) loans. Of the $42 million of deposits assumed, $18 million were immediately repriced rate-sensitive certificates of deposit which were subsequently redeemed in full by September 30, 2013. Given the nature and rates of the remaining deposits assumed, no core deposit intangible was recorded. The third quarter of 2013 included approximately $0.2 million pre-tax acquisition costs and a $2.4 million pre-tax bargain purchase gain.

8
 

 

 
Note 2 – Acquisitions, continued

Mid-Wisconsin Financial Services, Inc. (“Mid-Wisconsin”): On April 26, 2013, the Company consummated its acquisition of Mid-Wisconsin, pursuant to the Agreement and Plan of Merger by and among the Company and Mid-Wisconsin dated November 28, 2012, as amended January 17, 2013 (the “Merger Agreement”), whereby Mid-Wisconsin was merged with and into the Company, and Mid-Wisconsin Bank, Mid-Wisconsin’s wholly owned commercial bank subsidiary serving central Wisconsin, was merged with and into Nicolet National Bank. The system integration was completed, and the eleven branches of Mid-Wisconsin opened on April 29, 2013 as Nicolet National Bank branches.

The purpose of the merger was for strategic reasons beneficial to the Company. The acquisition is consistent with its growth plans to build a community bank of sufficient size to flourish in various economic environments, serve its expanded customer base with a wide variety of products and services, and effectively and efficiently meet growing regulatory compliance and capital requirements. The Company believes it is well-positioned to achieve stronger financial performance and enhance shareholder value through synergies of the combined operations.
 
Pursuant to the terms of the Merger Agreement, the outstanding shares of Mid-Wisconsin common stock, other than dissenting shares as defined in the merger agreement, were converted into the right to receive 0.3727 shares of Company common stock (and in lieu of any fractional share of Company common stock, $16.50 in cash) per share of Mid-Wisconsin common stock or, for record holders of 200 or fewer shares of Mid-Wisconsin common stock, $6.15 in cash per share of Mid-Wisconsin common stock. As a result, the total value of the consideration to Mid-Wisconsin shareholders was $10.2 million, consisting of $0.5 million in cash and 589,159 shares of the Company’s common stock. The Company’s common stock was valued at $16.50 per share, which was the value assigned in the merger agreement and considered to be the fair value of the stock on the date of the acquisition. Concurrently with the merger, the Company also closed a private placement of 174,016 shares of its common stock at an offering price of $16.50 per share, for an aggregate of $2.9 million in proceeds. Approximately $0.4 million in direct stock issuance costs for the merger and private placement were incurred and charged against additional paid in capital. Also as a condition of the merger, Mid-Wisconsin redeemed by the closing of the merger its preferred stock (issued to the Department of U.S. Treasury (“UST”) as part of its participation in the federal government’s Capital Purchase Program (“CPP”) with par value of $10.5 million) plus all accrued and unpaid dividends thereon.

The Company accounted for the transaction under the acquisition method of accounting, and thus, the financial position and results of operations of Mid-Wisconsin prior to the consummation date were not included in the accompanying consolidated financial statements. The accounting required assets purchased and liabilities assumed to be recorded at their respective fair values at the date of acquisition. The estimated fair values were subject to refinement as additional information relative to the closing date fair values became available through the measurement period of approximately one year from consummation. During the fourth quarter of 2013, there were developments related to an ongoing legal matter acquired in the Mid-Wisconsin transaction. Such litigation was pre-existing at the time of acquisition. The events in the fourth quarter supported a change in estimate of loss on this litigation to $0.9 million, net of tax, which was recorded against the bargain purchase gain of the Mid-Wisconsin transaction and imposed back against 2013 third quarter earnings. No other adjustments to the bargain purchase gain have been recorded.

As of the acquisition date, the transaction added approximately $436 million in assets at fair value, including cash and investments of $133 million, $272 million in loans, of which $15 million were classified as PCI loans, $4 million of core deposit intangible; and $27 million of other assets. Deposits of $346 million and junior subordinated debentures, borrowings and other liabilities of $70 million were acquired in the merger. The excess of assets over liabilities acquired of $20 million less the purchase price of $10 million resulted in a bargain purchase gain of $10 million.

Proforma results for 2014 periods are not necessary as the 2014 actual results fully include both 2013 acquisitions. The following unaudited pro forma information presents the results of operations for the six months ended June 30, 2013, as if the acquisitions had occurred January 1 of that year. These unaudited pro forma results are presented for illustrative purposes and are not intended to represent or be indicative of the actual results of operations of the combined company that would have been achieved had the acquisitions occurred at the beginning of each period presented, nor are they intended to represent or be indicative of future results of operations.

   
Six Months Ended
June 30, 2013
 
(in thousands)
     
Total revenues, net of interest expense
  $ 34,117  
Net income
    11,413  

9
 

 

 
Note 3 – Earnings per Common Share

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

 
 
Three Months Ended
 June 30,
   
Six Months Ended
 June 30,
 
 
 
2014
   
2013
   
2014
   
2013
 
(In thousands except per share data)
 
 
   
 
             
Net income, net of noncontrolling interest
  $ 2,554     $ 11,457     $ 4,768     $ 12,212  
Less: preferred stock dividends
    61       305       122       610  
Net income available to common shareholders
  $ 2,493     $ 11,152     $ 4,646     $ 11,602  
Weighted average common shares outstanding
    4,212       4,000       4,227       3,718  
Effect of dilutive stock instruments
    120       8       85       11  
Diluted weighted average common shares outstanding
    4,332       4,008       4,312       3,729  
Basic earnings per common share*
  $ 0.59     $ 2.79     $ 1.10     $ 3.12  
Diluted earnings per common share*
  $ 0.58     $ 2.78     $ 1.08     $ 3.11  

*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.

Options to purchase approximately 0.3 million and 0.5 million shares were outstanding at June 30, 2014 and 2013, respectively, but were excluded from the calculation of diluted earnings per common share as the effect would have been anti-dilutive.

Note 4 – Stock-based Compensation

Activity in the Company’s Stock Incentive Plans is summarized in the following tables:
 
Stock Options
 
Weighted-
Average Fair
Value of Options
Granted
   
 
Option Shares
Outstanding
   
Weighted-
Average
Exercise Price
   
 
 
Exercisable Shares
 
Balance – December 31, 2012
          825,532     $ 17.70       548,623  
Granted
    -       -       -          
Exercise of stock options
            (23,625 )     12.96          
Forfeited
            (8,750 )     15.78          
Balance – December 31, 2013
            793,157       17.86       600,846  
Granted
    -       -       -          
Exercise of stock options
            (18,215 )     16.35          
Forfeited
            (4,750 )     16.65          
Balance – June 30, 2014
            770,192     $ 17.90       614,243  

10
 

 


Note 4 – Stock-based Compensation, continued

Options outstanding at June 30, 2014 are exercisable at option prices ranging from $12.50 to $26.00. There are 328,618 options outstanding in the range from $12.50 - $17.00, 395,574 options outstanding in the range from $17.01 - $22.00, and 46,000 options outstanding in the range from $22.01 - $26.00. At June 30, 2014, the exercisable options have a weighted average remaining contractual life of approximately 3 years and a weighted average exercise price of $18.21.

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 six months of 2014, and full year of 2013 was approximately $19,000, and $80,000, respectively.
 
Restricted Stock
 
Weighted-Average Grant Date Fair Value
   
Restricted
Shares Outstanding
 
Balance – December 31, 2012
  $ 16.50       54,475  
Granted
    16.51       26,506  
Vested*
    16.50       (18,258 )
Forfeited
    16.50       (360 )
Balance – December 31, 2013
    16.50       62,363  
Granted
    -       -  
Vested *
    16.50       (12,919 )
Forfeited
    -       -  
Balance – June 30, 2014
  $ 16.50       49,444  
                 
*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 2,519 shares were surrendered during the six months ended June 30, 2014 and 5,606 shares were surrendered during 2013.

The Company recognized approximately $306,000 and $342,000 of stock-based employee compensation expense during the six months ended June 30, 2014 and 2013, respectively, associated with its stock equity awards. As of June 30, 2014, there was approximately $1.3 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 four years.

Note 5- Securities Available for Sale

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

   
June 30, 2014
 
(in thousands)
 
Amortized Cost
   
Gross
Unrealized
Gains
   
Gross
Unrealized Losses
   
Fair Value
 
U.S. government sponsored enterprises
  $ 1,532     $ 6     $ 1     $ 1,537  
State, county and municipals
    76,446       996       375       77,067  
Mortgage-backed securities
    62,946       676       694       62,928  
Corporate debt securities
    220       -       -       220  
Equity securities
    715       1,188       -       1,903  
    $ 141,859     $ 2,866     $ 1,070     $ 143,655  
 
                               
   
December 31, 2013
 
(in thousands)
 
Amortized Cost
   
Gross
Unrealized
Gains
   
Gross
Unrealized
Losses
   
Fair Values
 
U.S. government sponsored enterprises
  $ 2,062     $ 3     $ 8     $ 2,057  
State, county and municipals
    54,594       1,058       613       55,039  
Mortgage-backed securities
    68,642       585       1,348       67,879  
Corporate debt securities
    220       -       -       220  
Equity securities
    905       1,415       -       2,320  
    $ 126,423     $ 3,061     $ 1,969     $ 127,515  
 
11
 

 

 
Note 5- Securities Available for Sale, continued

The following table represents gross unrealized losses and the related fair value of investment securities available for sale, aggregated by investment category and length of time individual securities have been in a continuous unrealized loss position, at June 30, 2014 and December 31, 2013.

   
June 30, 2014
 
   
Less than 12 months
   
12 months or more
   
Total
 
(in thousands)
 
Fair
Value
   
Unrealized Losses
   
Fair
Value
   
Unrealized Losses
   
Fair
Value
   
Unrealized Losses
 
U.S. government sponsored enterprises
  $ 143     $ 1     $ -     $ -     $ 143     $ 1  
State, county and municipals
    17,281       94       12,938       281       30,219       375  
Mortgage-backed securities
    2,752       20       26,753       674       29,505       694  
    $ 20,176     $ 115     $ 39,691     $ 955     $ 59,867     $ 1,070  
       
   
December 31, 2013
 
   
Less than 12 months
   
12 months or more
   
Total
 
(in thousands)
 
Fair Value
   
Unrealized
Losses
   
Fair Value
   
Unrealized
Losses
   
Fair Value
   
Unrealized
Losses
 
U.S. government sponsored enterprises
  $ 511     $ 8     $ -     $ -     $ 511     $ 8  
State, county and municipals
    17,697       613       -       -       17,697       613  
Mortgage-backed securities
    36,687       1,240       2,920       108       39,607       1,348  
    $ 54,895     $ 1,861     $ 2,920     $ 108     $ 57,815     $ 1,969  

As of June 30, 2014, 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 six-month period ending June 30, 2014 or 2013.

The amortized cost and fair values of securities available for sale at June 30, 2014 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.
 
   
June 30, 2014
 
(in thousands)
 
Amortized Cost
   
Fair Value
 
Due in less than one year
  $ 5,220     $ 5,276  
Due in one year through five years
    62,344       62,986  
Due after five years through ten years
    9,549       9,471  
Due after ten years
    1,085       1,091  
      78,198       78,824  
Mortgage-backed securities
    62,946       62,928  
Equity securities
    715       1,903  
Securities available for sale
  $ 141,859     $ 143,655  
 
Proceeds from sales of securities available for sale during the first six months of 2014 and 2013 were approximately $4.0 million and $43.9 million, respectively. Net gains of approximately $341,000 and $239,000 were realized on sales of securities during the first six months of 2014 and 2013, respectively.
 
12
 

 

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

The loan composition as of June 30, 2014 and December 31, 2013 is summarized as follows.
 
   
Total
   
June 30, 2014
 
December 31, 2013
(in thousands)
 
Amount
   
% of
Total
   
Amount
   
% of
Total
 
Commercial & industrial
  $ 269,377       31.3 %   $ 253,674       29.9 %
Owner-occupied commercial real estate (“CRE”)
    187,225       21.8       187,476       22.1  
Agricultural (“AG”) production
    13,982       1.6       14,256       1.7  
AG real estate
    41,934       4.9       37,057       4.4  
CRE investment
    79,639       9.3       90,295       10.7  
Construction & land development
    45,504       5.3       42,881       5.1  
Residential construction
    11,895       1.4       12,535       1.5  
Residential first mortgage
    154,713       18.0       154,403       18.2  
Residential junior mortgage
    50,244       5.8       49,363       5.8  
Retail & other
    5,573       0.6       5,418       0.6  
Loans
    860,086       100.0
%
    847,358       100.0
%
Less allowance for loan losses
    9,642               9,232          
Loans, net
  $ 850,444             $ 838,126          
Allowance for loan losses to loans
    1.12 %             1.09 %        

   
Originated
   
June 30, 2014
 
December 31, 2013
(in thousands)
 
Amount
   
% of
Total
   
Amount
 
% of
Total
 
Commercial & industrial
  $ 242,150       37.4
%
  $ 227,572   36.5
%
Owner-occupied CRE
    129,315       20.0       127,759   20.5  
AG production
    4,653       0.7       3,230   0.5  
AG real estate
    18,189       2.8       13,596   2.2  
CRE investment
    50,929       7.9       60,390   9.7  
Construction & land development
    34,501       5.3       30,277   4.9  
Residential construction
    11,895       1.8       12,475   2.0  
Residential first mortgage
    110,084       17.0       104,180   16.7  
Residential junior mortgage
    40,913       6.3       39,207   6.3  
Retail & other
    4,847       0.8       4,192   0.7  
Loans
  $ 647,476       100.0
%
  $ 622,878   100.0
%

   
Acquired
 
   
June 30, 2014
 
December 31, 2013
(in thousands)
 
Amount
   
% of
Total
   
Amount
   
% of
Total
 
Commercial & industrial
  $ 27,227       12.8
%
  $ 26,102       11.6
%
Owner-occupied CRE
    57,910       27.2       59,717       26.6  
AG production
    9,329       4.4       11,026       4.9  
AG real estate
    23,745       11.2       23,461       10.5  
CRE investment
    28,710       13.5       29,905       13.3  
Construction & land development
    11,003       5.2       12,604       5.6  
Residential construction
    -       -       60       0.1  
Residential first mortgage
    44,629       21.0       50,223       22.4  
Residential junior mortgage
    9,331       4.4       10,156       4.5  
Retail & other
    726       0.3       1,226       0.5  
Loans
  $ 212,610       100.0
%
  $ 224,480       100.0
%

Practically all of the Company’s loans, commitments, 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.
 
13
 

 


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

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. Due to the short period of time since the acquisitions and consistent with acquisition accounting rules, no ALLL has been recorded on acquired loans since acquisition or at June 30, 2014.
 
