ITEM 1A. RISK FACTORS
An investment in our common stock involves risks. If any of the following risks, or other risks which have not been identified or which we may believe are immaterial or unlikely, actually occurs, our business, financial condition and results of operations could be harmed. In such a case, the trading price of our common stock could decline, and you could lose all or part of your investment. The risks discussed below also include forward-looking statements, and our actual results may differ substantially from those discussed in these forward-looking statements.
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Risks Relating to Nicolet’s Business
Nicolet may not be able to sustain its historical rate of growth, or may encounter issues associated with its growth, either of which could adversely affect our financial condition, results of operations, and share price.
We have grown over the past several years and intend to continue to pursue a significant growth strategy for our business. Our prospects must be considered in light of the risks, expenses and difficulties frequently encountered by companies in significant growth stages of development. We may not be able to further expand our market presence in existing markets or to enter new markets successfully, nor can we guarantee that any such expansion would not adversely affect our results of operations. Failure to manage growth effectively could have a material adverse effect on the business, future prospects, financial condition or results of our operations, and could adversely affect our ability to successfully implement business strategies. Also, if such growth occurs more slowly than anticipated or declines, our operating results could be materially adversely affected.
Our ability to grow successfully will depend on a variety of factors including the continued availability of desirable business opportunities, the competitive responses from other financial institutions in our market areas and the ability to manage our growth. While we believe we have the management resources and internal systems in place to manage future growth successfully, there can be no assurance that growth opportunities will be available or that any growth will be managed successfully. In addition, our recent growth may distort some of our historical financial ratios and statistics.
As part of our growth strategy, we regularly evaluate merger and acquisition opportunities and conduct due diligence activities related to possible transactions with other financial institutions and financial services companies. As a result, negotiations may take place and future mergers or acquisitions involving cash, debt, or equity securities may occur at any time. We seek merger or acquisition partners that are culturally similar, have experienced management, and possess either significant market presence or have potential for improved profitability through financial management, economies of scale, or expanded services. However, it is possible that some acquisitions might not close as a result of failure to meet closing conditions or the market could negatively affect the banking environment so much that an acquisition that may have, at one time, been beneficial to both institutions is now no longer prudent. The costs and effects of a such not completed acquisitions could negatively affect Nicolet.
Acquiring other banks, businesses, or branches involves potential adverse impact to our financial results and various other risks commonly associated with acquisitions, including, among other things, difficulty in estimating the value of the target company, payment of a premium over book and market values that may dilute our tangible book value and earnings per share in the short and long term, potential exposure to unknown or contingent liabilities of the target company, exposure to potential asset quality issues of the target company, potential volatility in reported income as goodwill impairment losses could occur irregularly and in varying amounts, difficulty and expense of integrating the operations and personnel of the target company, inability to realize the expected revenue increases, cost savings, increases in geographic or product presence, and / or other projected benefits, potential disruption to our business, potential diversion of our management’s time and attention, and the possible loss of key employees and customers of the target company.
The global coronavirus outbreak could harm business and results of operations for Nicolet.
In March 2020, the World Health Organization declared the coronavirus to be a pandemic. Given the ongoing and dynamic nature of the circumstances, it is difficult to predict the impact of the coronavirus pandemic on the businesses of Nicolet and on its customers, and there is no guarantee that efforts by Nicolet to address the adverse impacts of the coronavirus will be effective. The impact to date has included periods of significant volatility in financial, commodities and other markets. This volatility, if it continues, could have an adverse impact on Nicolet’s customers and on Nicolet’s business, financial condition and results of operations. Nicolet may also incur additional costs to remedy damages caused by business disruptions.
In addition, actions by U.S. federal, state and foreign governments to address the pandemic, including travel bans and school, business and entertainment venue closures, may also have a significant adverse effect on the markets in which Nicolet conducts its businesses. The extent of impacts resulting from the coronavirus pandemic and other events beyond the control of Nicolet will depend on future developments, which are highly uncertain and cannot be predicted, including new information which may emerge concerning the severity of the coronavirus pandemic and actions taken to contain the coronavirus or its impact, among others.
As a community bank, Nicolet’s success depends upon local and regional economic conditions and has different lending risks than larger banks.
We provide services to our local communities. Our ability to diversify economic risks is limited by our own local markets and economies. We lend primarily to individuals and small- to medium-sized businesses, which may expose us to greater lending risks than those of banks lending to larger, better-capitalized businesses with longer operating histories.
We manage our credit exposure through careful monitoring of loan applicants and loan concentrations in particular industries, and through loan approval and review procedures. We have established an evaluation process designed to determine the appropriateness of our allowance for credit losses. While this evaluation process uses historical and other objective information, the classification of
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loans and the establishment of credit losses is an estimate based on experience, judgment and expectations regarding borrowers and economic conditions, as well as regulator judgments. We can make no assurance that our credit loss reserves will be sufficient to absorb future credit losses or prevent a material adverse effect on our business, profitability or financial condition.
The core industries in our market area are manufacturing, wholesaling, paper, packaging, food production and processing, agriculture, forest products, retail, service, and businesses supporting the general building industry. The area has a broad range of diversified equipment manufacturing services related to these core industries and others. The residential and commercial real estate markets throughout these areas depend primarily on the strength of these core industries. A material decline in any of these sectors will affect the communities we serve and could negatively impact our financial results and have a negative impact on profitability.
If the communities in which we operate do not grow or if the prevailing economic conditions locally or nationally are less favorable than we have assumed, our ability to maintain our low volume of nonperforming loans and other real estate owned and implement our business strategies may be adversely affected and our actual financial performance may be materially different from our projections.
Nicolet may experience increased delinquencies and credit losses, which could have a material adverse effect on our capital, financial condition, results of operations, and share price.
Our success depends to a significant extent upon the quality of our assets, particularly loans. In originating loans, there is a substantial likelihood that we will experience credit losses. The risk of loss will vary with, among other things, general economic conditions, the type of loan, the creditworthiness of the borrower over the term of the loan, and, in the case of a collateralized loan, the quality of the collateral for the loan.
Our loan customers may not repay their loans according to the terms of these loans, and the collateral securing the payment of these loans may be insufficient to assure repayment. As a result, we may experience significant credit losses, which could have a material adverse effect on our operating results. Management makes various assumptions and judgments about the collectability of our loan portfolio, including the creditworthiness of our borrowers and the value of the real estate and other assets serving as collateral for the repayment of many of our loans. We maintain an allowance for credit losses in an attempt to cover any loan losses that may occur. In determining the size of the allowance, we rely on an analysis of our loan portfolio based on historical loss experience, volume and types of loans, trends in classification, volume and trends in delinquencies and nonaccruals, national and local economic conditions, reasonable and supportable forecasts, and other pertinent information.
If management’s assumptions are wrong, our current allowance may not be sufficient to cover future loan losses, and we may need to make adjustments to allow for different economic conditions or adverse developments in our loan portfolio. Material additions to our allowance would materially decrease net income. We expect our allowance to continue to fluctuate; however, given current and future market conditions, we can make no assurance that our allowance will be appropriate to cover future credit losses.
In addition, the market value of the real estate securing our loans as collateral could be adversely affected by the economy and unfavorable changes in economic conditions in our market areas. As of December 31, 2020, approximately 40% of our loans were secured by commercial-based real estate, 3% of loans were secured by agriculture-based real estate, and 21% of our loans were secured by residential real estate. Any sustained period of increased payment delinquencies, foreclosures, or losses caused by adverse market and economic conditions, including another downturn in the real estate market, in our markets could adversely affect the value of our assets, results of operations, and financial condition.
Nicolet is subject to extensive regulation that could limit or restrict our activities, which could have a material adverse effect on our results of operations or share price.
We operate in a highly regulated industry and are subject to examination, supervision, and comprehensive regulation by various regulatory agencies. Our compliance with these regulations, including compliance with regulatory commitments, is costly and restricts certain of our activities, including the declaration and payment of cash dividends to stockholders, mergers and acquisitions, investments, loans and interest rates charged, interest rates paid on deposits, and locations of offices. We are also subject to capitalization guidelines established by our regulators, which require us to maintain adequate capital to support our growth and operations.
The laws and regulations applicable to the banking industry have changed and are likely to continue to change, and we cannot predict the effects of these changes on our business and profitability. Some or all of the changes, including the rule-making authority granted to the CFPB, may result in greater reporting requirements, assessment fees, operational restrictions, capital requirements, and other regulatory burdens for us, and many of our competitors that are not banks or bank holding companies may remain free from such limitations. This could affect our ability to attract and retain depositors, to offer competitive products and services, and to expand our business. Because government regulation greatly affects the business and financial results of all commercial banks and bank holding companies, the cost of compliance could adversely affect our ability to operate profitably.
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Congress may consider additional proposals to substantially change the financial institution regulatory system and to expand or contract the powers of banking institutions, bank holding companies and financial holding companies. Such legislation may change existing banking statutes and regulations, as well as the current operating environment significantly. If enacted, such legislation could increase or decrease the cost of doing business, limit or expand permissible activities, or affect the competitive balance among banks, savings associations, credit unions, and other financial institutions. We cannot predict whether new legislation will be enacted and, if enacted, the effect that it, or any regulations, would have on our business, financial condition, or results of operations.
Nicolet’s profitability is sensitive to changes in the interest rate environment.
As a financial institution, our earnings significantly depend on net interest income, which is the difference between the interest income that we earn on interest-earning assets, such as investment securities and loans, and the interest expense that we pay on interest-bearing liabilities, such as deposits and borrowings. Therefore, any change in general market interest rates, including changes in federal fiscal and monetary policies, affects us more than non-financial institutions and can have a significant effect on our net interest income and total income. Our assets and liabilities may react differently to changes in overall market rates or conditions because there may be mismatches between the repricing or maturity characteristics of the assets and liabilities. As a result, an increase or decrease in market interest rates could have material adverse effects on our net interest margin and results of operations.
In addition, we cannot predict whether interest rates will continue to remain at present levels, or the timing of any anticipated changes. Changes in interest rates may cause significant changes, up or down, in our net interest income. If the interest rates paid on deposits and borrowings increase at a faster rate than the interest rates received on loans and investment securities, our net interest income, and therefore earnings, could be adversely affected. Earnings also could be adversely affected if the interest rates received on loans and investment securities fall more quickly than the interest rates paid on deposits and borrowings. In addition, if there is a substantial increase in interest rates, our investment portfolio is at risk of experiencing price declines that may negatively impact our total capital position through changes in other comprehensive income. Any significant increase in prevailing interest rates could also adversely affect our mortgage banking business because higher interest rates could cause customers to request fewer refinancing and purchase money mortgage originations.
Nicolet may be required to transition from the use of LIBOR interest rate index in the future.
Certain of our trust preferred securities, loans, investment securities, and junior subordinated debentures are currently indexed to LIBOR to calculate the interest rate. The continued availability of the LIBOR index is not guaranteed after 2021. We cannot predict whether and to what extent banks will continue to provide LIBOR submissions to the administrator of LIBOR or whether any additional reforms to LIBOR may be enacted. At this time, no consensus exists as to what rate or rates may become acceptable alternatives to LIBOR (with the exception of overnight repurchase agreements, which are expected to be based on the Secured Overnight Financing Rate, or SOFR). The language in our LIBOR-based contracts and financial instruments has developed over time and may have various events that trigger when a successor rate to the designated rate would be selected. If a trigger is satisfied, contracts and financial instruments may give the calculation agent discretion over the substitute index or indices for the calculation of interest rates to be selected.
Nicolet faces significant operational risk, including risk of loss related to cybersecurity breaches, due to the financial services industry’s increased reliance on technology.
We rely heavily on communications and information systems to conduct our business, and we rely on third party vendors to provide key components of these systems, including our core application processing. Any failure, interruption or breach in security of these systems could result in failures or disruptions in customer relationship management, general ledger, deposit, loan functionality and the effective operation of other systems. We rely on third parties to compile, process or store computer systems, company data and infrastructure, and such information may be vulnerable to attack by hackers or unauthorized access. While we have policies and procedures designed to prevent or limit the effect of a failure, interruption or security breach of our information systems, there can be no assurance that any such failures, interruptions or security breaches will not occur or, if they do occur, that they will be adequately addressed. The occurrence of any failures, interruptions or security breaches of our information systems could damage our reputation, result in a loss of customer business, damage vendor relationships, subject us to additional regulatory scrutiny, or expose us to civil litigation and possible financial liability, any of which could have a material adverse effect on our financial condition and results of operations.
We do not control the actions of the third party vendors we have selected to provide key components of our business infrastructure. Any problems caused by these third parties, including as a result of their not providing us their services for any reason or their performing their services poorly, or any failure, interruption or breach in security of the services they provide, could adversely affect our ability to deliver products and services to our customers and otherwise to conduct our business. Replacing these third party vendors could also entail significant delay and expense.
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Our business may be adversely affected by an increasing prevalence of fraud and other financial crimes.
As a financial institution, we are also susceptible to fraudulent activity that may be committed against us, our third party vendors, or our clients, which may result in financial losses or increased costs to us or our clients, disclosure or misuse of our information or our clients' information, misappropriation of assets, privacy breaches against our clients, litigation, or damage to our reputation. These risks may increase in the future as we continue to increase our mobile-payment and other internet-based product offerings and expand our internal usage of web-based products and applications.
Negative publicity could damage our reputation.
