ncbs-20211231
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
☒ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2021
☐TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from............to.............
Commission file number 001-37700
NICOLET BANKSHARES, INC.
(Exact name of registrant as specified in its charter)
111 North Washington Street
Green Bay, Wisconsin54301
(920) 430-1400
(Address, including zip code, and telephone number, including area code, of Registrant’s principal executive offices)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
Title of each class Trading Symbol Name of each exchange on which registered
Common Stock, par value $0.01 per share NCBS The Nasdaq Stock Market LLC
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☐ No☒
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐ No☒
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding12 months (or for such shorter period that the registrant was required to submit such files). Yes☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer ☐ Accelerated filer☒
Non-accelerated filer ☐ Smaller reporting company ☐ Emerging growth company ☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ̈
Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. ☒
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
As of June 30, 2021, (the last business day of the registrant’s most recently completed second fiscal quarter) the aggregate market value of the common stock held by nonaffiliates of the registrant was approximately $613 million based on the closing sale price of $70.34 per share as reported on Nasdaq on June 30, 2021.
As of February 23, 2022 13,589,091 shares of common stock were outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement (the “2022 Proxy Statement”) for the 2022 Annual Meeting of Shareholders to be held on May 9, 2022, are incorporated by reference into Part III of this Annual Report on Form 10-K by reference.
Nicolet Bankshares, Inc.
TABLE OF CONTENTS
PAGE
Forward-Looking Statements 3
PART I
Item 1. Business 4
Item 1A. Risk Factors 12
Item 1B. Unresolved Staff Comments 19
Item 2. Properties 19
Item 3. Legal Proceedings 19
Item 4. Mine Safety Disclosures 20
PART II
Item 6. [Reserved] 21
Item 7A. Quantitative and Qualitative Disclosures about Market Risk 44
Item 8. Financial Statements and Supplementary Data 45
Item 9A. Controls and Procedures 95
Item 9B. Other Information 95
Item 9C. Disclosure Regarding Foreign Jurisdictions that Prevent Inspections 95
PART III
Item 10. Directors, Executive Officers and Corporate Governance 96
Item 11. Executive Compensation 96
Item 14. Principal Accountant Fees and Services 97
PART IV
Item 15. Exhibits, Financial Statement Schedules 98
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Forward-Looking Statements
Statements made in this Annual Report on Form 10-K and in any documents that are incorporated by reference which are not purely historical are forward-looking statements, as defined in the Private Securities Litigation Reform Act of 1995, including any statements regarding descriptions of management’s plans, objectives, or goals for future operations, products or services, and forecasts of its revenues, earnings, or other measures of performance.Forward-looking statements are based on current management expectations and, by their nature, are subject to risks and uncertainties.These statements are neither statements of historical fact nor assurance of future performance and generally may be identified by the use of words such as “believe,” “expect,” “anticipate,” “plan,” “estimate,” “should,” “will,” “intend,” or similar expressions.Forward-looking statements include discussions of strategy, financial projections, guidance and estimates (including their underlying assumptions), statements regarding plans, objectives, expectations or consequences of various transactions or events, and statements about our future performance, operations, products and services, and should be viewed with caution. Shareholders should note that many factors, some of which are discussed elsewhere in this document, could affect the future financial results of Nicolet and could cause those results to differ materially from those implied or anticipated by the statements.Except as required by law, we expressly disclaim any obligations to publicly update any forward-looking statements whether written or oral, that may be made from time to time, whether as a result of new information, future developments or otherwise.Important factors, many of which are beyond Nicolet’s control that could cause our actual results and financial condition to differ materially from those indicated in the forward-looking statements, in addition to those described in detail under Item 1A of this Report, “Risk Factors”, include but are not necessarily limited to the following:
•the COVID-19 pandemic and its continuing effects on our business (including the diversion of management time and resources) as well as the business, customers, employees and third-party service providers of Nicolet or any of its acquisition targets;
•operating, legal and regulatory risks, including the effects of legislative or regulatory developments affecting the financial industry generally or Nicolet specifically;
•economic, market, political and competitive forces affecting Nicolet’s banking and wealth management businesses;
•changes in interest rates, monetary policy and general economic conditions, which may impact Nicolet’s net interest income;
•potential difficulties in identifying and integrating the operations of future acquisition targets with those of Nicolet;
•cybersecurity risks and the vulnerability of our network and online banking portals, and the systems or parties with whom we contract, to unauthorized access, computer viruses, phishing schemes, spam attacks, human error, natural disasters, power loss and other security breaches that could adversely affect our business and financial performance or reputation;
•changes in accounting standards, rules and interpretations and the related impact on Nicolet’s financial statements;
•compliance or operational risks related to new products, services, ventures, or lines of business, if any, that Nicolet may pursue or implement;
•changes in monetary and tax policies;
•changes occurring in business conditions and inflation;
•our ability to attract and retain key personnel;
•examinations by our regulatory authorities, including the possibility that the regulatory authorities may, among other things, require us to increase our allowance for credit losses, write-down assets, or take other actions;
•risks associated with actual or potential information gatherings, investigations or legal proceedings by customers, regulatory agencies or others;
•the potential effects of events beyond our control that may have a destabilizing effect on financial markets and the economy, such as weather events, natural disasters, epidemics and pandemics (including COVID-19), war or terrorist activities, disruptions in our customers’ supply chains, disruptions in transportation, essential utility outages or trade disputes and related tariffs;
•each of the factors and risks under the heading “Risk Factors” in our 2021 Annual Report on Form 10-K and in subsequent filings we make with the SEC; and
•the risk that Nicolet’s analysis of these risks and forces could be incorrect and/or that the strategies developed to address them could be unsuccessful.
These factors should be considered in evaluating the forward-looking statements, and you should not place undue reliance on such statements.
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PART I
ITEM 1. BUSINESS
General
Nicolet Bankshares, Inc. (individually referred to herein as the “Parent Company” and together with all its subsidiaries collectively referred to herein as “Nicolet,” the “Company,” “we,” “us” or “our”) is a registered bank holding company under the Bank Holding Company Act of 1956, as amended, and under the bank holding company laws of the State of Wisconsin. At December 31, 2021, Nicolet had total assets of $7.7 billion, loans of $4.6 billion, deposits of $6.5 billion and total stockholders’ equity of $892 million. For the year ended December 31, 2021, Nicolet earned net income of $61 million, or $5.44 per diluted common share.
Nicolet was founded upon five core values (Be Real, Be Responsive, Be Personal, Be Memorable, and Be Entrepreneurial) which are embodied within each of our employees and create a distinct competitive positioning in the markets within which we operate. Our mission is to be the lead community bank within the communities we serve, while our vision is to optimize the long-term return to our customers and communities, employees and shareholders (the “3 Circles”).
The Parent Company is a Wisconsin corporation, originally incorporated on April 5, 2000 as Green Bay Financial Corporation, a Wisconsin corporation, to serve as the holding company for and the sole shareholder of Nicolet National Bank. The Parent Company amended and restated its articles of incorporation and changed its name to Nicolet Bankshares, Inc. on March 14, 2002. It subsequently became the holding company for Nicolet National Bank upon the completion of the bank’s reorganization into a holding company structure on June 6, 2002. Nicolet elected to become a financial holding company in 2008.
Nicolet conducts its primary operations through its wholly owned subsidiary, Nicolet National Bank, a commercial bank which was organized in 2000 as a national bank under the laws of the United States and opened for business, in Green Bay, Wisconsin, on November 1, 2000 (referred to herein as the “Bank”). At December 31, 2021, the Parent Company also wholly owns a registered investment advisory firm, Nicolet Advisory Services, LLC (“Nicolet Advisory”), that provides brokerage and investment advisory services to customers, and Nicolet Insurance Services, LLC (“Nicolet Insurance”), acquired in 2021, was formed to facilitate the delivery of a crop insurance product associated with Nicolet’s agricultural lending. At December 31, 2021, the Bank wholly owns an investment subsidiary based in Nevada, an entity that owns the building in which Nicolet is headquartered, and a subsidiary that provides a web-based investment management platform for financial advisor trades and related activity. Other than the Bank, these subsidiaries are closely related to or incidental to the business of banking and none are individually or collectively significant to Nicolet’s financial position or results as of December 31, 2021.
Nicolet’s profitability is significantly dependent upon net interest income (interest income earned on loans and other interest-earning assets such as investments, net of interest expense on deposits and other borrowed funds), and noninterest income sources (including but not limited to service charges on deposits, trust and brokerage fees, card interchange income, and mortgage income from sales of residential mortgages into the secondary market), offset by the level of the provision for credit losses, noninterest expense (largely employee compensation and overhead expenses tied to processing and operating the Bank’s business), and income taxes.
Since its opening in late 2000, though more prominently since 2013, Nicolet has supplemented its organic growth with branch purchase and acquisition transactions. Merger and acquisition (“M&A”) activity has continued to be a source of strong growth for Nicolet, including the successful completion of nine acquisitions since 2012. For information on recent transactions, see Note 2, “Acquisitions,” of the Notes to Consolidated Financial Statements under Part II, Item 8.
Products and Services Overview
Nicolet’s principal business is banking, consisting of lending and deposit gathering, as well as ancillary banking-related products and services, to businesses and individuals of the communities it serves, and the operational support to deliver, fund and manage such banking products and services. Additionally, trust, brokerage and other investment management services predominantly for individuals and retirement plan services for business customers are offered. Nicolet delivers its products and services principally through 52 bank branch locations, online banking, mobile banking and an interactive website. Nicolet’s call center also services customers.