14
 

 

 
Note 6 – Loans, Allowance for Loan Losses, and Credit Quality, continued
 
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 six months ended June 30, 2014:
                                                                   
   
TOTAL – Six Months Ended June 30, 2014
 
(in thousands)
ALLL:
 
Commercial
& industrial
   
Owner- occupied
CRE
   
AG production
   
AG real
estate
   
CRE
investment
   
Construction & land development
   
Residential construction
   
Residential first
mortgage
   
Residential junior mortgage
   
Retail
& other
   
Total
 
Beginning balance
  $ 1,798     $ 766     $ 18     $ 59     $ 505     $ 4,970     $ 229     $ 544     $ 321     $ 22     $ 9,232  
Provision
    2,007       584       26       213       62       (2,174 )     (62 )     411       136       147       1,350  
Charge-offs
    (534 )     (268 )     -       -       -       (12 )     -       (123 )     (9 )     (33 )     (979 )
Recoveries
    10       14       -       -       8       -       -       1       -       6       39  
Net charge-offs
    (524 )     (254 )     -       -       8       (12 )     -       (122 )     (9 )     (27 )     (940 )
Ending balance
  $ 3,281     $ 1,096     $ 44     $ 272     $ 575     $ 2,784     $ 167     $ 833     $ 448     $ 142     $ 9,642  
As percent of ALLL
    34.0 %     11.4 %     0.5 %     2.8 %     6.0 %     28.9 %     1.7 %     8.6 %     4.6 %     1.5 %     100 %
                                                                                         
ALLL:
                                                                                       
Individually evaluated
  $ 213     $ -     $ -     $ -     $ -     $ 420     $ -     $ -     $ -     $ -     $ 633  
Collectively evaluated
    3,068       1,096       44       272       575       2,364       167       833       448       142       9,009  
Ending balance
  $ 3,281     $ 1,096     $ 44     $ 272     $ 575     $ 2,784     $ 167     $ 833     $ 448     $ 142     $ 9,642  
                                                                                         
Loans:
                                                                                       
Individually evaluated
  $ 332     $ 1,999     $ 27     $ 459     $ 1,913     $ 4,358     $ -     $ 1,319     $ 438     $ -     $ 10,845  
Collectively evaluated
    269,045       185,226       13,955       41,475       77,726       41,146       11,895       153,394       49,806       5,573       849,241  
Total loans
  $ 269,377     $ 187,225     $ 13,982     $ 41,934     $ 79,639     $ 45,504     $ 11,895     $ 154,713     $ 50,244     $ 5,573     $ 860,086  
                                                                                         
Less ALLL
  $ 3,281     $ 1,096     $ 44     $ 272     $ 575     $ 2,784     $ 167     $ 833     $ 448     $ 142     $ 9,642  
Net loans
  $ 266,096     $ 186,129     $ 13,938     $ 41,662     $ 79,064     $ 42,720     $ 11,728     $ 153,880     $ 49,796     $ 5,431     $ 850,444  
 
   
Originated – Six Months Ended June 30, 2014
(in thousands)
ALLL:
 
Commercial
& industrial
   
Owner-
occupied
CRE
   
AG
production
   
AG real
estate
   
CRE
investment
   
Construction & land development
   
Residential
construction
   
Residential
first
mortgage
   
Residential
junior
mortgage
   
Retail
& other
   
Total
 
Beginning balance
  $ 1,798     $ 766     $ 18     $ 59     $ 505     $ 4,970     $ 229     $ 544     $ 321     $ 22     $ 9,232  
Provision
    1,983       577       26       213       62       (2,186 )     (62 )     320       127       147       1,207  
Charge-offs
    (510 )     (252 )     -       -       -       -       -       (32 )     -       (33 )     (827 )
Recoveries
    10       5       -       -       8       -       -       1       -       6       30  
Net charge-offs
    (500 )     (247 )     -       -       8       -       -       (31 )     -       (27 )     (797 )
Ending balance
  $ 3,281     $ 1,096     $ 44     $ 272     $ 575     $ 2,784     $ 167     $ 833     $ 448     $ 142     $ 9,642  
As percent of ALLL
    34.0 %     11.4 %     0.5 %     2.8 %     6.0 %     28.9 %     1.7 %     8.6 %     4.6 %     1.5 %     100 %
                                                                                         
ALLL:
                                                                                       
Individually evaluated
  $ 213     $ -     $ -     $ -     $ -     $ 420     $ -     $ -     $ -     $ -     $ 633  
Collectively evaluated
    3,068       1,096       44       272       575       2,364       167       833       448       142       9,009  
Ending balance
  $ 3,281     $ 1,096     $ 44     $ 272     $ 575     $ 2,784     $ 167     $ 833     $ 448     $ 142     $ 9,642  
                                                                                         
Loans:
                                                                                       
Individually evaluated
  $ 323     $ 1,042     $ -     $ -     $ -     $ 3,879     $ -     $ -     $ -     $ -     $ 5,244  
Collectively evaluated
    241,827       128,273       4,653       18,189       50,929       30,622       11,895       110,084       40,913       4,847       642,232  
Total loans
  $ 242,150     $ 129,315     $ 4,653     $ 18,189     $ 50,929     $ 34,501     $ 11,895     $ 110,084     $ 40,913     $ 4,847     $ 647,476  
                                                                                         
Less ALLL
  $ 3,281     $ 1,096     $ 44     $ 272     $ 575     $ 2,784     $ 167     $ 833     $ 448     $ 142     $ 9,642  
Net loans
  $ 238,869     $ 128,219     $ 4,609     $ 17,917     $ 50,354     $ 31,717     $ 11,728     $ 109,251     $ 40,465     $ 4,705     $ 637,834  

15
 

 

 
Note 6 – Loans, Allowance for Loan Losses, and Credit Quality, continued
 
   
Acquired – Six Months Ended June 30, 2014
 
(in thousands)
ALLL:
 
Commercial
& industrial
   
Owner-
occupied
CRE
   
AG
production
   
AG real estate
   
CRE
investment
   
Construction & land development
   
Residential
construction
   
Residential
first
mortgage
   
Residential
junior
mortgage
   
Retail &
other
   
Total
 
Provision
  $ 24     $ 7     $ -     $ -     $ -     $ 12     $ -     $ 91     $ 9     $ -     $ 143  
Charge-offs
    (24 )     (16 )     -       -       -       (12 )     -       (91 )     (9 )     -       (152 )
Recoveries
    -       9       -       -       -       -       -       -       -       -       9  
Loans:
                                                                                       
Individually evaluated
  $ 9     $ 957     $ 27     $ 459     $ 1,913     $ 479     $ -     $ 1,319     $ 438     $ -     $ 5,601  
Collectively evaluated
    27,218       56,953       9,302       23,286       26,797       10,524       -       43,310       8,893       726       207,009  
Total loans
  $ 27,227     $ 57,910     $ 9,329     $ 23,745     $ 28,710     $ 11,003     $ -     $ 44,629     $ 9,331     $ 726     $ 212,610  
 
The following table presents the balance and activity in the ALLL by portfolio segment at or for the six months ended June 30, 2013.
 
   
TOTAL – Six Months Ended June 30, 2013
(in thousands)
ALLL:
 
Commercial
& industrial
   
Owner- occupied
CRE
   
AG production
   
AG real estate
   
CRE
investment
   
Construction & land development
   
Residential construction
   
Residential first mortgage
   
Residential junior mortgage
   
Retail
& other
   
Total
 
Beginning balance
  $ 1,969     $ 1,069     $ -     $ -     $ 337     $ 2,580     $ 137     $ 685     $ 312     $ 31     $ 7,120  
Provision
    170       259       5       12       485       802       36       128       57       (4 )     1,950  
Charge-offs
    (475 )     (113 )     -       -       (639 )     (36 )     -       (86 )     (83 )     (11 )     (1,443 )
Recoveries
    21       2       -       -       -       -       -       6       1       1       31  
Net charge-offs
    (454 )     (111 )     -       -       (639 )     (36 )     -       (80 )     (82 )     (10 )     (1,412 )
Ending balance
  $ 1,685     $ 1,217     $ 5     $ 12     $ 183     $ 3,346     $ 173     $ 733     $ 287     $ 17     $ 7,658  
As percent of ALLL
    22.0 %     15.9 %     0.1 %     0.2 %     2.4 %     43.7 %     2.3 %     9.5 %     3.7 %     0.2 %     100 %
                                                                                         
ALLL:
                                                                                       
Individually evaluated
  $ -     $ -     $ -     $ -     $ -     $ -     $ -     $ -     $ -     $ -     $ -  
Collectively evaluated
    1,685       1,217       5       12       183       3,346       173       733       287       17       7,658  
Ending balance
  $ 1,685     $ 1,217     $ 5     $ 12     $ 183     $ 3,346     $ 173     $ 733     $ 287     $ 17     $ 7,658  
                                                                                         
Loans:
                                                                                       
Individually evaluated
  $ 3     $ 1,800     $ -     $ -     $ 688     $ -     $ -     $ 1,099     $ -     $ 137     $ 3,727  
PCI Loans
    1       1,746       22       611       4,858       790       -       2,295       257       -       10,580  
Collectively evaluated
    245,852       177,555       13,092       38,372       111,718       36,964       10,288       137,861       48,672       5,865       826,239  
Total loans
  $ 245,856     $ 181,101     $ 13,114     $ 38,983     $ 117,264     $ 37,754     $ 10,288     $ 141,255     $ 48,929     $ 6,002     $ 840,546  
                                                                                         
Less ALLL
  $ 1,685     $ 1,217     $ 5     $ 12     $ 183     $ 3,346     $ 173     $ 733     $ 287     $ 17     $ 7,658  
Net loans
  $ 244,171     $ 179,884     $ 13,109     $ 38,971     $ 117,081     $ 34,408     $ 10,115     $ 140,522     $ 48,642     $ 5,985     $ 832,888  
 
16
 

 


Note 6 – Loans, Allowance for Loan Losses, and Credit Quality, continued
 
The following table presents nonaccrual loans by portfolio segment in total and then as a further breakdown by originated or acquired as of June 30, 2014 and December 31, 2013.

(in thousands)
 
June 30, 2014
   
% to Total
   
December 31, 2013
   
% to Total
 
Commercial & industrial
  $ 517       7.2 %   $ 68       0.7 %
Owner-occupied CRE
    1,975       27.4       1,087       10.6  
AG production
    27       0.4       11       0.1  
AG real estate
    461       6.4       448       4.3  
CRE investment
    1,607       22.3       4,631       45.1  
Construction & land development
    479       6.7       1,265       12.3  
Residential construction
    -       -       -       -  
Residential first mortgage
    1,671       23.2       2,365       23.0  
Residential junior mortgage
    461       6.4       262       2.6  
Retail & other
    -       -       129       1.3  
Nonaccrual loans - Total
  $ 7,198       100.0 %   $ 10,266       100.0 %
                                 
           
Originated
                 
(in thousands)
 
June 30, 2014
   
% to Total
   
December 31, 2013
   
% to Total
 
Commercial & industrial
  $ 486       26.0 %   $ 67       8.9 %
Owner-occupied CRE
    1,042       56.0       -       -  
AG production
    -       -       -       -  
AG real estate
    -       -       -       -  
CRE investment
    -       -       40       5.3  
Construction & land development
    -       -       -       -  
Residential construction
    -       -       -       -  
Residential first mortgage
    299       16.1       442       58.9  
Residential junior mortgage
    35       1.9       73       9.7  
Retail & other
    -       -       129       17.2  
Nonaccrual loans - Originated
  $ 1,862       100.0 %   $ 751       100.0 %
                               
           
Acquired
                 
(in thousands)
 
June 30, 2014
   
% to Total
   
December 31, 2013
   
% to Total
 
Commercial & industrial
  $ 31       0.6 %   $ 1       0.1 %
Owner-occupied CRE
    933       17.5       1,087       11.4  
AG production
    27       0.5       11       0.1  
AG real estate
    461       8.6       448       4.7  
CRE investment
    1,607       30.1       4,591       48.2  
Construction & land development
    479       9.0       1,265       13.3  
Residential construction
    -       -       -       -  
Residential first mortgage
    1,372       25.7       1,923       20.2  
Residential junior mortgage
    426       8.0       189       2.0  
Retail & other
    -       -       -       -  
Nonaccrual loans - Acquired
  $ 5,336       100.0 %   $ 9,515       100.0 %

17
 

 


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

The following tables present total past due loans by portfolio segment as of June 30, 2014 and December 31, 2013:

   
June 30, 2014
 
(in thousands)
 
30-89 Days
Past Due (accruing)
   
90 Days &
Over or non-accrual
   
Current
   
Total
 
Commercial & industrial
  $ 377     $ 517     $ 268,483     $ 269,377  
Owner-occupied CRE
    -       1,975       185,250       187,225  
AG production
    20       27       13,935       13,982  
AG real estate
    -       461       41,473       41,934  
CRE investment
    767       1,607       77,265       79,639  
Construction & land development
    165       479       44,860       45,504  
Residential construction
    -       -       11,895       11,895  
Residential first mortgage
    201       1,671       152,841       154,713  
Residential junior mortgage
    -       461       49,783       50,244  
Retail & other
    -       -       5,573       5,573  
Total loans
  $ 1,530     $ 7,198     $ 851,358     $ 860,086  
As a percent of total loans
    0.2 %     0.8 %     99.0 %     100.0 %
 
   
December 31, 2013
 
(in thousands)
 
30-89 Days Past Due (accruing)
   
90 Days &
Over or nonaccrual
   
Current
   
Total
 
Commercial & industrial
  $ -     $ 68     $ 253,606     $ 253,674  
Owner-occupied CRE
    1,247       1,087       185,142       187,476  
AG production
    -       11       14,245       14,256  
AG real estate
    -       448       36,609       37,057  
CRE investment
    491       4,631       85,173       90,295  
Construction & land development
    -       1,265       41,616       42,881  
Residential construction
    -       -       12,535       12,535  
Residential first mortgage
    387       2,365       151,651       154,403  
Residential junior mortgage
    12       262       49,089       49,363  
Retail & other
    12       129       5,277       5,418  
Total loans
  $ 2,149     $ 10,266     $ 834,943     $ 847,358  
As a percent of total loans
    0.3 %     1.2 %     98.5 %     100.0 %

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

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

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

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

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

8 Doubtful: Assets with this rating exhibit all the weaknesses as one rated Substandard with the added characteristic that such weaknesses make collection or liquidation in full highly questionable.
 
18
 

 

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

9 Loss: Assets in this category are considered uncollectible. Pursuing any recovery or salvage value is impractical but does not preclude partial recovery in the future.
 