Reputation risk, or the risk to our earnings and capital from negative public opinion, is inherent in our business. Negative public opinion could adversely affect our ability to keep and attract customers and expose us to adverse legal and regulatory consequences. Negative public opinion could result from our actual or alleged conduct in any number of activities, including lending or foreclosure practices, corporate governance, regulatory compliance, mergers and acquisitions, and disclosure, sharing or inadequate protection of customer information, and from actions taken by government regulators and community organizations in response to that conduct.
Competition in the banking industry is intense and Nicolet faces strong competition from larger, more established competitors.
The banking business is highly competitive, and we experience strong competition from many other financial institutions, as well as financial technology companies (“fintechs”). We compete with commercial banks, credit unions, savings and loan associations, mortgage banking firms, consumer finance companies, securities brokerage firms, insurance companies, money market funds, and other financial institutions that operate in our primary market areas and elsewhere. Because technology and other changes have lowered barriers to entry and made it possible for non-banks to offer products and services traditionally provided by banks, we also compete with fintechs seeking to disrupt conventional banking markets. In particular, the activity of fintechs has grown significantly over recent years and is expected to continue to grow. Fintechs have and may continue to offer bank or bank-like products and a number of fintechs have applied for bank or industrial loan charters. In addition, other fintechs have partnered with existing banks to allow them to offer deposit products to their customers.
We compete with these institutions both in attracting deposits and in making loans. In addition, we have to attract our customer base from other existing financial institutions and from new residents. Many of our competitors are well-established, much larger financial institutions. While we believe we can and do successfully compete with these other financial institutions, we may face a competitive disadvantage as compared to large national or regional banks as a result of our smaller size and relative lack of geographic diversification.
Although we compete by concentrating our marketing efforts in our primary market area with local advertisements, personal contacts, and greater flexibility in working with local customers, we can give no assurance that this strategy will be successful.
Nicolet continually encounters technological change, we may have fewer resources than our competition to continue to invest in technological improvements.
The banking and financial services industry is undergoing rapid technological changes, with frequent introductions of new technology-driven products and services. In addition to better serving customers, the effective use of technology increases efficiency and enables financial institutions to reduce costs. Our future success will depend, in part, upon our ability to address the needs of our customers by using technology to provide products and services that enhance customer convenience, as well as create additional efficiencies in operations. Many of our competitors have greater resources to invest in technological improvements, and we may not be able to effectively implement new technology-driven products and services, which could reduce our ability to effectively compete.
Risks Related to Ownership of Nicolet’s Common Stock
Our stock price can be volatile.
Stock price volatility may make it more difficult for you to sell your common stock when you want and at prices you find attractive. Our stock price can fluctuate widely in response to a variety of factors including, among other things:
•actual or anticipated variations in quarterly results of operations or financial condition;
•operating results and stock price performance of other companies that investors deem comparable to us;
•news reports relating to trends, concerns, and other issues in the financial services industry;
•perceptions in the marketplace regarding us and / or our competitors;
•new technology used or services offered by competitors;
•significant acquisitions or business combinations, strategic partnerships, joint ventures, or capital commitments by or involving us or our competitors;
•failure to integrate acquisitions or realize anticipated benefits from acquisitions;
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•changes in government regulations;
•geopolitical conditions such as acts or threats of terrorism or military conflicts;
•available supply and demand of investors interested in trading our common stock;
•our own participation in the market through our buyback program; and
•recommendations by securities analysts.
General market fluctuations, industry factors, and general economic and political conditions and events, such as economic slowdowns or recessions, interest rate changes, or credit loss trends, could also cause our stock price to decrease regardless of our operating results.
Nicolet has not historically paid dividends to our common shareholders, and we cannot guarantee that it will pay dividends to such shareholders in the future.
The holders of our common stock receive dividends if and when declared by the Nicolet board of directors out of legally available funds. Nicolet’s board of directors has not declared a dividend on the common stock since our inception in 2000. Any future determination relating to dividend policy will be made at the discretion of Nicolet’s board of directors and will depend on a number of factors, including the company’s future earnings, capital requirements, financial condition, future prospects, regulatory restrictions and other factors that the board of directors may deem relevant.
Our principal business operations are conducted through the Bank. Cash available to pay dividends to our shareholders is derived primarily, if not entirely, from dividends paid by the Bank. The ability of the Bank to pay dividends to us, as well as our ability to pay dividends to our shareholders, is subject to and limited by certain legal and regulatory restrictions, as well as contractual restrictions related to our junior subordinated debentures. Further, any lenders making loans to us may impose financial covenants that may be more restrictive than regulatory requirements with respect to the payment of dividends by us. There can be no assurance of whether or when we may pay dividends in the future.
Nicolet may need to raise additional capital in the future but that capital may not be available when it is needed or may be dilutive to our shareholders.
We are required by federal and state regulatory authorities to maintain adequate capital levels to support our operations. In order to support our growth and operations and to comply with regulatory standards, we may need to raise capital in the future. Our ability to raise additional capital will depend on conditions in the capital markets at that time, which are outside our control, and on our financial performance. Accordingly, we cannot assure you of our ability to raise additional capital, if needed, on favorable terms. The capital and credit markets have experienced significant volatility in recent years. In some cases, the markets have produced downward pressure on stock prices and credit availability for certain issuers without regard to those issuers’ underlying financial strength. If current levels of volatility worsen, our ability to raise additional capital may be disrupted. If we cannot raise additional capital when needed, our results of operations and financial condition may be adversely affected, and our banking regulators may subject us to regulatory enforcement action, including receivership. In addition, the issuance of additional shares of our equity securities will dilute the economic ownership interest of our common shareholders.
Nicolet’s directors and executive officers own a significant portion of our common stock and can influence shareholder decisions.
Our directors and executive officers, as a group, beneficially owned approximately 16% of our fully diluted issued and outstanding common stock as of December 31, 2020. As a result of their ownership, our directors and executive officers have the ability, if they voted their shares in concert, to influence the outcome of matters submitted to our shareholders for approval, including the election of directors.
Holders of Nicolet’s subordinated debentures have rights that are senior to those of its common shareholders.
We have supported our continued growth by issuing trust preferred securities and accompanying junior subordinated debentures and by assuming the trust preferred securities and accompanying junior subordinated debentures issued by companies we have acquired. As of December 31, 2020, we had outstanding trust preferred securities and associated junior subordinated debentures with an aggregate par principal amount of approximately $33.0 million and $32.1 million, respectively.
We have unconditionally guaranteed the payment of principal and interest on our trust preferred securities. Also, the junior subordinated debentures issued to the special purpose trusts that relate to those trust preferred securities are senior to our common stock. As a result, we must make payments on the junior subordinated debentures before we can pay any dividends on our common stock, and in the event of our bankruptcy, dissolution or liquidation, holders of our junior subordinated debentures must be satisfied before any distributions can be made on our common stock. We do have the right to defer distributions on our junior subordinated debentures (and related trust preferred securities) for up to five years, but during that time would not be able to pay dividends on our common stock.
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Because Nicolet is a regulated bank holding company, your ability to obtain “control” or to act in concert with others to obtain control over Nicolet without the prior consent of the Federal Reserve or other applicable bank regulatory authorities is limited and may subject you to regulatory oversight.
Nicolet is a bank holding company and, as such, is subject to significant regulation of its business and operations. In addition, under the provisions of the Bank Holding Company Act and the Change in Bank Control Act, certain regulatory provisions may become applicable to individuals or groups who are deemed by the regulatory authorities to “control” Nicolet or our subsidiary bank. The Federal Reserve and other bank regulatory authorities have very broad interpretive discretion in this regard and it is possible that the Federal Reserve or some other bank regulatory authority may, whether through a merger or through subsequent acquisition of Nicolet’s shares, deem one or more of Nicolet’s shareholders to control or to be acting in concert for purposes of gaining or exerting control over Nicolet. Such a determination may require a shareholder or group of shareholders, among other things, to make voluminous regulatory filings under the Change in Bank Control Act, including disclosure to the regulatory authorities of significant amounts of confidential personal or corporate financial information. In addition, certain groups or entities may also be required to either register as a bank holding company under the Bank Holding Company Act, becoming themselves subject to regulation by the Federal Reserve under that Act and the rules and regulations promulgated thereunder, which may include requirements to materially limit other operations or divest other business concerns, or to divest immediately their investments in Nicolet.
In addition, these limitations on the acquisition of our stock may generally serve to reduce the potential acquirers of our stock or to reduce the volume of our stock that any potential acquirer may be able to acquire. These restrictions may serve to generally limit the liquidity of our stock and, consequently, may adversely affect its value.
Nicolet’s securities are not FDIC insured.
Our securities are not savings or deposit accounts or other obligations of the Bank, and are not insured by the Deposit Insurance Fund, or any other agency or private entity and are subject to investment risk, including the possible loss of some or all of the value of your investment.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2. PROPERTIES
The corporate headquarters of both the Parent Company and the Bank are located at 111 North Washington Street, Green Bay, Wisconsin. At year-end 2020, including the main office, the Bank operated 36 bank branch locations, 28 of which are owned and eight that are leased. In addition, Nicolet owns or leases other real property that, when considered in aggregate, is not significant to its financial position. Most of the offices are free-standing, newer buildings that provide adequate access, customer parking, and drive-through and/or ATM services. The properties are in good condition and considered adequate for present and near term requirements. None of the owned properties are subject to a mortgage or similar encumbrance.
One leased location involves a director, with lease terms that management considers arms-length. For additional disclosure, see Note 14, “Related Party Transactions,” of the Notes to Consolidated Financial Statements under Part II, Item 8.
ITEM 3. 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 4. MINE SAFETY DISCLOSURES
Not applicable.
PART II
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Nicolet registered its common stock under Section 12(b) of the Exchange Act on February 24, 2016, in connection with listing on the Nasdaq Capital Market, and trades under the symbol “NCBS”. As of February 22, 2021, Nicolet had approximately 2,200 shareholders of record.
Nicolet has not paid dividends on its common stock since its inception in 2000. Any cash dividends paid by Nicolet on its common stock must comply with applicable Federal Reserve policies described further in “Business—Regulation of Nicolet—Dividend Restrictions.” The Bank is also subject to regulatory restrictions on the amount of dividends it is permitted to pay to Nicolet as
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further described in “Business—Regulation of the Bank—Payment of Dividends” and in Note 16, “Regulatory Capital Requirements,” in the Notes to Consolidated Financial Statements under Part II, Item 8.
Following are Nicolet’s monthly common stock purchases during the fourth quarter of 2020.
(a) During fourth quarter 2020, the Company repurchased 3,251 shares for minimum tax withholding settlements on restricted stock and repurchased 1,253 shares to satisfy the exercise price and/or tax withholding requirements of stock options, respectively. These purchases do not count against the maximum number of shares that may yet be purchased under the board of directors’ authorization.
(b) During 2014 the board of directors approved a common stock repurchase program which authorized, with subsequent modifications, the use of up to $126 million to repurchase up to 2,625,000 shares of outstanding common stock. The common stock repurchase program has no expiration date. During fourth quarter 2020, Nicolet spent $12.9 million to repurchase and cancel 205,001 shares at a weighted average price of $62.97 per share, bringing the life-to-date cumulative totals to $105.6 million to repurchase and cancel 2.1 million shares at a weighted average price of $50.92 per share. At December 31, 2020, approximately $20.4 million remained available to repurchase common shares.
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Performance Graph
The following graph shows the cumulative stockholder return on our common stock compared with the KBW NASDAQ Bank Index and the S&P 500 Index for the period of December 31, 2015 to December 31, 2020. The graph assumes the value of the investment in the Company’s common stock and in each index was $100 on December 31, 2015. Historical stock price performance shown on the graph is not necessarily indicative of the future price performance.
Period Ending
Source: S&P Global Market Intelligence
ITEM 6. SELECTED FINANCIAL DATA
The selected consolidated financial data presented as of December 31, 2020 and 2019 and for each of the years in the three-year period ended December 31, 2020 is derived from the audited consolidated financial statements and related notes included in this report and should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” The selected consolidated financial data for all other periods shown is derived from audited consolidated financial statements that are not required to be included in this report.
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EARNINGS SUMMARY AND SELECTED FINANCIAL DATA
At and for the years ended December 31,
Results of operations:
Preferred stock dividends — — — — 633
Earnings per common share:
Common shares:
Year-End Balances:
Average Balances:
Financial Ratios:
* The ratios of tangible book value per common share, return on average tangible common equity, and tangible common equity to tangible assets exclude goodwill and other intangibles, net. These financial ratios have been included as they are considered to be critical metrics with which to analyze and evaluate financial condition and capital strength.
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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion is management’s analysis to assist in the understanding and evaluation of the consolidated financial condition and results of operations of Nicolet. It should be read in conjunction with the consolidated financial statements and footnotes and the selected financial data presented elsewhere in this report.
Evaluation of financial performance and certain balance sheet line items was impacted by the timing and size of Nicolet's acquisitions, Choice Bancorp, Inc. (“Choice”) on November 8, 2019, at 12% of Nicolet’s then pre-merger asset size, and Advantage Community Bancshares, Inc. (“Advantage”) on August 21, 2020, at 4% of Nicolet’s then pre-merger asset size. Certain income statement results, average balances and related ratios for 2020 include full contribution from Choice and a partial contribution from Advantage, while 2019 includes partial contribution from Choice and no contribution from Advantage. At consummation, Choice added $457 million in assets, loans of $348 million, deposits of $289 million, core deposit intangible of $1.7 million, goodwill of $45 million, and one net new branch. At consummation, Advantage added $172 million in assets, loans of $88 million, deposits of $141 million, core deposit intangible of $1 million, goodwill of $12 million, and four branches.