Nicolet offers a variety of loans, deposits and related services to business customers (especially small and medium-sized businesses and professional concerns), including but not limited to: business checking and other business deposit products and cash management services, international banking services, business loans, lines of credit, commercial real estate financing, construction loans, agricultural real estate or production loans, and letters of credit, as well as retirement plan services. Similarly, Nicolet offers a variety of banking products and services to consumers, including but not limited to: residential mortgage loans and mortgage refinancing, home equity loans and lines of credit, residential construction loans, personal loans, checking, savings and money market accounts, various certificates of deposit and individual retirement accounts, safe deposit boxes, and personal brokerage, trust and fiduciary services. Nicolet also provides online services including commercial, retail and trust online banking, automated bill
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payment, mobile banking deposits and account access, remote deposit capture, and other services such as wire transfers, debit cards, credit cards, pre-paid gift cards, direct deposit, and official bank checks.
Lending is critical to Nicolet’s balance sheet and earnings potential. Nicolet seeks creditworthy borrowers principally within the geographic area of its branch locations. As a community bank with experienced commercial lenders and residential mortgage lenders, our primary lending function is to make loans in the following categories:
•commercial-related loans, consisting of:
◦commercial, industrial, and business loans and lines;
◦owner-occupied commercial real estate (“owner-occupied CRE”);
◦agricultural (“AG”) production and AG real estate;
◦commercial real estate investment loans (“CRE investment”);
◦construction and land development loans;
•residential real estate loans, consisting of:
◦residential first lien mortgages;
◦residential junior lien mortgages;
◦home equity loans and lines of credit;
◦residential construction loans; and
•other loans (mainly consumer in nature).
Lending involves credit risk. Nicolet has and follows extensive loan policies and procedures to standardize processes, meet compliance requirements and prudently manage underwriting, credit and other risks. Credit risk is further controlled and monitored through active asset quality management including the use of lending standards, thorough review of current and potential borrowers through Nicolet’s underwriting process, close relationships with and regular check-ins with borrowers, and active asset quality administration. For further discussion of the loan portfolio composition and credit risk management, see “Management’s Discussion and Analysis of Financial Condition and Results of Operation,” under Part II, Item 7.
Human Capital Resources
At December 31, 2021, Nicolet had 856 full-time equivalent employees and 876 headcount employees. None of our employees are represented by unions.
As noted under “General”, our mission is to be the lead community bank within the communities we serve, while our vision is to optimize the long-term return to our customers and communities, employees and shareholders (the “3 Circles”), guided by our five core values. Meaningful execution on the mission and vision comes from all employees embodying the core values and the 3 Circles in their decision-making and daily actions for their customers and communities.
Attracting and retaining talented team members is key to Nicolet’s ability to execute on its mission and vision; thus, we take a comprehensive approach to support the financial, physical, and emotional well-being of our team members. Our financial well-being includes a company match 401(k) plan, health savings accounts, Employee Stock Purchase Plan, education and adoption assistance programs. The physical well-being of our team members is supported by the Company’s health, dental, vision, life and various other insurance options, as well as a wellness program that helps employees lose weight to lead a healthy and balanced lifestyle. For emotional well-being, we provide paid time off, an employee assistance program, and fitness membership discounts.
We support the communities we serve through our employees’ dedication to giving back and we regularly sponsor local community events so that our employees can better integrate themselves in our communities. We believe that our employees’ well-being and personal and professional development is fostered by our outreach to the communities we serve. We support and encourage our employees’ desire for active community involvement by promoting causes of interest to employees, flexible schedules to support volunteerism, and giving of money to charities, community events or community organizations also served by employee volunteers. This includes Nicolet National Foundation, Inc., a public charity formed near our opening as a way for employees to give back, with 100% of the monies given by employees going directly back into our communities based on recommendations from our employees, and a 100% match of employee giving by the Bank to further support our community giving over time.
Nicolet believes that employee diversity is directly linked to organizational performance and is committed to diversity and inclusion, including women, minorities, age, individuals with disabilities, culture, and life experiences, among others. In support of this, all employees complete annual diversity training, managers complete additional diversity training in management foundation training, and we expect our employees to be active in promoting diversity within the Company and communities we serve. Nicolet also analyzes pay practices to seek to ensure we are fair and equitable among our diverse employee population. Our workforce at year end 2021 was 76% women, 24% men, and 42% of all officer titles were women.
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Market Area and Competition
The Bank is a full-service community bank, providing services ranging from commercial, agricultural, and consumer banking to wealth management and retirement plan services. Nicolet operates in Northeast and Central Wisconsin, Northern Michigan and the upper peninsula of Michigan. Nicolet markets its services to owner-managed companies, the individual owners of these businesses, and other residents of its market area, which at December 31, 2021 is through 52 branches located principally within the geographic area of its branch locations.
The financial services industry is highly competitive. Nicolet competes for loans, deposits and wealth management or financial services in all its principal markets. Nicolet competes directly with other bank and nonbank institutions located within our markets (some that may have an established customer base or name recognition), internet-based banks, out-of-market banks that advertise or otherwise serve its markets, money market and other mutual funds, brokerage houses, mortgage companies, insurance companies or other commercial entities that offer financial services products. Competition involves efforts to retain current or procure new customers, obtain new loans and deposits, increase the scope and type of products or services offered, and offer competitive interest rates paid on deposits or earned on loans, as well as to deliver other aspects of banking competitively. Many of Nicolet’s competitors may enjoy competitive advantages, including greater financial resources, fewer regulatory requirements, broader geographic presence, more accessible branches or more advanced technology to deliver products or services, more favorable pricing alternatives and lower origination or operating costs.
We believe our competitive pricing, personalized service and community engagement enable us to effectively compete in our markets. Nicolet employs seasoned banking and wealth management professionals with experience in its market areas and who are active in their communities. We believe our emphasis on meeting customer needs in a relationship-focused manner, combined with local decision making on extensions of credit, distinguishes Nicolet from its competitors, particularly in the case of large financial institutions. Nicolet believes it further distinguishes itself by providing a range of products and services characteristic of a large financial institution while providing the personalized service and convenience characteristic of a local, community bank.
Supervision and Regulation
We are extensively regulated, supervised and examined under federal and state law. Generally, these laws and regulations are intended to protect our Bank’s depositors, the FDIC’s Deposit Insurance Fund and the broader banking system, and not our shareholders. These laws and regulations cover all aspects of our business, including lending and collection practices, treatment of our customers, safeguarding deposits, customer privacy and information security, capital structure, liquidity, dividends and other capital distributions, and transactions with affiliates. Such laws and regulations directly and indirectly affect key drivers of our profitability, including, for example, capital and liquidity, product offerings, risk management and costs of compliance.
Set forth below is an explanation of the major pieces of legislation and regulation affecting the banking industry and how that legislation and regulation affects Nicolet’s business. The following summary is qualified by reference to the statutory and regulatory provisions discussed. Changes in applicable laws or regulations may have a material effect on the business and prospects of Nicolet or the Bank, and legislative changes and the policies of various regulatory authorities may significantly affect their operations. We cannot predict the effect that fiscal or monetary policies, or new federal or state legislation or regulation may have on the future business and earnings of Nicolet or the Bank.
Regulation of Nicolet
Because Nicolet owns all of the capital stock of the Bank, it is a bank holding company under the federal Bank Holding Company Act of 1956, as amended (the “Bank Holding Company Act”). As a result, Nicolet is primarily subject to the supervision, examination, and reporting requirements of the Bank Holding Company Act and the regulations of the Board of Governors of the Federal Reserve System (the “Federal Reserve”). As a bank holding company located in Wisconsin, the Wisconsin Department of Financial Institutions (the “WDFI”) also regulates and monitors all significant aspects of its operations.
Acquisitions of Banks. The Bank Holding Company Act requires every bank holding company to obtain the prior approval of the Federal Reserve before:
•acquiring direct or indirect ownership or control of any voting shares of any bank if, after the acquisition, the bank holding company will directly or indirectly own or control more than 5% of the bank’s voting shares;
•acquiring all or substantially all of the assets of any bank; or
•merging or consolidating with any other bank holding company.
Additionally, the Bank Holding Company Act provides that the Federal Reserve may not approve any of these transactions if it would result in or tend to create a monopoly, substantially lessen competition, or otherwise function as a restraint of trade, unless the anti-competitive effects of the proposed transaction are clearly outweighed by the public interest in meeting the convenience and needs of the community to be served. The Federal Reserve is also required to consider the financial and managerial resources and future prospects of the bank holding companies and banks involved in the transaction and the convenience and needs of the
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community to be served. The Federal Reserve’s consideration of financial resources generally focuses on capital adequacy, which is discussed below.
On July 9, 2021, President Biden issued an Executive Order on Promoting Competition in the American Economy. Among other initiatives, the Executive Order encouraged the federal banking agencies to review their current merger oversight practices under the Bank Holding Company Act and the Bank Merger Act and adopt a plan for revitalization of such practices. There are many steps that must be taken by the agencies before any formal changes to the framework for evaluating bank mergers can be finalized and the prospects for such action are uncertain at this time; however, the adoption of more expansive or prescriptive standards may have an impact on our acquisition activities.
Change in Control. Two statutes, the Bank Holding Company Act and the Change in Bank Control Act, together with regulations promulgated under them, require some form of regulatory review before any company may acquire “control” of a bank or a bank holding company. Under the Bank Holding Company Act, control is deemed to exist if a company acquires 25% or more of any class of voting securities of a bank holding company; controls the election of a majority of the members of the board of directors; or exercises a controlling influence over the management or policies of a bank or bank holding company. On January 30, 2020, the Federal Reserve issued a final rule (which became effective September 30, 2020) that clarified and codified the Federal Reserve’s standards for determining whether one company has control over another. The final rule established four categories of tiered presumptions of noncontrol that are based on the percentage of voting shares held by the investor (less than 5%, 5-9.9%, 10-14.9% and 15-24.9%) and the presence of other indicia of control. As the percentage of ownership increases, fewer indicia of control are permitted without falling outside of the presumption of noncontrol. These indicia of control include nonvoting equity ownership, director representation, management interlocks, business relationship and restrictive contractual covenants. Under the final rule, investors can hold up to 24.9% of the voting securities and up to 33% of the total equity of a company without necessarily having a controlling influence.