The following tables present total loans by loan grade as of June 30, 2014 and December 31, 2013:

   
June 30, 2014
 
(in thousands)
 
Grades 1- 4
   
Grade 5
   
Grade 6
   
Grade 7
   
Grade 8
   
Grade 9
   
Total
 
Commercial & industrial
  $ 253,077     $ 10,232     $ 802     $ 5,266     $ -     $ -     $ 269,377  
Owner-occupied CRE
    177,898       3,891       1,758       3,678       -       -       187,225  
AG production
    13,569       42       -       371       -       -       13,982  
AG real estate
    31,408       9,679       61       786       -       -       41,934  
CRE investment
    75,434       2,141       -       2,064       -       -       79,639  
Construction & land development
    34,717       2,463       -       8,324       -       -       45,504  
Residential construction
    11,378       -       -       517       -       -       11,895  
Residential first mortgage
    151,525       1,203       -       1,985       -       -       154,713  
Residential junior mortgage
    49,241       42       -       961       -       -       50,244  
Retail & other
    5,562       11       -       -       -       -       5,573  
Total loans
  $ 803,809     $ 29,704     $ 2,621     $ 23,952     $ -     $ -     $ 860,086  
Percent of total
    93.5 %     3.4 %     0.3 %     2.8 %     -       -       100 %

   
December 31, 2013
 
(in thousands)
 
Grades 1- 4
   
Grade 5
   
Grade 6
   
Grade 7
   
Grade 8
   
Grade 9
   
Total
 
Commercial & industrial
  $ 240,626     $ 7,134     $ 722     $ 5,192     $ -     $ -     $ 253,674  
Owner-occupied CRE
    174,070       6,605       2,644       4,157       -       -       187,476  
AG production
    13,631       267       -       358       -       -       14,256  
AG real estate
    26,058       10,159       62       778       -       -       37,057  
CRE investment
    83,475       1,202       15       5,603       -       -       90,295  
Construction & land development
    31,051       2,229       119       9,482       -       -       42,881  
Residential construction
    12,187       -       -       348       -       -       12,535  
Residential first mortgage
    150,343       1,365       -       2,695       -       -       154,403  
Residential junior mortgage
    48,886       215       -       262       -       -       49,363  
Retail & other
    5,274       15       -       129       -       -       5,418  
Total loans
  $ 785,601     $ 29,191     $ 3,562     $ 29,004     $ -     $ -     $ 847,358  
Percent of total
    92.8 %     3.4 %     0.4 %     3.4 %     -       -       100 %

Management considers a loan to be impaired when it is probable the Company will be unable to collect all contractual principal and interest payments due in accordance with the terms of the loan agreement. For determining the adequacy of the ALLL, management defines impaired loans as nonaccrual credit relationships over $250,000, plus additional loans with impairment risk characteristics. Management instituted the nonaccrual scope criteria in the second quarter of 2013, particularly in response to the higher volume of smaller nonaccrual loans acquired in the 2013 acquisitions. 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.
 
19
 

 


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

The following tables present impaired loans as of June 30, 2014 and December 31, 2013. As a further breakdown, impaired loans are also summarized by originated and acquired for the periods presented. 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 nonaccretable mark and a zero accretable mark. At June 30, 2014, $5.6 million of the $16.7 million remain in impaired loans. Included in the June 30, 2014 and December 31, 2013 impaired loans is one troubled debt restructuring totaling $3.9 million described below under “Troubled Debt Restructurings.”
 
   
Total Impaired Loans – June 30, 2014
 
(in thousands)
 
Recorded
Investment
   
Unpaid
Principal
Balance
   
Related
Allowance
   
Average
Recorded
Investment
   
Interest Income
Recognized
 
Commercial & industrial*
  $ 332     $ 341     $ 213     $ 167     $ 14  
Owner-occupied CRE
    1,999       3,033       -       1,543       111  
AG production
    27       95       -       18       5  
AG real estate
    459       560       -       451       12  
CRE investment
    1,913       5,351       -       3,210       131  
Construction & land development*
    4,358       4,939       420       6,869       65  
Residential construction
    -       -       -       -       -  
Residential first mortgage
    1,319       2,664       -       1,514       86  
Residential junior mortgage
    438       847       -       305       11  
Retail & Other
    -       -       -       -       -  
Total
  $ 10,845     $ 17,830     $ 633     $ 14,077     $ 435  
 
   
Originated – June 30, 2014
 
(in thousands)
 
Recorded
Investment
   
Unpaid
Principal
Balance
   
Related
Allowance
   
Average
Recorded
Investment
   
Interest Income
Recognized
 
Commercial & industrial*
  $ 323     $ 323     $ 213     $ 162     $ 13  
Owner-occupied CRE
    1,042       1,042       -       521       45  
AG production
    -       -       -       -       -  
AG real estate
    -       -       -       -       -  
CRE investment
    -       -       -       -       -  
Construction & land development*
    3,879       3,879       420       6,048       20  
Residential construction
    -       -       -       -       -  
Residential first mortgage
    -       -       -       -       -  
Residential junior mortgage
    -       -       -       -       -  
Retail & Other
    -       -       -       -       -  
Total
  $ 5,244     $ 5,244     $ 633     $ 6,731     $ 78  

   
Acquired – June 30, 2014
 
(in thousands)
 
Recorded
Investment
   
Unpaid
Principal
Balance
   
Related
Allowance
   
Average
Recorded
Investment
   
Interest Income
Recognized
 
Commercial & industrial
  $ 9     $ 18     $ -     $ 5     $ 1  
Owner-occupied CRE
    957       1,991       -       1,022       66  
AG production
    27       95       -       18       5  
AG real estate
    459       560       -       451       12  
CRE investment
    1,913       5,351       -       3,210       131  
Construction & land development
    479       1,060       -       821       45  
Residential construction
    -       -       -       -       -  
Residential first mortgage
    1,319       2,664       -       1,514       86  
Residential junior mortgage
    438       847       -       305       11  
Retail & Other
    -       -       -       -       -  
Total
  $ 5,601     $ 12,586     $ -     $ 7,346     $ 357  
 
*One commercial and industrial loan with a balance of $323,000 had a specific reserve of $213,000. One construction and land development loan with a balance of $3.9 million had a specific reserve of $420,000. No other loans had a related allowance at June 30, 2014 and, therefore, the above disclosure was not expanded to include loans with and without a related allowance.
 
20
 

 

 
 
Note 6 – Loans, Allowance for Loan Losses, and Credit Quality, continued
                               
   
Total Impaired Loans – December 31, 2013
 
(in thousands)
 
Recorded
Investment
   
Unpaid
Principal
Balance
   
Related
Allowance
   
Average
Recorded
Investment
   
Interest Income
Recognized
 
Commercial & industrial
  $ 1     $ 140     $ -     $ 1     $ 3  
Owner-occupied CRE
    1,086       4,151       -       1,268       169  
AG production
    9       76       -       11       5  
AG real estate
    443       558       -       443       9  
CRE investment
    4,507       9,056       -       4,592       451  
Construction & land development**
    9,379       10,580       3,204       9,406       178  
Residential construction
    -       -       -       -       -  
Residential first mortgage
    1,708       4,177       -       1,827       215  
Residential junior mortgage
    172       703       -       198       26  
Retail & Other
    -       36       -       -       3  
Total
  $ 17,305     $ 29,477     $ 3,204     $ 17,746     $ 1,059  

                               
   
Originated – December 31, 2013
 
(in thousands)
 
Recorded
Investment
   
Unpaid
Principal
Balance
   
Related
Allowance
   
Average
Recorded
Investment
   
Interest Income
Recognized
 
Commercial & industrial
  $ -     $ -     $ -     $ -     $ -  
Owner-occupied CRE
    -       -       -       -       -  
AG production
    -       -       -       -       -  
AG real estate
    -       -       -       -       -  
CRE investment
    -       -       -       -       -  
Construction & land development**
    8,217       8,217       3,204       8,215       43  
Residential construction
    -       -       -       -       -  
Residential first mortgage
    -       -       -       -       -  
Residential junior mortgage
    -       -       -       -       -  
Retail & Other
    -       -       -       -       -  
Total
  $ 8,217     $ 8,217     $ 3,204     $ 8,215     $ 43  

   
Acquired – December 31, 2013
 
(in thousands)
 
Recorded
Investment
   
Unpaid
Principal
Balance
   
Related
Allowance
   
Average
Recorded
Investment
   
Interest Income
Recognized
 
Commercial & industrial
  $ 1     $ 140     $ -     $ 1     $ 3  
Owner-occupied CRE
    1,086       4,151       -       1,268       169  
AG production
    9       76       -       11       5  
AG real estate
    443       558       -       443       9  
CRE investment
    4,507       9,056       -       4,592       451  
Construction & land development
    1,162       2,363       -       1,191       135  
Residential construction
    -       -       -       -       -  
Residential first mortgage
    1,708       4,177       -       1,827       215  
Residential junior mortgage
    172       703       -       198       26  
Retail & other
    -       36       -       -       3  
Total
  $ 9,088     $ 21,260     $ -     $ 9,531     $ 1,016  
 
**One loan with a balance of $3.9 million and a reserve of $3.2 million is included within the construction and land development category. No other loans had a related allowance at December 31, 2013 and, therefore, the above disclosure was not expanded to include loans with and without a related allowance.
 
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Note 6 – Loans, Allowance for Loan Losses, and Credit Quality, continued

Troubled Debt Restructurings
 
At June 30, 2014, there were five loans classified as troubled debt restructurings totaling $4.3 million. One loan had a premodification balance of $3.9 million and at June 30, 2014, had a balance of $3.9 million, was in compliance with its modified terms, was not past due, and was included in impaired loans with a specific reserve allocation of approximately $420,000. This loan is performing but is disclosed as impaired as a result of its classification as a troubled debt restructuring. The remaining four loans had a combined premodification balance of $438,000 and a combined outstanding balance of $407,000 at June 30, 2014. There were no other loans which were modified and classified as troubled debt restructurings at June 30, 2014. There were no loans classified as troubled debt restructurings during the previous twelve months that subsequently defaulted as of June 30, 2014. Loans which were considered troubled debt restructurings by Mid-Wisconsin prior to the acquisition were not required to be classified as troubled debt restructurings in the Company’s financial statements unless or until such loans would subsequently meet criteria to be classified as such, since acquired loans were recorded at their estimated fair values at the time of the acquisition.

Note 7- Notes Payable

The Company had the following long term notes payable:
 

(in thousands)
 
June 30, 2014
   
December 31, 2013
 
Joint venture note
  $ 9,799     $ 9,922  
Federal Home Loan Bank (“FHLB”) advances
    17,500       22,500  
Notes payable
  $ 27,299     $ 32,422  

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 rate of FHLB advances was 1.36% at June 30, 2014 and 1.85% at December 31, 2013. 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 $91.5 million and $85.9 million at June 30, 2014 and December 31, 2013, respectively.

The following table shows the maturity schedule of the notes payable as of June 30, 2014:

Maturing in
 
(in thousands)
 
2014
  $ 6,125  
2015
    5,762  
2016
    14,412  
2017
    -  
2018
    1,000  
    $ 27,299  
 
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Note 8 - Junior Subordinated Debentures

The Company’s carrying value of junior subordinated debentures was $12.2 million at June 30, 2014 and $12.1 million at December 31, 2013. 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 Mid-Wisconsin acquisition, 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 June 30, 2014, the carrying value of these junior debentures was $6.0 million and the $5.7 million carrying value of related trust preferred securities qualifies as Tier 1 capital.

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.
 
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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. There were no changes in Level 3 values to report during the first six months of 2014.
          Fair Value Measurements Using  
Measured at Fair Value on a Recurring Basis:
 
Total
   
Level 1
   
Level 2
   
Level 3
 
 (in thousands)
                       
 U.S. government sponsored enterprises
  $ 1,537     $ -     $ 1,537     $ -  
 State, county and municipals
    77,067       -       76,190       877  
 Mortgage-backed securities
    62,928       -       62,928       -  
 Corporate debt securities
    220       -       -       220  
 Equity securities
    1,903       1,903       -       -  
 Securities AFS, June 30, 2014
  $ 143,655     $ 1,903     $ 140,655     $ 1,097  
                                 
 (in thousands)
                               
 U.S. government sponsored enterprises
  $ 2,057     $ -     $ 2,057     $ -  
 State, county and municipals
    55,039       -       54,162       877  
 Mortgage-backed securities
    67,879       -       67,879       -  
 Corporate debt securities
    220       -       -       220  
 Equity securities
    2,320       2,320       -       -  
 Securities AFS, December 31, 2013
  $ 127,515     $ 2,320     $ 124,098     $ 1,097  
 
The following is a description of the valuation methodologies used by the Company for the items noted in the tables above. 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. At June 30, 2014 and December 31, 2013, it was determined that carrying value was the best approximation of fair value for these Level 3 securities, based primarily on receipt of par from refinances for the auction rate securities and the internal analysis on the corporate debt securities.

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

Measured at Fair Value on a Nonrecurring Basis
 
 
 
 
   
Fair Value Measurements Using
 
(in thousands)
 
Total
   
Level 1
   
Level 2
   
Level 3
 
June 30, 2014:
                       
Impaired loans
  $ 10,212     $ -     $ -     $ 10,212  
OREO
    1,502       -       -       1,502  
December 31, 2013:
                               
Impaired loans
  $ 14,101     $ -     $ -     $ 14,101  
OREO
    1,987       -       -       1,987  

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.
 
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Note 9 - Fair Value Measurements, continued

The Company is required under accounting guidance to report the fair value of all financial instruments in the consolidated balance sheets, including those financial instruments carried at cost. The carrying amounts and estimated fair values of the Company’s financial instruments at June 30, 2014 and December 31, 2013 are shown below.
 