The detailed financial discussion that follows focuses on 2020 results compared to 2019. See “2019 Compared to 2018” for the summary comparing 2019 and 2018 results. Some tabular information is shown for trends of three years or for five years as required under SEC regulations.
Overview
Nicolet provides a diversified range of traditional commercial and retail banking services, as well as wealth management services, to individuals, business owners, and businesses in its market area primarily through, as of year-end 2020, the 36 bank branch offices of its banking subsidiary, located in northeast and central Wisconsin and Menominee, Michigan.
The 2020 year was marked by significant events (health pandemic, large sudden rate drop by the Federal Reserve, unprecedented government stimulus, political changes and social issues, and other market and economic disruptions), volatility, and uncertainty, that turned 2020 into a very tactical year for Nicolet management. Management took several actions to respond: added $0.2 billion of liquidity (which later proved to not be necessary, leading to a reduction in non-deposit leverage in the second half of the year), temporarily (and later permanently) closed 8 branches, provided temporary relief to customers through loan payment modifications on nearly 1,000 loans (with only a fraction remaining on modified terms at year end), dramatically elevated the credit loss provision given pervading uncertainty (though slowed the provision in fourth quarter as potential deterioration of loan quality metrics initially anticipated had not materialized), channeled significant resources to originate PPP loans (peaking at 2,725 loans totaling $351 million during 2020) and residential mortgages (over $1 billion originated to consumers under atypical conditions), granted $1.25 million of aid to expedite funds to smaller businesses who would have otherwise waited for small PPP loans, kept people safe (with $0.6 million of expense in second quarter for onsite-bonuses, testing and protective supplies), and prioritized full return to on-site work by June to allow us to move forward on goals and improvements (with offsite workforce peaking at 52%, comprised of 34% remote and 18% paid to stay home and not work due to risk concerns or location closure). During 2020, we still executed on our acquisition strategy, completing the all-cash acquisition of Advantage. While we announced a merger agreement with a $0.7 billion bank in February 2020, we exercised discipline, mutually terminating that deal in May 2020, (given the level of uncertainty and pricing in the significantly depressed market that made the transaction unlikely to close) and incurred a $0.5 million charge. Nicolet has used acquisitions as part of its growth strategy over the past few years and has successfully integrated and realized cost efficiencies related to scale quickly after each acquisition.
In 2020, despite the turbulent year and through the many actions noted above, Nicolet delivered on growth, profitability, capital positioning, and sound asset quality management. At December 31, 2020, Nicolet had total assets of $4.6 billion, loans of $2.8 billion, deposits of $3.9 billion and stockholders’ equity of $539 million, representing increases over December 31, 2019 of 27%, 8%, 32% and 4%, in assets, loans, deposits and total equity, respectively, largely due to the significant increase in liquidity, and only partly due to the Advantage acquisition. At December 31, 2020, cash and cash equivalents grew significantly, up $0.6 billion to $0.8 billion or 18% of assets (compared to $0.2 billion or 5% of assets at year end 2019), while loans increased $0.2 billion and investments grew $0.1 billion, funded by the surge in deposits (up $956 million) over year end 2019. Asset quality remained sound, with nonperforming assets to assets of 0.29% at December 31, 2020 (down from 0.42% at year-end 2019), as the borrowing base has largely remained resilient, profitable and liquid in the uncertain times. The allowance for credit losses-loans grew to $32.2 million (1.15% of loans, or 1.24% of loans excluding PPP loans) compared to $14.0 million or 0.54% of loans at December 31, 2019. The large increase in the allowance resulted from the $10.3 million provision exceeding $1.4 million of net charge-offs (or 0.05% of average loans), and a $9.3 million addition upon adoption of the current expected credit losses (“CECL”) model. Nicolet repurchased approximately 646,700 shares of common stock for $40.5 million in 2020 under its common stock repurchase program, given the opportunity of a depressed market. At December 31, 2020 there remained $20.4 million authorized under the repurchase program, as modified. With total stockholders’ equity to assets of 11.85% at year-end 2020, Nicolet has capacity to act on targets of interest in relevant or growth markets that provide a path to or support our position as the lead-local community bank.
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For 2020, net income was record-breaking at $60.1 million (10% higher than $54.6 million for 2019), and return on average assets was 1.41% (compared to 1.75% for 2019), with 2020 impacted by the sizable increase in average assets (mainly cash). Diluted earnings per common share for 2020 was $5.70 (3% higher than 2019), benefiting from the stronger net income, while covering a 6% increase in average diluted shares, mostly due to the timing of the 1.2 million shares issued in the Choice acquisition net of strong repurchase activity throughout 2020 (totaling 0.6 million shares). Notably, second quarter 2020 net income unfavorably included $4 million of isolated expenses ($3 million after tax) related to the onset of the pandemic, a terminated acquisition and branch closure decisions. During second quarter 2019, net income favorably included $5.4 million (or $0.55 of diluted earnings per share) related to two one-time actions combined, the sale of 80% of Nicolet's equity investment in a data processing entity ($7.4 million after-tax gain) and $2.75 million retirement-related compensation declared to benefit all employees after that sale ($2.0 million after-tax cost).
Net income before taxes for 2020 was $80.9 million ($9.5 million or 13% higher than 2019), predominantly due to increased net interest income (up $13 million or 11% aided mainly on higher volumes, despite an 81bps decline in net interest margin between the years, dominated by the very high proportion of low-earning cash in total interest-earning assets), record net mortgage income (at $30 million versus $12 million in 2019) and strong wealth revenues (up $2 million or 13%), which more than covered a $10 million negative swing in net asset gains or losses (at $2 million net loss for 2020 versus $8 million net gain for 2019), higher credit loss provision (up $9 million) and a $4 million or 4% increase in overall expenses, evidencing diligent expense management and improved efficiencies in a difficult year.
For 2021, Nicolet’s focus will return to its long-term strategies, especially M&A, as we believe such opportunities have grown in light of industry stress, and we have remained well-positioned to capitalize on it through a solid core franchise, strong asset quality, and an experienced team. That said, when evaluating transactions, quantitative and qualitative factors need to make sense in combination with each other, including but not limited to the economics of the transaction, cultural and strategic fit, geographic and business line relevance, and current or potential talent. We will remain committed on driving growth in core earnings through our expanded customer base. Our objective is to achieve solid organic growth in loans, core deposits, wealth management services and other revenue lines within all our markets, in a cost-effective, profitable manner to sustain a healthy return on average assets. We plan to remain active on-site as a differentiator to many of our competitors, remain adaptable for our customers in the continuing uncertainty, and deliver on our long-term leadership succession plans. Additional resources are planned in 2021 for furthering automation and data analysis (to enhance customer experiences and company efficiencies and decision-making), for personnel expenses (in support of deepening talent and leadership in light of growth and succession needs), and for capital management (to balance safety and opportunity for the long-term). While Nicolet believes delivering strong earnings, return on assets, and disciplined capital management aligned with growth will provide upward pressure on our common stock performance throughout the year, ongoing uncertainties remain for 2021 across many environments (health, social, political and economic), which will likely heighten potential challenges for the year.
INCOME STATEMENT ANALYSIS
Net Interest Income
Net interest income is the primary source of Nicolet’s revenue, and is the difference between interest income on earning assets, such as loans and investment securities, 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, mix and composition of interest-earning assets and interest-bearing liabilities, including characteristics such as the fixed or variable nature of the financial instruments, contractual maturities, and repricing frequencies. Tax-equivalent net interest income is a non-GAAP measure, but is a preferred industry measurement of net interest income (and is used in calculating a net interest margin) as it enhances the comparability of net interest income arising from taxable and tax-exempt sources. Tables 1, 2, and 3 present information to facilitate the review and discussion of selected average balance sheet items, tax-equivalent net interest income, interest rate spread, and net interest margin.
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Table 1: Average Balance Sheet and Net Interest Income Analysis - Tax-Equivalent Basis
Years Ended December 31,
ASSETS
Interest-earning assets
Investment securities:
LIABILITIES AND STOCKHOLDERS’ EQUITY
Interest-bearing liabilities
Selected Additional Information:
Net interest rate spread ex PPP & PPPLF 3.15 % 3.84 % 3.77 %
(1)Nonaccrual loans and loans held for sale 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 21% and adjusted for the disallowance of interest expense.
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Table 2: Volume/Rate Variance - Tax-Equivalent Basis
Volume Rate Net (1) Volume Rate Net (1)
Interest-earning assets
PPP Loans $ 8,062 $ — $ 8,062 $ — $ — $ —
Investment securities:
Interest-bearing liabilities
(1)The change in interest due to both rate and volume has been allocated in proportion to the relationship of dollar amounts of change in each.
(2)Nonaccrual loans and loans held for sale are included in the daily average loan balances outstanding.
(3)The yield on tax-exempt loans and tax-exempt investment securities is computed on a tax-equivalent basis using a federal tax rate of 21% and adjusted for the disallowance of interest expense.
Table 3: Interest Rate Spread, Margin and Average Balance Mix - Tax-Equivalent Basis
Years Ended December 31,
Contribution from net free funds 0.23 % 0.35 % 0.27 %
Comparison of 2020 versus 2019
Net interest income was up 11% over 2019, despite an 81 bps decline in net interest margin. Overall asset volumes increased net interest income while the mix of interest-earning assets (particularly the very high cash levels) squeezed the related net interest margin. In general, the lower interest rate environment pressured both net interest income and net interest margin.
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The interest rate environment experienced dramatic change in 2020. Prior to the pandemic, the Federal Reserve steadily raised short-term interest rates during 2017 and 2018 in support of a growing economy (up 175 bps total to 2.50% at December 31, 2018), and then reduced rates by 75 bps in three moves during the second half of 2019 (to 1.75% at December 31, 2019) largely responding to global issues and slowing growth, which contributed to a flattened yield curve with periods of inversion. In response to the pandemic in March 2020, the Federal Reserve dropped short-term rates by 150 bps (to 25 bps at March 31, 2020) in two emergency moves, which brought slope back into the yield curve, though still fairly flat. Comparatively, short-term rates were 150 bps lower at December 31, 2020 than at December 31, 2019. While the following paragraphs will discuss the comparison of 2020 and 2019, we expect that the pandemic impacts will continue to evolve and pressure future quarters even further, including continued margin pressure in the low rate environment and potential unusual loan or deposit volume or pricing impacts.
At the onset of the pandemic, but prior to the announcement of government stimulus, we added liquidity to ensure we could meet customer needs. The action demonstrated our capacity to support our communities, but proved later to not be necessary, leading us to reduce non-deposit leverage in the second half of 2020. Efforts to minimize pressure on net interest income during the changes throughout 2020 included prudent pricing actions on deposits and loans, allowing brokered deposits to mature without renewal, prepayment of selected FHLB advances, and full payback of the PPPLF funding (approximately $335 million used for 5 months at a cost of 35 bps). In addition, we fully redeemed our subordinated notes ($12 million at 5% fixed) in November 2020 and one of our junior subordinated debenture issuances ($6 million at 8% fixed) in December 2020, which combined will reduce annual interest expense by approximately $1.1 million going forward.
Tax-equivalent net interest income was $130.3 million for 2020, up $13.2 million (11%), compared to 2019, comprised of net interest income of $129.3 million ($13.3 million or 11% higher than 2019) and a $1.0 million tax-equivalent adjustment (down nearly $0.1 million between the years). The $13.2 million increase in tax-equivalent net interest income was comprised of $10.6 million higher interest income and $2.6 million lower interest expense. Higher volumes added $26.3 million to net interest income, including a $31.8 million increase to interest income on higher interest-earning assets (mostly from higher loan volumes, due to the inclusion of loans acquired with Choice and Advantage, as well as PPP loans), offset partly by a $5.4 million increase to interest expense on higher interest-bearing liabilities (mostly from higher deposit volumes also related to the inclusion of Choice and Advantage, as well as overall deposit growth from increased liquidity of consumers and businesses). Rate changes reduced net interest income $13.1 million, comprised of $21.2 million lower interest income (with $16.8 million was from lower rates on loans and $3.7 million from the dramatically reduced cash rate earned), but also lower interest expense on funding of $8.1 million (including $7.7 million savings from non-brokered interest-bearing core deposits and $0.9 million savings from wholesale funding, partly offset by $0.6 million more interest expense from term brokered deposits).
The interest rate spread decreased 69 bps between the periods, as the interest-earning asset yield decreased 110 bps to 3.90% and the cost of funds declined favorably 41 bps to 0.75%. The significantly higher mix of cash assets (to 15% of interest-earning assets versus 4% in 2019) combined with their dramatic decline in yield (to 0.46% versus 2.65% in 2019), has pressured the net interest margin most. Loans yielded 4.90% for 2020, down 67 bps from 2019, in part from the inclusion of lower-earning PPP loans (yielding 3.66%) in 2020, while all other loans earned 5.00%, down 57 bps from 2019. Investments yielded 2.26%, 31 bps lower than 2019. The 41 bps favorable decline in the 2020 cost of funds was primarily attributable to prudent pricing actions on core interest-bearing deposits (down 45 bps to 0.57%) and lower wholesale funding rates (down 159 bps to 3.13% for funding costs excluding PPPLF), offset partly by higher-costing brokered deposits (acquired with the Choice acquisition and procured with the March-April 2020 liquidity actions under competitive conditions). The contribution from net free funds decreased 12 bps, due mostly to the reduced value in the lower interest rate environment, though offset partly by the increase in average net free funds (largely from average noninterest-bearing demand deposits and stockholders' equity) between the years. As a result, the net interest margin was 3.38% for 2020, down 81 bps compared to 4.19% for 2019.