Under the Change in Bank Control Act, a person or company is required to file a notice with the Federal Reserve if it will, as a result of the transaction, own or control 10% or more of any class of voting securities or direct the management or policies of a bank or bank holding company and either if the bank or bank holding company has registered securities or if the acquirer would be the largest holder of that class of voting securities after the acquisition. For a change in control at the holding company level, both the Federal Reserve and the subsidiary bank’s primary federal regulator must approve the change in control; at the bank level, only the bank’s primary federal regulator is involved. Transactions subject to the Bank Holding Company Act are exempt from Change in Bank Control Act requirements.
Permitted Activities. The Bank Holding Company Act has generally prohibited a bank holding company from engaging in activities other than banking or managing or controlling banks or other permissible subsidiaries and from acquiring or retaining direct or indirect control of any company engaged in any activities other than those determined by the Federal Reserve to be closely related to banking or managing or controlling banks as to be a proper incident thereto. Provisions of the Gramm-Leach-Bliley Act have expanded the permissible activities of a bank holding company that qualifies as a financial holding company to engage in activities that are financial in nature or incidental or complementary to financial activities. Those activities include, among other activities, certain insurance, advisory and security activities.
Nicolet meets the qualification standards applicable to financial holding companies, and elected to become a financial holding company in 2008. In order to remain a financial holding company, Nicolet must continue to be considered well managed and well capitalized by the Federal Reserve, and the Bank must continue to be considered well managed and well capitalized by the Office of the Comptroller of the Currency (the “OCC”) and have at least a “satisfactory” rating under the Community Reinvestment Act.
Support of Subsidiary Institutions. Under Federal Reserve policy and the Dodd-Frank Act, Nicolet is expected to act as a source of financial strength for the Bank and to commit resources to support the Bank. This support may be required at times when, without this Federal Reserve policy or the related rules, Nicolet might not be inclined to provide it.
In addition, any capital loans made by Nicolet to the Bank will be repaid only after the Bank’s deposits and various other obligations are repaid in full.
Capital Adequacy. Nicolet is subject to capital requirements applied on a consolidated basis, which are substantially similar to those required of the Bank, which are summarized under “Regulation of the Bank” below.
Dividend Restrictions. Under Federal Reserve policies, bank holding companies may pay cash dividends on common stock only out of income available over the past year if prospective earnings retention is consistent with the organization’s expected future needs and financial condition and if the organization is not in danger of not meeting its minimum regulatory capital requirements. Federal Reserve policy also provides that bank holding companies should not maintain a level of cash dividends that undermines the bank holding company’s ability to serve as a source of strength to its banking subsidiaries. Under Federal Reserve policy, bank holding companies are expected to inform the Federal Reserve reasonably in advance of declaring or paying a dividend that exceeds
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earnings for the period (e.g., quarter) for which the dividend is being paid or that could result in a material adverse change to the organization’s capital structure.
Stock Buybacks and Other Capital Redemptions. Under Federal Reserve policies and regulations, bank holding companies must seek regulatory approval prior to any redemption that would reduce the bank holding company’s consolidated net worth by 10% or more, prior to the redemption of most instruments included in Tier 1 or Tier 2 capital with features permitting redemption at the option of the issuing bank holding company, or prior to the redemption of equity or other capital instruments included in Tier 1 or Tier 2 capital prior to stated maturity, if such redemption could have a material effect on the level or composition of the organization’s capital base. Bank holding companies are also expected to inform the Federal Reserve reasonably in advance of a redemption or repurchase of common stock if such buyback results in a net reduction of the company’s outstanding amount of common stock below the amount outstanding at the beginning of the fiscal quarter.
Regulation of the Bank
Because the Bank is chartered as a national bank, it is primarily subject to the supervision, examination, and reporting requirements of the National Bank Act and the regulations of the OCC. The OCC regularly examines the Bank’s operations and has the authority to approve or disapprove mergers, the establishment of branches and similar corporate actions. The OCC also has the power to prevent the continuance or development of unsafe or unsound banking practices or other violations of law. Because the Bank’s deposits are insured by the FDIC to the maximum extent provided by law, it is also subject to certain FDIC regulations and the FDIC also has examination authority and back-up enforcement power over the Bank. The Bank is also subject to numerous state and federal statutes and regulations that affect Nicolet, its business, activities, and operations.
Branching. National banks are required by the National Bank Act to adhere to branching laws applicable to state banks in the states in which they are located. Under Wisconsin law and the Dodd-Frank Act, and with the prior approval of the OCC, the Bank may open branch offices within or outside of Wisconsin, provided that a state bank chartered by the state in which the branch is to be located would also be permitted to establish a branch. In addition, with prior regulatory approval, the Bank may acquire branches of existing banks located in Wisconsin or other states.
Capital Adequacy. Banks and bank holding companies, as regulated institutions, are required to maintain minimum levels of capital. The Federal Reserve and the OCC have adopted minimum risk-based capital requirements (Tier 1 capital, common equity Tier 1 capital (“CET1”) and total capital) and leverage capital requirements, as well as guidelines that define components of the calculation of capital and the level of risk associated with various types of assets. Financial institutions are expected to maintain a level of capital commensurate with the risk profile assigned to their assets in accordance with the guidelines.
In addition to the minimum risk-based capital and leverage ratios, banking organizations must maintain a “capital conservation buffer” consisting of CET1 in an amount equal to 2.5% of risk-weighted assets in order to avoid restrictions on their ability to make capital distributions and to pay certain discretionary bonus payments to executive officers. In order to avoid those restrictions, the capital conservation buffer effectively increases the minimum well-capitalized CET1 capital, Tier 1 capital, and total capital ratios for U.S. banking organizations to 7.0%, 8.5%, and 10.5%, respectively. Banking organizations with capital levels that fall within the buffer will be required to limit dividends, share repurchases or redemptions (unless replaced within the same calendar quarter by capital instruments of equal or higher quality), and discretionary bonus payments. The following table presents the risk-based and leverage capital requirements applicable to the Bank:
Although capital instruments such as trust preferred securities and cumulative preferred shares are excluded from Tier 1 capital for certain larger banking organizations, Nicolet’s trust preferred securities are grandfathered as Tier 1 capital (provided they do not exceed 25% of Tier 1 capital) so long as Nicolet has less than $15 billion in total assets.
The capital rules require that goodwill and other intangible assets (other than mortgage servicing assets), net of associated deferred tax liabilities (“DTLs”), be deducted from CET1 capital. Additionally, deferred tax assets (“DTAs”) that arise from net operating loss and tax credit carryforwards, net of associated DTLs and valuation allowances, are fully deducted from CET1 capital. However, DTAs arising from temporary differences that could not be realized through net operating loss carrybacks, along with mortgage servicing assets and “significant” (defined as greater than 10% of the issued and outstanding common stock of the unconsolidated
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financial institution) investments in the common stock of unconsolidated “financial institutions” are partially includible in CET1 capital, subject to deductions defined in the rules.
The OCC also considers interest rate risk (arising when the interest rate sensitivity of the Bank’s assets does not match the sensitivity of its liabilities or its off-balance sheet position) in the evaluation of the bank’s capital adequacy. Banks with excessive interest rate risk exposure are required to hold additional amounts of capital against their exposure to losses resulting from that risk. Through the risk-weighting of assets, the regulators also require banks to incorporate market risk components into their risk-based capital. Under these market risk requirements, capital is allocated to support the amount of market risk related to a bank’s lending and trading activities.
The Bank’s capital categories are determined solely for the purpose of applying the “prompt corrective action” rules described below and they are not necessarily an accurate representation of its overall financial condition or prospects for other purposes. Failure to meet capital guidelines could subject a bank or bank holding company to a variety of enforcement remedies, including issuance of a capital directive, the termination of deposit insurance by the FDIC, a prohibition on accepting brokered deposits, and certain other restrictions on its business. See “Prompt Corrective Action” below.
Prompt Corrective Action. The Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”) establishes a system of prompt corrective action to resolve the problems of undercapitalized financial institutions. Under this system, the federal banking regulators have established five capital categories: well-capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized, in which all institutions are placed. The federal banking agencies have also specified by regulation the relevant capital levels for each category.
A “well-capitalized” bank is one that is not required to meet and maintain a specific capital level for any capital measure pursuant to any written agreement, order, capital directive, or prompt corrective action directive, and has a total risk-based capital ratio of at least 10%, a Tier 1 risk-based capital ratio of at least 8%, a CET1 capital ratio of at least 6.5%, and a Tier 1 leverage ratio of at least 5%. Generally, a classification as well-capitalized will place a bank outside of the regulatory zone for purposes of prompt corrective action. However, a well-capitalized bank may be reclassified as “adequately capitalized” based on criteria other than capital, if the federal regulator determines that a bank is in an unsafe or unsound condition, or is engaged in unsafe or unsound practices, which requires certain remedial action.
As of December 31, 2021, the Bank satisfied the requirements of “well-capitalized” under the regulatory framework for prompt corrective action. See Note 17, “Regulatory Capital Requirements,” in the Notes to Consolidated Financial Statements, under Part II, Item 8, for regulatory capital ratios of Nicolet and the Bank.