   
June 30, 2014
 
(in thousands)
 
Carrying
Amount
   
Estimated
Fair Value
   
Level 1
   
Level 2
   
Level 3
 
Financial assets:
                             
Cash and cash equivalents
  $ 85,588     $ 85,588     $ 85,588     $ -     $ -  
Certificates of deposit in other banks
    7,144       7,172       -       7,172       -  
Securities AFS
    143,655       143,655       1,903       140,655       1,097  
Other investments
    8,056       8,056       -       5,915       2,141  
Loans held for sale
    3,589       3,589       3,589       -       -  
Loans, net
    850,444       854,732       -       -       854,732  
Bank owned life insurance
    26,980       26,980       26,980       -       -  
                                         
Financial liabilities:
                                       
Deposits
  $ 1,011,121     $ 1,013,407     $ -     $ -     $ 1,013,407  
Short-term borrowings
    3,399       3,399       3,399       -       -  
Notes payable
    27,299       30,316       -       30,316       -  
Junior subordinated debentures
    12,228       12,215       -       -       12,215  

   
December 31, 2013
 
(in thousands)
 
Carrying
Amount
   
Estimated
Fair Value
   
Level 1
   
Level 2
   
Level 3
 
Financial assets:
                             
Cash and cash equivalents
  $ 146,978     $ 146,978     $ 146,978     $ -     $ -  
Certificates of deposit in other banks
    1,960       1,983       -       1,983       -  
Securities AFS
    127,515       127,515       2,320       124,098       1,097  
Other investments
    7,982       7,982       -       5,841       2,141  
Loans held for sale
    1,486       1,486       1,486       -       -  
Loans, net
    838,126       842,758       -       -       842,758  
Bank owned life insurance
    23,796       23,796       23,796       -       -  
                                         
Financial liabilities:
                                       
Deposits
  $ 1,034,834     $ 1,036,564     $ -     $ -     $ 1,036,564  
Short-term borrowings
    7,116       7,116       7,116       -       -  
Notes payable
    32,422       32,548       -       32,548       -  
Junior subordinated debentures
    12,128       12,704       -       -       12,704  
 
Not all the financial instruments listed in the table above are subject to the disclosure provisions of ASC 820, as certain assets and liabilities result in their carrying value approximating fair value. These include cash and cash equivalents, other investments, loans held for sale, BOLI, nonmaturing deposits, and short-term borrowings. 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.
 
Securities AFS: Fair values for securities are based on quoted market prices on securities exchanges, when available, which is considered a Level 1 measurement. If quoted market prices are not available, fair value is generally determined using pricing models widely used in the industry, quoted market prices of securities with similar characteristics, or discounted cash flows, which is considered a Level 2 measurement, and Level 3 was deemed appropriate for auction rate securities (for which there has been no liquid market since 2008) and corporate debt securities which include trust preferred security instruments. The corporate debt securities were acquired in the Mid-Wisconsin acquisition and valued based on a discounted cash flow analysis and the underlying credit quality of the issuer. The fair value approximates the cost at acquisition. For 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.
 
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Note 9 - Fair Value Measurements, continued
 
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: The fair values of junior subordinated debentures are estimated based on an evaluation 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 June 30, 2014 and December 31, 2013 was insignificant. Loan commitments on which the committed interest rate is less than the current market rate are also insignificant at June 30, 2014 and December 31, 2013.

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.

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

Nicolet Bankshares, Inc. is a bank holding company headquartered in Green Bay, Wisconsin, providing a diversified range of traditional banking and wealth management services to individuals and businesses in its market area through the 23 branch offices of its banking subsidiary, Nicolet National Bank, in northeastern and central Wisconsin and Menominee, Michigan.

The primary revenue sources of Nicolet Bankshares, Inc. and its subsidiaries (“Nicolet” or the “Company”) are net interest income, representing interest income from loans and other interest earning assets such as investments, less interest expense on deposits and other borrowings, and noninterest income, including, among others, trust fees, secondary mortgage income and other fees or revenue from financial services provided to customers or ancillary to loans and deposits. Business volumes and pricing drive revenue potential and tend to be influenced by overall economic factors, including market interest rates, business spending, consumer confidence, economic growth and competitive conditions within the marketplace.

At June 30, 2014, total assets were $1.2 billion and net income for the six months ended June 30, 2014 was $4.8 million. When comparing 2014 results to prior year periods, the timing of Nicolet’s 2013 acquisitions impacts the 2013 financial results and comparisons to 2014. These acquisitions (collectively referred to as the “2013 acquisitions”) consisted of the predominantly stock-for-stock acquisition of Mid-Wisconsin Financial Services, Inc. (“Mid-Wisconsin”), which was consummated on April 26, 2013, and the FDIC-assisted transaction to acquire Bank of Wausau, which was effective August 9, 2013. The transactions were accounted for under the acquisition method of accounting, and thus, the results of operations of the acquired entities prior to their respective consummation dates were not included in the accompanying consolidated financial statements. The eleven banking branches of Mid-Wisconsin and the one branch of Bank of Wausau opened as Nicolet National Bank branches on April 29 and August 10, 2013, respectively. At acquisition, the Mid-Wisconsin transaction increased total assets by $435 million, total liabilities by $415 million, common equity by approximately $9.3 million, and resulted in a bargain purchase gain of $10.4 million during the second quarter of 2013. In the third quarter of 2013, a $0.9 million negative adjustment was recorded to that bargain purchase gain relative to a change in estimate of a now settled legal action. The 2013 income statement also included approximately $1.7 million (approximately $0.1 million and $1.6 million in the first and second quarters, respectively, of 2013) of pre-tax, non-recurring merger related expenses tied to preparation for, consummation of and integration of Mid-Wisconsin into the Company. On a smaller scale, the Bank of Wausau transaction increased total assets by $47 million at acquisition (of which $18 million of cash was used during the month of September 2013 to immediately redeem rate-sensitive certificates of deposit), and resulted in a pre-tax bargain purchase gain of $2.4 million and approximately $0.2 million of pre-tax, non-recurring merger related expenses recorded in the third quarter of 2013. Finally, acquisition accounting requires assets purchased and liabilities assumed to be recorded at their respective fair values at the date of acquisition, which impacted various ratios, but most notably asset quality measures (as loans are recorded directly at their estimated fair value and no addition to the allowance for loan losses is recorded at consummation) and taxes. Therefore, the 2014 results include both acquisitions fully, while the six months ended June 30, 2013, includes approximately two months of Mid-Wisconsin and no results of Bank of Wausau. For additional details, see “Note 2 – Acquisitions” and “Note 6 – Loans, Allowance for Loan Losses, and Credit Quality” in the Notes to the Unaudited Consolidated Financial Statements, and “--Income Taxes” within this document.

On November 28, 2012, Nicolet entered into a merger agreement with Mid-Wisconsin and initially filed a Registration Statement on Form S-4 (Regis. No. 333-186401) (the “Registration Statement”) with the Securities and Exchange Commission under the provisions of the Securities Act. On March 26, 2013, the Registration Statement became effective and Nicolet became a public reporting company under Section 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”).

Forward-Looking Statements

Statements made in this document and in 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. Stockholders should note that many factors, some of which are discussed elsewhere in this document, could affect the future financial results of Nicolet and could cause those results to differ materially from those expressed in forward-looking statements contained in this document. These factors, many of which are beyond Nicolet’s control, include, but are not necessarily limited to the following:

 
operating, legal and regulatory risks, including the effects of the Dodd-Frank Wall Street Reform and Consumer Protection Act and regulations promulgated thereunder, as well as the rules by the Federal bank regulatory agencies to implement the Basel III capital accord;
 
economic, political and competitive forces affecting Nicolet’s banking and wealth management businesses;
 
27
 

 

 
 
changes in interest rates, monetary policy and general economic conditions, which may impact Nicolet’s net interest income;
 
potential difficulties in integrating the operations of Nicolet with those of acquired entities, if any;
 
compliance or operational risks related to new products, services, ventures, or lines of business, if any, that Nicolet may pursue or implement; and
 
the risk that Nicolet’s analyses of these risks and forces could be incorrect and/or that the strategies developed to address them could be unsuccessful.

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

The consolidated financial statements of Nicolet are prepared in conformity with U.S. GAAP and follow general practices within the industry in which it operates. This preparation requires management to make estimates, assumptions and judgments that affect the amounts reported in the consolidated financial statements and accompanying notes. These estimates, assumptions and judgments are based on information available as of the date of the consolidated financial statements; accordingly, as this information changes, actual results could differ from the estimates, assumptions and judgments reflected in the consolidated financial statements. Certain policies inherently have a greater reliance on the use of estimates, assumptions and judgments and, as such, have a greater possibility of producing results that could be materially different than originally reported. Estimates that are particularly susceptible to significant change include the valuation of loans acquired in the 2013 acquisitions, as well as the determination of the allowance for loan losses and income taxes and, therefore, are critical accounting policies.

Business Combinations and Valuation of Loans Acquired in Business Combinations

We account for acquisitions under FASB ASC Topic 805, Business Combinations, which requires 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. As provided for under GAAP, management has up to 12 months following the date of the acquisition to finalize the fair values of acquired assets and assumed liabilities, where it was not possible to estimate the acquisition date fair value upon consummation. Once management has finalized the fair values of acquired assets and assumed liabilities within this 12-month period, management considers such values to be the Day 1 Fair Values. This was completed for the Mid-Wisconsin transaction during the second quarter of 2014 and will be completed for the Bank of Wausau transaction in the third quarter of 2014.

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 nonaccretable 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.

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Allowance for Loan Losses

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 June 30, 2014. 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 annually 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.

The following discussion is Nicolet management’s analysis of the consolidated financial condition as of June 30, 2014 and December 31, 2013 and results of operations for the three and six-month periods ended June 30, 2014 and 2013. It should be read in conjunction with Nicolet’s audited consolidated financial statements as of December 31, 2013 and 2012, and for the two years ended December 31, 2013, included in Nicolet’s Annual Report on Form 10-K.

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Performance Summary

Nicolet reported net income of $4.8 million for the six months ended June 30, 2014, compared to $12.2 million for the first six months of 2013. After $122,000 of preferred stock dividends, first half 2014 net income available to common shareholders was $4.6 million, or $1.08 per diluted common share. Comparatively, after $610,000 of preferred stock dividends, first half 2013 net income available to common shareholders was $11.6 million, or $3.11 per diluted common share. 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 U.S. Treasury related to its participation in the Small Business Lending Fund (“SBLF”), compared to the previous 5% annual rate, resulting in the $488,000 reduction in preferred stock dividends between the first six months of 2014 and 2013. Income statement results and average balances for the first half 2014 fully include the 2013 acquisitions, while, as noted previously, the first half of 2013 included approximately two months of the Mid-Wisconsin acquisition only, as well as the related $10.4 million of bargain purchase gain and pre-tax non-recurring expenses of approximately $1.7 million.

Net interest income was $20.5 million for the first half of 2014, an increase of $5.9 million or 40% over $14.6 million for the first half of 2013. The improvement was predominantly volume related, given the timing of the 2013 acquisitions, but was also favorably impacted by an increase in interest rate spread on higher average earning assets. On a tax-equivalent basis, the net interest margin for the first half of 2014 was 3.79%, up 5 basis points (“bps”) from 3.74% for the comparable 2013 period. The cost of interest-bearing liabilities was 0.79%, 12 bps lower than the first half of 2013, while the average yield on earning assets was 4.45%, 4 bps lower than first half 2013, resulting in an 8 bps improvement in the interest rate spread between the comparable six-month periods.
 
Loans were $860 million at June 30, 2014, up $13 million or 2% over $847 million at December 31, 2013, and up $19 million or 2% over $841 million at June 30, 2013. Removing the $284 million of loans added at acquisition (i.e. removing $272 million from Mid-Wisconsin from both June 30, 2014 and 2013, and $12 million from Bank of Wausau from June 30, 2014), loans grew organically 1% between the first six-month periods. Between the comparative six-month periods, average loans grew 31%, at $851 million in 2014 yielding 5.31%, compared to $651 million in 2013 yielding 5.09%.
 
Total deposits were $1.01 billion at June 30, 2014, down $24 million or 2% from $1.03 billion at December 31, 2013 (following a customary pattern of deposit decline historically following year ends through the first six-month periods), and up $103 million or 11% over $908 million in total deposits a year ago. Removing the $370 million of deposits added at acquisition (i.e. removing $346 million from Mid-Wisconsin from both June 30, 2014 and 2013, and $24 million net deposits acquired from Bank of Wausau given the quick redemption of $18 million of rate-sensitive certificates of deposit from June 30, 2014), deposits grew organically 14% between the first six-month periods. Between the comparative six-month periods, average total deposits grew 47%, at $1.02 billion in 2014, with interest-bearing deposits costing 0.62%, compared to $699 million in 2013, with interest-bearing deposits costing 0.69%.
 
Asset quality measures were strong at June 30, 2014, though were impacted initially by the 2013 acquisitions. Nonperforming assets were $8.7 million at June 30, 2014, down 29% from year end 2013 and down 51% from a year ago. Nonperforming assets represented 0.74%, 1.02% and 1.62% of total assets at June 30, 2014, December 31, 2013, and June 30, 2013, respectively. The allowance for loan losses was $9.6 million or 1.12% of loans at June 30, 2014 (impacted by the 2013 acquisitions adding no allowance for loan losses while adding $284 million to loans at acquisition), compared to $9.2 million or 1.09%, respectively at year end 2013, and $7.7 million or 0.91%, respectively at June 30, 2013. The provision for loan losses was $1.4 million with net charge offs of $0.9 million for the first half of 2014, versus provision of $2.0 million with $1.4 million of net charge offs for the comparable 2013 period.
 
Noninterest income was $6.6 million for the first six months of 2014 (including $0.3 million net gain on sales or writedowns of assets) compared to $16.5 million for the first half of 2013 (including $10.4 million of bargain purchase gain and net gain on sale of assets, combined). Removing these net gains, noninterest income was up $0.3 million or 5% between the six-month periods. Notable increases over prior year, largely due to increased business from the expanded size of the Company, were in service charges (up $0.3 million or 38%), trust fee income (up $0.3 million or 19%), brokerage fee income (up $0.1 million or 50%) and other income (up $0.3 million or 61%, mostly attributable to income from higher debit card volumes). Mortgage income was down $0.9 million or 59% between the six-month periods, resulting from a significantly more robust mortgage market a year ago where production was strong until the start of third quarter 2013 when production slowed dramatically largely in response to rising mortgage rates.
 
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Noninterest expense was $19.1 million for the first half of 2014, up $3.1 million or 20% over the first half of 2013; however, excluding $1.7 million of non-recurring merger-based expenses (of which approximately $1 million was in personnel and $0.7 million was in other expense) incurred in the 2013 period, expenses were up 35%. The increase in most all noninterest expense line items is predominantly due to the larger operating base from the 2013 acquisitions being fully included in 2014 and only partially included in the first half of 2013. Most notably, between the six-month periods, salaries and benefits were up $1.6 million or 17% (or up 32% excluding the 2013 merger-based expense, given the larger workforce and merit increases between the years), occupancy was up $0.6 million or 42% (given the larger operating base and a harsher winter), office expense was up $0.4 million or 41% (given the larger operating base, as well as continued integration on systems and phones), processing costs were up $0.5 million or 54% (mostly commensurate with growth in the number of accounts), and core deposit intangible amortization increased $0.2 million or 50%, fully attributable to the Mid-Wisconsin merger. Other expense was down $0.7 million, as the 2013 period included $0.7 million of non-recurring merger-based expense.

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.