Average interest-earning assets were $3.8 billion for 2020, $1.1 billion (38%) higher than 2019, primarily due to the timing of the acquisitions (Choice in November 2019 and Advantage in August 2020), addition of PPP loans (beginning in second quarter 2020), and significantly higher cash starting in second quarter 2020. Average loans increased $531 million (24%) to $2.8 billion (which includes $348 million of Choice loans at acquisition, $88 million of Advantage loans at acquisition, and $186 million of net PPP loans at December 31, 2020), investments increased $81 million, and other interest-earning assets (which are predominantly cash) increased $444 million. The mix of average interest-earning assets shifted to lower-yielding assets, at 72% loans (comprised of 6% PPP loans and 66% all other loans), 13% investments, and 15% other interest-earning assets (mostly cash) for 2020, compared to 81%, 15%, and 4%, respectively, for 2019.
Tax-equivalent interest income was $150.2 million, up $10.5 million (8%) over 2019, while the related interest-earning asset yield decreased 110 bps to 3.90%. Interest income on loans increased $10.8 million (9%) over 2019, aided by strong volumes, including the Choice and Advantage acquisitions, as well as PPP loans. The 2020 loan yield was 4.90%, down 67 bps from 2019, largely from the significantly lower interest rate environment impacting yields on new, renewed, and variable rate loans, as well as from inclusion of PPP loans at a 3.66% yield. Between the years, interest income on non-loan earning assets combined decreased $0.2
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million to $13.7 million, impacted by a 130 bps decline in the yield (to 1.29%) in the lower rate environment, partially offset by higher average volumes (up 98%) from the significantly higher cash.
Average interest-bearing liabilities were $2.7 billion for 2020, an increase of $721 million (37%) from 2019, primarily due to the timing of the acquisitions (Choice in November 2019 and Advantage in August 2020), as well as the significant increase in deposits from government stimulus activities and deposited PPP loan proceeds. Average core interest-bearing deposits increased $335 million, brokered deposits grew $214 million, and funding increased $171 million (mostly PPPLF funding). The mix of average interest-bearing liabilities was 80% core deposits, 11% brokered deposits, and 9% other funding for 2020, compared to 92% core deposits, 4% brokered deposits, and 4% other funding in 2019, with the mix changes (especially increased money markets and brokered deposits) influenced by the composition of the $289 million of Choice deposits acquired, and the procurement of brokered deposits in March-April 2020 as part of previously discussed liquidity actions.
Interest expense was $20 million for 2020, down $3 million (12%) from 2019, on larger average interest-bearing liabilities volumes (up 37% to $2.7 billion) but at a lower overall cost (down 41 bps to 0.75%). Interest expense on deposits decreased $2.3 million from 2019 given 29% higher average interest-bearing deposit balances, but at a lower cost (down 33 bps to 0.69%). The 2020 cost of savings, interest-bearing demand, money market accounts, and core time deposits decreased from 2019 by 31 bps, 30 bps, 43 bps, and 48 bps, respectively, as product rate changes were made in the lower interest rate environment, and brokered deposits cost 52 bps more than 2019 largely from higher-costing term brokered funds acquired with the Choice acquisition in November 2019 and procured during March-April 2020 under competitive conditions as part of previously discussed liquidity actions. Interest expense on other interest-bearing liabilities decreased $0.3 million (9%), as additional interest expense on higher average balances (up $171 million) was substantially offset by lower rates (down 341 bps to 1.31%), mostly impacted by the inclusion of the low-costing PPPLF (average balance of $162 million for 2020 at a 0.35% rate), and variable rate debt repricing and maturing advances replaced in the lower rate environment.
Provision for Credit Losses
The provision for credit losses in 2020 was $10.3 million, exceeding $1.4 million of net charge-offs. Comparatively, 2019 provision for credit losses and net charge-offs were $1.2 million and $0.4 million, respectively. The increase in the provision for credit losses between the years was largely due to the unprecedented economic disruptions and uncertainty surrounding the COVID pandemic, and to a lesser extent, to the acquisition of Advantage.
The provision for credit losses is predominantly a function of Nicolet’s methodology and judgment as to qualitative and quantitative factors used to determine the appropriateness of the ACL-Loans. The appropriateness of the ACL-Loans is affected by changes in the size and character of the loan portfolio, changes in levels of collateral-dependent 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 ACL-Loans, see “BALANCE SHEET ANALYSIS — Loans,” and “— Allowance for Credit Losses - Loans” and “—Nonperforming Assets.”
Noninterest Income
Table 4: Noninterest Income
(in thousands) Years Ended December 31, Change From Prior Year
N/M means not meaningful.
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Comparison of 2020 versus 2019
Noninterest income was $62.6 million for 2020, an increase of $9.3 million (17%) over 2019, which included a $7.4 million gain on the equity investment sale previously noted in the “Overview” section. Noninterest income excluding net asset gains increased $19.0 million (42%) between 2020 and 2019. Notable contributions to the change in noninterest income were:
•Trust services fee income and brokerage fee income combined were $16.2 million for 2020, up $1.9 million (13%) from 2019, consistent with the growth in assets under management.
•Mortgage income represents net gains received from the sale of residential real estate loans into the secondary market, capitalized mortgage servicing rights (“MSRs”), servicing fees net of MSR amortization, fair value marks on the mortgage interest rate lock commitments and forward commitments (“mortgage derivatives”), and MSR valuation changes, if any. Net mortgage income was $29.8 million for 2020, up $17.9 million (151%) over 2019, predominantly from higher sale gains and capitalized gains combined (up $18.9 million or 168%, commensurate with the increase in volumes sold into the secondary market, aided by the current refinance boom and better pricing between the years), partially offset by a $1.0 million MSR asset valuation allowance given faster paydown activity. See also “Off-Balance Sheet Arrangements, Lending-Related Commitments and Contractual Obligations” and Note 6, “Goodwill and Other Intangibles and Mortgage Servicing Rights” in the Notes to Consolidated Financial Statements, under Part II, Item 8
•Service charges on deposit accounts were down $0.6 million (13%) to $4.2 million for 2020, mainly as we waived certain fees during second quarter 2020 to provide economic relief to our customers.
•Card interchange income grew $0.5 million (8%) to $7.0 million in 2020 due to higher volume and activity.
•BOLI income increased $0.3 million (14%) to $2.7 million for 2020, attributable to the difference in BOLI death benefits received in each year (up $0.2 million) and income on higher average balances from $5 million new BOLI purchased in mid-2019, $6 million BOLI acquired with Choice, and $3 million BOLI acquired with Advantage.
•Other income of $4.5 million was down $1.1 million (19%) from 2019, largely due to $0.5 million lower income from the smaller equity interest in a data processing entity after the partial sale in 2019 and $0.3 million attributable to the fee earned on a customer loan interest rate swap in 2019.
•The $1.8 million net asset losses in 2020 were comprised primarily of $1.0 million market losses on equity securities held in the lower, more volatile market and $0.9 million of net losses on branch other real estate owned write-downs. Net asset gains in 2019 of $7.9 million were comprised primarily of the $7.4 million gain on the equity investment sale in second quarter 2019 and $1.1 million of favorable fair value marks on equity securities, partially offset by losses of $0.6 million on the disposal and write-down of fixed assets, OREO, and an other investment. Additional information on the net gains is also included in Note 15, “Asset Gains (Losses), Net,” in the Notes to Consolidated Financial Statements, under Part II, Item 8.
Noninterest Expense
Table 5: Noninterest Expense
($ in thousands) Years Ended December 31, Change From Prior Year
Average full-time equivalent employees 553 560 553 (7) (1) % 7 1 %
Comparison of 2020 versus 2019
Noninterest expense was $100.7 million, an increase of $3.9 million (4%) over 2019, with second quarter 2020 including $4 million of isolated expenses related to the onset of the pandemic, a terminated acquisition, and branch closure decisions. Personnel costs increased $2.7 million, and non-personnel expenses combined increased $1.2 million over 2019. Notable contributions to the change in noninterest expense were:
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•Personnel expense (including salaries, overtime, cash and equity incentives, and employee benefit and payroll-related expenses) was $57.1 million for 2020, an increase of $2.7 million (5%) over 2019. Salaries increased $2.3 million (7%) over 2019, of which $0.6 million was attributable to branch closure severances and on-site bonus pay in second quarter 2020, and $1.7 million (representing a 5% increase over 2019) was due to merit increases and hires between the years. Cash and equity award incentives increased $1.5 million, while retirement-based compensation (401k, profit sharing and nonqualified deferred compensation) declined $1.0 million between the years, rewarding strong performance of both years and matching the mix of incentive compensation to be meaningful to recipients. Overtime pay doubled to $0.6 million (up $0.3 million over 2019), largely to cover the effort of processing PPP originations and significant mortgage volume. All other fringe benefits combined declined $0.4 million from 2019, mainly on lower health costs between the years.
•Occupancy, equipment and office expense was $16.7 million for 2020, up $1.9 million (13%) from 2019, with 2020 including $0.5 million of accelerated depreciation and write-offs related to the branch closures, higher expense for software and technology to drive operational efficiencies and enhance products or services, and for additional licenses and equipment to expand remote workers in response to the pandemic. 2019 also included $0.4 million of accelerated depreciation for branch facility upgrades.
•Business development and marketing expense was $5.4 million for 2020, down $0.3 million (5%), largely due to lower business development costs from less travel and entertainment during the pandemic, partly offset by $1.25 million for the micro-grant program.
•Data processing expense was $10.7 million for 2020, up $0.7 million (7%) over 2019, mostly due to volume-based increases in core processing charges.
•Intangible amortization decreased $0.3 million mainly from declining amortization on the aging intangibles of previous acquisitions, partly offset by amortization from the new intangibles of the August 2020 Advantage and November 2019 Choice acquisitions.
•Other expense was $7.2 million for 2020, down $0.8 million (10%) from 2019. Other expense for 2020 included $1.0 million of lease termination charges related to the branch closures and $0.5 million to terminate the Commerce merger agreement. Other expense for 2019 included a $0.7 million lease termination charge for the closure of Nicolet's Oshkosh branch in conjunction with the Choice acquisition, an $0.8 million full write-off of non-bank goodwill, and $0.7 million related to a fraud loss contingency.
Income Taxes
Income tax expense was $20.5 million, up 4.0 million (24%) over 2019, partly due to 13% higher pre-tax earnings. The 2020 effective tax rate was 25.3%, higher than 23.0% for 2019. The increase in effective tax rate was due to the favorable tax treatment of the partial equity investment sale of a data processing company in 2019, as well as the change in tax benefit on stock-based compensation (see Note 10, “Stock-Based Compensation” for additional information on the tax benefit on stock-based compensation), and nondeductible compensation from compensation limits between the years.
The accounting for income taxes requires deferred income taxes to 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. This analysis involves the use of estimates, assumptions, interpretation, and judgment concerning accounting pronouncements and federal and state tax codes; therefore, income taxes are considered a critical accounting policy. At December 31, 2020 and 2019, no valuation allowance was determined to be necessary. Additional information on the subjectivity of income taxes is discussed further under “Critical Accounting Policies-Income Taxes.” The Company’s accounting policy for income taxes are described in Note 1, “Nature of Business and Significant Accounting Policies,” and additional disclosures relative to income taxes are included in Note 12, “Income Taxes” in the Notes to Consolidated Financial Statements, under Part II, Item 8.
BALANCE SHEET ANALYSIS
Loans
Nicolet services a diverse customer base throughout northeastern and central Wisconsin and in Menominee, Michigan including the following industries: manufacturing, wholesaling, paper, packaging, food production and processing, agriculture, forest products, retail, service, and businesses supporting the general building industry. The Company concentrates on originating loans in its local markets and assisting current loan customers. Nicolet actively utilizes government loan programs such as those provided by the U.S. Small Business Administration (“SBA”), including the Paycheck Protection Program, to help customers with current economic conditions and positioning their businesses for the future. In addition to the discussion that follows, accounting policies for loans are described in Note 1, “Nature of Business and Significant Accounting Policies,” and additional disclosures are included in Note 4, “Loans, Allowance for Credit Losses - Loans, and Credit Quality,” in the Notes to Consolidated Financial Statements, under Part II, Item 8.
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Table 6: Period End Loan Composition
PPP loans 186,016 7 % — — % — — % — — % — — %
Total loans were $2.8 billion at December 31, 2020, an increase of $215 million (8%), compared to total loans of $2.6 billion at December 31, 2019. During 2020, we acquired Advantage, which added total loans of $88 million at acquisition. In addition, we originated 2,725 PPP loans totaling $351 million, bearing a 1% contractual rate, and earned a $12.3 million fee, of which $5.7 million was accreted into interest income during 2020. At December 31, 2020, the net carrying value of PPP loans was $186 million, or 7% of loans, with the decline in balance coming almost exclusively from SBA loan forgiveness, boosting overall borrower equity in their businesses. Given strong participation in the PPP and caution around debt levels, utilization of conventional lines of credit fell. For the first time in recent history, commercial lines of credit declined between year-end periods to $221 million (down $104 million or 32% from December 31, 2019). Excluding PPP loans and commercial lines of credit, all other loans combined increased $133 million (6%) over December 31, 2019 (or up 2%, further excluding loans acquired from Advantage).