As a bank’s capital position deteriorates, federal banking regulators are required to take various mandatory supervisory actions and are authorized to take other discretionary actions with respect to institutions in the three undercapitalized categories: undercapitalized, significantly undercapitalized, and critically undercapitalized. The severity of the action depends upon the capital category in which the institution is placed. Generally, subject to a narrow exception, the banking regulator must appoint a receiver or conservator for an institution that is critically undercapitalized.
CECL. The Financial Accounting Standards Board (“FASB”) adopted a new credit loss accounting standard applicable to all banks, savings associations, credit unions, and financial holding companies, regardless of size. This standard became effective for the Bank for our fiscal year beginning on January 1, 2020. The final rule allows for an optional three-year phase in of the day-one adverse effects on a bank’s regulatory capital. This Current Expected Credit Losses (“CECL”) standard requires financial institutions to determine periodic estimates of lifetime expected credit losses on loans, and recognize the expected credit losses as an allowance for credit losses.
The CECL rules changed the prior “incurred losses” method of providing Allowances for Credit Losses (“ACL”), which has required us to increase our allowance, and to greatly increase the data we need to collect and review to determine the appropriate level of the ACL. Under CECL, the allowance for credit losses is an estimate of the expected credit losses on financial assets measured at amortized cost, which is measured using relevant information about past events, including historical credit loss experience on financial assets with similar risk characteristics, current conditions, and reasonable and supportable forecasts that affect the collectability of the remaining cash flows over the contractual term of the financial assets. CECL requires an allowance to be created upon the origination or acquisition of a financial asset measured at amortized cost, which may significantly impact the cost of M&A activity in the future. Any increase in our ACL, or expenses incurred to determine the appropriate level of the ACL, may have a material adverse effect on our financial condition and results of operations. For additional discussion of CECL, see section “Allowance for Credit Losses-Loans” within Note 1 “Nature of Business and Significant Accounting Policies,” of the Notes to Consolidated Financial Statements under Part II, Item 8.
FDIC Insurance Assessments. The Bank’s deposits are insured by the Deposit Insurance Fund of the FDIC up to $250,000, the maximum amount permitted by law. The FDIC uses the Deposit Insurance Fund to protect against the loss of insured deposits if an
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FDIC-insured bank or savings association fails. The Bank is thus subject to FDIC deposit premium assessments. The cost of premium assessments are impacted by, among other things, a bank’s capital category under the prompt corrective action system.
Commercial Real Estate Lending. The federal banking regulators have issued the following guidance to help identify institutions that are potentially exposed to significant commercial real estate lending risk and may warrant greater supervisory scrutiny:
•total reported loans for construction, land development and other land represent 100% or more of the institution’s total capital, or
•total commercial real estate loans represent 300% or more of the institution’s total capital, and the outstanding balance of the institution’s commercial real estate loan portfolio has increased by 50% or more.
At December 31, 2021 the Bank’s commercial real estate lending levels are below the guidance levels noted above.
Enforcement Powers. The Financial Institution Reform Recovery and Enforcement Act (“FIRREA”) expanded and increased civil and criminal penalties available for use by the federal regulatory agencies against depository institutions and certain “institution-affiliated parties.” Institution-affiliated parties primarily include management, employees, and agents of a financial institution, as well as independent contractors and consultants such as attorneys and accountants and others who participate in the conduct of the financial institution’s affairs. These practices can include the failure of an institution to timely file required reports or the filing of false or misleading information or the submission of inaccurate reports. Civil penalties may be over $1.9 million per day for such violations. Criminal penalties for some financial institution crimes have been increased to 20 years.
Community Reinvestment Act. The Community Reinvestment Act (“CRA”) requires that, in connection with examinations of financial institutions within their respective jurisdictions, the federal banking agencies evaluate the record of each financial institution in meeting the credit needs of its local community, including low- and moderate-income neighborhoods. These facts are also considered in evaluating mergers, acquisitions, and applications to open a branch or facility. Failure to adequately meet these criteria could impose additional requirements and limitations on the Bank. Additionally, the Bank must publicly disclose the terms of various Community Reinvestment Act-related agreements. The Bank received an “outstanding” CRA rating in its most recent evaluation.
In December 2019, the OCC and the FDIC issued a notice of proposed rulemaking intended to (i) clarify which activities qualify for CRA credit; (ii) update where activities count for CRA credit; (iii) create a more transparent and objective method for measuring CRA performance; and (iv) provide for more transparent, consistent, and timely CRA-related data collection, recordkeeping, and reporting. However, the Federal Reserve has not joined the proposed rulemaking. In May 2020, the OCC issued its final CRA rule, which was later rescinded in December 2021. On the same day that the OCC announced its plans to rescind the June 2020 rule, the OCC, FDIC, and Federal Reserve announced that they are working together to “strengthen and modernize the rules implementing the CRA.” The effects on the Bank of any potential change to the CRA rules will depend on the final form of any federal rulemaking and cannot be predicted at this time. Management will continue to evaluate any changes to the CRA’s regulations and their impact to the Bank.
Payment of Dividends. Statutory and regulatory limitations apply to the Bank’s payment of dividends to the Parent Company. If, in the opinion of the OCC, the Bank were engaged in or about to engage in an unsafe or unsound practice, the OCC could require that the Bank stop or refrain from engaging in the practice. The federal banking agencies have indicated that paying dividends that deplete a depository institution’s capital base to an inadequate level would be an unsafe and unsound banking practice.
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 (1) the total of the Bank’s net profits for that year, plus (2) the Bank’s retained net profits of the preceding two years. The payment of dividends may also be affected by other factors, such as the requirement to maintain adequate capital above regulatory guidelines or any conditions or restrictions that may be imposed by regulatory authorities.
Transactions with Affiliates and Insiders. The Bank is subject to the provisions of Regulation W promulgated by the Federal Reserve, which implements Sections 23A and 23B of the Federal Reserve Act. Regulation W places limits and conditions on the amount of loans or extensions of credit to, investments in, or certain other transactions with, affiliates and on the amount of advances to third parties collateralized by the securities or obligations of affiliates. Regulation W also prohibits, among other things, an institution from engaging in certain transactions with certain affiliates unless the transactions are on terms substantially the same, or at least as favorable to such institution or its subsidiaries, as those prevailing at the time for comparable transactions with nonaffiliated companies. Federal law also places restrictions on the Bank’s ability to extend credit to its executive officers, directors, principal shareholders and their related interests. These extensions of credit must be made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unrelated third parties; and must not involve more than the normal risk of repayment or present other unfavorable features.
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USA PATRIOT Act. The Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the “USA PATRIOT Act") requires each financial institution to: (i) establish an anti-money laundering program; and (ii) establish due diligence policies, procedures and controls with respect to its private and correspondent banking accounts involving foreign individuals and certain foreign banks. In addition, the USA PATRIOT Act encourages cooperation among financial institutions, regulatory authorities and law enforcement authorities with respect to individuals, entities and organizations engaged in, or reasonably suspected of engaging in, terrorist acts or money laundering activities.
Customer Protection. The Bank is also subject to consumer laws and regulations intended to protect consumers in transactions with depository institutions, as well as other laws or regulations affecting customers of financial institutions generally. While the list set forth herein is not exhaustive, these laws and regulations include the Truth in Lending Act, the Truth in Savings Act, the Electronic Funds Transfer Act, the Expedited Funds Availability Act, the Equal Credit Opportunity Act, the Fair Housing Act, the Real Estate Settlement and Procedures Act, the Fair Credit Reporting Act and the Federal Trade Commission Act, among others. These laws and regulations mandate certain disclosure requirements and regulate the manner in which financial institutions must deal with customers when taking deposits or making loans to such customers.
Financial Privacy and Cybersecurity. Under privacy protection provisions of the Gramm-Leach-Bliley Act of 1999 and related regulations, we are limited in our ability to disclose non-public information about consumers to nonaffiliated third parties. These limitations require disclosure of privacy policies to consumers and, in some circumstances, allow consumers to prevent disclosure of certain personal information to a nonaffiliated third party. Federal banking agencies have adopted guidelines for establishing information security standards and cybersecurity programs for implementing safeguards under the supervision of the board of directors. These guidelines, along with related regulatory materials, increasingly focus on risk management and processes related to information technology and the use of third parties in the provision of financial services.
Consumers must be notified in the event of a data breach under applicable state laws. Multiple states and Congress are considering laws or regulations which could create new individual privacy rights and impose increased obligations on companies handling personal data. For example, on November 18, 2021, the federal financial regulatory agencies published a final rule that will impose upon banking organizations and their service providers new notification requirements for significant cybersecurity incidents. Specifically, the final rule requires banking organizations to notify their primary federal regulator as soon as possible and no later than 36 hours after the discovery of a “computer-security incident” that rises to the level of a “notification incident” within the meaning attributed to those terms by the final rule. Banks’ service providers are required under the final rule to notify any affected bank to or on behalf of which the service provider provides services “as soon as possible” after determining that it has experienced an incident that materially disrupts or degrades, or is reasonably likely to materially disrupt or degrade, covered services provided to such bank for as much as four hours. The final rule will take effect on April 1, 2022 and banks and their service providers must be in compliance with the requirements of the rule by May 1, 2022.
Consumer Financial Protection Bureau. The Dodd-Frank Act centralized responsibility for consumer financial protection including implementing, examining and enforcing compliance with federal consumer financial laws with the Consumer Financial Protection Bureau (the “CFPB”). Depository institutions with less than $10 billion in assets, such as the Bank, are subject to rules promulgated by the CFPB but will continue to be examined and supervised by federal banking regulators for consumer compliance purposes.