Comparison of the six months ending June 30, 2014 versus 2013

Net interest income in the consolidated statements of income (which excludes any taxable equivalent adjustment) was $20.5 million in the first six months of 2014, 40% higher than $14.6 million in the first six months of 2013. Taxable equivalent adjustments (adjustments to bring tax-exempt interest to a level that would yield the same after-tax income had that been subject to a 34% tax rate) were $329,000 and $275,000 for the first six months of 2014 and 2013, respectively, resulting in taxable equivalent net interest income of $20.8 million and $14.8 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.
 
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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: Year-To-Date Net Interest Income Analysis
                                     
   
For the Six Months Ended June 30,
 
   
2014
   
2013
 
(in thousands)
 
Average
Balance
   
Interest
   
Average
Rate
   
Average
Balance
   
Interest
   
Average
Rate
 
ASSETS
                                   
Earning assets
                                   
Loans, including loan fees (1)(2)
  $ 851,033     $ 22,686       5.31 %   $ 651,256     $ 16,658       5.09 %
Investment securities
                                               
Taxable
    86,676       833       1.92 %     57,508       402       1.40 %
Tax-exempt (2)
    41,539       609       2.93 %     28,889       585       4.05 %
Other interest-earning assets
    112,790       263       0.47 %     51,205       149       0.58 %
Total interest-earning assets
    1,092,038     $ 24,391       4.45 %     788,858     $ 17,794       4.49 %
Cash and due from banks
    36,078                       4,449                  
Other assets
    64,996                       59,991                  
Total assets
  $ 1,193,112                     $ 853,298                  
LIABILITIES AND STOCKHOLDERS’ EQUITY
                                               
Interest-bearing liabilities
                                               
Savings
  $ 103,854     $ 128       0.25 %   $ 63,812     $ 98       0.31 %
Interest-bearing demand
    205,956       752       0.74 %     135,395       591       0.88 %
MMA
    273,851       396       0.29 %     197,793       370       0.38 %
Core CDs and IRAs
    231,590       1,123       0.98 %     156,038       851       1.10 %
Brokered deposits
    43,871       247       1.13 %     35,589       116       0.66 %
Total interest-bearing deposits
    859,122       2,646       0.62 %     588,627       2,026       0.69 %
Other interest-bearing liabilities
    53,722       940       3.48 %     61,679       923       2.98 %
Total interest-bearing liabilities
    912,844       3,586       0.79 %     650,306       2,949       0.91 %
Noninterest-bearing demand
    165,177                       110,189                  
Other liabilities
    7,997                       6,656                  
Total equity
    107,094                       86,147                  
Total liabilities and stockholders’ equity
  $ 1,193,112                     $ 853,298                  
Net interest income and rate spread
          $ 20,805       3.66 %           $ 14,845       3.58 %
Net interest margin
                    3.79 %                     3.74 %
 
(1) Nonaccrual loans are included in the daily average loan balances outstanding.
(2)
The yield on tax-exempt loans and tax-exempt investment securities is computed on a tax-equivalent basis using a federal tax rate of 34% and adjusted for the disallowance of interest expense.
 
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Table 2: Year-To-Date Volume/Rate Variance

Comparison of the six months ended June 30, 2014 versus 2013 follows:
 
   
Increase (decrease)
Due to Changes in
 
(in thousands)
 
Volume
   
Rate
   
Net
 
Earning assets
                 
                   
Loans                                                                      
  $ 5,296     $ 732     $ 6,028  
Investment securities
                       
Taxable
    251       180       431  
Tax-exempt                                                                      
    213       (189 )     24  
Other interest-earning assets
    100       14       114  
                         
Total interest-earning assets                                                                      
  $ 5,860     $ 737     $ 6,597  
                         
Interest-bearing liabilities
                       
Savings deposits                                                                      
  $ 52     $ (22 )   $ 30  
Interest-bearing demand                                                                      
    270       (109 )     161  
MMA                                                                      
    122       (96 )     26  
Core CDs and IRAs                                                                      
    375       (103 )     272  
Brokered deposits                                                                      
    32       99       131  
                         
Total interest-bearing deposits                                                                      
    851       (231 )     620  
Other interest-bearing liabilities                                                                      
    (30 )     47       17  
                         
Total interest-bearing liabilities                                                                      
    821       (184 )     637  
Net interest income                                                                      
  $ 5,039     $ 921     $ 5,960  
 
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Table 3: Quarterly Net Interest Income Analysis
                                     
   
For the Three Months Ended June 30,
 
   
2014
   
2013
 
(in thousands)
 
Average
Balance
   
Interest
   
Average
Rate
   
Average
Balance
   
Interest
   
Average
Rate
 
ASSETS
                                   
Earning assets
                                   
Loans, including loan fees (1)(2)
  $ 855,315     $ 11,647       5.40 %   $ 754,352     $ 9,860       5.18 %
Investment securities
                                               
Taxable
    85,326       415       1.95 %     88,622       275       1.24 %
Tax-exempt (2)
    46,062       312       2.71 %     31,792       309       3.89 %
Other interest-earning assets
    96,859       128       0.52 %     32,580       69       0.85 %
Total interest-earning assets
    1,083,562     $ 12,502       4.58 %     907,346     $ 10,513       4.60 %
Cash and due from banks
    29,367                       2,271                  
Other assets
    64,725                       78,244                  
Total assets
  $ 1,177,654                     $ 987,861                  
LIABILITIES AND STOCKHOLDERS’ EQUITY
                                               
Interest-bearing liabilities
                                               
Savings
  $ 107,025     $ 67       0.25 %   $ 78,476     $ 50       0.25 %
Interest-bearing demand
    208,668       384       0.74 %     154,196       286       0.74 %
MMA
    262,779       185       0.28 %     203,043       172       0.34 %
Core CDs and IRAs
    229,251       614       1.08 %     195,713       443       0.91 %
Brokered deposits
    36,509       115       1.26 %     41,876       74       0.71 %
Total interest-bearing deposits
    844,232       1,365       0.65 %     673,304       1,025       0.61 %
Other interest-bearing liabilities
    50,815       468       3.64 %     82,810       515       2.46 %
Total interest-bearing liabilities
    895,047       1,833       0.82 %     756,114       1,540       0.81 %
Noninterest-bearing demand
    165,909                       129,978                  
Other liabilities
    8,885                       7,196                  
Total equity
    107,813                       94,573                  
Total liabilities and stockholders’ equity
  $ 1,177,654                     $ 987,861                  
Net interest income and rate spread
          $ 10,669       3.76 %           $ 8,973       3.79 %
Net interest margin
                    3.90 %                     3.92 %
 
(1)           Nonaccrual loans are included in the daily average loan balances outstanding.
(2)
The yield on tax-exempt loans and tax-exempt investment securities is computed on a tax-equivalent basis using a federal tax rate of 34% and adjusted for the disallowance of interest expense.
 
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Table 4: Quarterly Volume/Rate Variance

Comparison of the three months ended June 30, 2014 versus 2013 follows:
 
   
Increase (decrease)
Due to Changes in
 
(in thousands)
 
Volume
   
Rate
   
Net
 
Earning assets
                 
                   
Loans                                                                      
  $ 1,343     $ 444     $ 1,787  
Investment securities
                       
Taxable
    (1 )     141       140  
Tax-exempt                                                                      
    113       (110 )     3  
Other interest-earning assets
    44       15       59  
                         
Total interest-earning assets
  $ 1,499     $ 490     $ 1,989  
                         
Interest-bearing liabilities
                       
Savings deposits                                                                      
  $ 18     $ (1 )   $ 17  
Interest-bearing demand
    100       (2 )     98  
MMA
    45       (32 )     13  
Core CDs and IRAs
    83       88       171  
Brokered deposits
    (11 )     52       41  
                         
Total interest-bearing deposits                                                                      
    235       105       340  
Other interest-bearing liabilities                                                                      
    (137 )     90       (47 )
                         
Total interest-bearing liabilities
    98       195       293  
Net interest income                                                                      
  $ 1,401     $ 295     $ 1,696  

Table 5: Interest Rate Spread, Margin and Average Balance Mix — Taxable-Equivalent Basis

   
Six Months Ended June 30,
 
   
2014
   
2013
 
(in thousands)
 
Average
Balance
   
% of
Earning
Assets
   
Yield/Rate
   
Average
Balance
   
% of
Earning
Assets
   
Yield/Rate
 
Total loans
  $ 851,033       77.9 %     5.31 %   $ 651,256       82.6 %     5.09 %
                                                 
Securities and other earning assets
    241,005       22.1 %     1.42 %     137,602       17.4 %     1.65 %
Total interest-earning assets
  $ 1,092,038       100 %     4.45 %   $ 788,858       100 %     4.49 %
                                                 
Interest-bearing liabilities
  $ 912,844       83.6 %     0.79 %   $ 650,306       82.4 %     0.91 %
                                                 
Noninterest-bearing funds, net
    179,194       16.4 %             138,552       17.6 %        
Total funds sources
  $ 1,092,038       100 %     0.66 %   $ 788,858       100 %     0.75 %
Interest rate spread
                    3.66 %                     3.58 %
Contribution from net
free funds
                    0.13 %                     0.16 %
Net interest margin
                    3.79 %                     3.74 %
 
Taxable-equivalent net interest income was $20.8 million for the first six months of 2014, an increase of $6.0 million or 40% over the same period in 2013. The increase in taxable-equivalent net interest income was predominantly volume related, given the timing of the acquisitions, but was also favorably impacted by an increase in interest rate spread. Taxable equivalent interest income increased $6.6 million (or 37%) between the six-month periods driven by loans (including $5.3 million more interest income from higher loan volumes and $0.7 million from higher loan yields, aided by higher levels of purchase-accounting loan accretion on acquired loans). Interest expense increased only $0.6 million (or 22%) between the periods driven mainly by interest-bearing deposits (including $0.8 million more interest expense from higher volumes, offset by $0.2 million less interest expense from lower deposit rates.)
 
The taxable-equivalent net interest margin was 3.79% for the six months of 2014, up 5 bps over the first six months of 2013, with a decrease in the cost of funds to 0.79% (down 12 bps), offset by a lower earning asset yield of 4.45% (down 4 bps) and a 3 bps decrease in net free funds. The cost of funds between the six-month periods has benefited from a lower rate structure acquired with the 2013 acquisitions and rate reductions made particularly in commercial deposit products. In general, there has been and will be underlying downward margin pressure as assets mature in this prolonged low-rate environment, with current reinvestment rates substantially lower than previous rates and less opportunity to offset such with similar changes in the already low cost of funds; however, in 2014 such pressure continues to be mitigated partly by the favorable income from acquired loans.
 
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The earning asset yield was influenced mainly by loans, representing 78% of average earning assets and yielding 5.31% for first six months of 2014, compared to 83% and 5.09%, respectively, for the first six months of 2013. The 22 bps improvement in loan yield between the six-month periods was aided in part by the positive rate profile of acquired loans. The earning asset yield was also supported by a higher mix of investments (representing 12% versus 11% of average earning assets between the six-month periods) which yield more than other interest earning assets (representing 10% versus 6% of average earning assets, and which carried a higher proportion of low-earning cash in the first half of 2014 versus 2013). All other interest earning assets combined yielded 1.42%, down 23 bps compared to the first half of 2013, mainly from the higher mix of low-earning cash noted above.
 
Nicolet’s cost of funds continued its favorable decline during the low-rate environment, at 0.79% for the first six months of 2014, 12 bps lower than the first six months of 2013. The average cost of interest-bearing deposits (which represent over 90% of average interest-bearing liabilities for both periods), was 0.62% for the first six months of 2014, down 7 bps versus the first six months of 2013, with favorable rate variances in all deposit categories except brokered deposits. Lower-costing transactional deposits (savings, checking and MMA) saw rate declines in response to reductions made across products between the years, while such balances continued to rise. Average brokered deposit balances increased nominally for the comparable six-month periods but their cost increased from 0.66% in 2013 to 1.13% in 2014, as longer-termed funding replaced maturing shorter-term instruments. The cost of other interest-bearing liabilities (comprised of short- and long-term borrowings) increased to 3.48%, up 50 bps between the six-month periods, from 2013 favorable rates on short-term advances, prepayment in 2013 of $10 million in higher-costing advances, and the 2013 acquisition at fair value of a lower-rate junior subordinated debenture.
 
Average interest-earning assets were $1.1 billion for the first six months of 2014, $303 million or 38% higher than the first six months of 2013, led by a $200 million increase in average loans (to $851 million or 78% of interest earning assets) and a $103 million increase in all other interest-earning assets combined (to $241 million or 22% of earning assets), both heavily influenced by the size and timing of the 2013 acquisitions, and a higher level of low-earning cash balances.
 
Average interest-bearing liabilities were $913 million, up $263 million or 40% over the first six months of 2013, led by a $262 million increase in non-brokered interest-bearing deposits (to $815 million or 89% of average interest-bearing liabilities), an $8 million increase in average brokered deposits (to $44 million), and an $8 million decrease in average other interest-bearing liabilities (to $54 million), both heavily influenced by the size and timing of the acquisitions in 2013.

Provision for Loan Losses

The provision for loan losses for the six months ended June 30, 2014 and 2013 was $1.4 million and $2.0 million, respectively, exceeding net charge offs of $0.9 million and $1.4 million, respectively. Asset quality trends remained relatively strong with continued resolutions of problem loans. The ALLL was $9.6 million (1.12% of loans) at June 30, 2014, compared to $9.2 million (1.09% of loans) at December 31, 2013 and notably higher than $7.7 million (0.91% of loans) at June 30, 2013, which was shortly after the acquisition of Mid-Wisconsin. The ALLL to loans ratio was impacted most after each of the 2013 acquisitions, which combined at their acquisition dates added no ALLL to the numerator and $284 million of loans into the denominator. As events occur in the acquired loan portfolios, an ALLL will be established for this pool of assets as appropriate. Growth in the ALLL to loans ratio is mostly a result of the provision for loan losses exceeding net charge offs.

Nonperforming loans continue to improve. Nonperforming loans were declining prior to the acquisitions, starting at $7.0 million (or 1.3% of total loans) at December 31, 2012, decreasing to $2.7 million (or 0.5% of loans) at March 31, 2013, increasing to a high of $17.4 million (or 2.0% of loans) at September 30, 2013, and declining to $7.2 million (or 0.84% of loans) at June 30, 2014. Of the nonaccrual loans initially acquired in the 2013 acquisitions, $5.3 million remain which is included in the $7.2 million of nonaccruals at June 30, 2014.

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.
 