As noted in Table 6 above, year-end 2020 loans were broadly 78% commercial-based and 22% retail-based compared to 75% commercial-based and 25% retail-based at year-end 2019. 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, PPP loans, 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, including the PPP loans, continue to be the largest segment of Nicolet’s portfolio, representing 34% of the portfolio at year-end 2020.
Owner-occupied CRE loans represented 19% of loans at year-end 2020, unchanged from year-end 2019. This category primarily consists of loans within a diverse range of industries secured by business real estate that is occupied by borrowers 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 loans consist of loans secured by farmland and the 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. These loans represented 4% of loans at year-end 2020, unchanged from a year ago.
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. These loans represented 16% of loans at December 31, 2020, compared to 17% of loans at year-end 2019.
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Loans in the construction and land development portfolio represented 5% of total loans at year-end 2020. Construction and land development 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.
On a combined basis, Nicolet’s residential real estate loans represented 21% of total loans at year-end 2020 compared to 24% of total loans at year-end 2019. Residential first mortgage loans include conventional first-lien home mortgages. Residential junior mortgage loans consist of home equity lines and term loans secured by junior mortgage liens. As part of its management of originating residential mortgage loans, the vast majority of Nicolet’s long-term, fixed-rate residential first mortgage loans are sold in the secondary market with the servicing rights retained. Nicolet’s mortgage loans are typically of high quality and have historically had low net charge-off rates.
Loans in the retail and other classification represented approximately 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.
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 appropriate ACL-Loans, 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 December 31, 2020, no significant industry concentrations existed in Nicolet’s portfolio in excess of 10% of total loans. Nicolet has also developed guidelines to manage its exposure to various types of concentration risks.
Table 7: Loan Maturity Distribution
The following table presents the maturity distribution of the loan portfolio at December 31, 2020.
(in thousands) Loan Maturity
One Yearor Less Over One Yearto Five Years OverFive Years Total
Percent by maturity distribution 23 % 54 % 23 % 100 %
Floating rate percent 47 % 5 % 46 % 24 %
* The residential construction loans with a loan maturity over five years represent a construction to permanent loan product.
Allowance for Credit Losses - Loans
In addition to the discussion that follows, accounting policies for the allowance for credit losses - loans are described in Note 1, “Nature of Business and Significant Accounting Policies,” and additional ACL-Loans disclosures are included in Note 4, “Loans, Allowance for Credit Losses - Loans, and Credit Quality,” in the Notes to Consolidated Financial Statements, under Part II, Item 8.
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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 ongoing 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. Loans charged off are subject to continuous review, and specific efforts are taken to achieve maximum recovery of principal, interest, and related expenses. For additional information regarding nonperforming assets see “BALANCE SHEET ANALYSIS – Nonperforming Assets.”
The ACL-Loans represents management’s estimate of expected credit losses in the Company’s loan portfolio at the balance sheet date. To assess the overall appropriateness of the ACL-Loans, management applies an allocation methodology 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 nonaccrual 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 economic conditions; (ix) the fair value of underlying collateral; and (x) other qualitative and quantitative factors which could affect expected credit losses. Assessing these factors involves significant judgment; therefore, management considers the ACL-Loans a critical accounting policy, as further discussed under “Critical Accounting Policies – Allowance for Credit Losses - Loans.”
Management allocates the ACL-Loans by pools of risk within each loan portfolio segment. The allocation methodology consists of the following components. First, a specific reserve is established for individually evaluated and other credit-deteriorated loans, which management defines as nonaccrual credit relationships over $250,000, collateral dependent loans, and other loans with evidence of credit deterioration. The specific reserve in the ACL-Loans for these credit deteriorated loans is equal to the aggregate collateral or discounted cash flow shortfall. Management allocates the ACL-Loans with historical loss rates by loan segment. The loss factors are measured on a quarterly basis and applied to each loan segment based on current loan balances and projected for their expected remaining life. Next, management allocates the ACL-Loans using the qualitative and environmental factors mentioned above. Consideration is given to those current qualitative or environmental factors that are likely to cause estimated credit losses at the evaluation date to differ from the historical loss experience of each loan segment. Lastly, management considers reasonable and supportable forecasts to assess the collectability of future cash flows.
Management performs ongoing intensive analysis 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 ACL-Loans. In addition, various regulatory agencies periodically review the ACL-Loans. These agencies may require the Company to make additions to the ACL-Loans or may require that certain loan balances be charged off or downgraded into classified loan categories when their credit evaluations differ from those of management based on their judgments of collectability from information available to them at the time of their examination.
At December 31, 2020, the ACL-Loans was $32.2 million (representing 1.15% of period end loans and 1.24% of period end loans excluding PPP loans) compared to $14.0 million at December 31, 2019. The increase in the ACL-Loans was largely due to the $9.3 million impact from the adoption of CECL (comprised of $8.5 million for the CECL impact on the loan portfolio and $0.8 million for the PCD gross-up) and a much higher provision for credit losses in 2020 given the unprecedented economic disruption and uncertainty surrounding the COVID pandemic. The components of the ACL-Loans are detailed further in Tables 8 and 9 below.
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Table 8: Allowance for Credit Losses - Loans
(in thousands) Years Ended December 31,
Allowance for credit losses - loans:
Adoption of CECL 8,488 — — — —
Initial PCD ACL 797 — — — —
Total impact for adoption of CECL 9,285 — — — —
Loans charged off:
Agricultural — — — — —
CRE investment (190) — (37) — —
Construction & land development — — — (13) —
Residential construction — (226) — — —
Residential first mortgage (2) (22) (85) (8) (80)
Residential junior mortgage — (80) — (72) (57)
Recoveries of loans previously charged off:
Agricultural — — — — —
CRE investment — — — 1 221
Construction & land development — — — — —
Residential construction — — — — —
Ratios:
The allocation of the ACL-Loans by loan category for each of the past five years is shown in Table 9. The largest portions of the ACL-Loans were allocated to commercial & industrial loans and owner-occupied CRE loans combined, representing 54% and 61% of the ACL-Loans at December 31, 2020 and 2019, respectively. The change in allocated ACL-Loans from December 31, 2019 to December 31, 2020 was consistent with changes related to the adoption of CECL, as well as changes in outstanding loan balances between the years and risk trends within loan categories.
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Table 9: Allocation of the Allowance for Credit Losses - Loans
* See Table 6 for the ratio of loans by category to total loans.
Nonperforming Assets
As part of its overall credit risk management process, management is 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. Management is actively working with customers and monitoring credit risk from the unprecedented economic disruptions surrounding the COVID pandemic (as also discussed in the Overview section). Since the pandemic started, nearly 1,000 loans with a current balance of $456 million were provided temporary payment modifications. Initial metrics reflected the loan modifications as 88% commercial and 12% retail, with 67% on interest only payments and 33% on full payment deferrals. As of December 31, 2020, $408 million (90%) had returned to normal payment structures, $29 million (6%) were paid off, $15 million (3%) remain under temporary modification structure, and only $4 million (1%) became troubled debt restructurings (included in Table 10 below). The combined $19 million under modification or restructure represented less than 1% of total loans at December 31, 2020. In addition to the discussion that follows, accounting policies for loans and the ACL-Loans are described in Note 1, “Nature of Business and Significant Accounting Policies,” and additional credit quality disclosures are included in Note 4, “Loans, Allowance for Credit Losses - Loans, and Credit Quality,” in the Notes to Consolidated Financial Statements, under Part II, Item 8.
Nonperforming loans are considered one indicator of potential future loan losses. Nonperforming loans are defined as nonaccrual loans 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 $9 million at December 31, 2020, compared to $14 million at December 31, 2019. Nonperforming assets (which include nonperforming loans and other real estate owned “OREO”) were $13 million at December 31, 2020, compared to $15 million at December 31, 2019. OREO was $4 million at December 31, 2020, up from $1 million at year-end 2019, with the increase primarily due to the addition of closed bank branch properties. Nonperforming assets as a percent of total assets was 0.29% at December 31, 2020, compared to 0.42% at December 31, 2019.
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 appropriate level of the ACL-Loans. 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 $21 million (0.7% of total loans) and $23 million (0.9% of total loans) at December 31, 2020 and 2019, 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.
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Table 10: Nonperforming Assets
Nonaccrual assets:
PPP loans — — — — —
Residential construction — — 1 80 260
Retail & other 88 1 — 4 —
Accruing loans past due 90 days or more — — — — —
OREO:
Residential real estate owned — — — 70 29
Performing troubled debt restructurings $ 2,120 $ — $ — $ — $ —
Ratios:
Table 11 shows the approximate gross interest that would have been recorded if the loans accounted for on a nonaccrual basis at the end of each year shown had performed in accordance with their original terms, in contrast to the amount of interest income that was included in interest income on such loans for the period. The interest income recognized generally includes cash interest received and potentially includes prior nonaccrual interest on acquired loans which existed at acquisition and was subsequently collected.
Table 11: Foregone Loan Interest
(in thousands) Years Ended December 31,
Interest income in accordance with original terms $ 651 $ 1,178 $ 1,046
Reduction in interest income $ 71 $ 243 $ 98
Investment Securities Portfolio
The investment securities portfolio is intended to provide Nicolet with adequate liquidity, flexible asset/liability management and a source of stable income. The portfolio is structured with minimal credit exposure to Nicolet. All securities are classified as available for sale (“AFS”) and are carried at fair value. In addition to the discussion that follows, the investment securities portfolio accounting policies are described in Note 1, “Nature of Business and Significant Accounting Policies,” and additional disclosures are included in Note 3, “Securities Available for Sale,” in the Notes to Consolidated Financial Statements, under Part II, Item 8.
Table 12: Investment Securities Portfolio
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At December 31, 2020, the total fair value of investment securities was $539 million (representing 12% of total assets), compared to $449 million (representing 13% of total assets) at December 31, 2019. The increase in securities AFS from year-end 2019 was primarily due to the purchase of approximately $50 million U.S. Treasury securities in early 2020, $24 million of investments Advantage added at acquisition and an $11 million change in the unrealized gain position (from an unrealized gain of $6 million at December 31, 2019 to an unrealized gain of $17 million at December 31, 2020). At December 31, 2020, the securities AFS portfolio did not contain securities of any single issuer, including any securities issued by a state or political subdivision that were payable from and secured by the same source of revenue or taxing authority where the aggregate carrying value of such securities exceeded 10% of stockholders’ equity.
In addition to securities AFS, Nicolet had other investments of $28 million and $24 million at December 31, 2020 and 2019, respectively, consisting of capital stock in the Federal Reserve and the Federal Home Loan Bank (“FHLB”) (required as members of the Federal Reserve Bank System and the FHLB System), equity securities with readily determinable fair values, and to a lesser degree equity investments in other private 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 private company equity investments have no quoted market prices, and are carried at cost less impairment charges, if any. The other investments are evaluated periodically for impairment, considering financial condition and other available relevant information. A $0.1 million write-off was recorded on the surrender of our Commerce common stock in connection with the terms of the mutual termination of the Commerce merger agreement during 2020, and a $0.1 million impairment charge was recorded on a private company equity investment during 2019.
Table 13: Investment Securities Portfolio Maturity Distribution (1)
(1) The yield on tax-exempt investment securities is computed on a tax-equivalent basis using a federal tax rate of 21% 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 number of non-deposit investment alternatives available to depositors, such as mutual funds, money market funds, annuities, and other brokerage investment products. Deposit challenges include competitive deposit product features, 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. Additional disclosures on deposits are included in Note 7, “Deposits,” in the Notes to Consolidated Financial Statements, under Part II, Item 8.
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Table 14: Period End Deposit Composition
Amount % ofTotal Amount % ofTotal Amount % ofTotal
Total deposits were $3.9 billion at December 31, 2020, an increase of $956 million (32%) over year-end 2019. Since December 31, 2019, customer transaction accounts increased $884 million (38%), including $490 million in interest-bearing transaction accounts and $394 million in noninterest-bearing transaction accounts, influenced by the very uncertain times, government stimulus payments and pandemic stay-at-home orders, which reduced spending and increased liquidity of many consumers and businesses, and by PPP loan proceeds retained on deposit by commercial borrowers. In addition, during 2020, we acquired Advantage, which added customer deposits of $141 million at acquisition. Total brokered deposits increased $165 million over year-end 2019, largely due to our liquidity build executed at the onset of the pandemic. In the second half of 2020, given continued growth in core deposit funding, brokered deposits were allowed to mature without renewal and nearly half of the brokered time deposits outstanding at year-end 2020 are expected to mature in 2021.
On average, deposits grew $841 million (32%) between 2020 and 2019 (as detailed in Table 1), primarily due to the timing of the acquisitions (Choice in November 2019 and Advantage in August 2020) and the signficant increase in deposits from government stimulus activities and deposited PPP loan proceeds. Noninterest-bearing demand deposits increased $292 million (40%) and core interest-bearing deposits (savings, interest-bearing demand, money market) increased $347 million (25%), while core time deposits decreased $12 million (3%). Average brokered deposits grew $214 million, attributable to the mix of deposits acquired with Choice and the procurement of brokered deposits at the onset of the pandemic as part of liquidity actions.