UDAP and UDAAP. Bank regulatory agencies have increasingly used a general consumer protection statute to address “unethical” or otherwise “bad” business practices that may not necessarily fall directly under the purview of a specific banking or consumer finance law. The law of choice for enforcement against such business practices has been Section 5 of the Federal Trade Commission Act—the primary federal law that prohibits “unfair or deceptive acts or practices” and unfair methods of competition in or affecting commerce (“UDAP” or “FTC Act”). “Unjustified consumer injury” is the principal focus of the FTC Act. Prior to the Dodd-Frank Act, there was little formal guidance to provide insight to the parameters for compliance with the UDAP law. However, the UDAP provisions have been expanded under the Dodd-Frank Act to apply to “unfair, deceptive or abusive acts or practices” (“UDAAP”). The CFPB has brought a variety of enforcement actions for violations of UDAAP provisions and CFPB guidance continues to evolve.
Available Information
Nicolet’s internet address is www.nicoletbank.com. We file or furnish to the SEC annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports, proxy statements and annual reports to shareholders and, from time to time, registration statements and other documents. These documents are available free of charge to the public on or through the “Investor Relations” section of our website as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. These filings are available to the public on the Internet at the SEC’s website at www.sec.gov. The information on any website referenced in this Report is not incorporated by reference into, and is not a part of this Report. Further, our references to website URLs are intended to be inactive textual references only.
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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.
Growth and Strategic Risks
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.
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.
Future acquisitions may be delayed, impeded, or prohibited due to regulatory issues.
Our future acquisitions, particularly those of financial institutions, are subject to approval by a variety of federal and state regulatory agencies. Regulatory approvals could be delayed, impeded, restrictively conditioned or denied due to existing or new regulatory issues we have, or may have, with regulatory agencies, including, without limitation, issues related to anti-money laundering/Bank Secrecy Act compliance, fair lending laws, fair housing laws, consumer protection laws, unfair, deceptive, or abusive acts or practices regulations, Community Reinvestment Act issues, and other similar laws and regulations. We may fail to pursue, evaluate or complete strategic and competitively significant acquisition opportunities as a result of our inability, or perceived or anticipated inability, to obtain regulatory approvals in a timely manner, under reasonable conditions or at all. Difficulties associated with potential acquisitions that may result from these factors could have a material adverse effect on our business, and, in turn, our financial condition and results of operations.
Moreover, in July 2021, President Biden issued an Executive Order on Promoting Competition in the American Economy which encouraged the federal banking agencies to review their current merger oversight practices. The Executive Order has received significant public support from members of Congress as well as a majority of the board members of the FDIC. In addition, the Director of the CFPB has publicly sought a greater role for the CFPB in the evaluation of proposed bank mergers. Any enhanced
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regulatory scrutiny of bank mergers and acquisitions and revision of the framework for merger application review may adversely affect the marketplace for such transactions, could result in our acquisitions in future periods being delayed, impeded or restricted in certain respects and result in new rules that possibly limit the size of financial institutions we may be able to acquire in the future and alter the terms for such transactions.
COVID-19 and Economic-Related Risks
The ongoing COVID-19 pandemic could have an adverse impact on our financial performance and results of operations.
As the COVID-19 pandemic has evolved from its emergence in early 2020, so has its impact. Many states have re-instituted, or strongly encouraged, varying levels of quarantines and restrictions on travel and in some cases have at times limited operations of certain businesses and taken other restrictive measures designed to help slow the spread of COVID-19 and its variants. Governments and businesses have also instituted vaccine mandates and testing requirements for employees. While vaccine availability and uptake has increased, the longer-term macro-economic effects on global supply chains, inflation, labor shortages and wage increases continue to impact many industries, including the collateral underlying certain of our loans. Moreover, with the potential for new strains of COVID-19 to emerge, governments and businesses may re-impose aggressive measures to help slow its spread in the future. For this reason, among others, as the COVID-19 pandemic continues, the potential impacts are uncertain and difficult to assess.
Although financial markets have largely rebounded from the significant declines that occurred earlier in the pandemic and global economic conditions showed signs of improvement during the second half of 2020 and throughout 2021, many of the circumstances that arose or became more pronounced after the onset of the COVID-19 pandemic persist, which may subject us to any of the following risks:
•lower loan demand and an increased risk of loan delinquencies, defaults, and foreclosures due a number of factors, including continuing supply chain issues, decreased consumer and business confidence and economic activity;
•collateral for loans, especially real estate, may decline in value, which may reduce our ability to liquidate such collateral and could cause loan losses to increase and impair our ability over the long run to maintain our targeted loan origination volume;
•volatility in financial and capital markets, interest rates, and exchange rates;
•a significant decline in the market value of our common stock, which may result in us recording a goodwill impairment charge, which could adversely affect our results of operations;
•increased demands on capital and liquidity;
•a reduction in the value of the assets that we manage or otherwise administer or service for others, affecting related fee income and demand for our services;
•heightened cybersecurity, information security, and operational risks as cybercriminals attempt to profit from the disruption resulting from the pandemic given increased online and remote activity;
•disruptions to business operations experienced by counterparties and service providers;
•increased risk of business disruption from the loss of employees due to their inability to work effectively because of illness, quarantines, government actions, or other effects of the COVID-19 pandemic (including the increase in employee resignations currently taking place throughout the United States in connection with the COVID-19 pandemic, which is commonly referred to as the “great resignation”); and
•decreased demands for our products and services.
We have also experienced and may experience other negative impacts to our business as a result of the pandemic that could exacerbate other risks discussed in this “Risk Factors” section. The ongoing fluidity of this situation precludes any prediction as to the ultimate adverse impact of COVID-19 on economic and market conditions, and, as a result, presents material uncertainty and risk with respect to us.
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 loans and the establishment of credit losses is an estimate based on experience, judgment and expectations regarding borrowers and
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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, hospitality, 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, this may result in deterioration in the credit quality of our borrowers and the demand for our products and services, an increase in the number of loan delinquencies, defaults and charge-offs, foreclosures, additional provision for credit losses, adverse asset values of the collateral securing our loans, and an overall material adverse effect on the quality of our loan portfolio, and a reduction in assets under management or administration. These negative effects may cause us to incur losses and may adversely affect our capital, liquidity and financial condition.
Credit and Interest Rate Risks
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. Determining the appropriate level of the allowance involves a high degree of subjectivity and requires management to make significant estimates using quantitative and qualitative information about our loan portfolio, including 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, 2021, approximately 39% of our loans were secured by commercial-based real estate, 9% of loans were secured by agriculture-based real estate, and 19% 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 a downturn in the real estate market, in our markets could adversely affect the value of our assets, results of operations, and financial condition.
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
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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 will be required to transition from the use of the LIBOR interest rate index in the future.
We have certain loans, investment securities, subordinated notes, and junior subordinated debentures indexed to LIBOR to calculate the interest rate. The continued availability of the LIBOR index is not guaranteed as the administrators of LIBOR have announced that the publication of the most commonly used LIBOR settings will cease to be published after June 2023. 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). There also remains uncertainty in the LIBOR transition as new index rates and payments will differ from LIBOR, which may lead to increased volatility as well as potential changes in risk, pricing or valuation models.
The language in our LIBOR-based contracts has developed over time, as such, the timing and manner in which each contract transitions to a new index will vary on a case-by-case basis. As of December 31, 2021, we are no longer originating new LIBOR-based loan contracts, and the majority of our existing LIBOR-based loan contracts are line of credit agreements with an annual renewal. These contracts are expected to transition to 1-month term SOFR or another index at the next annual renewal date. In addition, we have sufficient fallback language in our remaining LIBOR-based loan contracts with maturities that extend past the June 2023 LIBOR cease date. With respect to our investment securities, subordinated notes, and junior subordinated debentures, we expect similar transition resolutions.
Legal, Regulatory and Compliance Risks
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.
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.
We face a risk of noncompliance with the Bank Secrecy Act and other anti-money laundering statutes and regulations and corresponding enforcement proceedings.
The federal Bank Secrecy Act, the PATRIOT Act, and other laws and regulations require financial institutions, among our other duties, to institute and maintain effective anti-money laundering programs and to file suspicious activity and currency transaction reports as appropriate. The federal Financial Crimes Enforcement Network, established by the U.S. Treasury Department to administer the Bank Secrecy Act, is authorized to impose significant civil money penalties for violations of those requirements and has recently engaged in coordinated enforcement efforts with the individual federal banking regulators, as well as the U.S. Department of Justice, Drug Enforcement Administration and Internal Revenue Service. There is also increased scrutiny of
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compliance with the rules enforced by the Office of Foreign Assets Control. Federal and state bank regulators also focus on compliance with Bank Secrecy Act and anti-money laundering regulations. If our policies, procedures and systems are deemed deficient or the policies, procedures and systems of the financial institutions that we have already acquired or may acquire in the future are deficient, we would be subject to liability, including fines and regulatory actions such as restrictions on our ability to pay dividends and the necessity to obtain regulatory approvals to proceed with certain aspects of our business plan, including our acquisition plans, which would negatively impact our business, financial condition and results of operations. Failure to maintain and implement adequate programs to combat money laundering and terrorist financing could also have serious reputational consequences for us.
We are subject to federal and state fair lending laws, and failure to comply with these laws could lead to material penalties.
Federal and state fair lending laws and regulations, such as the Equal Credit Opportunity Act and the Fair Housing Act, impose nondiscriminatory lending requirements on financial institutions. The Department of Justice, the CFPB and other federal and state agencies are responsible for enforcing these laws and regulations. Private parties may also have the ability to challenge an institution’s performance under fair lending laws in private class action litigation. A successful challenge to our performance under the fair lending laws and regulations could adversely impact our rating under the Community Reinvestment Act and result in a wide variety of sanctions, including the required payment of damages and civil money penalties, injunctive relief, imposition of restrictions on merger and acquisition activity and restrictions on expansion activity, which could negatively impact our reputation, business, financial condition, and results of operations.