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Noninterest Income

Table 6: Noninterest Income

   
For the three months ended June 30,
   
For the six months ended June 30,
 
   
2014
   
2013
   
$ Change
   
% Change
   
2014
   
2013
   
$ Change
   
% Change
 
(in thousands)
                                               
Service charges on deposit accounts
  $ 544     $ 470     $ 74       15.7 %   $ 1,038     $ 754     $ 284       37.7 %
Trust services fee income
    1,119       1,074       45       4.2       2,224       1,876       348       18.6  
Mortgage income
    431       714       (283 )     (39.6 )     646       1,586       (940 )     (59.3 )
Brokerage fee income
    166       115       51       44.3       326       217       109       50.2  
Bank owned life insurance (“BOLI”)
    220       212       8       3.8       434       381       53       13.9  
Rent income
    288       274       14       5.1       588       524       64       12.2  
Investment advisory fees
    102       76       26       34.2       212       162       50       30.9  
Gain on sale or writedown of assets, net
    (442 )     45       (487 )     N/M *     308       49       259       N/M *
Bargain purchase gain (“BPG”)
    -       10,435       (10,435 )     N/M *     -       10,435       (10,435 )     N/M *
Other income
    452       351       101       28.8       864       538       326       60.6  
Total noninterest income
  $ 2,880     $ 13,766     $ (10,886 )     (79.1 )%   $ 6,640     $ 16,522     $ (9,882 )     (59.8 )%
Noninterest income without BPG and net gains
  $ 3,322     $ 3,286     $ 36       1.1 %   $ 6,332     $ 6,038     $ 294       4.9 %
*N/M means not meaningful.

Comparison of the six months ending June 30, 2014 versus 2013

Noninterest income was $6.6 million for the first six months of 2014 (including $0.3 million of net gain on sales of assets), compared to $16.5 million for the first half of 2013 (including $10.5 million of combined bargain purchase gain and net gain on sale of assets). Removing these net gains, noninterest income was up $0.3 million or 4.9% between the six-month periods.

The bargain purchase gain recognized from the Mid-Wisconsin acquisition was calculated as the difference in the fair value of the net assets acquired less the consideration paid. Net gain on sale or writedown of assets was $0.3 million and $49,000 for the six months of 2014 and 2013, respectively. The 2014 activity consisted of a $0.3 million gain on the sale of an equity security holding, a $0.6 million net gain on sales of OREO, and a $0.6 million write-down of an acquired former branch building moved to OREO in second quarter 2014. The 2013 activity consisted of $0.3 million of net gains on OREO sales, offset by $0.2 million net losses on sales of investments (mainly the result of selling a large portion of the acquired investment portfolio in second quarter to prepay higher costing debt assumed in the Mid-Wisconsin acquisition).

Service charges on deposit accounts were $1.0 million for the first six months of 2014, up $0.3 million or 37.7% over the comparable period of 2013. The increase resulted from greater service charges on deposits given the higher deposit balances and number of accounts from the acquisitions and from higher non-sufficient funds fees.

Trust service fees increased to $2.2 million for the first six months of 2014, up $0.3 million or 18.6% over the comparable 2013 period. In addition to the larger base of customers acquired through the merger, there was continued market improvement over last year on assets under management, on which fees are based. Similarly, brokerage fees were $0.3 million, up $0.1 million or 50.2% over the first six months of 2013, from increased legacy business, market improvements and to a lesser degree from the merger. Management believes the expanded footprint of the bank should provide growth potential for wealth management in future periods.

Mortgage income represents net gains received from the sale of residential real estate loans service-released into the secondary market and to a small degree, some related income. Residential refinancing activity and new purchase activity remained steady for the first six months of 2013; however, mortgage production slowed considerably during the last half of 2013 and into 2014, largely in response to rising mortgage rates and certain mortgage regulation changes. As a result, mortgage income in the first six months of 2014 was $0.6 million compared to $1.6 million for the first half of 2013. While business has picked up in the second quarter of 2014, levels still trail 2013. The change between six-month periods was not significantly impacted by the acquisitions.

The remaining income categories included modest first half 2014 increases compared to the first half of 2013. BOLI income was $0.4 million for the first six months of 2014, up $53,000 or 13.9% from the comparable period in 2013 as a result of the $4.3 million increase of BOLI acquired in the Mid-Wisconsin transaction. An additional $2.8 million of BOLI was purchased during June 2014 but given the timing did not impact the 2014 year-to-date average balance. Rent income, investment advisory fees and other noninterest income combined were $1.7 million for the first six months of 2014 compared to $1.2 million for the comparable 2013 period, with the majority of the increase due to ancillary fees tied to deposit-related products, most particularly debit card, check cashing and wire fee income.
 
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Noninterest Expense

Table 7: Noninterest Expense

   
For the three months ended June 30,
   
For the six months ended June 30,
 
   
2014
   
2013
   
$ Change
   
% Change
   
2014
   
2013
   
$ Change
   
% Change
 
(in thousands)
                                               
Salaries and employee benefits
  $ 5,384     $ 5,555     $ (171 )     (3.1 )%   $ 10,679     $ 9,114     $ 1,565       17.2 %
Occupancy, equipment and office
    1,737       1,466       271       18.5       3,635       2,570       1,065       41.4  
Business development and marketing
    537       473       64       13.5       1,072       898       174       19.4  
Data processing
    775       572       203       35.5       1,529       995       534       53.7  
FDIC assessments
    203       130       73       56.2       387       240       147       61.3  
Core deposit intangible amortization
    315       286       29       10.1       650       434       216       49.8  
Other
    533       1,104       (571 )     (51.7 )     1,120       1,675       (555 )     (33.1 )
Total noninterest expense
  $ 9,484     $ 9,586     $ (102 )     (1.1 )%   $ 19,072     $ 15,926     $ 3,146       19.8 %

Comparison of the six months ending June 30, 2014 versus 2013
 
Total noninterest expense was $19.1 million for the first six months of 2014, up $3.1 million, or 19.8% over the first six months of 2013; however, excluding the $1.7 million of non-recurring merger-based expenses (of which approximately $1 million was in personnel and $0.7 million was in other expense) incurred in the 2013 period, expenses were up 35%. The increase in most all noninterest expense line items is predominantly due to the larger operating base from the 2013 acquisitions being fully included in 2014 and only partially included in the first half of 2013.
 
Salaries and employee benefits expense was $10.7 million for the first half of 2014, up $1.6 million or 17.2% (or up 32.1% excluding the 2013 non-recurring merger-based expense), over the comparable 2013 period. The increase was partially attributable to the growing workforce from the acquisitions (though less than a one-to-one increase as a result of realization of operating efficiencies) and was also impacted by merit increases between the years, higher health insurance premiums, and increased 401k expense. Average full time equivalent employees for the first half of 2014 were 289, up 28% versus 226 for the comparable 2013 period.

Occupancy, equipment and office expense increased $1.1 million to $3.6 million for the first six months of 2014 compared to 2013. This 41.4% increase is in line with the addition of 12 branches from the acquisitions which more than doubled the physical facilities and related expenses. Utilities, rent, snowplowing, and other occupancy expenses increased proportionately in conjunction with the acquisitions, however, a harsher 2014 winter, continued integration on systems and phones, and postage resulted in higher expense between the six-month periods.
 
Business development and marketing expense increased $0.2 million between the comparable six-month periods. This 19.4% increase includes a greater focus on growth in new markets, including television costs, and higher expense on promotional materials.
 
Data processing expenses, which are primarily volume-based, rose $0.5 million or 53.7% between the six-month periods, in line with the increase in number of accounts and continued integration of systems. FDIC assessments increased by $0.1 million, mainly given the increase in assets (on which the assessments are based) between the six-month periods. Core deposit intangible amortization increased $0.2 million, attributable to the core deposit intangible recorded with the Mid-Wisconsin acquisition.

Other expense decreased $0.6 million (or 33.1%) to $1.1 million for the first six months of 2014. The first half of 2013 carried non-recurring merger-based expenses (mainly consulting and legal fees) of $0.7 million; without these direct costs, other expense increased modestly by $0.1 million, with the largest variance being an $89,000 increase in foreclosure and OREO expense given the higher amount of OREO acquired and worked.
 
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Income Taxes

For the first six months of 2014, income tax expense was $1.9 million compared to $1.0 million for the same period of 2013. Tax expense for 2014 includes a $0.5 million tax benefit recorded to the deferred tax asset in the second quarter due to the increased ability to utilize net operating losses under the Internal Revenue Code section 382 following the one-year evaluation period related to the acquisition. Tax expense for the first six months of 2013 was influenced by the $10 million bargain purchase gain related to the Mid-Wisconsin acquisition which was a tax free transaction. The effective tax rate was 28% for the first half of 2014 compared to 7% for the same period in 2013. Excluding the deferred tax adjustment and the bargain purchase gain, effective tax rates were approximately 35% for both six-month periods. 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 June 30, 2014 or December 31, 2013.

Comparison of the three months ending June 30, 2014 versus 2013
 
Nicolet reported net income of $2.6 million for the three months ended June 30, 2014, compared to $11.5 million for the comparable period of 2013, with second quarter 2013 including $10.4 million bargain purchase gain and approximately $1.5 million of non-recurring pre-tax merger-related expenses. Net income available to common shareholders for the second quarter of 2014 was $2.5 million, or $0.58 per diluted common share, compared to net income available to common shareholders of $11.2 million, or $2.78 per diluted common share, for the second quarter of 2013. Income statement results and average balances for second quarter 2013 include approximately two months of activity from Mid-Wisconsin, while those for the second quarter of 2014 include fully the results of both the Mid-Wisconsin and Bank of Wausau acquisitions.
 
Taxable equivalent net interest income was $10.7 million for second quarter 2014, up $1.7 million or 19% over second quarter 2013, with $1.4 million of the increase due to volume variances from the larger post-merger balance sheet and $0.3 million from rate variances driven by a higher loan yield.
 
The earning asset yield was 4.58% for second quarter 2014, 2 bps lower than second quarter 2013, mainly due to a decline in the yield on non-loan earning assets which had a combined yield of 1.50%, down 21 bps from second quarter 2013. The earning asset yield was also influenced by the non-loan earning asset mix which represented a higher percentage of average earning assets (21% for second quarter 2014 versus 17% for second quarter 2013) and carried a higher proportion of low-earning cash between the three-month periods. Loans yielded 5.40%, up 22 bps over second quarter 2013, aided by the positive rate profile of acquired loans.
 
Between the second quarter periods, the cost of funds increased 1 bp to 0.82% in 2014 versus 2013. This relatively unchanged position is due to a higher proportion of interest bearing liabilities in our lower costing transaction-based deposits (i.e. savings, checking and MMA balances combined represented 65% of average interest bearing liabilities versus 58%, and all showed equal or lower rates than the year ago period in response to rate reductions made to related products). Rates on all term-based funding (i.e. core CDs and IRAs, brokered deposits and other wholesale funding) rose between the second quarter periods, though their combined balances represented 35% of average interest bearing liabilities versus 42% in the second quarter 2013. A portion of brokered deposits and other wholesale funds were paid down post-acquisition (with second quarter 2013 carrying a $0.2 million recovery of prepayment penalty on delayed payoff of acquired FHLB advances), and those renewed were generally at extended maturities, for interest rate risk considerations, at higher rates. Core CDs and IRAs cost more between the second quarter periods, largely from the conclusion in February 2014 of a favorable fair value mark on acquired CDs.
 
Noninterest income was $2.9 million for second quarter 2014 as compared to $13.8 million for the second quarter 2013, (or $3.3 million without the bargain purchase gain). Mortgage fee income was down $0.3 million due to lower production. Net gain on sale or writedown of assets for second quarter 2014 consisted of a $0.6 million writedown of an acquired former branch building moved to OREO offset by a $0.2 million net gain on OREO resolutions, while second quarter 2013 included $0.3 million of net gains on OREO sales offset by $0.2 million net losses on sales of investments (mainly the result of selling a large portion of the acquired investment portfolio in second quarter to prepay higher costing debt assumed in the Mid-Wisconsin acquisition). The remaining noninterest income categories were comparable between the second quarters, in light of the larger operating base and timing of 2013 acquisitions.
 
Noninterest expense was $9.5 million for the second quarter of 2014, down $0.1 million from second quarter 2013; however, excluding the $1.5 million of non-recurring merger-based expenses (approximately $1 million in personnel costs and $0.5 million other expenses) incurred in the 2013 period, expenses were up 16.7%, reflecting proportionate increases as a result of the timing of the 2013 acquisitions. Salaries and employee benefits declined slightly between the second quarter periods, but were up 18.2% excluding the impact of the above-noted merger costs, and reflective of only two months of merged activity in 2013 and merit increases between the years. Period end full time equivalent employees have remained nearly unchanged from June 30, 2013 to June 30, 2014. FDIC assessments were up 56.2% from the prior year as a result of the larger asset size upon which assessments are based. Other expenses (including legal, consulting and audit expense) decreased $0.6 million between the second quarter periods, primarily due to the above-noted merger costs in the 2013 period. The remaining expense categories reflected proportional increases, considering second quarter 2013 only included two months of merged activity.
 
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The provision for loan losses for the three months ended June 30, 2014 and 2013 was $0.7 million and $1.0 million respectively. Net charge offs for the quarter ending June 30, 2014 were $0.3 million compared to $0.9 million for the same period in 2013. At June 30, 2014, the ALLL was $9.6 million (or 1.12% of total loans) compared to $7.7 million (or 0.91% of total loans) at June 30, 2013.

Income tax expense was $0.6 million and $0.5 million for the second quarters of 2014 and 2013, respectively. The effective tax rates were 19.9% for second quarter 2014 (impacted by the $0.5 million tax benefit recorded to the deferred tax asset in the quarter related to net operating loss utilization potential) and 4.5% for second quarter 2013 (impacted by the tax free nature of the Mid-Wisconsin acquisition).

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 commercial loans, consisting of commercial and industrial business loans, agricultural production, and owner-occupied commercial real estate loans; CRE loans, consisting of commercial investment real estate loans, agricultural real estate, and construction and land development loans; residential real estate loans, including residential first mortgages, residential junior mortgages (such as home equity loans and lines), and to a lesser degree residential construction loans; and retail and other loans.
 
Total loans were $860 million at June 30, 2014 compared to $847 million at December 31, 2013. This $13 million increase represented 2% growth in the first half of 2014 and $20 million or 2% growth over the balance at June 30, 2013. Removing the $284 million of loans added at acquisition (i.e. removing $272 million from Mid-Wisconsin from both June 30, 2014 and 2013, and $12 million from Bank of Wausau from June 30, 2014), loans grew organically 1% between the June 30 periods.
 