Table 15: Maturity Distribution of Certificates of Deposit of $100,000 or More
Other Funding Sources
Other funding sources include short-term borrowings (zero at both December 31, 2020 and 2019) and long-term borrowings (totaling $54 million and $68 million at December 31, 2020 and 2019, respectively). Short-term borrowings consist mainly of short-term FHLB advances, customer repurchase agreements maturing in less than nine months or federal funds purchased. Long-term borrowings include FHLB advances, PPP Liquidity Facility (“PPPLF”) funding (credit provided by the Federal Reserve to financial institutions participating in the PPP loan program), junior subordinated debentures (largely qualifying as Tier 1 capital for regulatory purposes given their long maturity dates, even though they are redeemable in whole or in part at par), and subordinated notes (issued in 2015 with 10-year maturities, callable on or after the fifth anniversary date of their respective issuance dates, and qualifying as Tier 2 capital for regulatory purposes). The interest on all long-term borrowings is current.
During 2020, the Company added $24 million in long-term FHLB advances to support liquidity actions initiated at the onset of the pandemic (prior to the announcement of government stimulus) and $344 million of PPPLF funding to support the PPP loans. Based on growth in core deposits during the year, select long-term FHLB advances and the full PPPLF funding was repaid in the second half of 2020. In addition, the subordinated notes ($12 million at 5% fixed) were fully redeemed on November 16, 2020, and one issuance of junior subordinated debentures ($6 million at 8% fixed) was redeemed in full on December 31, 2020. See Note 8, “Short
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and Long-Term Borrowings,” of the Notes to Consolidated Financial Statements under Part II, Item 8 for additional details. See section “Liquidity Management,” for information on available other funding sources at December 31, 2020.
RISK MANAGEMENT AND CAPITAL
Liquidity Management
Liquidity management refers to the ability to ensure that cash is available in a timely and cost-effective manner to meet cash flow requirements of depositors and borrowers and to meet other commitments as they fall due, including the ability to service debt, invest in subsidiaries, repurchase common stock, pay dividends to shareholders (if any), and satisfy other operating requirements.
Given the stable core customer deposit base, fairly consistent patterns of activity in the core deposit base (including extra growth in core deposits during the pandemic as previously discussed), and the minimal use of capacity available in numerous non-core funding sources, Nicolet's liquidity levels and resources have been sufficient to fund loans, accommodate deposit trends and cycles, and to meet other cash needs as necessary. At the onset of the pandemic, but prior to the announcement of government stimulus, management initiated preparatory actions to increase on-balance sheet liquidity to ensure we could meet customer needs, and brokered deposits of approximately $200 million were procured, increasing liquid cash. These actions proved later to not be necessary, leading us to reduce non-deposit leverage in the second half of 2020. In addition to the on-balance sheet liquidity build, remaining liquidity facilities continue to provide capacity and flexibility in an uncertain time.
Funds are available from a number of basic banking activity sources including, but not limited to, the core deposit base; repayment and maturity of loans; investment securities calls, maturities, and sales; and procurement of additional brokered deposits or other wholesale funding. All securities AFS and equity securities (included in other investments) are reported at fair value on the consolidated balance sheet. At December 31, 2020, approximately 27% of the $539 million securities AFS portfolio was pledged to secure public deposits and short-term borrowings, as applicable, and for other purposes as required by law. Additional funding sources at December 31, 2020, consist of a $10 million available and unused line of credit at the holding company, $175 million of available and unused Federal funds lines, available borrowing capacity at the FHLB of $163 million, and borrowing capacity in the brokered deposit market.
In consideration of the funds availability for the Bank and the current high levels of cash in a very low interest rate environment, management has taken prudent pricing actions on deposits and loans, as well as actions to reduce non-deposit funding. Brokered deposits have matured without renewal, selected FHLB advances were repaid early, and the PPPLF funding was fully paid back (approximately $335 million used for 5 months at a cost of 35 bps). In addition, we fully redeemed our subordinated notes ($12 million at 5% fixed) in November and one of our junior subordinated debenture issuances ($6 million at 8% fixed) in December.
Management is committed to the Parent Company being a source of strength to the Bank and its other subsidiaries, and therefore, regularly evaluates capital and liquidity positions of the Parent Company in light of current and projected needs, growth or strategies. The Parent Company uses cash for normal expenses, debt service requirements and, when opportune, for common stock repurchases or investment in other strategic actions such as mergers or acquisitions. At December 31, 2020, the Parent Company had $50 million in cash. Additional cash sources, among others, available to the Parent Company include its $10 million available and unused line of credit, and access to the public or private markets to issue new equity, subordinated notes or other debt. Dividends from the Bank and, to a lesser extent, stock option exercises, represent significant sources of cash flows for the Parent Company. The Bank is required by federal law to obtain prior approval of the OCC for payments of dividends if the total of all dividends declared by the Bank in any year will exceed certain thresholds, as more fully described in “Business—Regulation of the Bank – Payment of Dividends” and in Note 16, “Regulatory Capital Requirements,” in the Notes to the Consolidated Financial Statements under Part II, Item 8. Management does not believe that regulatory restrictions on dividends from the Bank will adversely affect its ability to meet its cash obligations.
Cash and cash equivalents at December 31, 2020 and 2019 were approximately $803 million and $182 million, respectively. The $621 million increase in cash and cash equivalents since year-end 2019 included $79 million net cash provided by operating activities (mostly earnings), more than offset by $209 million net cash used in investing activities (primarily to fund loan growth, mostly PPP loans) and $751 million net cash provided by financing activities (with funds from increased deposits partly offset by the early redemption of selected debt and common stock repurchases). Nicolet’s liquidity resources were sufficient as of December 31, 2020 to fund loans, accommodate deposit trends and cycles, and to meet other cash needs as necessary.
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Interest Rate Sensitivity Management and Impact of Inflation
A reasonable balance between interest rate risk, credit risk, liquidity risk and maintenance of yield, is highly important to Nicolet’s business success and profitability. As an ongoing part of its financial strategy and risk management, Nicolet attempts to understand and manage the impact of fluctuations in market interest rates on its net interest income. The consolidated balance sheet consists mainly of interest-earning assets (loans, investments and cash) which are primarily funded by interest-bearing liabilities (deposits and other borrowings). Such financial instruments have varying levels of sensitivity to changes in market rates of interest. Market rates are highly sensitive to many factors beyond our control, including but not limited to general economic conditions and policies of governmental and regulatory authorities. Our operating income and net income depends, to a substantial extent, on “rate spread” (i.e., the difference between the income earned on loans, investments and other earning assets and the interest expense paid to obtain deposits and other funding liabilities).
Asset-liability management policies establish guidelines for acceptable limits on the sensitivity to changes in interest rates on earnings and market value of assets and liabilities. Such policies are set and monitored by management and the board of directors’ Asset and Liability Committee.
To understand and manage the impact of fluctuations in market interest rates on net interest income, Nicolet measures its overall interest rate sensitivity through a net interest income analysis, which calculates the change in net interest income in the event of hypothetical changes in interest rates under different scenarios versus a baseline scenario. Such scenarios can involve static balance sheets, balance sheets with projected growth, parallel (or non-parallel) yield curve slope changes, immediate or gradual changes in market interest rates, and one-year or longer time horizons. The simulation modeling uses assumptions involving market spreads, prepayments of rate-sensitive instruments, renewal rates on maturing or new loans, deposit retention rates, and other assumptions.
Among other scenarios, Nicolet assessed the impact on net interest income in the event of a gradual +/-100 bps and +/-200 bps change in market rates (parallel to the change in prime rate) over a one-year time horizon to a static (flat) balance sheet. The results provided include the liquidity measures mentioned above and reflect the changed interest rate environment in response to the current crisis. The interest rate scenarios are used for analytical purposes only and do not necessarily represent management’s view of future market interest rate movements. Based on financial data at December 31, 2020 and 2019, the projected changes in net interest income over a one-year time horizon, versus the baseline, are presented in Table 16 below. The results were within Nicolet’s guidelines of not greater than -10% for +/- 100 bps and not greater than -15% for +/- 200 bps, and given the relatively short nature of the Company’s balance sheet, reflect a largely unchanged risk position as expected.
Table 16: Interest Rate Sensitivity
200 bps decrease in interest rates (0.8) % (1.8) %
100 bps decrease in interest rates (0.8) % (1.0) %
100 bps increase in interest rates 4.0 % 0.8 %
200 bps increase in interest rates 8.1 % 1.7 %
Actual results may differ from these simulated results due to timing, magnitude and frequency of interest rate changes, as well as changes in market conditions and their impact on customer behavior and management strategies.
The effect of inflation on a financial institution differs significantly from the effect on an industrial company. While a financial institution’s operating expenses, particularly salary and employee benefits, are affected by general inflation, the asset and liability structure of a financial institution consists largely of monetary items. Monetary items, such as cash, investments, loans, deposits and other borrowings, are those assets and liabilities which are or will be converted into a fixed number of dollars regardless of changes in prices. As a result, changes in interest rates have a more significant impact on a financial institution’s performance than does general inflation. Inflation may also have impacts on the Bank’s customers, on businesses and consumers and their ability or willingness to invest, save or spend, and perhaps on their ability to repay loans. As such, there would likely be impacts on the general appetite of banking products and the credit health of the Bank’s customer base.
Capital
Management regularly reviews the adequacy of its capital to ensure that sufficient capital is available for current and future needs and is in compliance with regulatory guidelines and actively reviews capital strategies in light of perceived business risks associated with current and prospective earning levels, liquidity, asset quality, economic conditions in the markets served, and level of returns available to shareholders. Management intends to maintain an optimal capital and leverage mix for growth and for shareholder return.
Capital balances and changes in capital are presented in the Consolidated Statements of Changes in Stockholders’ Equity in Part II, Item 8. Further discussion of capital components is included in Note 11, “Stockholders' Equity,” and a summary of dividend
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restrictions, as well as regulatory capital amounts and ratios for Nicolet and the Bank is presented in Note 16, “Regulatory Capital Requirements,” of the Notes to Consolidated Financial Statements under Part II, Item 8.
The Company’s regulatory capital ratios remain well above minimum regulatory ratios, including the capital conservation buffer. At December 31, 2020, the Bank’s regulatory capital ratios qualify the Bank as well-capitalized under the prompt-corrective action framework. This strong base of capital has allowed Nicolet to be opportunistic in the current environment and in strategic growth. For a discussion of the regulatory restrictions applicable to the Company and the Bank, see section “Business-Regulation of Nicolet” and “Business-Regulation of the Bank,” included within Part I, Item 1. A summary of Nicolet’s and the Bank’s regulatory capital amounts and ratios, as well as selected capital metrics are presented in Table 17.
Table 17: Capital
Company Stock Repurchases: *
Common stock repurchased during the year (dollars) $ 40,544 $ 18,701
Common stock repurchased during the year (shares) 646,748 310,781
Company Risk-Based Capital:
Total capital ratio 12.9 % 13.4 %
Common equity tier 1 capital ratio 11.4 % 11.6 %
Tier 1 leverage ratio 9.0 % 11.9 %
Bank Risk-Based Capital:
Total capital ratio 11.2 % 10.8 %
Common equity tier 1 capital ratio 10.5 % 10.3 %
Tier 1 leverage ratio 7.8 % 9.8 %
At December 31, 2020, Nicolet’s total capital was $539 million, compared to $516 million at December 31, 2019 (mostly due to solid earnings and favorable changes in the fair value AFS securities, partly offset by common stock repurchase activity and the $6 million net impact of adopting CECL). Book value per common share increased to $53.86 at year-end 2020, up 10% over $48.76 at year-end 2019.
In managing capital for optimal return, we evaluate capital sources and uses, pricing and availability of our stock in the market, and alternative uses of capital (such as the level of organic growth or acquisition opportunities) in light of strategic plans. Based on this evaluation, the Company early redeemed certain capital-equivalent debt during fourth quarter 2020, including its higher-costing subordinated Notes ($12 million at 5% fixed) and one issuance of junior subordinated debentures ($6 million at 8% fixed). These redemptions reduced the Company’s Tier 1 risk-based capital $6 million and Total risk-based capital $16 million. The redemptions had no impact on the Bank’s risk-based capital.
Through an ongoing repurchase program, the Board has authorized the repurchase of Nicolet’s common stock as an alternative use of capital. During 2020, $40.5 million was used to repurchase and cancel nearly 646,700 shares at a weighted average price per share of $62.69. At December 31, 2020, there remained $20.4 million authorized under this repurchase program, as modified, to be utilized from time to time to repurchase shares in the open market, through block transactions or in private transactions.
Off-Balance Sheet Arrangements, Lending-Related Commitments and Contractual Obligations
Nicolet is party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. At December 31, 2020, interest rate lock commitments to originate residential mortgage loans held for sale of $113 million (included in the commitments to extend credit) and forward commitments to sell residential mortgage loans held for sale of $20 million are considered derivative instruments. Further information and discussion of these commitments is included in Note 13, “Commitments and Contingencies” of the Notes to Consolidated Financial Statements, under Part II, Item 8.
The table below outlines the principal amounts and timing of Nicolet’s contractual obligations. The amounts presented below exclude amounts due for interest, if applicable, and include any unamortized premiums / discounts or other similar carrying value
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adjustments. Most of these obligations are routinely refinanced into similar replacement obligations. However, renewal of these obligations is dependent on the ability to procure competitive interest rates, liquidity needs, availability of collateral for pledging purposes supporting the long-term advances, or other borrowing alternatives. As of December 31, 2020, Nicolet had the following contractual obligations.