We face risks related to the adoption of future legislation and potential changes in federal regulatory agency leadership, policies, and priorities.
With a new Congress taking office in 2021, Democrats have retained control of the U.S. House of Representatives, and have gained control of the U.S. Senate, albeit with a majority found only in the tie-breaking vote of Vice President Harris. However slim the majorities, though, the net result was a unified Democratic control of the White House and both chambers of Congress, and consequently Democrats are able to set the agenda both legislatively, in the Administration, and in the regulatory agencies that have rulemaking and supervisory authority over the financial services industry generally and the Company and the Bank specifically. Congressional committees with jurisdiction over the banking sector have pursued oversight and legislative initiatives in a variety of areas, including addressing climate-related risks, promoting diversity and equality within the banking industry and addressing other Environmental, Social, and Governance matters, improving competition in the banking sector and enhancing oversight of bank mergers and acquisitions, establishing a regulatory framework for digital assets and markets, and oversight of the COVID-19 pandemic response and economic recovery. The prospects for the enactment of major banking reform legislation are unclear at this time.
Moreover, the turnover of the presidential administration resulted in certain changes in the leadership and senior staffs of the federal banking agencies, the CFPB, CFTC, SEC, and the Treasury Department, with certain significant leadership positions yet to be filled, including the Comptroller of the Currency, the Chair of the FDIC and three vacancies among the Governors of the Federal Reserve Board, including the Vice Chair for Supervision. These changes have impacted the rulemaking, supervision, examination and enforcement priorities and policies of the agencies and likely will continue to do so over the next several years. The potential impact of any changes in agency personnel, policies and priorities on the financial services sector, including the Company and the Bank, cannot be predicted at this time. Regulations and laws may be modified at any time, and new legislation may be enacted that will affect us. Any future changes in federal and state laws and regulations, as well as the interpretation and implementation of such laws and regulations, could affect us in substantial and unpredictable ways, including those listed above or other ways that could have a material adverse effect on our business, financial condition or results of operations.
From time to time we are, or may become, involved in suits, legal proceedings, information-gatherings, investigations and proceedings by governmental and self-regulatory agencies that may lead to adverse consequences.
Many aspects of the banking business involve a substantial risk of legal liability. From time to time, we are, or may become, the subject of information-gathering requests, reviews, investigations and proceedings, and other forms of regulatory inquiry, including by bank regulatory agencies, self-regulatory agencies, the SEC and law enforcement authorities. The results of such proceedings could lead to significant civil or criminal penalties, including monetary penalties, damages, adverse judgements, settlements, fines, injunctions, restrictions on the way we conduct our business or reputational harm.
Operational Risks
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
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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.
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
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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;
•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 13% of our fully diluted issued and outstanding common stock as of December 31, 2021. As a result of their ownership, our directors and executive officers have the ability, if they
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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, 2021, we had outstanding trust preferred securities and associated junior subordinated debentures with an aggregate par principal amount of approximately $49.8 million and $48.0 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.
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 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 2021, including the main office, the Bank operated 52 bank branch locations, 40 of which are owned and 12 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 15, “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
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material adverse effect on our results of operations or financial position. For additional disclosure, see Note 14, “Commitments and Contingencies,” of the Notes to Consolidated Financial Statements under Part II, Item 8.
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
Stock. Nicolet’s common stock trades on the Nasdaq Capital Market under the symbol “NCBS”. As of February 22, 2022, Nicolet had approximately 3,800 shareholders of record.
Dividends. Nicolet has not paid dividends on its common stock since its inception in 2000. The payment of dividends is a decision of our Board based upon then-existing circumstances, including our rate of growth, profitability, financial condition, existing and anticipated capital requirements, the amount of funds legally available for the payment of cash dividends, regulatory constraints and such other factors as the Board determines relevant. For the foreseeable future, we do not intend to declare cash dividends, as we intend to retain earnings to grow our business and strengthen our capital base, while returning value to our shareholders by continuing to repurchase shares from time to time. 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 further described in “Business—Regulation of the Bank—Payment of Dividends” and in Note 17, “Regulatory Capital Requirements,” in the Notes to Consolidated Financial Statements under Part II, Item 8.
Stock Repurchases. Following are Nicolet’s monthly common stock purchases during the fourth quarter of 2021.
October 1 – October 31, 2021 — $ — —
(a) The board of directors approved a common stock repurchase program which authorized, with subsequent modifications, the use of up to $236 million to repurchase outstanding shares of common stock. This common stock repurchase program has no expiration date. During fourth quarter 2021, Nicolet spent $28 million to repurchase and cancel 345,166 shares. At December 31, 2021, approximately $69 million remained available under this common stock repurchase program, or approximately 804,500 shares of common stock (based on the closing stock price of $85.75 on December 31, 2021).
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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, 2016 to December 31, 2021. The graph assumes the value of the investment in the Company’s common stock and in each index was $100 on December 31, 2016. Historical stock price performance shown on the graph is not necessarily indicative of the future price performance. The following performance graph does not constitute soliciting material and should not be deemed filed or incorporated by reference into any other Company filing under the Securities Act of 1933 or the Securities Exchange Act of 1934, except to the extent that we specifically incorporate the performance graphs by reference therein.
Period Ending
Source: S&P Global Market Intelligence
ITEM 6. [RESERVED]
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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 2021 acquisitions, County Bancorp, Inc. (“County”) and Mackinac Financial Corporation (“Mackinac”). Certain income statement results, average balances and related ratios for 2021 include partial contributions from County and Mackinac, each from the respective acquisition date. Additional information on Nicolet’s recent acquisition activity is included in Note 2, “Acquisitions” in the Notes to Consolidated Financial Statements, under Part II, Item 8.
The detailed financial discussion that follows focuses on 2021 results compared to 2020. For a discussion of 2020 results compared to 2019, see the information under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2020, filed with the SEC on February 26, 2021, which information under that caption is incorporated herein by reference. Historical results of operations are not necessarily predictive of future results.
Overview
2021 Highlights
In 2021, Nicolet delivered on growth, profitability, capital positioning, and sound asset quality management. On December 3, 2021, Nicolet completed its acquisition of County for a total purchase price of $224 million, including the issuance of 2.4 million shares of common stock valued at $176 million and the remainder in cash consideration. County added total assets of $1.4 billion, loans of $1.0 billion, and deposits of $1.0 billion, at acquisition. On September 3, 2021, Nicolet completed its acquisition of Mackinac for a total purchase price of $229 million, comprised of stock consideration of $180 million, or 2.3 million shares of common stock, and cash consideration of $49 million. At acquisition, Mackinac added total assets of $1.6 billion, loans of $0.9 billion, and deposits of $1.4 billion.
Net income for the year ended December 31, 2021 was $61 million and earnings per diluted common share was $5.44, compared to net income of $60 million and earnings per diluted common share of $5.70 for 2020. Non-core items, and the related tax effect of each, in net income included merger and integration related expenses, Day 2 credit provision expense required under the CECL model, branch optimization costs, and gains on other investments. For the full year, non-core items negatively impacted diluted earnings per common share $1.13 for 2021 and $0.24 for 2020.
At December 31, 2021, Nicolet had total assets of $7.7 billion, an increase of $3.1 billion (69%) over December 31, 2020, largely due to the acquisitions of Mackinac and County. Total loans increased $1.8 billion (66%) and total deposits increased $2.6 billion (65%) from December 31, 2020, also largely due to the acquisitions of Mackinac and County. Total stockholders’ equity was $892 million at December 31, 2021, an increase of $353 million since December 31, 2020, mostly due to the common stock issued in the Mackinac and County acquisitions. For the year ended December 31, 2021, Nicolet repurchased approximately 793,000 shares of common stock for a total cost of $61.5 million, or an average cost of $77.50 per share.
Nonperforming assets were $56 million at December 31, 2021, consisting of $44 million of nonaccrual loans (largely due to nonaccrual agricultural loans acquired with County) and $12 million of other real estate owned (primarily closed bank branch properties yet to be sold), and representing 0.73% of total assets, compared to $13 million or 0.29% at year-end 2020. The allowance for credit losses-loans increased to $50 million (1.07% of loans), mostly due to the Day 2 allowance increase from acquisitions.
Nicolet’s board and management team has several objectives in 2022, with the primary being to ensure the successful cultural integration of the Mackinac and County acquisitions from the prior year. The respective branch and system conversions of both acquisitions were completed with very little disruption to our customers during 2021. However, as with any sizable acquisition, the melding of cultures does not happen immediately, and takes a tremendous amount of effort by our entire employee base. We have worked hard to retain the right people and hire new talent in many of the markets we’ve entered in the past year. As with past acquisitions, we plan to show how our words matter, and will be investing in the new communities we now serve. While new acquisitions take time and resources to fully integrate, we don’t plan to lose sight of our core franchise. We expect to achieve solid organic growth in loans, deposits, wealth management service revenue, and other revenue lines across our footprint. As the U.S. economy continues to emerge from the pandemic of the past two years, there will be several economic policy changes that will impact the banking industry in the coming year and beyond. Nicolet is an asset sensitive bank, and therefore an increase in interest rates is expected to increase our net interest income over time. As interest rates are currently forecasted to increase several times during 2022, we expect our revenues to be positively impacted, although the degree to which remains unknown given several factors
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at play. We believe 2022 will be another year of opportunity, and have positioned the Company to take advantage by maintaining a solid balance sheet funded almost entirely by core deposits, ample liquidity, and prudent capital management. Nicolet enters 2022 as a “well capitalized” financial institution with more than $80 million in cash at its holding company. We expect this cash to be deployed through continued use of our share repurchase program, potential acquisitions, and other strategic long-term investments that will position Nicolet for years to come.