Table 8: Period End Loan Composition
 
   
June 30, 2014
   
December 31, 2013
   
June 30, 2013
 
   
Amount
   
% of
Total
   
Amount
   
% of
Total
   
Amount
   
% of
Total
 
Commercial & industrial
  $ 269,377       31.3 %   $ 253,674       29.9 %   $ 245,856       29.3 %
Owner-occupied CRE
    187,225       21.8       187,476       22.1       181,101       21.5  
Ag production
    13,982       1.6       14,256       1.7       13,114       1.6  
Ag real estate
    41,934       4.9       37,057       4.4       38,983       4.6  
CRE investment
    79,639       9.3       90,295       10.7       117,264       14.0  
Construction & land development
    45,504       5.3       42,881       5.1       37,754       4.5  
Residential construction
    11,895       1.4       12,535       1.5       10,288       1.2  
Residential first mortgage
    154,713       18.0       154,403       18.2       141,255       16.8  
Residential junior mortgage
    50,244       5.8       49,363       5.8       48,929       5.8  
Retail & other
    5,573       0.6       5,418       0.6       6,002       0.7  
Total loans
  $ 860,086       100 %   $ 847,358       100 %   $ 840,546       100 %
 
Broadly, commercial-based loans (i.e. commercial, agricultural, CRE and construction loans combined) versus retail-based loans (i.e. residential real estate and other retail loans) were unchanged at 74% commercial-based and 26% retail-based at June 30, 2014 and December 31, 2013. Commercial-based loans are considered to have more inherent risk of default than retail-based loans, in part because the commercial balance per borrower is typically larger than that for retail-based loans, implying higher potential losses on an individual customer basis.
 
Commercial and industrial loans consist primarily of commercial loans to small businesses and, to a lesser degree, to municipalities within a diverse range of industries. The credit risk related to commercial and industrial loans is largely influenced by general economic conditions and the resulting impact on a borrower’s operations, or on the value of underlying collateral, if any. Commercial and industrial loans increased $16 million since year end 2013. Commercial and industrial loans continue to be the largest segment of Nicolet’s portfolio and increased to 31.3% of the total portfolio at June 30, 2014, up from 29.9% at December 31, 2013.
 
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Owner-occupied CRE loans declined to 21.8% of loans at June 30, 2014 from 22.1% at December 31, 2013 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 combined 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, the agricultural loans increased $5 million since year end 2013, representing 6.5% of total loans at June 30, 2014, versus 6.1% at December 31, 2013.
 
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 declined $11 million since year end 2013, declining as a percent of loans from 10.7% to 9.3% at June 30, 2014.
 
Loans in the construction and land development portfolio represent 5.3% of total loans at June 30, 2014 and such loans provide financing for the development of commercial income properties, multi-family residential development, and land designated for future development. Nicolet controls the credit risk on these types of loans by making loans in familiar markets, reviewing the merits of individual projects, controlling loan structure, and monitoring the progress of projects through the analysis of construction advances. Credit risk is managed by employing sound underwriting guidelines, lending primarily to borrowers in local markets, periodically evaluating the underlying collateral, and formally reviewing the borrower’s financial soundness and relationships on an ongoing basis. Lending on originated loans in this area declined steadily both in total dollars and as a percentage of the portfolio over the past several years, with the 2013 increase attributable to the 2013 acquisitions. Since December 31, 2013, balances have increased $3 million but remained relatively consistent as a percent of loans given the overall increase in total loan balances since year end.
 
On a combined basis, Nicolet’s residential real estate loans represent 25.2% of total loans at June 30, 2014, down 0.3% from December 31, 2013. 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, falling 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. While mortgage loans normally hold terms of 30 years, Nicolet’s portfolio mortgages have an average contractual life of less than 15 years.
 
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, 2013 to June 30, 2014.
 
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 June 30, 2014, no significant industry concentrations existed in Nicolet’s portfolio in excess of 25% of total loans. Nicolet has also developed guidelines to manage its exposure to various types of concentration risks.
 
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Allowance for Loan and Lease Losses
 
In addition to the discussion that follows, see also Note 1, “Basis of Presentation,” and Note 6, “Loans, Allowance for Loan Losses and Credit Quality,” in the Notes to the Unaudited Consolidated Financial Statements.
 
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. Beginning in the first quarter of 2014, management extended the look-back period on which the average historical loss rates are determined, from a prior three-year period to a rolling 20-quarter (5 year) average, as a means of capturing more of a full credit cycle now that recent period loss levels are stabilizing. Contrarily, the three-year average (used by the Company’s methodology during 2009-2013) was considered more appropriate for the severe and prolonged economic downturn particularly evidenced by higher net charge off levels in 2008 through 2011. 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 June 30, 2014, the ALLL was $9.6 million compared to $9.2 million at December 31, 2013. The six-month increase was a result of a 2014 provision of $1.4 million offset by 2014 net charge offs of $0.9 million. Comparatively, the provision for loan losses in the first six months of 2013 was $2.0 million and net charge offs were $1.4 million. Annualized net charge offs as a percent of average loans were 0.22% in the first half of 2014 compared to 0.49% for the first half of 2013 and 0.54% for the entire year of 2013. 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.
 
42
 

 

 
The ratio of the ALLL as a percentage of period-end loans was 1.12% at June 30, 2014 compared to 1.09% at December 31, 2013 and 0.91% at June 30, 2013. The ALLL to loans ratio was impacted most after each of the 2013 acquisitions, which combined at their acquisition dates added no ALLL to the numerator and $284 million to the denominator. As events occur in the acquired loan portfolios, an ALLL will be established for this pool of assets as appropriate. At June 30, 2014 $9.6 million of the ALLL was reserved against loans (representing 1.49% of originated loans).
 
The largest portions of the ALLL were allocated to construction and land development loans and commercial & industrial loans combined, representing 62.9% and 73.3% of the ALLL at June 30, 2014 and December 31, 2013, respectively. The decrease allocation to these categories since December 31, 2013 was the result of changes to allowance allocations as additional qualitative factors are refined, creating a more ratable distribution of the provision across categories.

Table 9: Loan Loss Experience

   
For the six months ended
   
Year ended
 
(in thousands)
 
June 30,
2014
 
June 30,
2013
   
December 31, 2013
 
Allowance for loan losses (ALLL):
                 
Balance at beginning of period
  $ 9,232     $ 7,120     $ 7,120  
Provision for loan losses
    1,350       1,950       6,200  
Charge-offs
    979       1,443       4,238  
Recoveries
    39       31       150  
Net charge-offs
    940       1,412       4,088  
Balance at end of period
  $ 9,642     $ 7,658     $ 9,232  
                         
Net loan charge-offs (recoveries):
                       
Commercial & industrial
  $ 524     $ 454     $ 534  
Owner-occupied CRE
    254       111       1,851  
Agricultural production
    -       -       -  
Agricultural real estate
    -       -       -  
CRE investment
    (8 )     639       992  
Construction & land development
    12       36       304  
Residential construction
    -       -       -  
Residential first mortgage
    122       80       148  
Residential junior mortgage
    9       82       189  
Retail & other
    27       10       70  
Total net loans charged-off
  $ 940     $ 1,412     $ 4,088  
                         
ALLL to total loans
    1.12 %     0.91 %     1.09 %
ALLL to net charge-offs
    1,026 %     542 %     226 %
Net charge-offs to average loans, annualized
    0.22 %     0.49 %     0.54 %
 
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The allocation of the ALLL is based on Nicolet’s estimate of loss exposure by category of loans and is shown in Table 10 for June 30, 2014 and December 31, 2013.

Table 10: Allocation of the Allowance for Loan Losses
(in thousands)
 
June 30,
2014
   
% of Loan
Type to
Total
Loans
   
December 31, 2013
   
% of Loan
Type to
Total
Loans
 
ALLL allocation
                       
Commercial & industrial
  $ 3,281       31.3 %   $ 1,798       29.9 %
Owner-occupied CRE
    1,096       21.8       766       22.1  
Agricultural production
    44       1.6       18       1.7  
Agricultural real estate
    272       4.9       59       4.4  
CRE investment                                   
    575       9.3       505       10.7  
Construction & land development
    2,784       5.3       4,970       5.1  
Residential construction
    167       1.4       229       1.5  
Residential first mortgage
    833       18.0       544       18.2  
Residential junior mortgage
    448       5.8       321       5.8  
Retail & other                                   
    142       0.6       22       0.6  
Total ALLL                                   
  $ 9,642       100 %   $ 9,232       100 %
                                 
ALLL category as a percent of total ALLL:
                               
Commercial & industrial
    34.0 %             19.5 %        
Owner-occupied CRE
    11.4               8.3          
Agricultural production
    0.5               0.2          
Agricultural real estate
    2.8               0.6          
CRE investment                                   
    6.0               5.5          
Construction & land development
    28.9               53.8          
Residential construction
    1.7               2.5          
Residential first mortgage
    8.6               5.9          
Residential junior mortgage
    4.6               3.5          
Retail & other                                   
    1.5               0.2          
Total ALLL                                   
    100 %             100 %        
 
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 $7.2 million (consisting of $1.9 million originated loans and $5.3 million acquired loans) at June 30, 2014 compared to $10.3 million at December 31, 2013. Nonperforming assets (which include nonperforming loans and OREO) were $8.7 million at June 30, 2014 compared to $12.3 million at December 31, 2013. OREO decreased from $2.0 million at year end 2013 to $1.5 million at June 30, 2014. OREO at June 30, 2014 included a branch which was moved from active to inactive status and written to a fair value of $0.2 million resulting in a $0.6 million charge to second quarter earnings. Nonperforming assets as a percent of total assets were 0.74% at June 30, 2014 compared to 1.02% at December 31, 2013.
 
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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 $16.8 million (2.0% of loans) and $18.7 million (2.2% of loans) at June 30, 2014 and December 31, 2013, 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 11: Nonperforming Assets
       
(in thousands)
 
June 30,
2014
   
December 31, 2013
   
June 30,
 2013
 
Nonaccrual loans:
                 
Commercial & industrial
  $ 517     $ 68     $ 4  
Owner-occupied CRE
    1,975       1,087       3,546  
Agricultural production
    27       11       22  
Agricultural real estate
    461       448       611  
CRE investment
    1,607       4,631       5,546  
Construction & land development
    479       1,265       790  
Residential construction
                 
Residential first mortgage
    1,671       2,365       3,394  
Residential junior mortgage
    461       262       257  
Retail & other
          129       135  
Total nonaccrual loans
    7,198       10,266       14,307  
Accruing loans past due 90 days or more
                 
Total nonperforming loans
  $ 7,198     $ 10,266     $ 14,307  
CRE investment
  $ 558     $ 935     $ 360  
Owner-occupied CRE
    259             604  
Construction & land development
    418       854       1,925  
Residential real estate owned
    67       198       471  
Bank property real estate owned
    200              
OREO
    1,502       1,987       3,360  
Total nonperforming assets
  $ 8,700     $ 12,253     $ 17,667  
Total restructured loans accruing
  $ 3,879     $ 3,862     $  
Ratios
                       
Nonperforming loans to total loans
    0.84 %     1.21 %     1.70 %
Nonperforming assets to total loans plus OREO
    1.01 %     1.44 %     2.09 %
Nonperforming assets to total assets
    0.74 %     1.02 %     1.62 %
ALLL to nonperforming loans
    134.0 %     89.9 %     43.4 %
ALLL to total loans
    1.12 %     1.09 %     0.91 %
 
Table 12: Investment Securities Portfolio
             
   
June 30, 2014
   
December 31, 2013
 
(in thousands)
 
Amortized
Cost
   
Fair
Value
   
% of
Total
   
Amortized
Cost
   
Fair
Value
   
% of
Total
 
U.S. Government sponsored enterprises
  $ 1,532     $ 1,537       1 %   $ 2,062     $ 2,057       2 %
State, county and municipals
    76,446       77,067       54 %     54,594       55,039       43 %
Mortgage-backed securities
    62,946       62,928       44 %     68,642       67,879       53 %
Corporate debt securities
    220       220       -       220       220       -  
Equity securities
    715       1,903       1 %     905       2,320       2 %
Total
  $ 141,859     $ 143,655       100 %   $ 126,423     $ 127,515       100 %
 
45
 

 

 
At June 30, 2014 the total carrying value of investment securities was $144 million, up from $128 million at December 31, 2013, and represented 12.2% and 10.6% of total assets at June 30, 2014 and December 31, 2013, respectively. At June 30, 2014, 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 shareholders’ equity.

In addition to securities available for sale, Nicolet had other investments of $8.0 million at June 30, 2014 and December 31, 2013, 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), 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 2013 or year to date 2014.

Table 13: Investment Securities Portfolio Maturity Distribution
 
   
As of June 30, 2014
 
   
Within
One Year
   
After One
but Within
Five Years
   
After Five
but Within
Ten Years
   
After
Ten Years
   
Mortgage-
related
and Equity
Securities
   
Total
Amortized
Cost
   
Total
Fair
Value
Amount
 
   
Amount
 
Yield
   
Amount
 
Yield
   
Amount
 
Yield
   
Amount
 
Yield
   
Amount
 
Yield
   
Amount
 
Yield
 
(in thousands)
                                                                 
U.S. government sponsored enterprises
  $ 1,011     4.1 %   $     %   $ 521     1.8 %   $     %   $     %   $ 1,532     3.3 %   $ 1,537  
State and county municipals (1)
    4,209     3.2       62,344     2.5       9,028     3.0       865     3.0                 76,446     2.6       77,067  
Corporate debt securities
                                  220     2.0                 220     2.0       220  
Mortgage-backed securities
                                            62,946     3.4       62,946     3.4       62,928  
Equity securities
                                            715           715           1,903  
                                                                                             
Total amortized cost
  $ 5,220     3.4 %   $ 62,344     2.5 %   $ 9,549     2.9 %   $ 1,085     2.8 %   $ 63,661     3.4 %   $ 141,859     3.0 %   $ 143,655  
Total fair value and carrying value
  $ 5,276           $ 62,986           $ 9,471           $ 1,091           $ 64,831                         $ 143,655  


(1)
The yield on tax-exempt investment securities is computed on a tax-equivalent basis using a federal tax rate of 34% adjusted for the disallowance of interest expense.
 
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 14 are brokered deposits of $29 million at June 30, 2014 and $50 million at December 31, 2013.
 
Table 14: Deposits
 
   
June 30, 2014
   
December 31, 2013
 
(in thousands)
 
Amount
   
% of
Total
   
Amount
   
% of
Total
 
Demand
  $ 190,464       18.8 %   $ 171,321       16.6 %
Money market and NOW accounts
    451,791       44.7 %     492,499       47.6 %
Savings
    112,232       11.1 %     97,601       9.4 %
Time
    256,634       25.4 %     273,413       26.4 %
Total deposits
  $ 1,011,121       100 %   $ 1,034,834       100 %
 
Total deposits were $1.01 billion at June 30, 2014, with no significant change since December 31, 2013. On average for the first six months of 2014, total deposits were $1.03 billion.
 