Table 18: Contractual Obligations
(in thousands) Note Maturity by Years
Reference Total 1 or less 1-3 3-5 Over 5
Fourth Quarter 2020 Results
Nicolet recorded net income of $18.0 million for fourth quarter 2020, or $1.74 for diluted earnings per common share, compared to $12.3 million, or $1.18, respectively for fourth quarter 2019. Return on average assets was 1.58% and 1.46% for fourth quarter 2020 and 2019, respectively, even with the elevated cash assets in 2020. See Table 19 for selected quarterly information.
Net interest income increased $3.5 million (12%) between the comparable fourth quarter periods, despite a 77 bps decline in net interest margin, mostly due to the high cash levels and much lower interest rate environment. Interest income increased $1.8 million (including $6.3 million on higher volumes, partly offset by $4.5 million lower rates), while interest expense decreased $1.7 million (with $2.8 million from lower rates more than covering the $1.1 million higher volumes). The net interest margin between the comparable quarters decreased 77 bps to 3.29% in fourth quarter 2020, comprised of 60 bps lower interest rate spread (to 3.10%, as the yield on earning assets decreased 114 bps and the rate on interest-bearing liabilities decreased 54 bps) and a 17 bps lower contribution from net free funds (with the higher balances worth less in the very low interest rate environment).
Average interest-earning assets increased $1.1 billion to $4.1 billion for fourth quarter 2020, largely due to growth in loans (up $430 million) and other interest-earning assets, which is mostly cash (up $591 million). The mix of average earning assets between fourth quarter periods shifted from 82% in average loans, 14% in average investments, and 4% in other interest-earning assets (mostly low-earning cash assets) to 70% in loans, 13% in investments, and 17% in other interest-earning assets for fourth quarter 2020. On the funding side, average interest-bearing deposits were up $651 million and average demand deposits increased $386 million.
Noninterest income for fourth quarter 2020 increased $3.6 million (27%) to $16.9 million versus fourth quarter 2019. Net mortgage income increased $2.9 million (60%), mostly on higher sale gains and capitalized gains combined (up $3.6 million) from strong refinance activity and better pricing between the comparable quarters, partly offset by an unfavorable change in the fair values on the mortgage derivatives and mortgage servicing asset combined (down $0.8 million). Trust services fee income and brokerage fee income combined grew $0.6 million (17%), consistent with growth in accounts and assets under management in a volatile market.
On a comparable quarter basis, noninterest expense was minimally changed (down $0.1 million) to $25.4 million for fourth quarter 2020. Personnel expense of $15.2 million, increased $1.6 million (12%) from fourth quarter 2019, reflecting changes in the timing (with 2019 including a mid-year profit sharing contribution after the partial equity sale of a data processing entity versus a fourth quarter contribution in 2020) and mix of incentive compensation. All nonpersonnel expense categories combined were down $1.7 million (14%), as fourth quarter 2019 included a $0.7 million lease termination charge for the closure of Nicolet's Oshkosh branch in conjunction with the Choice acquisition and a $0.8 million full write-off of non-bank goodwill.
For fourth quarter 2020, Nicolet recognized income tax expense of $6.1 million with an effective tax rate of 25.4%, compared to income tax expense of $5.7 million with an effective tax rate of 31.4% for fourth quarter 2019. The increase in income tax expense was attributable to a 34% increase in pretax income, partly offset by salary deduction limitations that exceeded the tax benefit on stock-based compensation between the comparable fourth quarter periods (tax benefit of $0.1 million and $1.3 million in fourth quarter 2020 and 2019, respectively, mainly due to large stock option exercises in fourth quarter 2019). Additional information on income taxes is also included in “Income Taxes,” and Note 12, “Income Taxes” in the Notes to Consolidated Financial Statements, under Part II, Item 8.
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Selected Quarterly Financial Data
The following is selected financial data summarizing the results of operations for each quarter in the years ended December 31, 2020 and 2019.
Table 19: Selected Quarterly Financial Data
(in thousands, except per share data) 2020 Quarter Ended
December 31, September 30, June 30, March 31,
Less: Net income attributable to noncontrolling interest 98 30 101 118
Diluted earnings per common share* $ 1.74 $ 1.72 $ 1.28 $ 0.98
December 31, September 30, June 30, March 31,
Less: Net income attributable to noncontrolling interest 87 82 95 83
Diluted earnings per common share* $ 1.18 $ 1.40 $ 1.91 $ 1.05
*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.
2019 Compared to 2018
Net income attributable to Nicolet was $54.6 million for 2019, or $5.52 per diluted common share. Comparatively, 2018 net income attributable to Nicolet was $41.0 million or $4.12 per diluted common share. Return on average assets was 1.75% and 1.38% for 2019 and 2018, respectively, while return on average common equity was 12.89% for 2019 and 11.04% for 2018. Book value per common share was $48.76 at December 31, 2019, up 20% over $40.72 at December 31, 2018.
Key factors contributing to the 2019 versus 2018 results are discussed below.
•Net income for 2019 benefited from the net of two nonrecurring items in the second quarter, a $7.4 million after-tax gain on the partial sale of our equity interest in a data processing company, and $2.75 million ($2.0 million after-tax) in personnel expense for retirement-related compensation declared to benefit all employees after that sale. Excluding these two nonrecurring items, 2019 net income would be $49.2 million (20% over 2018), return on average assets would be 1.58% and diluted earnings per share would be $4.98 (or 21% over 2018).
•Net interest income was $116.1 million for 2019, an increase of $9.4 million or 9% compared to 2018, as we exercised discipline in the challenging rate environment. Interest income grew $13.1 million (overcoming $0.9 million lower aggregate discount income on purchased loans), aided by a 5% increase in average interest-earning assets and the elevated rate environment particularly on new, renewed and variable rate loans through the first half of 2019, before rates declined
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during the second half. Interest expense increased $3.6 million, primarily due to the initially rising rates on a relatively unchanged funding base. The improvement consisted of $7.1 million from net favorable volume and mix variances, and $2.2 million from favorable rate variances. The interest rate spread increased 7 bps to 3.84% for 2019, due to the increase in the interest-earning asset yield (up 26 bps to 5.00% for 2019), exceeding the rise in the cost of funds (up 19 bps to 1.16% for 2019). The contribution from net free funds increased 8 bps due to stronger net free fund balances (led by a 16% increase in average noninterest-bearing demand deposits) and the higher cost of funds. As a result, the net interest margin increased 15 bps to 4.19% for 2019, compared to 4.04% for 2018. Tables 1, 2, and 3 show additional average balance sheet, net interest income, and net interest margin information.
•Loans were $2.6 billion at December 31, 2019, an increase of $408 million (19%) compared to $2.2 billion at December 31, 2018, largely due to the acquisition of Choice. Excluding the $348 million loans Choice added at acquisition in 2019, loans increased $60 million (3%) over year-end 2018, reflective of the growth in Nicolet's markets. Average loans were $2.3 billion in 2019 yielding 5.57%, compared to $2.1 billion in 2018 yielding 5.37%, a 6% increase in average balances. Table 6 shows additional information on loans.
•Total deposits were $3.0 billion at December 31, 2019, an increase of $340 million (13%) over December 31, 2018, largely due to the acquisition of Choice. Excluding the $289 million deposits Choice added at acquisition in 2019, deposits increased $51 million (2%) over 2018. Between 2019 and 2018, average deposits increased $89 million (4%), with average cored deposits up $106 million from solid growth in noninterest-bearing demand deposits (up $99 million to represent 28% of total deposits for 2019 versus 25% for 2018), partly offset by a reduction in brokered deposits. Tables 14 and 15 show additional information on deposits.
•Asset quality measures remained strong. Nonperforming assets were $15 million, representing 0.42% of total assets at December 31, 2019, compared to $6 million, representing 0.19% of assets at December 31, 2018. For 2019, the provision for credit losses was $1.2 million, exceeding net charge-offs of $0.4 million, versus provision of $1.6 million and net charge-offs of $1.1 million for 2018. The ACL-Loans was $14.0 million at December 31, 2019 (representing 0.54% of loans), compared to $13.2 million (representing 0.61% of loans) at December 31, 2018. Tables 8, 9, 10, and 11 show additional information on asset quality measures.
•Noninterest income was $53.4 million for 2019 (including $7.9 million of net asset gains, largely from the equity interest sale noted above), compared to $39.5 million for 2018 (including $1.2 million of net asset gains). Excluding the net asset gains, noninterest income was up $7.1 million (19%), most notably in net mortgage income (up $5.5 million or 87% on significantly higher volumes), trust and brokerage fees combined (up $0.8 million or 6%), and card interchange income (up $0.8 million or 15%), benefiting from increased business and activity. Table 4 shows additional noninterest income information.
•Noninterest expense was $96.8 million for 2019, an increase of $7.0 million (8%) over 2018 noninterest expense of $89.8 million, mostly due to the continued investment in people and improvements. Personnel expense was $54.4 million for 2019, up $5.0 million (10%) over 2018, including the one-time compensation action noted above, as well as merit increases on a minimally changed workforce (with average full-time equivalent employees up 1% between the years), and higher cash and equity incentives supporting strong performance. Non-personnel expenses also increased on a combined basis (up $2.1 million or 5%), mostly due to volume-based processing costs partially offset by process efficiencies, as well as a $0.7 million lease termination charge on a branch closure related to the Choice acquisition and $0.8 million full write-off of non-bank goodwill for a change in business strategy. Table 5 shows additional noninterest expense information.
Critical Accounting Policies
The consolidated financial statements of Nicolet are prepared in conformity with U.S. generally accepted accounting principles (“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 loan acquisition transactions, as well as the determination of the allowance for credit losses and income taxes and, therefore, are critical accounting policies. The critical accounting policies are discussed directly with Nicolet’s Audit Committee. In addition to the discussion that follows, these critical accounting policies are further described in Note 1, “Nature of Business and Significant Accounting Policies,” in the Notes to Consolidated Financial Statements, under Part II, Item 8.
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Business Combinations and Valuation of Loans Acquired in Business Combinations
We account for acquisitions under Financial Accounting Standards Board (“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 the 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. Management finalized the fair values of acquired assets and assumed liabilities within this 12-month period and management currently considers such values to be the Day 1 Fair Values for the acquisition transactions.
In particular, the valuation of acquired loans involves significant estimates, assumptions and judgment based on information available as of the acquisition date. Loans acquired in a business combination transaction are evaluated either individually or in pools of loans with similar characteristics; including consideration of a credit component. 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.
Allowance for Credit Losses - Loans
Management’s evaluation process used to determine the appropriateness of the ACL-Loans 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 credit losses and therefore the appropriateness of the ACL-Loans could change significantly. Effective January 1, 2020, the Company changed its methodology for accounting for the allowance for credit losses-loans due to the adoption of a new accounting standard, which requires use of a lifetime expected credit losses model versus the historical incurred credit losses model. See section Recent Accounting Pronouncements Adopted within Note 1, “Nature of Business and Significant Accounting Policies,” in the Notes to Consolidated Financial Statements, under Part II, Item 8 for additional information on this new accounting standard.
The allocation methodology applied by Nicolet is designed to assess the appropriateness of the ACL-Loans and includes allocations for individually evaluated credit-deteriorated 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 and environmental factors. The methodology includes evaluation and consideration of several factors, including but not limited to: management’s ongoing review and grading of the loan portfolio, evaluation of facts and issues related to specific loans, consideration of historical loan loss and delinquency experience on each portfolio segment, trends in past due and nonaccrual loans, the risk characteristics of specific loans or various loan segments, changes in the size and character of the loan portfolio, concentrations of loans to specific borrowers or industries, the fair value of underlying collateral, existing economic conditions, and other qualitative and quantitative factors which could affect expected credit losses. In addition, with adoption of CECL in 2020, the model also now considers reasonable and supportable forecasts to assess the collectability of future cash flows. While management uses the best information available to make its evaluation, future adjustments to the ACL-Loans may be necessary if there are significant changes in economic conditions (both existing and forecast) or circumstances underlying the collectability of loans. Because each of the criteria used is subject to change, the allocation of the ACL-Loans is made for analytical purposes and is not necessarily indicative of the trend of future credit losses in any particular loan category. The ACL-Loans is available to absorb losses from any segment of the loan portfolio. Management believes the ACL-Loans is appropriate at December 31, 2020. The allowance analysis is reviewed by the board of directors on a quarterly basis in compliance with regulatory requirements.
Consolidated net income and stockholders’ equity could be affected if management’s estimate of the ACL-Loans necessary to cover expected credit losses is subsequently materially different, requiring a change in the level of provision for credit losses to be recorded. While management uses currently available information to recognize expected credit losses on loans, future adjustments to the ACL-Loans may be necessary based on newly received appraisals, updated commercial customer financial statements, rapidly deteriorating customer cash flow, and changes in economic conditions or forecassts that affect Nicolet’s customers. As an integral part of their examination process, federal regulatory agencies also review the ACL-Loans. Such agencies may require additions to the ACL-Loans or may require that certain loan balances be charged-off or downgraded into classified 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.
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.