Pandemic Effects, Actions and Updates
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 2020), 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 Paycheck Protection Program (“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. During 2020, we still executed on our acquisition strategy, completing the all-cash acquisition of Advantage.
The dramatic events surrounding the pandemic, fluctuating social and economic changes since the onset of the pandemic, and uncertainty about the longevity of the pandemic’s effects have abated somewhat during 2021 as consumers and businesses were supported by government stimulus and the vaccination rollout. Despite these challenges, Nicolet continues to focus on serving the needs of its communities, including originating 2,205 PPP loans totaling $160 million during 2021, as well as serving our communities through charitable donations, volunteerism, and community events. However, much uncertainty remains from new strains of the virus, ongoing supply chain issues and competitive labor markets, which could result in continued volatility.
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Table 1: Earnings Summary and Selected Financial Data
At and for the years ended December 31,
Results of operations:
Net income attributable to noncontrolling interest — 347 347
Net income attributable to Nicolet Bankshares, Inc. $ 60,652 $ 60,122 $ 54,641
Earnings per common share:
Common shares:
Year-End Balances:
Financial Ratios:
Tangible common equity to tangible assets (1) 7.51 8.31 10.27
Reconciliation of Non-GAAP Financial Measures:
Adjusted net income reconciliation: (2)
Adjustments:
Provision expense related to merger 14,400 — —
Branch closure expense 944 500 —
Adjusted Diluted earnings per common share (Non-GAAP) $ 6.57 $ 5.94 $ 4.93
Tangible assets:
Tangible common equity:
Tangible average common equity:
(1) 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.
(2) The adjusted net income measure and related reconciliation provide information useful to investors in understanding the operating performance and trends of Nicolet and also to aid investors in the comparison of Nicolet’s financial performance to the financial performance of peer banks.
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Non-GAAP Financial Measures
We identify “tangible book value per common share,” “return on average tangible common equity,” “tangible common equity to tangible assets” “adjusted net income,” and “adjusted diluted earnings per common share” as “non-GAAP financial measures.” In accordance with the SEC’s rules, we identify certain financial measures as non-GAAP financial measures if such financial measures exclude or include amounts in the most directly comparable measures calculated and presented in accordance with generally accepted accounting principles (“GAAP”) in effect in the United States in our statements of income, balance sheet or statements of cash flows. Non-GAAP financial measures do not include operating and other statistical measures, ratios or statistical measures calculated using exclusively financial measures calculated in accordance with GAAP.
Management believes that the presentation of these non-GAAP financial measures (a) are important metrics used to analyze and evaluate our financial condition and capital strength and provide important supplemental information that contributes to a proper understanding of our operating performance and trends, (b) enables a more complete understanding of factor and trends affecting our business, and (c) allows investors to compare our financial performance to the financial performance of our peers and to evaluate our performance in a manner similar to management, the financial services industry, bank stock analysts, and bank regulators. Management uses non-GAAP measures as follows: in the preparation of our operating budgets, monthly financial performance reporting, and in our presentation to investors of our performance. However, we acknowledge that these non-GAAP financial measures have a number of limitations. Limitations associated with non-GAAP financial measures include the risk that persons might disagree as to the appropriateness of items comprising these measures and that different companies might calculate these measures differently. These disclosures should not be considered an alternative to our GAAP results. A reconciliation of non-GAAP financial measures to the most directly comparable GAAP financial measures is presented in the table above.
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 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 2: 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
(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 3: Volume/Rate Variance - Tax-Equivalent Basis
Volume Rate Net (1) Volume Rate Net (1)
Interest-earning assets
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.
Comparison of 2021 versus 2020
Short-term interest rates have remained steady since March 2020, while the yield curve has begun to steepen since year end 2020. The succeeding quarters felt the pressure of a low interest rate environment and bloated cash balances from government stimulus, both in the form of stimulus checks to individuals and PPP loans for businesses. The continued elevation of low interest-earning asset balances have further decreased margins along with the normal pressures of a near-zero rate environment. Though margins remain depressed, interest income dollars continue to rise on favorable asset volumes and proactive expense reduction measures. The following paragraphs will discuss the comparison of 2021 and 2020, with the pandemic impacts appearing second quarter 2020 and the economy beginning to rebound in the first part of 2021. Though improving, we see continued margin pressure and pricing impacts on loans and deposits.
Tax-equivalent net interest income was $159 million for 2021, comprised of net interest income of $158 million ($29 million or 22% higher than 2020) and a $1 million tax-equivalent adjustment. The increase in tax-equivalent net interest income was comprised of $22 million higher interest income and $6 million lower interest expense. Higher volumes added $24 million to interest income (mostly from higher loan volumes related to the Mackinac and County acquisitions and organic loan growth, as well as growth in other interest-earning assets), offset partly by a $2 million increase to interest expense on higher interest-bearing liabilities (also mostly from volumes due to the Mackinac and County acquisitions, as well as $100 million of subordinated notes issued in July 2021). Rate changes added $7 million to net interest income, mostly due to $9 million lower interest expense (including $7 million from prudent deposit pricing actions on interest-bearing core deposits).
Average interest-earning assets were $4.7 billion for 2021, $0.9 billion (23%) higher than 2020. Average loans increased $396 million (14%) to $3.2 billion, largely due to the timing of the acquisitions (with Mackinac adding $0.9 billion at acquisition in September 2021 and County adding $1.0 billion at acquisition in December 2021). Investment securities increased $248 million, including growth related to the acquisitions, as well as the strategic re-investment of approximately $0.5 billion excess cash liquidity into U.S. Treasury securities of varying yields and durations during fourth quarter 2021. Other interest-earning assets were up $225
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million, mostly cash, reflecting the continued liquidity of businesses and consumers. As a result, the mix of average interest-earning assets shifted. Other interest-earning assets increased to 17% of total interest-earning assets for 2021 (compared to 15% for 2020) and investment securities increased to represent 16% of total interest-earning assets for 2021 (compared to 13% in 2020), while the percentage of loans decreased to represent 67% of total interest-earning assets for 2021 (compared to 72% in the prior year).
Average interest-bearing liabilities were $3.1 billion for 2021, an increase of $480 million (18%) from 2020, primarily due to the significant increase in deposits from government stimulus activities and deposited PPP loan proceeds, as well as the timing of the acquisitions (Mackinac in September 2021 and County in December 2021). Average core interest-bearing deposits increased $605 million and brokered deposits grew $19 million, while funding decreased $143 million (mostly PPPLF funding). The mix of average interest-bearing liabilities was 87% core deposits, 10% brokered deposits, and 3% other funding for 2021, compared to 80% core deposits, 11% brokered deposits, and 9% other funding in 2020.
The interest rate spread increased 8 bps between the periods, attributable to the low interest rate environment and the changing balance sheet mix. The 2021 interest-earning asset yield decreased 24 bps to 3.66% for 2021, largely due to the lower loans-to-earning asset mix given the higher mix of cash assets (as noted above) combined with continued decline in yield (to 0.36% versus 0.46% in 2020). Loans yielded 4.92% for 2021, up slightly (2 bps) from 2020, mostly from the yield on PPP loans (at 11.78% for 2021), as the yield on all other loans decreased 40 bps (to 4.60%) largely from the lower interest rate environment continuing to impact yields on new, renewed and variable rate loans. Investments yielded 1.77%, 49 bps lower than 2020, attributable to the lower rate environment along with the strategic re-investment of excess cash put into lower yielding U.S. Treasuries, compared to the mix of the balance of the portfolio. The cost of funds declined 32 bps to 0.43% for 2021, mainly due to lower rates on core interest-bearing deposits (down 33 bps to 0.24%), as well as the changing mix of interest-bearing liabilities (as noted above). The contribution from net free funds decreased 9 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 higher average noninterest-bearing demand deposits and stockholders’ equity) between the years. As a result, the net interest margin was 3.37% for 2021, down 1 bps compared to 3.38% for 2020.
Tax-equivalent interest income was $173 million, up $22 million (15%) over 2020. Interest income on loans increased $20 million (15%) over 2020, mostly due to strong volumes from the 2021 acquisitions and organic loan growth. Between the years, interest income on investment securities increased $2 million to $13 million, with $3 million from higher average volumes due to the 2021 acquisitions and strategic re-investment of cash (as noted above), partially offset by $1 million lower rate from declining yields in the low interest rate environment. Interest expense was $14 million for 2021, down $6 million (32%) from 2020. Interest expense on deposits decreased $6 million from 2020 given higher average deposit balances at a lower cost (down 35 bps to 0.34%) as product rate changes were made in the lower interest rate environment, and brokered deposits cost 32 bps less (largely from maturities of higher-costing term brokered funds procured under competitive conditions in mid-2020 during the pandemic). Interest expense on wholesale funding was minimally changed (down 2%), as interest expense on lower average balances (down $143 million, mostly PPPLF) was offset by higher rates (up 175 bps to 3.06%), reflecting the July 2021 subordinated notes issuance ($100 million at 3.125%), debt acquired with County, and the inclusion of the low-costing PPPLF during 2020.
Provision for Credit Losses
The provision for credit losses in 2021 was $14.9 million (comprised of $12.5 million related to the ACL-Loans, and $2.4 million for the ACL on unfunded commitments). The 2021 provision for credit losses was mostly due to the required Day 2 ACL increase from the acquisitions of County and Mackinac. Comparatively, 2020 provision for credit losses was $10.3 million largely due to the unprecedented economic disruptions and uncertainty surrounding the COVID pandemic. Net charge-offs were negligible for both years.
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.”
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Noninterest Income
Table 4: Noninterest Income
(in thousands) Years Ended December 31, Change From Prior Year
N/M means not meaningful.