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Table 15: Average Deposits
 
 
For the six months ended,
 
 
June 30, 2014
 
June 30, 2013
 
(in thousands)
Amount
 
% of
Total
 
Amount
 
% of
Total
 
Demand
  $ 165,177       16.1 %   $ 110,189       15.8 %
Money market and NOW accounts
    485,895       47.5 %     340,787       48.8 %
Savings
    103,854       10.1 %     64,602       9.2 %
Time
    269,373       26.3 %     183,238       26.2 %
Total
  $ 1,024,299       100 %   $ 698,816       100 %
 
Table 16: Maturity Distribution of Certificates of Deposit
 
(in thousands)
 
June 30, 2014
 
3 months or less
 
$
39,140
 
Over 3 months through 6 months
   
37,496
 
Over 6 months through 12 months
   
52,765
 
Over 12 months
   
127,233
 
         
Total
 
$
256,634
 
 
Other Funding Sources
 
Other funding sources, which include short-term and long-term borrowings (notes payable and junior subordinated debentures), were $43 million and $52 million at June 30, 2014 and December 31, 2013, respectively. Short-term borrowings, consisting mainly of customer repurchase agreements maturing in less than three months, totaled $3 million at June 30, 2014 and $7 million at December 31, 2013. Long-term borrowings include a joint venture note and FHLB advances, totaling $27 million and $32 million at June 30, 2014 and December 31, 2013, respectively. Junior subordinated debentures are another long-term funding source totaling $12 million at June 30, 2014 and December 31, 2013. Junior subordinated debentures of $6.2 million were issued in July 2004 in connection with the $6 million of trust preferred securities. Acquired junior subordinated debentures of $10.3 million in connection with $10 million of trust preferred securities were assumed in the 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. Further information regarding these junior subordinated debentures is located in “Note 8 – Junior Subordinated Debentures” in the Notes to the Unaudited Consolidated Financial Statements.
 
Off-Balance Sheet Obligations
 
As of June 30, 2014 and December 31, 2013, Nicolet had the following commitments that did not appear on its balance sheet:
 
Table 17: Commitments

   
June 30,
   
December 31,
 
   
2014
   
2013
 
(in thousands)
           
Commitments to extend credit — Fixed and variable rate
  $ 226,255     $ 234,930  
Standby and irrevocable letters of credit-fixed rate
    5,906       6,371  
 
Liquidity and Interest Rate Sensitivity
 
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 $55 million of the $144 million investment securities portfolio on hand at June 30, 2014 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.
 
47
 

 

 
Cash and cash equivalents at June 30, 2014 and December 31, 2013 were approximately $86 million and $147 million, respectively. The increased cash and cash equivalents at year end 2013 was predominantly due to strong customer deposit growth outpacing the loan demand. These levels have declined through the first half of 2014 as is typical of Nicolet’s historical deposit behaviors. Nicolet’s liquidity resources were sufficient as of June 30, 2014 to fund loans and to meet other cash needs as necessary.
 
Interest Rate Sensitivity Gap Analysis

The primary market risk faced by Nicolet is interest rate risk. The static gap analysis starts with contractual repricing information for assets, liabilities, and off-balance sheet instruments. These items are then combined with repricing estimations for administered rate (interest-bearing demand deposits, savings, and money market accounts) and non-rate related products (demand deposit accounts, other assets, and other liabilities) to create a baseline repricing balance sheet. In addition to the contractual information, residential mortgage whole loan products and mortgage-backed securities are adjusted based on industry estimates of prepayment speeds that capture the expected prepayment of principal above the contractual amount based on how far away the contractual coupon is from market coupon rates. The interest rate sensitivity assumptions for savings accounts, money market accounts, and interest-bearing demand deposits accounts are based on current and historical experiences regarding portfolio retention and interest rate repricing behavior. Based on these experiences, a portion of these balances are considered to be long-term and fairly stable and are, therefore, included in categories beyond the immediate contractual repricing category.

At December 31, 2013, the one year cumulative gap was $85 million with a cumulative ratio of rate sensitive assets to rate sensitive liabilities of 114% representing a slightly asset sensitive position. At December 31, 2013 the cumulative one year gap to total assets ratio was 7% which was within Nicolet’s established guidelines of not greater than +25% or -25% of total assets. During the first six months of 2014, interest bearing cash equivalents declined in conjunction with Nicolet’s cyclical decline in deposits. The one year cumulative gap at June 30, 2014 increased slightly to $120 million and represented a cumulative ratio of rate sensitive assets to rate sensitive liabilities of 123%, versus 114% at year end 2013. At June 30, 2014 the cumulative one year gap to total assets ratio was 10% which was within Nicolet’s established guidelines of not greater than +25% or -25% of total assets.
 
In order to limit exposure to interest rate risk, management monitors the liquidity and gap analysis on a monthly basis and may adjust pricing, term and product offerings when necessary to stay within applicable guidelines and maximize the effectiveness of asset/liability management.
 
Along with the static gap analysis, Nicolet’s management also estimates the effect a gradual change and a sudden change in interest rates could have on expected net interest income through income simulation. The simulation is run using the prime rate as the base with the assumption of rates increasing 100, 200, and 300 bps or decreasing 100, 200 and 300 bps. All rates are increased or decreased parallel to the change in prime rate. The simulation assumes a static mix of assets and liabilities. As a result of the simulation, over a 12-month time period ending June 30, 2015, net interest income was estimated to decrease 2.6% if rates increase 100 bps in an immediate shock scenario, and was estimated to decrease 2.6% in a 100 bps declining rate environment assumption. These results are in line with Nicolet’s interest rate sensitivity position, including relatively short (though extending) loan maturities and level of variable rate loans with interest floors; as rates remain low, asset maturities extend, and deposit maturities contract, pressuring the position to become more liability-sensitive. These results are based solely on the modeled changes in the market rates and do not reflect the earnings sensitivity that may arise from other factors such as changes in the shape of the yield curve, changes in spreads between key market rates, or changes in consumer or business behavior. These results also do not include any management action to mitigate potential income variances within the modeled process. The simulation results are one indicator of interest rate risk, and actual net interest income is largely impacted by the allocation of assets, liabilities and product mix. Management continually reviews its interest rate risk position through the Asset/Liability Committee process, and such Committee reports to the full board of directors on a monthly basis.
 
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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. Nicolet’s management 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. Nicolet’s management intends to maintain an optimal capital and leverage mix for growth and for shareholder return.
 
The Small Business Lending Fund (“SBLF”) is a U.S. Treasury program made available to community banks, designed to boost lending to small businesses by providing participating banks with capital and liquidity. In particular, the SBLF program targets commercial, industrial, owner-occupied real-estate and agricultural-based lending to qualifying small businesses, which include businesses with less than $50 million in revenue, and promotes outreach to women-owned, veteran-owned and minority-owned businesses.
 
For participating banks, the annual dividend rate upon funding and for the following nine full calendar quarters was 5%, unless there was growth in qualifying small business loans outstanding over a baseline which could reduce the rate to as low as 1% (as determined under the terms of the Securities Purchase Agreement (the “Agreement”)), adjusted quarterly. The dividend rate fixes for the tenth full quarter after funding through the end of the first four and one-half years based on the amount of qualifying small business loans at that time per the terms of the agreement. The dividend rate is then fixed at 9% after four and one-half years if the preferred stock is not repaid. On September 1, 2011, under the SBLF, Nicolet received $24.4 million from the Treasury for the issuance of 24,400 shares of Non-Cumulative Perpetual Preferred Stock, Series C, with $1,000 per share liquidation value. Nicolet paid an annual dividend rate of 5% from funding through September 30, 2013, paid 1% for the quarter ended December 31, 2013, (i.e. the ninth full quarter after funding) and has qualified beginning in the first quarter of 2014 for the 1% fixed annual dividend rate for the remainder of the first four and one-half years. Nicolet does not have current plans to repay its SBLF funding. Under the terms of the Agreement, Nicolet is required to provide various information, certifications, and reporting to the Treasury. At June 30, 2014, Nicolet believes it was in compliance with the requirements set by the Treasury in the Agreement. The preferred stock (under SBLF) qualifies as Tier 1 capital for regulatory purposes.
 
On April 26, 2013, through a private placement, the Company raised $2.9 million in capital, issuing 174,016 shares of common stock.
 
On April 26, 2013, in connection with its acquisition of Mid-Wisconsin, the Company issued 589,159 shares of its common stock at a value of $9.7 million. The $0.4 million of incurred issuance costs was charged against additional paid in capital. As a result of this merger, Nicolet became an SEC-reporting company again and listed its common stock on the Over-the-Counter markets under the trading symbol of “NCBS.”
 
On January 21, 2014, Nicolet’s board of directors approved a resolution authorizing a stock repurchase program whereby Nicolet may utilize up to $6 million to purchase up to 350,000 shares of its outstanding common stock from time to time in the open market or block transactions as market conditions warrant or in private transactions. During the first six months of 2014, $2.46 million was used to repurchase 124,035 shares with a weighted average price of $19.82 per share including commissions.
 
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A summary of Nicolet’s and Nicolet National Bank’s regulatory capital amounts and ratios as of June 30, 2014 and December 31, 2013 are presented in the following table.
 
Table 19: Capital
                                     
   
Actual
   
For Capital
Adequacy Purposes
   
To Be Well
Capitalized
Under Prompt
Corrective Action
Provisions (2)
 
(in thousands)
 
Amount
   
Ratio
(1)
   
Amount
   
Ratio
(1)
   
Amount
   
Ratio
(1)
 
As of June 30, 2014:
                                   
Nicolet
                                   
Total capital
  $ 123,037       14.0 %   $ 70,131       8.0 %     N/A       N/A  
Tier I capital
    113,395       12.9       35,065       4.0       N/A       N/A  
Leverage
    113,395       9.7       46,825       4.0       N/A       N/A  
                                                 
Nicolet National Bank
                                               
Total capital
  $ 118,656       13.7 %   $ 69,218       8.0 %   $ 86,522       10.0 %
Tier I capital
    109,014       12.6       34,609       4.0       51,913       6.0  
Leverage
    109,014       9.4       46,366       4.0       57,957       5.0  
                                                 
As of December 31, 2013:
                                               
Nicolet
                                               
Total capital
  $ 119,050       13.8 %   $ 69,075       8.0 %     N/A       N/A  
Tier I capital
    109,817       12.7       34,538       4.0       N/A       N/A  
Leverage
    109,817       9.5       46,322       4.0       N/A       N/A  
                                                 
Nicolet National Bank
                                               
Total capital
  $ 111,343       13.1 %   $ 68,110       8.0 %   $ 85,138       10.0 %
Tier I capital
    102,111       12.0       34,055       4.0       51,083       6.0  
Leverage
    102,111       8.9       43,858       4.0       57,323       5.0  


 
(1)
The total capital ratio is defined as tier1 capital plus tier 2 capital divided by total risk-weighted assets. The tier 1 capital ratio is defined as tier1 capital divided by total risk-weighted assets. The leverage ratio is defined as tier1 capital divided by the most recent quarter’s average total assets.
 
(2)
Prompt corrective action provisions are not applicable at the bank holding company level.
 
On July 2, 2013, the Federal Reserve approved final rules that substantially amend the regulatory risk-based capital rules applicable to Nicolet and Nicolet National Bank. On July 9, 2013, the FDIC also approved, as an interim final rule, the regulatory capital requirements for U.S. banks, following the actions of the Federal Reserve. The final rules implement the “Basel III” regulatory capital reforms, as well as certain changes required by the Dodd-Frank Act.
 
The final rules include new risk-based capital and leverage ratios that will be phased in from 2015 to 2019. The rules include a new minimum common equity Tier 1 capital to risk-weighted assets ratio of 4.5% and a common equity Tier 1 capital conservation buffer of 2.5% of risk-weighted assets, which is in addition to the Tier 1 and Tier 2 risk-based capital requirements. The final rules also raise the minimum ratio of Tier 1 capital to risk-weighted assets from 4.0% to 6.0% and require a minimum leverage ratio of 4.0%. The required minimum ratio of total capital to risk-weighted assets will remain 8.0%. The new risk-based capital requirements (except for the capital conservation buffer) will become effective for Nicolet on January 1, 2015. The capital conservation buffer will be phased in over four years beginning on January 1, 2016, with a maximum buffer of 0.625% of risk-weighted assets for 2016, 1.25% for 2017, 1.875% for 2018, and 2.5% for 2019 and thereafter. Failure to maintain the required capital conservation buffer will result in limitations on capital distributions and on discretionary bonuses to executive officers.
 
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The final rules also implement revisions and clarifications consistent with Basel III regarding the various components of Tier 1 capital, including common equity, unrealized gains and losses and instruments that will no longer qualify as Tier 1 capital. The final rules provide that depository holding companies with less than $15 billion in total assets as of December 31, 2009, such as Nicolet, may permanently include trust preferred securities and certain other non-qualifying instruments issued and included in Tier 1 or Tier 2 capital before May 19, 2010 in additional Tier 1 (subject to a maximum of 25% of Tier 1 capital) or Tier 2 capital until maturity or redemption.
 
The final rules also set forth certain changes for the calculation of risk-weighted assets that the Company will be required to implement beginning January 1, 2015. Based on Nicolet’s current capital composition and levels, management does not presently anticipate that the final rules present a material risk to Nicolet’s financial condition or results of operations.
 
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not applicable for smaller reporting companies.

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.

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

Not applicable for smaller reporting company.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

Not applicable.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

Not applicable.

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

ITEM 5. OTHER INFORMATION

Not applicable.
 
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ITEM 6. EXHIBITS

The following exhibits are filed herewith:
     
Exhibit
   
Number   Description
31.1   Certification of CEO under Section 302 of Sarbanes-Oxley Act of 2002
31.2   Certification of CFO under Section 302 of Sarbanes-Oxley Act of 2002
32.1   Certification of CEO Pursuant to 18 U.S.C Section 1350 as Adopted Pursuant to Section 906 of Sarbanes-Oxley Act of 2002
32.2   Certification of CFO Pursuant to 18 U.S.C Section 1350 as Adopted Pursuant to Section 906 of Sarbanes-Oxley Act of 2002
101*   Interactive data files pursuant to Rule 405 of Regulation S-T: (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Income, (iii) Consolidated Statements of Comprehensive Income, (iv) Consolidated Statements of Stockholders’ Equity, (v) Consolidated Statement of Cash Flows, and (vi) Notes to Consolidated Financial Statements tagged as blocks of text.

*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.
 
 
NICOLET BANKSHARES, INC.
       
August 8, 2014 
/s/ Robert B. Atwell  
  Robert B. Atwell
  Chairman, President and Chief Executive Officer
 
August 8, 2014 
/s/ Ann K. Lawson
 
 
Ann K. Lawson
 
Chief Financial Officer
 
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