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Nicolet files a consolidated federal income tax return and a combined state income tax return (both of which include Nicolet and its wholly owned subsidiaries). Accordingly, amounts equal to tax benefits of those companies having taxable federal losses or credits are reimbursed by the companies that incur federal tax liabilities. Amounts provided for income tax expense are based on income reported for financial statement purposes and do not necessarily represent amounts currently payable under tax laws. Deferred income tax assets and liabilities are computed quarterly for differences between the financial statement and tax bases of assets and liabilities that will result in taxable or deductible amounts in the future based on enacted tax law rates applicable to the periods in which the differences are expected to affect taxable income. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through provision for income tax expense. Valuation allowances are established when it is more likely than not that a portion of the full amount of the deferred tax asset will not be realized. In assessing the ability to realize deferred tax assets, management considers the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies. Nicolet may also recognize a liability for unrecognized tax benefits from uncertainty in income taxes. 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.
Future Accounting Pronouncements
Recent accounting pronouncements adopted are included in Note 1, “Nature of Business and Significant Accounting Policies” of the Notes to Consolidated Financial Statements under Part II, Item 8.
In March 2020, the FASB issued ASU 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting. This ASU provides optional guidance for a limited period of time to ease the potential burden in accounting for (or recognizing the effects of) reference rate reform on financial reporting. It provides optional expedients and exceptions for applying GAAP to contracts, hedging relationships, and other transactions affected by reference rate reform if certain criteria are met. The updated guidance is effective for all entities as of March 12, 2020 through December 31, 2022. The Company continues to evaluate the impact of reference rate reform on its consolidated financial statements.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
For additional disclosure, see section, “Interest Rate Sensitivity Management and Impact of Inflation,” of the Management’s Discussion and Analysis of Financial Condition and Results of Operation under Part II, Item 7.
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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
NICOLET BANKSHARES, INC.Consolidated Balance Sheets
Assets
Federal funds sold — —
Certificates of deposit in other banks 29,521 19,305
Securities available for sale (“AFS”), at fair value 539,337 449,302
Allowance for credit losses - loans (“ACL-Loans”) (32,173) (13,972)
Accrued interest receivable and other assets 55,516 39,461
Liabilities and Stockholders’ Equity
Liabilities:
Short-term borrowings — —
Accrued interest payable and other liabilities 48,332 38,188
Stockholders’ Equity:
Accumulated other comprehensive income (loss) 12,747 4,418
Total Nicolet Bankshares, Inc. stockholders’ equity 539,189 516,262
Noncontrolling interest — 728
Total stockholders’ equity and noncontrolling interest 539,189 516,990
Preferred shares issued and outstanding — —
See accompanying Notes to Consolidated Financial Statements.
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Interest income:
Investment securities:
Interest expense:
Short-term borrowings 66 5 9
Noninterest income:
Noninterest expense:
Less: Net income attributable to noncontrolling interest 347 347 317
Net income attributable to Nicolet Bankshares, Inc. $ 60,122 $ 54,641 $ 41,036
Earnings per common share:
Weighted average common shares outstanding:
See accompanying Notes to Consolidated Financial Statements.
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Other comprehensive income (loss), net of tax:
Unrealized gains (losses) on securities AFS:
Net (gains) losses included in income (395) 22 212
Total other comprehensive income (loss), net of tax 8,329 10,058 (2,557)
See accompanying Notes to Consolidated Financial Statements.
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Nicolet Bankshares, Inc. Stockholders’ Equity
Comprehensive income:
Other comprehensive income (loss) — — — (2,557) — (2,557)
Stock-based compensation expense — 4,901 — — — 4,901
Exercise of stock options, net 1 1,517 — — — 1,518
Issuance of common stock — 282 — — — 282
Purchase and retirement of common stock (4) (22,745) — — — (22,749)
Distribution to noncontrolling interest — — — — (275) (275)
Adoption of new accounting pronouncement — — 937 (937) — —
Comprehensive income:
Other comprehensive income (loss) — — — 10,058 — 10,058
Stock-based compensation expense — 5,038 — — — 5,038
Exercise of stock options, net 3 8,147 — — — 8,150
Issuance of common stock — 592 — — — 592
Purchase and retirement of common stock (4) (28,456) — — — (28,460)
Distribution to noncontrolling interest — — — — (362) (362)
Comprehensive income:
Other comprehensive income (loss) — — — 8,329 — 8,329
Stock-based compensation expense — 5,700 — — — 5,700
Exercise of stock options, net — 1,474 — — — 1,474
Issuance of common stock — 581 — — — 581
Purchase and retirement of common stock (6) (42,082) — — — (42,088)
Purchase of noncontrolling interest — (5,016) — — (860) (5,876)
Distribution to noncontrolling interest — — — — (215) (215)
Adoption of new accounting pronouncement (See Note 1) — — (6,175) — — (6,175)
See accompanying Notes to Consolidated Financial Statements.
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Cash Flows From Operating Activities:
Increase in cash surrender value of life insurance (2,199) (1,967) (1,857)
Net change in accrued interest receivable and other assets 6,991 (2,951) (666)
Net change in accrued interest payable and other liabilities 5,716 9,010 242
Cash Flows From Investing Activities:
Proceeds from sales of other investments — 17,144 807
Proceeds from sales of other real estate and other assets 343 457 2,824
Purchase of BOLI — (5,000) —
Net cash (paid) received in business combination (21,820) 7,331 —
Cash Flows From Financing Activities:
Net increase (decrease) in short-term borrowings — (4,233) —
Proceeds from long-term borrowings 367,842 — —
Distribution to noncontrolling interest (215) (362) (275)
Purchase of noncontrolling interest (8,000) — —
Capitalized issuance costs, net — (163) —
Proceeds from issuance of common stock, net 2,055 8,742 1,800
Supplemental Disclosures of Cash Flow Information:
Transfer of loans and bank premises to other real estate owned 2,608 1,025 607
Acquisitions:
Common stock issued in acquisitions — 79,797 —
* Cash and cash equivalents at December 31, 2020 include restricted cash of $1.9 million pledged as collateral on interest rate swaps and no reserve balance was required with the Federal Reserve. At December 31, 2019 cash and cash equivalents included restricted cash of $1.3 million pledged as collateral on interest rate swaps and $6.0 million for the reserve balance required with the Federal Reserve, while at December 31, 2018, cash and cash equivalents included $6.3 million for the reserve balance required with the Federal Reserve and no cash was pledged as collateral on interest rate swaps.
See accompanying Notes to Consolidated Financial Statements.
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NICOLET BANKSHARES, INC.
Notes to Consolidated Financial Statements
NOTE 1. NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
Nature of Banking Activities and Subsidiaries: Nicolet Bankshares, Inc. (the “Company” or “Nicolet”) was incorporated on April 5, 2000, to serve as the holding company and sole shareholder of Nicolet National Bank (the “Bank”). The Bank opened for business on November 1, 2000. Since its opening in late 2000, Nicolet has supplemented its organic growth with branch purchase and acquisition transactions. See Note 2 for additional information on the Company’s recent acquisitions.
At December 31, 2020, the Company had two wholly owned subsidiaries, the Bank and Nicolet Advisory Services, LLC (“Nicolet Advisory”). At December 31, 2020, the Bank wholly owns an investment subsidiary based in Nevada, a subsidiary in Green Bay that provides a web-based investment management platform for financial advisor trades and related activity, and an entity that owns the building in which Nicolet is headquartered, Nicolet Joint Ventures, LLC (the “JV”). The JV was owned 50% by a real estate development and investment firm (the “Firm”) through the JV until late 2020 when the Bank became the 100% owner and sole managing member of the JV. The Firm is considered a related party, as one of its principals is a Board member and shareholder of the Company. See Note 14 for additional related party disclosures, including details of the 50% interest purchased from the Firm.
Nicolet Advisory is a registered investment advisor subsidiary that provides brokerage and investment advisory services to customers. In late 2020, to improve process efficiencies and organizational structure, the Company dissolved its wholly owned subsidiary, Brookfield Investment Partners, LLC, which provided limited investment services (transactional and strategy) to a few smaller banks, and Nicolet Advisory assumed those additional investment services contracts.
Principles of Consolidation: The consolidated financial statements of the Company include the accounts of its subsidiaries. The JV underlies the noncontrolling interest reflected in the consolidated financial statements until late 2020 when the Bank purchased the remaining interest as discussed in Note 1 above under Nature of Banking Activities and Subsidiaries. The consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”) and conform to general practices within the banking industry. All significant intercompany accounts and transactions have been eliminated in the consolidated financial statements. Results of operations of companies purchased, if any, are included from the date of acquisition.
Operating Segment: The consolidated income of the Company is derived principally from the Bank, which conducts lending (primarily commercial-based loans, as well as residential and consumer loans) and deposit gathering (including other banking- and deposit-related products and services, such as ATMs, safe deposit boxes, check cashing, wires, and debit cards) to businesses, consumers and governmental units principally in its trade area of northeastern and central Wisconsin, and Menominee, Michigan, trust services, brokerage services (delivered through the Bank and Nicolet Advisory), and the support to deliver, fund and manage all such banking and wealth management services to its customer base. The individual contribution from wealth management was not significant to the consolidated balance sheet or net income for 2020, 2019, or 2018. While the chief operating decision makers monitor the revenue streams of the various products and services, and evaluate costs, balance sheet positions and quality, all such products, services and activities are directly or indirectly related to the business of community banking, with no regular, formal or material segment delineations. Operations are managed and financial performance is evaluated on a company-wide basis, and accordingly, all the financial service operations are considered by management to be aggregated in one reportable operating segment.
Use of Estimates: Preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying disclosures. These estimates are based on management’s best knowledge of current events and actions the Company may undertake in the future. Estimates are used in accounting for, among other items, the allowance for credit losses, valuation of loans in acquisition transactions, useful lives for depreciation and amortization, fair value of financial instruments, impairment calculations, valuation of 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 credit losses-loans, determination and assessment of deferred tax assets and liabilities, and the valuation of loans acquired in acquisition transactions; 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 or tax regulations, and changes to deferred tax estimates. Actual results may ultimately differ from estimates, although management does not generally believe such differences would materially affect the consolidated financial statements in any individual reporting period presented.
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NICOLET BANKSHARES, INC.
Notes to Consolidated Financial Statements
Business Combinations: The Company accounts for business combinations under the acquisition method of accounting in accordance with Accounting Standards Codification (“ASC”) 805, Business Combinations (“ASC 805”). The Company recognizes the full fair value of the assets acquired and liabilities assumed and immediately expenses transaction costs. If the amount of consideration exceeds the fair value of assets purchased less the fair value of liabilities assumed, goodwill is recorded. Alternatively, if the amount by which the fair value of assets purchased exceeds the fair value of liabilities assumed and consideration paid, a gain (“bargain purchase gain”) is recorded. Fair values are subject to refinement for up to one year after the closing date of an acquisition as information relative to closing date fair values becomes available. Results of operations of the acquired business are included in the statements of income from the effective date of the acquisition. Additional information regarding recent acquisitions is provided in Note 2.
Cash and Cash Equivalents: For purposes of the consolidated statements of cash flows, cash and cash equivalents include cash and due from banks, interest-earning deposits in other banks with original maturities of less than 90 days, if any, and federal funds sold. The Bank maintains amounts in due from banks which, at times, may exceed federally insured limits. Management monitors these correspondent relationships. The Bank has not experienced any losses in such accounts. The Bank may have restrictions on cash and due from banks as it is required to maintain certain vault cash and reserve balances with the Federal Reserve Bank to meet specific reserve requirements. At December 31, 2020, no reserve balance was required with the Federal Reserve Bank (as the Federal Reserve’s board authorized a reduction to the reserve requirement ratios to 0% effective March 26, 2020 to provide monetary stimulus in response to the economic disruptions resulting from the pandemic), while at December 31, 2019, the required reserve balance was approximately $6.0 million, of which there was sufficient cash to cover the reserve requirement. In addition, cash and cash equivalents includes restricted cash of $1.9 million and $1.3 million pledged as collateral on an interest rate swap at December 31, 2020 and 2019, respectively.
Securities Available for Sale: Securities classified as AFS are those securities that the Company intends to hold for an indefinite period of time, but not necessarily to maturity. Any decision to sell a security classified as AFS would be based on various factors, including significant movements in interest rates, changes in the maturity mix of the Company’s assets and liabilities, liquidity needs, regulatory capital considerations, and other similar factors. Securities classified as AFS are carried at fair value, with unrealized gains or losses, net of related deferred income taxes, reported as increases or decreases in accumulated other comprehensive income. Realized gains or losses on sales of securities AFS (using the specific identification method) are included in the consolidated statements of income under asset gains (losses), net. Premiums and discounts are amortized or accreted into interest income over the estimated life of the related securities using the effective interest method.
Management evaluates securities AFS in unrealized loss positions on a quarterly basis to determine whether the decline in fair value below the amortized cost basis (impairment) is due to credit-related factors or noncredit-related factors. In making this evaluation, management considers the extent to which the fair value has been less than cost, the financial condition and near-term prospects of the issuer, and the intent and ability of the Company to hold the security for a period of time sufficient to allow for any anticipated recovery in fair value. Any impairment that is not credit-related is recognized in other comprehensive income, net of related deferred income taxes. Credit-related impairment is recognized as an allowance for credit losses (“ACL”) on the balance sheet based on the amount by which the amortized cost basis exceeds the fair value, with a corresponding charge to net income. Both the ACL and charge to net income may be reversed if conditions change. However, if the Company intends to sell an impaired AFS security or more likely than not will be required to sell such a security before recovering its amortized cost basis, the entire impairment must be recognized in net income with a corresponding adjustment to the security’s amortized cost basis rather than through the establishment on an ACL. See Note 3 for additional disclosures on AFS securities.