Comparison of 2021 versus 2020
Noninterest income was $67 million for 2021, an increase of $5 million (8%) over 2020. Excluding net asset gains (losses), noninterest income for 2021 was down $1 million (2%) compared to 2020. Notable contributions to the change in noninterest income were:
•Trust services fee income and brokerage fee income combined were $20 million for 2021, up $4 million (23%) from 2020, consistent with the growth in accounts and 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 $22 million for 2021, down $8 million (26%) between the years, predominantly on slowing mortgage activity from the record levels experienced in 2020. Gains on sales and capitalized gains combined decreased $9 million, commensurate with the lower volume of loans sold into the secondary market, while MSR impairment was down $1 million on slower paydown activity. See also “Off-Balance Sheet Arrangements, Lending-Related Commitments and Contractual Obligations” and Note 6, “Goodwill and Other Intangibles and Servicing Rights” in the Notes to Consolidated Financial Statements, under Part II, Item 8
•Service charges on deposit accounts were up $1 million (19%) to $5 million for 2021, partly due to the waiver of certain fees during 2020 to provide economic relief to our customers at the inception of the pandemic and partly due to the larger deposit base from the 2021 acquisitions.
•Card interchange income grew $2 million (31%) to $9 million in 2021 largely due to higher volume and activity, though 2020 activity was also tempered by cautionary spending of consumers given the economic uncertainty of the pandemic.
•BOLI income decreased $0.3 million (12%) to $2 million for 2021, attributable to BOLI death benefits received in 2020, partly offset by income on higher average balances from the BOLI acquired in recent acquisitions.
•The $4 million net asset gains in 2021 were primarily attributable to favorable fair value marks on equity securities (including $3.5 million related to the initial public offering of an equity investment). Net asset losses in 2020 of $2 million were comprised primarily of $1 million market losses on equity securities held in the lower, more volatile market and $1 million of net losses on branch other real estate owned write-downs. Additional information on the net gains is also included in Note 16, “Asset Gains (Losses), Net,” in the Notes to Consolidated Financial Statements, under Part II, Item 8.
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Noninterest Expense
Table 5: Noninterest Expense
($ in thousands) Years Ended December 31, Change From Prior Year
Comparison of 2021 versus 2020
Noninterest expense was $129 million, an increase of $29 million (28%) over 2020. Personnel costs increased $13 million, while non-personnel expenses combined increased $15 million over 2020. Notable contributions to the change in noninterest expense were:
•Personnel expense (including salaries, overtime, cash and equity incentives, and employee benefit and payroll-related expenses) was $71 million for 2021, an increase of $13 million (24%) over 2020. Salary expense increased $5 million (16%) over 2020, reflecting higher salaries from the larger employee base (with average full-time equivalent employees up 13%) as well as merit increases between the years. Cash, equity and other incentives increased $6 million, reflective of the strong earnings for the year, the successful integration of two acquisitions, and large option grants during the year (intended to align incentives with future strategic goals). Fringe benefits increased $2 million over 2020, mainly on higher health costs between the years.
•Occupancy, equipment and office expense was $21 million for 2021, up $4 million (26%) from 2020, with 2021 including $0.9 million of accelerated depreciation and write-offs related to the branch closures, as well as higher expense for the expanded branch network with the Mackinac and County acquisitions, and additional expense for software and technology to drive operational efficiencies, and enhance products or services. 2020 also included $0.5 million of accelerated depreciation and write-offs related to branch closures.
•Business development and marketing expense was $5 million for 2021, minimally changed from 2020. During 2021, business development costs have increased as travel and entertainment is returning to more normal levels (though still down from pre-pandemic levels), as well as lower marketing costs from differences in the timing and extent of donations, marketing campaigns, promotions, and media. In comparison, business development costs during 2020 were low from less travel and entertainment during the pandemic. In addition, 2020 also included $1.25 million for the micro-grant program (which provided funds directly to customers who otherwise qualified for small PPP loans of less than $5,000, as a more cost beneficial result for the customer).
•Data processing expense was $12 million for 2021, up $1.5 million (14%) over 2020, mostly due to volume-based increases in core processing charges, as well as the larger operating base following the Mackinac and County acquisitions.
•Intangible amortization was down slightly (2%) between the years, with the declining amortization on the aging intangibles of previous acquisitions, substantially offset by amortization from the new intangibles of recent acquisitions.
•FDIC assessments increased to $2 million for 2021 as the small bank assessment credits were fully utilized during third quarter 2020, and also reflecting the higher assessment base.
•Other expense was $9 million for 2021, up $3 million (59%) from 2020, mostly due to an increase in director fees (reflective of the additional complexity of a larger company, including the addition of four new directors), higher professional fees, costs to carry closed bank branches, and overall higher expenses related to the larger operating base. In addition, 2021 included a $2 million contract termination charge, while 2020 included $1 million of lease termination charges related to the branch closures.
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Income Taxes
Income tax expense was $20 million (effective tax rate of 25.2%) for 2021, unchanged from 2020 income tax expense (effective tax rate of 25.3%). 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, 2021 and 2020, 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 income taxes accounting policy is described in Note 1, “Nature of Business and Significant Accounting Policies,” and additional disclosures relative to income taxes are included in Note 13, “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 Northeast and Central Wisconsin, Northern Michigan and the upper peninsula of 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, and the U.S. Department of Agriculture’s Farm Service Agency (“FSA”) 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.
Table 6: Period End Loan Composition
(in thousands) Amount % ofTotal Amount % ofTotal Amount % ofTotal
Total loans were $4.6 billion at December 31, 2021, an increase of $1.8 billion (66%), compared to total loans of $2.8 billion at December 31, 2020. The increase in loans during 2021 was largely due to the acquisitions of Mackinac and County, which added total loans of $0.9 billion and $1.0 billion, respectively, at acquisition, and also shifted the composition of the loan portfolio. In addition, during 2021, under the latest round of the SBA’s program, we originated 2,205 PPP loans totaling $160 million, bearing a 1% contractual rate, and earned a $9 million fee. In comparison, during 2020 we originated 2,725 PPP loans totaling $351 million and earned a $12 million fee. Of the total fees, $15 million was accreted into interest income during 2021 and $6 million was accreted during 2020. At December 31, 2021, the net carrying value of PPP loans was $25 million, or 1% of loans, with the decline in balance due to SBA loan forgiveness.
As noted in Table 6 above, year-end 2021 loans were broadly 80% commercial-based and 20% retail-based compared to 78% commercial-based and 22% retail-based at year-end 2020. Commercial-based loans are considered to have more inherent risk of
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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 23% of the portfolio at year-end 2021.
Owner-occupied CRE loans represented 17% of loans at year-end 2021, down from 19% at year-end 2020. 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 agricultural economy, including market prices for the cost of feed and the price of milk, and/or the underlying value of the farmland. These loans represented 17% of loans at year-end 2021, compared to 4% a year ago, with the increase attributable to the acquisition of County.
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 18% of loans at December 31, 2021, compared to 16% of loans at year-end 2020.
Loans in the construction and land development portfolio represented 5% of total loans at year-end 2021, unchanged from a year ago. 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 19% of total loans at year-end 2021 compared to 21% of total loans at year-end 2020. 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 enhanced over the past several years to further strengthen the controls.
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Table 7: Loan Maturity Distribution
The following table presents the maturity distribution of the loan portfolio at December 31, 2021.
(in thousands) Loan Maturity
Percent by maturity distribution 23 % 48 % 17 % 12 % 100 %
Fixed rate loans:
Floating rate loans:
* The residential construction loans with a loan maturity after 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.
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.”
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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 Estimates – 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 credit deteriorated loans, which management defines as nonaccrual credit relationships over $250,000, collateral dependent loans, purchased credit deteriorated 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. Second, 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, 2021, the ACL-Loans was $50 million (representing 1.07% of period end loans) compared to $32 million at December 31, 2020. The increase in the ACL-Loans was largely due to the acquisitions of Mackinac and County, which combined added $12 million of provision for the Day 2 allowance and $5 million related to purchased credit deteriorated loans. Net charge-offs (0.01% of average loans) remain negligible. 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 —
ACL on PCD loans acquired 5,159 — —
Net charge-offs:
Owner-occupied CRE — (449) (91)
Agricultural (48) — —
CRE investment (2) (190) —
Construction & land development — — —
Residential construction — — (226)
Residential first mortgage (93) 9 14
Residential junior mortgage 4 67 (41)
Ratio of net charge-offs to average loans by loan composition
Commercial & industrial (0.01) % 0.07 % (0.04) %
Owner-occupied CRE — % 0.09 % 0.02 %
Agricultural 0.02 % — % — %
CRE investment — % 0.04 % — %
Construction & land development — % — % — %
Residential construction — % — % 0.57 %
Residential first mortgage 0.02 % — % — %
Residential junior mortgage — % (0.06) % 0.04 %
Total net charge-offs to average loans 0.01 % 0.05 % 0.02 %
The allocation of the ACL-Loans by loan category for each of the past three years is shown in Table 9. The largest portions of the ACL-Loans were allocated to commercial & industrial loans and agricultural loans, representing 25% and 19%, respectively, of the ACL-Loans at December 31, 2021. In comparison, the largest portions of the ACL-Loans were allocated to commercial & industrial loans and owner-occupied CRE, representing 36% and 18%, respectively, of the ACL-Loans at December 31, 2020. This change in allocated ACL-Loans was attributable to the change in loan portfolio composition, mostly related to the agricultural loans acquired with County, as well as changes in outstanding loan balances between the years and risk trends within loan categories.
Table 9: Allocation of the Allowance for Credit Losses - Loans
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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 continues to actively work with customers to monitor credit risk from the ongoing economic disruptions surrounding the pandemic. Since the pandemic started, nearly 1,000 loans were provided temporary payment modifications, and as of December 31, 2021, no loans remain under temporary payment modification structure. 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.